State of the Industry

December 1, 2007 By    

For the past several years, our research for LP Gas Magazine’s annual State of the Industry issue has focused on details … looking at the business models and practices retailers used to manage and operate their businesses. The results were interesting, displaying, for example, the details of the differences between small and large retailers, and the fundamental differences in goals, objectives and practices between owner or investor-owned businesses and customer-owned farm co-op retailers.

This year we took a different approach … stepping back to look at the larger, more strategic issues in the propane retailing business. Although issues headlined in our previous years’ reports – like regulatory compliance and insurance costs – are still present, the issue that seems overwhelmingly front-of-mind for retailers is propane prices – prices paid and prices charged.

What does this mean for the propane retailing business? According to the U.S. Department of Energy’s Energy Information Administration (EIA), it puts propane – as well as heating oil – at distinct price disadvantages against natural gas and electricity. The chart on page 17 shows EIA’s estimates of the cost of residential heating for this winter for these four sources, as well as the percent of increase for each (all national averages).

 Stimated cost of residential heating
Stimated cost of residential heating

As of this report being written, the price of a barrel of crude oil hovers near $100. The direct impact is obvious. The prices of petroleum-derived products are near, at or above record levels – at least without adjusting for inflation. Unfortunately, the factors that drive the price of oil show few signs of abating.

Average price per gallon to consumers
Average price per gallon to consumers

The most fundamental factor is supply and demand. The consumption rates in other parts of the world – especially China – are closing the gap on the United States. The EIA projects that the United States and China together will account for more than half of the world consumption growth in 2007 and 2008.1

On the supply side, global oil inventories have been tight. Production has been limited by Organization of the Petroleum Exporting Countries (OPEC) production decisions and low spare production capacities, lower than expected non-OPEC production growth and, in the United States, limits on new on- and off-shore exploration and production as a result of environmental concerns and regulation.

Who’s the competition?
Who’s the competition?

Magnifying the supply situation, the rate of converting crude into finished product has been hampered by worldwide refining bottle-necks and, in the United States, by unexpected refinery outages and the decades-long lack of new refining capacity.

This foundational supply/demand price driver is compounded by the continuing and uncertain geopolitical risks in the OPEC region, and increasingly in non-OPEC regions and countries such as Venezuela.

Adding another pricing layer is the American dollar in which the world crude oil markets trade. As the dollar falls against other world currencies, the United States pays a relatively higher price for each barrel than other countries.

If all that were not enough, the rapid rise in oil prices has caught the interest of investors who have no direct involvement in physical oil markets — i.e. speculators. While it is uncertain how much effect they have, it is difficult to believe that speculation does not at least add measurably to the volatility of prices.

We’ve seen in our own annual State of the Industry surveys how the retailer’s cost of propane has been passed on to customers for the past five years.

Percent of retailers seeing growth potential
Percent of retailers seeing growth potential

This drain on customers would be disturbing even if it were the only item in their household budget.

But it is not.

When the price of oil shows up at the gas pump, it makes headline news on TV – and leaves holes in the pockets and purses of consumers. This is coupled with unintended consequences of diverting significant portions of U.S. corn production to ethanol fuel, now evidenced in many rising food-product prices on grocery shelves. What’s more, the upcoming election year ensures we will be reminded continually of rising costs of health care coverage.

The combined impact of these costs on household budgets suggests customers may be exploring decisions they’ve never before considered – such as driving less, buying smaller vehicles, changing their eating habits … and perhaps even changing the form of home heating energy they use.

Consumers do have attractive alternatives. While it is somewhat limited by the delivery infrastructure required, the supply of natural gas is growing. With new production from the Gulf of Mexico and the Rocky Mountain region, as well as new pipeline projects coming online this year that will add 2 to 2.5 billion cubic feet to the supply, Tim Evans, an analyst at Citigroup projects, “We could have all-time-record storage by the beginning of February.”2

Although the National Oceanic and Atmospheric Administration forecasts a somewhat colder season than last, and EIA expects natural gas prices to increase 10 percent over last winter, recent natural gas future prices actually have fallen. Whatever happens, the upward pressures on natural gas prices are dramatically less than on propane.

Price. The hot topic.
Price. The hot topic.

This is understandable. In addition to electricity’s price advantage – some would say unfair price advantage – and the growing interest in alternative energy sources, more public and private funds are flowing into research of alternative electric production methodology. MIT, conducting a project currently, suggests it is feasible for deep geothermal – known as enhanced geothermal – to produce electricity in the 3.6¢ to 9.2¢ per kilowatt hour range in the foreseeable future. (Current national average is 10.3¢ per kilowatt hour.)

Small farm supply?
Small farm supply?

And then – from below-ground to above-ground competitive energy development – there are the advanced methods being developed in wind and solar production.

It is a challenging, uncertain and, for many, a stressful time. Many propane retailers told us this is the most intensely competitive environment they have ever faced in their time in the business, often spanning decades.

Meeting the challenges

Obviously, there isn’t a single strategy for meeting the challenges. In general terms, propane retailers face common challenges. But they also face individual challenges based on their size, type of business, location and competitive environment. With that in mind, the following is somewhat a benchmark of the averages nationwide for the basic structures and components of the propane retailing business. Where there are significant differences from the averages based on identifiable factors, we will point them out. Otherwise, you can assume the averages describe – within reasonable differences – the “average propane retailer” and that the observation has changed very little from last year’s SOI survey results.

Average % of retailer sales by source
Average % of retailer sales by source

For the last several years, we have been expecting a “passing of the guard” – the next generation of retailers taking over. That hasn’t shown up in our survey. Very similar for the last five years, the average retailing business has existed for 33.3 years – the average survey respondent personally involved for 22.9 years. Lots of experience.

The type of propane retailing business, too, is a distribution that hasn’t changed by more than a few percentage points.

Business composition of propane retailing
Business composition of propane retailing

However, after an extensive analysis of retailing business types for last year’s State of the Industry, we’ve had a much greater appreciation for importance of differences among them. Comparing the first three retailer types – owner-operator, investor-owned and franchise – with farm co-ops yielded startling differences.

Revelations in numbers

One of these differences is in the question, “Do you consider retail propane sales to be the primary business of your operation?” When responses from all four retailer types are combined, 69.2 percent said, “Yes,” with the remaining 30.8 percent saying, “No.”

Farm co-ops answered much differently though. Only 23.7 percent considered propane retailing their primary business. That is also apparent when considering the percentage of retailers that sell competing energy products. An average of 34.3 percent of all responding retailers reported selling energy sources that compete with propane. But that number is skewed significantly by the 67.8 percent of farm co-ops that sell competing forms of energy.

Other propane-related  products & services offered by propane retailers
Other propane-related products & services offered by propane retailers

Propane retailers operating in geographic areas with few or no farm co-ops may have a stereotypical impression of a farm co-op being a small operation – confined to serving farmers in a relatively confined community. Think again.

This year’s results suggest that retailers, regardless of ownership type, may be getting more of their business from non-propane-related sales and services. This is a comparison of our last three years of surveys:

One might surmise from these figures that retailers are adding non-propane-related products and services to broaden their offerings and reduce the risk of relying solely on propane sales. However, only 8 percent of respondents said they had added new products or services during the last 12 months, and those products or services were almost entirely propane-related.

That would seem to indicate instead that, though not newly added, non-propane-related sales have become a larger portion, on average, of a propane retailers’ business.

Specific to propane-related products and services, the number of retailers offering them has changed little from last year.

An interesting picture emerges when we look at the different products and services based on whether they are “core” to selling propane gas with mass storage, customer tanks, and equipment service, or whether they are ancillary to the direct sale of gas. While 49.1 percent of retailers from all business types report that they display products in showrooms, only 23.7 percent of co-ops have showrooms, offering far fewer of these products. Only when compared with the core products of tanks and equipment service do co-op numbers closely match other retailers.

Retailers reported an average of 2,012 retail propane customers this year. And, to support servicing these customers, on average they had 89,944 gallons of storage, 4.02 bobtails and 2.72 service vehicles. 65.2 percent of their customers were on a “Keep full” basis, 32.5 percent on “Will call” and 2.3 percent on other arrangements.

The average retailer sold 1,308,169 gallons of propane during the last 12 months, generating revenue of $2,548,664. As mentioned earlier, the average price per gallon charged was about 14.7 percent higher than in 2006’s SOI report – a number that may seem low. It should be noted that the increase reflected in this number includes the last heating season when a larger percentage of the year’s gas was sold and, therefore, is heavily weighted by propane prices at the beginning of 2007 – not accurately reflecting the scale of price increases during most of those 12 months.

Also pertaining to retailers’ propane sales, the breakout between their retail and wholesale sales – 94.6 percent vs. 5.4 percent – has remained essentially unchanged over recent years.

Average infrastructure to support retail propane sales
Average infrastructure to support retail propane sales

Propane sales to retail outlets

The smallest retailers (those that sell less than 500,000 gallons per year) report average sales of 11,666 gallons per retail bottle outlet that they service. Herein was a surprise. The number of gallons steadily declines with increase in retailer size – down to 6,250 gallons per customer for the largest retailers (those that sell over 6 million gallons of propane per year).

Why would that be? Though certainly not conclusive, some small retailers may have a lot of eggs in very few baskets.

Competing on Price

Not surprisingly, this retailer operates in New England, competing against pricey fuel oil.

It would seem that the days of “It’s just a temporary price peak” are gone. How does the propane industry meet the challenge of a potentially permanent price disadvantage?

Average infrastructure to support retail propane sales
Average infrastructure to support retail propane sales

There is no other subject in this year’s survey that elicited more intense responses than the issue of price.

There are three major strategies we can glean from these answers. Arbitrarily, we’ve labeled them …

“Long-term success” strategy

This strategy may be best represented by a comment we received from an Arkansas retailer who sells about 1 million gallons of propane per year:

“We’ve gotten away from the approach of doing whatever it takes to get a new customer – which usually meant free tank rent, free installation, etc. We established good, fair prices for tank rent, labor, piping. And we have seen an increase in the number and quality of customers we now have.”

In essence, this strategy prices from the bottom up. The biggest component is the cost of propane. Then the cost-of-doing-business items are added, such as delivery, regulatory compliance, insurance, employee training and administrative elements. On top of that goes a fair, competitive margin – and that’s the price.

Proponents of this strategy believe that this is the only way to ensure long-term survival – for them as a business and for the industry as a whole. Critics of this strategy would argue that no level of service will outweigh price, and that what may appear to be a sustaining price will drive customers away.

It’s all about costs or margins.
It’s all about costs or margins.

“Go with the flow” strategy

This strategy certainly is the simplest of the three. Just look up and down the street and match the prices you see – maybe a little lower, maybe a little higher, depending on how the “wind is blowing.” While the “Long-term success” pricing strategy in some ways ignores competitors’ prices, the “Go with the flow” strategy, by matching the local market price, attempts to make competitors’ prices irrelevant.

This is by far the most commonly used pricing strategy in the industry, based on the answers and comments we received on this year’s survey. Unless retailers believe there is a clear way to differentiate their operations from the competition, pricing must be “what the market will bear.”

“Whatever it takes” strategy

This strategy certainly is the most controversial and emotional. Some of the comments retailers sent use words we can’t repeat here. There are basically four groups that bear the brunt of their anger – rural electric co-ops, farm co-ops, “fly-by-night” retailers and competing retailers with just-plain-bad management.

Expanding territory – a big decision.
Expanding territory – a big decision.

Whether fair or unfair, there are many propane retailers who believe these four groups have a major negative impact on propane retailing … electric co-ops with “unfair” tax advantages, farm co-ops with a different set of goals and objectives, the “new players” who “steal” customers with low, give-away prices and then sully the reputation of the propane business with horrible service, and then management having adopted the “give-away” theory of growing business.

Wal-Mart succeeded with its “Low Everyday Prices” mantra due to its enormous buying power. Consumer product suppliers must sell at prices Wal-Mart dictates. Of course, few propane retailers have such enviable buying power, so how do price-cutting retailers justify low prices?

Retailers who must face off with low-price competitors complain, in particular, of the volatility this creates. Another retailer wrote us about large, multi-location retailers whose business practices, he believes “… drive customers away … with their inept, poorly managed local districts and charging for bad service. (Good for small, family-owned businesses like us, as their customers really appreciate us more once they switch back.)”

Methods of communicating with homebuilders
Methods of communicating with homebuilders

So, the pricing strategies run the gambit … from “Play by the rules, give good service and make a fair return on your investment of time and money” … to “Don’t make much money, but try to make it up on volume later.”

Methods of communicating with customers
Methods of communicating with customers

However, very few retailers are totally satisfied with their pricing strategies. When asked how effective their pricing actions had been, 34.4 percent said, “Very effective.” The remaining 65.6 percent rated their efforts as “Somewhat” or “Not at all effective.” And no one strategy worked for all.

At the same time, different retailers rated “Raised prices” and “Lowered prices” both “Very effective” and “Not at all effective.”

Retailers' promotion  media choices
Retailers’ promotion media choices

The one element that rated either “Somewhat effective” or “Very effective” was pricing contracts with customers – some with fixed prices, some with volume discounts and some with budget payment plans.

Tank pricing fares poorly in effectiveness as part of a business strategy. 76.8 percent rated their efforts as only “Somewhat” or “Not at all effective.” Another issue regarding tanks is the 41.5 percent of retailers who sell tanks. Although a few retailers rated selling tanks or lease-to-own programs as “Somewhat effective,” one retailer cautioned, “Selling propane gas tanks to retail customers will eventually provide propane retailers with all the problems now facing heating oil. Price-shopping consumers [and] lower margins for all!”

Average retail propane sales by customer type
Average retail propane sales by customer type

The market area

Over half – 53.3 percent – of the propane retailers responding to this year’s SOI survey do business in areas that have increasing populations. That situation varies by size of retailer. Less than half – 44.6 percent – of the smallest retailers (less than 500,000 gallons annually) report increasing populations in their territories, while 80 percent of the largest retailers (over 6 million gallons) operate in areas with increasing populations.

About a third of retailers have multi-home communities being developed in their areas that could use propane.

In the average retailer’s territory, 46.8 percent of all residences have access to natural gas, while only 13.2 percent of the retailers’ customers have natural gas service.

As noted earlier, survey respondents cited competition within market areas as a mix of other propane retailers and alternative energy sources. 60.2 percent of retailers indicated the threat of either natural gas or electricity as their strongest competitor.

However, retailers do see potential in their market areas.

Retailer capabilities

Adding capabilities during the last 12 months seems to have been a good decision, with 69.2 percent of retailers who commented on their actions – rating the results as “Very effective,” another 26.89 percent reporting “Somewhat effective.”

A point of excelling
A point of excelling

With the exception of a few retailers who had early implementation problems, the addition of technology was universally rated either “Very” or “Somewhat effective.”

Getting and keeping customers

While it’s obviously a tough market out there, we have seen that retailers believe there is still potential for growth in nearly every segment.

How do they pursue that potential, and – once captured – how do they keep their customers?

The vast majority of retailers believe that the true competitive advantage critical to success in propane retailing is customer service. 63.0 percent rated “Delivery dependability” as the most important competitive advantage, followed by 33.2 percent who chose “Responsive maintenance service.”

Percent of retailers adding infrastructure
Percent of retailers adding infrastructure

How do retailers capitalize on a reputation for providing excellent customer service to get new customers? It begins with communication.

Unfortunately, of those respondents with ad or promo efforts, 84.2 percent rated their advertising and promotion efforts as “Somewhat” or “Not at all effective.” However, several retailers told us their direct mailing programs were the most effective of communication options.

The highest-rated technique for getting new customers was direct, personal contact. Nearly two-thirds of responding retailers have staff dedicated to the sales function.

Those retailers who reported adding staff dedicated to sales uniformly rated the move as “Very effective.” In addition, retailers rated telemarketing – direct phone calls – as “Very effective.”

Percent of retailers adding technology
Percent of retailers adding technology

But the communication doesn’t stop with a formal sales program. 59.9 percent of respondents give their employees customer-relationship training in both face-to-face and telephone settings. One retailer reported excellent results – higher sign-up rates – solely by changing the content of the phone response to inquiries. Another respondent gave delivery drivers more flexibility to make calls – with good results.

How are retailers stepping out beyond consumer prospects to promote propane?

Staff dedicated to sales
Staff dedicated to sales

The data shows that 61.9 percent of savvy retailers made a point of contacting those people and organizations that influence the use of propane in their territories.

Of those retailers who contact homebuilders – the most commonly contacted group of propane-use influencers – retailers noted their methods of reaching out:

Providing dependable delivery and responsive service is the foundation for building a great reputation.

But that reputation can be enhanced into a real competitive advantage by demonstrating a visible interest in customers.

Making propane-influencing contacts
Making propane-influencing contacts

We asked retailers if they made regular contact with customers when not making deliveries or service calls. 46.0 percent of all responding retailers said they make personal contact, and 44.6 percent contact customers by phone.

Of those retailers reporting contact frequency, 76.8 percent provide education and updates about propane and notify customers of special offers and/or promotions. We asked what methods they use:

Finally, in this “e-driven” age, businesses are expected to have Web sites. Among propane retailers responding to this year’s SOI survey, 36.3 percent have Web sites. However, having a Web site and having an effective Web site may not be one and the same. Those with Web sites detailed what their customers could gain from accessing their sites:

Missed opportunity?

It would appear that retailers are missing some opportunities to highlight the competitive advantages of their products and services. This may reflect how retailers perceive the Internet. While all survey respondents who have a Web site categorized it as part of their advertising/promotion efforts, only 2.8 percent of those use e-mail to reach customers and/or prospects. And when asked to rate the effectiveness of their ad/promo efforts, not one retailer even listed or rated their Web site as part of their communications program.

Web site capabilities offered customers
Web site capabilities offered customers

State of the industry

In each year’s State of the Industry survey, we ask retailers about their expectations for the next year – a telling barometer of retailers’ current “state of mind.”

And, every year, well more than half of our respondents expect to have more customers, and slightly less than half expect to have higher profits. This year was no exception. What is particularly informative, however, is the comparison of retailers’ expectations over the past five years of our surveys.

Average frequency of retailers'  customer contact
Average frequency of retailers’ customer contact

Retailers’ current expectations are somewhat more pessimistic than last year – with nearly 10 percent fewer retailers projecting “More customers,” and 11 percent fewer looking for “Higher profits” in the coming 12 months.

Much of the information retailers provided this year might be summed up by one retailer who wrote “… our customers are using less gallons per year due to cost, and higher [efficiency] appliances. So, we have to deliver to more customers with the same amount of equipment and personnel.”

Retailer expectations for the coming year
Retailer expectations for the coming year

Retailers see propane price increases and fluctuations causing competing energy products to become more attractive to consumers. Increasing energy prices overall have encouraged conservation, having an impact on demand. So, it is not surprising that they see a smaller increase in the growth of customers in 2008 than they had projected last year for 2007. And with demands on the retail propane business certainly not shrinking – regulatory compliance, training, insurance, etc. – profit margins are squeezed.

Summing it up
Summing it up

As usual, retailer opinions about the business are “all over the map.” From the optimistic “I am just a start-up company, but I love this industry” … to “I am tired and ready to sell out and retire” resignation … to “I am worried that if propane prices continue to increase, we will be priced out of the energy market” (a legitimate concern) … to “I have always been a small local seller, but we have all intentions of becoming a regional player” spirited rededication.

1 EIA, October 7, 2007

2 ABC News, October 9, 2007

3 U.S. News & World Report, November 5, 2007

2007 LP Gas Magazine’s State of the Industry survey, data compilation and analysis project was conducted by Distinctive Communications Inc.

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