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What is Cannibalization?
Date Added: July 19th, 2004
By Chris Stallman | E-mail
A company I'm invested in recently reported that they're experiencing a lot of cannibalization in their stores? What does this mean and should I be concerned?
Good question, Erik. Cannibalization is a pretty common theme for fast-growing retail companies. The basic concept of cannibalization in finance terms is similar to something you might hear about on the Discovery Channel. In nature, cannibals are people or animals that feed off of their own kind. The same is true in retail, as I'm about to explain.
Cannibalization occurs when a company's store is stealing traffic away from another one of their stores. A way to explain this is let's say an Abercrombie & Fitch opens up 20 miles away from your house. You really like their clothes so you're happy to drive 20 miles to shop there. But then a new Abercrombie & Fitch opens up right by your house so you don't have to drive as far to shop there. The A&F that was 20 miles away has essentially lost a repeat customer (or customers, since there were probably more like you). Therefore the sales in that store will drop and they will have experienced cannibalization--another one of their stores is feeding off of the original store's traffic.
So why would a company put two stores in such a close proximity to each other? Oftentimes, this occurs when a company thinks that the market is large enough to support both stores. They are willing to do a little less in sales in each store as long as their total sales are still above a certain threshold.
Cannibalization also occurs when companies want to push a competitor out of a certain market. Here's an example: let's say you live in an area with a fairly large population. Perhaps you have a Sam's Club and a Costco. Your area might be generating a lot of sales for each of these stores so Costco decides to put two stores in your area and gain 66% of the market. They were originally getting 50% of the total market so building this new store isn't necessarily improving their business but it is hurting their competitor's market share. If Sam's Club can't sustain itself with just 34% of the total market, it may be forced to close up. In that case, Costco would own 100% of the market.
Cannibalization is a lot more common in companies that own most of their own stores as opposed to franchising them. For example, Abercrombie & Fitch is more likely to be a victim of cannibalization than Krispy Kreme because most of Krispy Kreme's stores are franchised. When an investor purchases a franchise, they get a protected franchise area that allows them to have exclusive rights to a given radius. This protects them from having another Krispy Kreme popping up across the street and stealing some of their customers.
The way you can investigate cannibalization is look at trends for the company's comparable-store sales ("comps"). If comps are slowing or declining, it could be a sign that the company is cannibalizing itself. Cannibalization isn't always a bad thing because it sometimes involves strategy. However, it can also be a sign that a company is running out of room to grow so they have to keep putting more and more stores in an already saturated market. I recommend reading the company's conference call transcripts or 10-k's to determine if this cannibalization is a threat to the company's growth prospects. |
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