10) The Club: Higher Margins, Happy Customers

Higher margins & sales for gasoline price protection & C-store discounts
Membership Fee: $25 for 6 months    Benefits: 100-gallon price guarantee, discounts on C-store items

Similar to other retail clubs (e.g. big-box retailers) customers pay a membership fee to join your Club. At enrollment, Club members receive a no-risk/no-cost* 100-gallon gasoline price guarantee card valid until the 100 gallons on the card are used up or until the card expires. Members also receive discounts on all or some C-store items.

Price guarantees (or caps) are set by retailers based on targeted fuel margins, market prices & expectations, and other factors at the time the cards are issued, applying the Formulas below. Club members pay the price of gasoline on their card when they use it at a participating location in the state or region where it is designated.

If the station owner is a dealer where the Club member uses his card, the station owner receives the pump price, and the customer pays the card price.  The difference is covered with part of the gains on its offset. Given price caps are established at high margins (e.g. 25 ¢/g) it is highly likely the gains on offsets more than cover the savings realized by Card owners.

While it would be visually appealing, it is not assumed Club members see pump price rollbacks when using their cards. The Club member sees the guarantee price (e.g. $2.94/gal) applied to the gallons in the transaction on his monthly statement.

* No up-front cost.  The member pays the price on the card when the card is used.  Therefore, the card is also no-risk/all-gain.

Formulas
Price Lock = Margin target + Futures + Basis + Rack/Spot diff. + Transp. + Taxes
Price Cap = Price Lock + 10 ¢/g **

** The 10 ¢/g is arbitrary but an important difference between the price cap and price lock.

More information on The Club can be found here and here.  A detailed Example on how the Club works may be made available on request.

8) Roads to Higher Margins: Fuel Cards

The Cadillac Way

A fuel card-based Price Protection Program is a “Cadillac” way to achieve higher fuel margins and sales — and increase customer loyalty. A detailed document on the program may be downloaded here. This post is an overview.

In a fuel card-based program, price lock and price cap fuel cards may be obtained by consumers and used at participating stations in a particular region or state until the fixed-price or capped-price gallons on the fuel card run out or until the expiration date (if any) on the card.  Following are images of what the fuel cards might look like:

  

 

 

 

 

 

 

 

 

 

Specific examples of price lock and price cap cards may be viewed here.

If price lock cards have expiration dates and expire before all the gallons are used, card owners may be reimbursed an expiration value. Price cap cards always have expiration dates, but no expiration value.

Responses to a fuel card-based price protection program survey show strong consumer interest in utilizing fuel cards.  Responses are summarized here.

Next … Storage – the Classic Way

6) The Money Margin

Part 2: Making Money

As discussed in Part 1 (Post #4), fuel gross margin must exceed 10 ¢/g for a retailer to profit on fuel sales. Given that, history shows retailers actually lose money on gasoline sales 25% of the time (see the cumulative frequency line on the chart). Weak and unprofitable margins are likely to continue given increased competition and other market pressures.

Fuel retailers leave themselves at the mercy of the market for fuel margins. They react to the most volatile component of fuel cost (i.e. the rack price), their own sales volumes, and what the competition is doing. Is that any way to run a business? Retailers try to make up for low fuel margins with high margin C-store sales. But that “strategy” just masks the problem; it doesn’t solve it. Is the primary business of gas stations to sell gas or store items? Is the reason most people stop at gas stations to get gas or something in the store?

How can retailers directly solve the problem of low fuel margins; i.e. how do they make money on the money margin? As discussed in Post #1, retailers need to be proactive about their fuel margins. Essentially, that just means retailers need to control their rack prices. The easiest and most effective way to control rack prices is to control futures. Remember from Post #2, futures prices set spot prices that, in turn, set rack prices –

Futures prices à Spot prices à Rack prices

Returning to the equation for fuel gross margin:

FGM = Retail price – Futures – Basis – (Rack/Spot differential) – Transportation – Taxes

If the Futures price is locked or limited, the retailer controls the most volatile and heaviest potential drag on fuel margins. The futures price may be locked with futures contracts or commodity funds (see Post #3); it may be limited with futures or commodity fund call options. On balance, locking the futures price with a commodity fund (UGA for gasoline, UHN for diesel fuel) is the simplest and most economic choice (e.g. 6 shares of UGA is equivalent to 100 gallons of gasoline futures). A commodity fund may be held indefinitely (like a stock) without the need for “rolling” the position like a futures contract. The fuel retailer may then easily hold the commodity fund until an advantageous time to sell. (More on that “advantageous time” in Post #9.)

The Basis is an important component but less volatile and less of a potential drag on fuel margins. For example, since 2005, the Basis for U.S. gasoline has averaged 4.1 ¢/g with a standard deviation of 8.2 ¢/g. Over the same period, gasoline futures have averaged 195.2 ¢/g with a standard deviation of 56.3 ¢/g.

The Rack/Spot differential is a relatively stable and predictable 1 to 3 ¢/g. It reflects the cost of moving product from spot locations to rack locations, plus the cost of operating a rack.

Transportation is the cost of trucking product from a rack to a retail station. It is also stable and predictable and averages 2 ¢/g.

Lastly, Taxes are a combination of federal and state taxes and are stable enough (though too high!). Taxes by state and product are shown here http://www.api.org/statistics/fueltaxes/.

What’s the bottom line? Control futures and you control the money margin. Control the money margin and you make money selling fuel – consistently and predictably. Even better, control futures and you may increase sales and customer loyalty, and achieve other benefits. That’s called a Fuel Price Protection Program.

Next …
The Roads to Higher Margins: Fuel Card or Storage

4) The Money Margin (Fuel Gross Margin)

Part 1: Where’s the Money?

Fuel gross margin or FGM is the money margin for fuel retailers. It is the common measure of fuel sales profitability. FGM minus net operating cost (NOC) equals a station’s net fuel profit margin. Given that most retail stations have an NOC of 10 ¢/g or more, FGM must exceed 10 ¢/g for a station to profit by selling gasoline or diesel fuel.

The equation for fuel gross margin is:

Fuel Gross Margin (FGM) = Retail price – Delivered Cost – Taxes

Delivered Cost = Rack price + Transportation

Rack price = Spot Price + Rack/Spot differential

Spot Price = Futures price + Spot/Futures differential

(The Spot/Futures differential is referred to as the Basis.)

Bringing all the components together:

FGM = Retail price – Futures – Basis – (Rack/Spot differential) – Transportation – Taxes

Fuel retailers control their retail price, though the retail price is affected by factors outside the retailer’s control (competitor prices, fuel sales volumes, convenience store sales and traffic). Fuel retailers have no control over the other components of FGM – futures, basis, rack/spot differential, transportation costs, and taxes. Retailers are at the mercy of the market for those other components. So, in effect, retailers have very little control over their FGMs and, therefore, little control over their net fuel profit margin.

Given the significant volatility in futures prices, some degree of volatility in basis, and little (but some) volatility in the rack/spot differential, transportation, and taxes, it is not surprising that data over the last five years show a wide range in FGMs. This wide range is exhibited in the following histograms (frequency distributions) based on U.S. average data and is representative of areas across the country.

 

As indicated on the charts, the 5-year average FGM for regular gasoline is 18.4 ¢/g (median 16.7 ¢/g) and the 5-year average FGM for diesel fuel is 22.5 ¢/g (median 20.2 ¢/g). In 2009, the average FGM for regular gasoline decreased to 14.9 ¢/g.

California shows a similar pattern:

With NOCs of 10 ¢/g or higher, the net profit margin in 2009 on regular gasoline in the U.S. is less than 5 ¢/g, and less than 4 ¢/g in California.

Will average FGMs improve on their own? Not likely, given increased competition in retail fuel marketing from big-box retailers and grocery stores, whose primary objective is profitable store sales – not profitable fuel sales. Add a weak economy and political pressures to keep retail prices down and you have a recipe for FGMs averaging 12 to 17 ¢/g for the foreseeable future.

So what’s a fuel retailer to do? Most have decided to make the best of their C-store sales and hope for the best with FGMs. Will C-store sales make up for low margin fuel sales? For some, yes. For others … that’s a big gamble and, as the casinos in Las Vegas can attest, few gamblers win.

Well informed and creative fuel retailers will also make the best of their C-store sales, but they will go on offense to improve their fuel sales profitability. Going on offense entails understanding and utilizing currently available tools to manage futures prices and basis, and thereby actually set forward FGMs – not just hope the competition disappears or the market magically gets better.

Which type of retailer are you?  Do you want to just hope the market takes care of your business, or do you want to take care of your business?

Next …
Part 2: Making Money

1) Higher Margins & Sales (and Happy Customers)

Achieving all three – regardless of the number of retail sites

Retail gasoline and diesel fuel margins are volatile, unreliable, and sometimes unprofitable.  All fuel retailers know that, but most are unaware (or unwilling) to take advantage of opportunities in the wholesale markets to improve fuel margins.  They focus instead on increasing sales of profitable merchandise from C-stores; i.e. they take a “Costco-lite” approach to their fuel margin challenge.
 
Why are fuel margins so tight?  Competition, of course, but equally (or maybe, more) important is the fact that fuel retailers react to the market (rack and delivered prices, competitor prices, existing sales volumes) when setting pump prices.  In such a reactive mode, fuel margins are a hope-for-the-best proposition.  Fuel retailers are at continual risk of fuel sales being marginally profitable, and sometimes unprofitable.  (Statistics show gasoline fuel gross margins are below net operating costs roughly 25% of the time).

What to do about fuel margins?  Raise pump prices?  No, that drives sales down and customers away.  Focus on merchandise and food sales?  Ok, but that masks the problem and forces C-store owners onto big-box retailers’ and grocery store chains’ turf.  Hope you outlast the competition and then raise pump prices?  Everyone else is doing that, and how long is that going to take — assuming you make it to the “promised land” of less competition?
In order for fuel retailers to capture higher fuel margins (and achieve other benefits) they must go on offense.  The best defense is a good offense.  Offense against what?  The futures market where gasoline and diesel prices (among other commodity prices) are set.  Evidence is overwhelming — statistical and behavioral — that the futures market sets spot prices which set rack prices that, lastly, set retail prices.  In short, the futures market is the driver.  And it’s going to stay that way.  The good news is tools are available that enable retailers to control their “margin destination” and, at the same time, the “price destination” of their customers.  Friendly tools.  Today.