You will never go broke appealing to people's vanity and insecurity

On January 6, And posted this request:

“I want an investigative report on GNC- there are two good sized stores costing I’m guessing a lot of money in at least 2 square miles of Back Bay, Boston. I never see anyone in those stores. I want to know what they are, really.”

Great question, and one that crosses the minds of millions of Americans every time we walk past one of those horrible stores. The answer is below the jump.

Here’s a bit of history. GNC was founded in 1935 by a Depression-era snake-oil salesman in Pittsburgh. It grew under his family’s control until 2003, when it was bought by the huge private equity firm Apollo. In 2008 it went to a different private equity owner. The company has nearly 3,700 stand-alone stores in the US, and another 2,000 store-within-a-store sites through a partnership with Rite-Aid, making it one of the largest retail chains in the country. It has over 12,000 employees, 5,300 of which are full-time.

Sports nutrition products make up 43% of GNC’s sales, and vitamins/health supplements make up another 40%. GNC is by far the largest retailer in both categories, achieving market dominance of over 75% in some sub-segments.

Great, but why so many stores, many of which seem to be empty? Let’s turn to the economics. In trying to maximize profits, firms would love to know exactly how many of their products consumers will buy so they can match their production perfectly.  But that is not possible.  In deciding how much product to offer, firms must weigh the lost profits of missing a sale against the costs of creating more than can be sold. If my firm makes widgets for $1 and sells them for $100, for a profit of $99/widget, I would rather make 99 too many widgets than lose a single sale. I will overproduce. Conversely, if my company makes widgets for $99 that sell for $100, I would rather lose 99 sales than eat a single unsold unit. I will underproduce.

Retail coffee is a great example of the former. You have NEVER been to a Starbucks that has run out of coffee. Why? Because you pay $3.00 for $0.15 worth of coffee. They would sooner throw out 20 cups than not have one ready to sell to you. Land Rovers are an example of the latter. Yesterday our local dealership had two available, and wasn’t going to receive any more until the 2013 models arrive this summer. Cars cost a lot to manufacture, and margins are razor thin. Land Rover would rather miss a few sales than be left with a single 2012 model on the lot (an “expired” car) when the 2013s come out.

When we look at GNC’s income statement, we see that it had nearly $2 billion in sales in 2010. Interestingly, it had only $500 million of product cost. Its products are incredibly profitable, which makes sense when you stop to think about it. All you are buying is crushed peanut shells (protein power!) and pulverized cow bones (calcium supplements!) which cost nothing. GNC’s top product is the 6 lb container of house-branded GNC Performance AMP Amplified Mass XXX in chocolate, which they sell for $70. I’d be surprised if it cost them any more than $7 in raw materials and packaging. GNC would rather overproduce a lot of this stuff than miss a single sale.

When we talk about overproduction with GNC, we should not think about the actual product expiring (sawdust and cow bones can last for years). What “expires” is an hour of an employee’s time or an hour of rent.

To combine all of the above concepts, because GNC’s product line is wildly profitable on a per-unit basis, the company would much rather have too many stores, with hourly employees sitting idle in them, then to miss a single potential sale. Thus And has her two empty stores in Back Bay, with two indifferent employees texting their friends all afternoon, all in the hopes that one Southy meathead is going to walk through the door and plunk down $43.08 for a 12-pack of BSN Synthia-6 Protein Bars.

Posted on January 26th, 2012 Filed in: Politics/Economics Tags: Ask Sparks, Sparks=Wrong