The Bank of 7-Eleven?


Think 7-Eleven (SE), and what comes to mind are Slurpees, hot dogs, and gasoline. But the outfit that made middle-of-the night needs available wants to expand that perception and is trying to improve the business it pioneered. CEO Jim Keyes says he has lavished funds on training, technology upgrades, and setting up a distribution system for fresh foods like sushi and salads. Offering financial services is another part of Keyes's strategy to make 7-Eleven more appealing.

Take 7-Eleven's prepaid Vcom cards. Developed by retail-transaction-services concern Alliance Data Systems (ADS), Vcom cards will let customers make ATM transactions as well as buy money orders, transfer funds, cash checks, and eventually pay bills. By the end of May, 7-Eleven will outfit 1,000 of its 5,800 U.S. stores with Vcom machines. Now that the U.S. has myriad all-night shopping options, Dallas-based 7-Eleven, which reported net income of $41 million on $10.1 billion in revenues in 2002, is betting big on the service. (Some 73% of 7-Eleven's common stock is owned by IYG Holding, which comprises Ito-Yokado Co. and Seven-Eleven Japan Co.)

Keyes thinks the Vcom cards, which can also be used to buy gas or store merchandise, could take off the way credit-card readers at the gas pump did. "When we did that, a lot of people thought that was crazy," the CEO says. "But customers saw it as more convenient. Both gas and merchandise sales went up." Customers will get freebies and discounts for using the card. And he adds that franchisees, recalling the boost that came from in-store ATMs, are eager to see Vcom become a reality.

Wall Street is taking a wait-and-see attitude toward Vcom. "These systems cost lots of money to install. At some stage, they ought to kick into earnings growth," says Merrill Lynch analyst Mark Husson. He thinks that will happen by yearend, though he fears it could be a challenge to bring franchise operators on board: "Sometimes it's like herding cats." Husson gives 7-Eleven stock, which trades around $8, a hold rating.

BusinessWeek Online reporter Amy Tsao spoke with Keyes on Jan. 29 about Vcom and other improvement efforts. Edited excerpts of their conversation follow:

Q: In 1946, when you opened your first stores, being open 7 a.m. until 11 p.m. was a big deal. That has changed with 24-hour stores of all kinds open everywhere. How do you position yourself in a more crowded market?

A: We've been running between 4% and 5% same-store sales increases for five years. In a good or bad economy, we just keep chugging along. I attribute that to our ability to keep up with changing needs. And that's what we're obsessed with. New products and new services are the opportunities we have to differentiate 7-Eleven. The prepaid card gives another reason to pick 7-Eleven vs. another 24-hour alternative.

Q: What about expansion? Can you grow a business that has 25,000 stores worldwide?

A: We're still growing, but one of the more interesting challenges is to evolve as convenience needs change. We want to go from a seller of traditional convenience products -- soft drinks and Slurpees -- into whatever it is people need. One of those emerging needs is more convenient alternative methods of payment. In the late 1980s, we brought back to the U.S. from our Asian and European operations prepaid telephone cards and began to build that business here. A natural evolution is expanding that concept to a prepaid anything card.

Q: What kind of impact do you expect this to have on the bottom line?

A: In the near term, not much. Longer term, when we have the critical mass, there's the incremental transaction that we get from Vcom as we pick up another 50 to 100 customers per day, which we have the potential to do. Those customers will buy financial services and products from the store, too.

And second, the cost of Vcom is a cheaper transaction for us to manage. Using credit cards to make small purchases has a high cost of service. That's not practical for us or the credit-card company. With the prepaid cards, there would be no interchange fee.

Q: Who do you expect to be the main users of Vcom?

A: You'd be surprised. Our target is those who might carry a credit card but tend to be a cash customer. We have 7 million customers a day in North America, most of whom use cash. A lot of people still don't do direct deposit. That's why, on a Friday afternoon, people are waiting in line to cash their paycheck. From construction workers to office workers, all kinds of people would like the convenience of cashing their paycheck 24 hours a day.

Q: How will Vcom fees work?

A: When someone cashes a check with Vcom, they would pay a fee just like they would at a supermarket. Fees can be from 0.5% to 2%. The same is true with money orders. We sell about $5 billion a year, face value, in money orders, and we charge a fee from $1 to $5 depending on size of money order.

Q: Over the last five years, annual revenues have been growing steadily, but earnings performance has not been as consistent. What has been causing the earnings fluctuation?

A: Some of it is due to higher investment spending over the last several years. In addition, there has been some noise with net income due to some unusual events. Our royalty structure with our largest licensee, Seven-Eleven Japan, changed, and so we had about $30 million to $40 million in adverse effect. It finally cycled through this year. Last year, the adoption of new Financial Accounting Standard Board principles resulted in sizable one-time charges. That explains most of the variation seen in net-income results.

Q: What would it take for investors to get excited about 7-Eleven stock?

A: No one else is really doing what we're doing, so we have no comparisons out there. Ultimately, the proof for the investment community will be continued improvement in operating performance. Our plans have been somewhat unique. [About 10 years ago,] we set out on a long-term path to completely reinvent not only our business, but the way people look at conveniences as an industry.

We said it would be more of a 5- to 10-year horizon before we started to see the advantages of the infrastructure we were building, and we're finally beginning to see the payoff. We now have 85% of North American 7-Eleven stores covered with daily distribution, so we finally can talk to consumers about fresh foods being available.

We've been working on the Vcom system for seven or eight years, and 2002 and 2003 will be the last two years of the heavy investment. By 2004, we would be able to show the investment community the advantages of what we've built.


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