REI: Helping Consumers Explore the Outdoors
REI has become the largest Outdoor Specialty Retailer, built on an old school cooperative business model.
REI was founded in 1938 when a couple in Seattle had to buy an ice axe from Austria because they did not find a suitable alternative. The Andersons created a cooperative to help others find quality outdoor gear at reasonable prices. REI has grown tremendously in its 77-year history, now with revenues of $2.2B and consistently outperforming the S&P Retail Index in revenue.
While some may argue that the co-op structure is an antiquated business model and a solution for farmers, I believe that it has been core to REI’s success. REI is the largest Outdoor Specialty Retailer by store footprint and revenue. So how did REI with an old-school cooperative model grow to be one of the biggest outdoor gear retailers in the US?
Business Model
REI is an outdoor retail cooperative which offers high quality gear at affordable prices. Anybody can walk into an REI store and purchase products. A lifetime membership costs $20. Members receive 10% back on annual purchases in dividends. In 2015, memberships increased 20% to 5.5M active members.
With retail margins so slim, it is surprising that this business model works. Especially as a brick-and-mortar retail business, REI needs cash flow to re-invest into the business. The Pre-Tax Operating Income for REI was 8.2%, with $181M in Operating Income in 2014. Net dividends was only 4.8% of sales — some dividends were uncollected and some sales are attributed to non-members. The membership fee is also a key source of revenue, $18M in 2014. Given the slim margins and relative high fixed cost structure (i.e., stores), continuing to grow the membership base and revenue is critical.
Operating model
Customer-Centric Positioning and Policies
Core to REI’s operating model is executing a customer-centric system that aligns with its co-operative structure and to position itself as not “out to make a profit”. For example, REI has differentiated itself with especially consumer-friendly policies (e.g. very generous one year return policy and is known to accept just about anything back). Also, in 2015, REI took a dramatic move to not open stores on Black Friday to show consumers that it is not focused on just profits. The movement was called #OptOutside and peaked as the top trending hashtag on Black Friday.
Investing for Growth
Many may assume that a cooperative would not be focused on investing in growth, not at REI. In the last few years, it has grown to 143 stores, fully re-launched the online e-commerce platform, and added new business lines (i.e., the Outdoor School). These investments have allowed REI to scale revenue and memberships, essential to maintaining its business model.
Increasing the Member Base
There is a strong emphasis on membership sales for sales staff in stores – a key performance metric. In a recent Reddit “Ask Me Anything”, the REI CEO was confronted by several REI employees who had been let go because of they did not generate enough membership sales, though performed well in other areas.
Private Label
In order to keep prices low for consumers and maintain margins, REI carries not only branded products, but also its own private labels: REI, REI Co-Op, Nova, and evgrn brands.
Data using Membership Database
One of the key advantages is a long-term membership database, especially for their heaviest users. This gives REI a key advantage by better understanding consumer behaviors to help design better promotions, higher in-stocks, etc.
Aligning the Business & Operating Model
With it’s unique cooperative model, the key to success is maintaining operating margins to pay 10% dividend to consumers by 1) growing revenue and member base 2) managing operating costs all while delivering high quality products and shopping experiences to the consumer. REI’s distinct competitive advantage is the vast size of active members. The value is not only in customer loyalty but also the data these members have generated through the years.
Evaluating REI’s performance is a tricky question. As a cooperative owned by its very customers, there are several different ways to measure success. One way may be to evaluate based on number of members served, which grew +20% in 2015! Another way may be to evaluate based on value delivered to customers – is REI selling high quality products at the lowest price possible? While not a perfect metric, the revenue outperformance vs S&P retail stocks is at least an indicator to support that consumers believe in the value of REI. As the retail landscape continues to change with the proliferation of e-commerce, increases in retail competition, and more personalized/specialized products, time will tell if REI’s co-operative business model and operating model is here to stay!
Sources:
[1] REI Corporate Website & Financial Statements: http://www.rei.com
[2] Bloomberg: http://www.bloomberg.com/news/articles/2015-03-27/rei-s-crunchy-business-model-is-crushing-retail-competitors
[3] Washington Post: https://www.washingtonpost.com/news/on-leadership/wp/2015/10/28/one-big-reason-rei-can-decide-to-skip-black-friday/
[4] Internet Retailer: https://www.internetretailer.com/2014/09/30/web-overhaul-underway-rei
[5] New York Times: http://www.nytimes.com/2015/11/13/business/expecting-warm-embrace-rei-chief-is-harangued-in-reddit-forum.html?_r=0
[6] SNews Outdoor: http://www.snewsnet.com/news/strength-in-numbers-2014-outdoor-specialty-retailers-list/
Thanks, Danielle!
I hadn’t realized REI “increasing membership base” (aka sell more co-op memberships) was such a large part of their operating strategy. Obviously the $20 per new membership is a great source of cash for a retail company with lots of overhead and a long cash conversion cycle. But is this strategy sustainable? I am concerned that that margins will continue to fall at large retailers like REI, and membership dividend payouts may put them in the red. Alternatively, REI may have a slow membership sales year and that will drive them to unprofitability. Thoughts?
Hi Margo –
Thanks for the question! I had a similar concern. As the retail landscape gets more competitive, especially with increased online price transparency at time of purchase. There are three moves that REI has made that I believe will make their model defendable:
1. Private Label. On these labels, REI can produce direct at a cheap price (given large quantities) and offer very competitive prices. It will also be very hard for consumers to directly price match on these items
2. Brand and Loyalty. I believe REI has a built a very loyal customer base through their co-op model. From the return policy, to the mission of the brand, I believe many REI shoppers have a deep belief in the brand and will be less likely to switch.
3. Longitudinal Data. REI must be very smart on the behaviors of consumers given a membership database with extensive history, before loyalty cards became the lure for consumer data. I think this allows REI to predict and out-perform the competition on understanding how to capture consumer while maintaining margin.
In terms of your specific concern about REI going in the red, we don’t have to worry about that! There is a clause in their dividend agreement that only allows them to max dividends at operating income in any given year. Consumers may be upset, however there is minimal financial risk posed
Nice post, Danielle. I’ve been familiar with REI for many years, but I never realized it was a co-op. I was thinking about the stress REI places on membership sales, and it is somewhat counterintuitive to me. Membership sales are more “costly” to the store than non-membership sales. Last year, REI paid $123M in dividends to its 5.5M members, or roughly $22/member. Ironically, the most profitable business would involve collecting membership fees from customers A, B, and C but selling its products to non-member customers E, F, and G. Basically, this was a long-winded way of asking why membership sales are a key performance metric for employees.
Hi Anthony –
Thanks for the question! The membership sales are important because a significant percent of REI operating costs are fixed (i.e., Store costs, Website management). The product gross margin are actually 43%. The more that REI can scale it’s membership base to drive sales, the more then burden of these fixed costs can be distributed. In addition, membership sales are ~10% of Pre-Tax Operating profits, which go straight to the bottom line. Hope that answers your question! Thanks! Danielle