In the wake of record breaking oil price spikes, fuel retailers have little choice but to increase the price motorists pay at the pump. Datamonitor's Anne Marie Davis explores the idea that sustained high oil prices might damage forecourt shop sales in the short term - one of the very things that oil companies have invested in to counteract the impact of the price surge on petrol margins.

There is no shortage of articles exploring the price elasticity of demand for petrol over the last 30 years or so. Opinions of the precise figure vary from

-0.1 to -0.5 in the short term (typically anything up to a year), to -0.3 to -1.3 in the longer term, depending on, among other things, the market under discussion. For those unfamiliar with the precise concept, this means that a 10% increase in price results in anything from a 3% to a 13% reduction in the quantity of petrol purchased by motorists after they have had a year to adapt to the change.

In general, we know that overall fuel sales are quite insensitive to price in the short term due to the limited availability of substitutes. Smaller and more fuel efficient cars take some time to buy, and new market innovations such as electric cars and alternative fuels are not readily available and are often expensive. Citroen has recently joined forces with Gaz de France to enable owners of the Citroen C3 to refuel with compressed natural gas (CNG) direct from the mains supply in their homes. Such an initiative goes some way to solving the availability problem, but there is still a long way to go. Realizing this, a German insurer has provided motorists with an alternative way to protect themselves against rising petrol prices: it has launched a policy whereby it will pay the difference for up to 2,000 liters of petrol if prices increase by more than 15%.

What is becoming equally as important as the impact of high oil prices on motorist demand for petrol is the effect on forecourt shop sales. In the event of the current price of oil being sustained, there is a strong possibility that consumers might start to alter their behavior, not so much when it comes to using their cars, more with regards to the number of non-fuel purchases made. In the German market there was an average decrease of approximately 3% in non-fuel sales last year and the price at the pump was cited as a core factor in the lull in forecourt shop activity. While the short-term impact of oil prices on fuel consumption is marginal and will only have a small impact on the frequency with which the shop is visited, what is more important is that customers will buy less too. This is chiefly because the amount of spare change in consumers' pockets is reduced, but also because they feel an element of dissatisfaction towards the oil companies.

This impact of high oil prices on shop sales has implications for forecourt retailers more than at any other time in their history. The last two to three years have witnessed oil companies investing heavily in ancillary services such as food service and coffee counters due to diminishing margins in petrol retail. Moreover, the investment has often been in premium products: for example, some 80% of BP Connect's offering is described as premium. However if petrol prices remain high it may mean that consumers reject a lot of the additional services petrol retailers are investing in, such as skipping their mid-morning cafe latte and muffin.

Furthermore, this income effect of high oil prices exacerbates the competitive advantage of supermarkets and hypermarkets selling fuel across Europe. The last thing they want is for consumers to spend less in the store - groceries are their bread and butter. However, they are far less vulnerable to this trend anyway, largely because they are protected by their brand and reputation - the 'halo effect' in action. This may also help to benefit the fuel retailers in joint ventures with supermarkets or convenience stores.

All of this leads to important lessons for traditional fuel retailers investing heavily in their shop concept. First and foremost, oil companies, both major and minor, should be tracking the correlation between high fuel prices and shop sales and taking action when a significant adverse impact on trade is apparent. The big players already have the systems in place to do this. The key lesson is to think carefully about the products and services being offered, cutting back on the range of premium impulse items when consumers are feeling the pinch and ensuring that grocery staples are not neglected. Motorists might not have many alternatives when it comes to reducing their petrol spend, but in selecting a retailer for their bread and milk, options are far more abundant. 

SOURCE: DATAMONITOR COMMENTWIRE (c) 2004 Datamonitor. All rights reserved. Republication or redistribution, including by framing or similar means, is expressly prohibited without prior written consent. Datamonitor shall not be liable for errors or delays in the content, or for any actions taken in reliance thereon.