Features, Grocery and Food

Costco’s Peculiar Online Strategy

Costco may be crazy like a fox.

Costco Wholesale is a huge and successful retailer. Yet there are a few recent signs that it might be increasingly difficult for Costco to maintain and grow revenue in the future as it has in the past. That hasn’t stopped Costco and it certainly isn’t sitting around waiting for that to happen. Instead, it is moving in new directions. It is also boosting its hugely successful Kirkland Signature private brand by making it available on websites that are competitive with Costco itself. At first glance, that seems pretty counterintuitive. We’ll take a closer look at this odd strategy, but first let’s consider some background about Costco.

  • Costco, based near Seattle, is the most successful membership club. It has been wildly popular for many years, attracting a loyal following, especially among affluent suburban shoppers who like to stock up on super-large-sized commodity items, such as paper goods and food.
  • This model works well, obviating shoppers’ hassle of having to search frequently for basic consumables.
  • A key Costco benefit is that with its limited selection of 3,800 SKUs, shoppers have fewer buying decisions.
  • Shoppers have come to trust that goods bought at Costco represent the best quality at the lowest possible price. The halo effect is that its Kirkland private brand is also seen by shoppers as a great value. Natural and organic Kirkland food products have been particularly successful for Costco.

Costco’s Wallop

Costco packs a variety of goods into its product range. Beyond food, there is apparel, footwear, consumer electronics, jewelry, optical, pharmacy and much more. All those goods are packed into warehouses of about 145,000 square feet. Costco runs a total of 730 warehouses, most in the U.S. but some elsewhere such as Canada, Europe, Asia and Mexico.
With its broad array of products, Costco looks a little like other retail channels, notably department and consumer-electronics stores. Because of its low prices, it is a competitor to mass and discount. So Costco is pretty much competitive with everyone.

Costco has prospered since it was founded by way of a merger in 1983. In its early years, Costco grew sales at a prodigious rate on a year-over-year basis. Its annual sales volume is now about $120 billion, making it second only to Walmart, as measured by gross sales and by food and consumable sales. Sales of Kirkland brand product are nearly $25 billion a year, making it one of the biggest brands of any type. Its ubiquity blurs the line between private label and a national brand.

Swamping Competitors

Costco’s chief competitor is Walmart’s Sam’s Club, which Costco easily outdistances by producing more than twice the sales volume with about 150 fewer clubs. Some Costco warehouses have daily sales nearing $1 million per day.

Membership fees are very important to all clubs, but especially to Costco because of its vast size. It has about 85 million members paying either $55 annually for a membership, or twice that for a higher-tier membership that offers a 2 percent rebate on most purchases. In June, those fees are slated to increase. The lower-tier membership will rise to $60. The upper-tier membership to $120. This move will allow Costco to increase margin in a fairly painless way from the viewpoint to its members.

Those fees constitute about 75 percent of Costco’s profitability, which substantially unburdens the contribution product sales must make to profitability. Fees also front-load revenue production, which means members contribute to Costco’s bottom line before they purchase a single product. So fees are key to low prices, and low prices are what underpin the entire club business model. Clearly, if a disruptor emerged that undermined the viability of the fee concept, Costco would be in big trouble.

Trouble Afoot

As it happens, there is trouble afoot and—not too surprisingly—it’s Amazon Prime and its $99 per year membership program. Amazon Prime, by the way, was modeled after the membership-club fee system, and scaled up on steroids.

Let’s see how Amazon Prime stacks up against a Costco membership, and what early indications suggest about consumer response.

  • Amazon Prime offers several perks, such as two-day free shipping of a majority of goods. Prime also includes streaming music and video, a book-lending library for Kindle owners, and Alexa.
  • At first glance, it might seem that Amazon Prime has a big advantage; in particular, streaming and the lending library are features that Costco will never match. Amazon’s free shipping is highly valued by many consumers, although you might wonder if the higher Prime membership is enough to offset the shipping offer.
  • Nothing on Amazon goes on sale. Costco members are entitled to that 2 percent rebate for the highest-tier membership rank.
  • Costco’s biggest advantage is that, very broadly speaking, its prices are noticeably below those of Amazon. Plus, Costco’s position in the marketplace is protected by its very large corps of loyal members. Costco also functions as a cash-and-carry wholesaler for many small business owners. That feature can’t be matched in any substantial way by Amazon Prime. Yet.

Customers React

So, given those comparisons, how are consumers reacting? Current research shows that Amazon Prime is challenging Costco. Households only holding an Amazon Prime membership went from 7.1 percent four years ago to 13 percent now. Households holding only a Costco membership went from 14.9 percent four years ago to 9.8 percent now. Costco’s revenue has slipped to 1.3 percent in its most recent fiscal year after being quite a bit higher for many years. That metric might be lower if it weren’t for Costco’s new-warehouse rollouts.

The bottom line? Costco’s business model is starting to erode. What can Costco do to retain members? One obvious way is to offer its own online proposition. Costco does have an online business, but it lacks Amazon’s sophistication and is far from being a market leader among all online retailers. Costco is still grappling with basics such as establishing multiple shipping depots to reduce delivery time. Plus it’s still figuring out how to simplify the online checkout process. Lots of other retailers cleared those hurdles some time ago.

Sleeping With the Enemy

Now, here’s where things get strange. Curiously—and as if from a parallel universe—several hundred SKUs of Costco’s hugely successful Kirkland brand are offered for sale on Amazon, including the all-important food category. And many of these items qualify for no-cost shipping with Amazon Prime. So now shoppers have ready access to Costco’s crown-jewel brand without needing a Costco membership, and they’re incentivized to get an Amazon Prime membership to enjoy the shipping perk.

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Why is Costco sleeping with the enemy, or to be more precise, the enemies? It’s “enemies” because several other web-based retailers sell hundreds of Kirkland brands.

Most surprising of all is that more than 600 SKUs of Kirkland product in more than a dozen categories, including food, can be found on Walmart.com. Hundreds of Kirkland products are also on the Walmart-owned Jet.com site. That’s not all. Kirkland is also on Google Shopping Express, Instacart, and Boxed.com. Global exposure is afforded by Alibaba’s Global Tmall, which also carries Kirkland.

What Costco Teaches Everyone Else

Let’s take a stab at fathoming the meaning of these Kirkland online sales. It’s a frequently cited truism in retailing that the best time to shore up a business is not when it’s failing, but when it’s still doing pretty well. It may be that Costco is spreading the Kirkland brand far and wide as a bulwark against the day that membership revenue goes into significant decline.

Experimenting with its own future, Costco plans to open soon a small-version warehouse in Iceland. The membership fee there will be lower than it is elsewhere. This suggests there’s flexibility in Costco’s core and how Costco might enter certain markets in the future. This flexibility is something that could be emulated by many retailers.

Some retailers have pinned hopes for their future on private brands. The now-declining Whole Foods is rolling out a few off-price, private-label “365 by Whole Foods” small format units as part of a turnaround strategy. Loblaw enjoyed quite a bit of success for a long while with its private brand “Joe Fresh” stores. Sears, too, is in the process of wringing capital out of its iconic private brand Craftsman by selling it. But that’s more of a tactic in the slow-motion liquidation of the company than a real strategy.

Costco could conceivably open Kirkland stores, although the presence in the market of 350 or so Kirkland’s (Costco unaffiliated) home decor stores could be a problem.

Finally, as if we needed any further proof, Costco demonstrates anew being victim of disruptors that can creep up on any business, no matter how successful. Costco’s declining revenues suggest that apparel and other items common to department, mass, discount and electronics stores are slipping. Food sales, which constitute the majority of Costco’s revenue, are holding steady.

So Costco is now poised to experience some of the woes being visited on other brick-and-mortar retail channels. Maybe Costco’s preemptive online strategy isn’t so strange after all.

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