What’s up with Costco?

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Costco is a bit of a puzzle at the moment. A best-in-class retailer by most standards, they are noteworthy for legions of devoted shoppers. But earnings per share declined year over year in its most recent first quarter, falling short of analysts’ expectations.

Factors that hurt Costco included the strong dollar, a non-recurring legal issue, stock compensation which will diminish, and a decline in credit card signups to zero in expectation of the switch away from American Express to a new VISA credit card from Citigroup early next year. (Sam’s Club is now accepting American Express cards and advertising that fact.)

Membership sign-ups were up 7 percent for the quarter to a total in market of 45.6 million (82.7 million if you include extra cards), although membership fees fell short of analysts’ estimates. Costco opened 23 new units in fiscal 2015 and plans for 32 new units in fiscal 2016, which would represent approximately 5 percent growth.

According to Fortune, Costco has been able to defy the trend towards online shopping, with only three percent of its sales coming from e-commerce. CFO Richard Galanti says Costco has grown sales and cut long-term costs such as freight, vendor pricing and packaging, while passing 80 percent to 90 percent of the savings back to customers. Fortune also noted that annual membership renewal is 91 percent, which is a record high.

Retail Dive highlighted the opinion of Deutsche Bank retail analyst Paul Trussell that Costco is now “Amazon-proof” due to its membership model and physical store advantage. Members may go with a list, but tend to pick up a few impulse purchases each as well, he says.

Potential bumps in the road include competition from Amazon Prime, which makes it easy to get most items delivered to one’s doorstep in two to three days. Also, aging Baby Boomers may not be as eager to push carts laden with heavy, bulky items around large warehouse stores. And with empty nests, they may no longer be in the market for three pound cans of nuts.

BrainTrust

"I do think that an aging Boomer population could hurt Costco and, like most retailers, they will need to consider how to appeal to Millennials without alienating current shoppers."

Zel Bianco

President, founder and CEO Interactive Edge


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Adrian Weidmann

Managing Director, StoreStream Metrics, LLC


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Adrian Weidmann

Managing Director, StoreStream Metrics, LLC


Discussion Questions

Is Costco’s business model as relevant as always, or do you see chinks in the armor? Who or what is the greatest competitive threat to Costco? What adjustments may be required?

Poll

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Zel Bianco
Zel Bianco
8 years ago

It sounds like Costco’s weaker than expected quarter was mainly due to extenuating circumstances and I am not particularly worried about their immediate future. I do think that an aging Boomer population could hurt Costco and, like most retailers, they will need to consider how to appeal to Millennials without alienating current shoppers. They key to this may be staying front of mind and embracing factors that are already in place: free samples, being able to look at what you are buying (which makes it easier to judge how much you are buying — something that can be difficult on Amazon) and buying everything all at once, without having to dispose of all the extra, wasteful packaging that is one of the most serious drawbacks of Amazon.

Tony Orlando
Tony Orlando
8 years ago

This to me is misleading, as Costco continues to grow membership and increase their new stores being built. Yes there will be some issues moving forward, but they are still the king of warehouse stores by a mile. Yes Amazon will chip away at them, and the aging population will have an effect on all of us, but exponential growth is not happening anywhere, except perhaps a new start up, so I don’t see too many problems here. Obamacare is certainly going to cut into profits next year, and something has to give on the wage issues as well. That being said, the stores are always packed all day long and a slight increase in their overall pricing will hardly be noticed at all. The vendors are going to be pummeled even harder to make up some lost profits, and Costco knows how to pressure them better than anyone.

To me, small business is in more peril than ever, as they are going to find it harder to spread out their mandated costs than Costco will. So I think they will be fine, where as Main Street will continue to get the brunt of our bad economy.

Mike B
Mike B
8 years ago

I see big challenges ahead. Millennials whose parents loved this store shop there but it’s with less frequency than their parents. Some of my young friends pay for the membership and often talk about planning to go to Costco but then 80 percent of the time don’t end up going. It’s a big hassle and time commitment to go to Costco. The store in my city is located far from other major retailers.

I think Costco needs to make its stores more accessible and easy for a quicker shop.

As Millennials have families of their own they could gravitate back to Costco somewhat but I’m not so sure. I think many of the challenges facing malls are also facing Costco. Online competition is fierce and Millennials can’t afford as much stuff as their parents.

I think the best focus is international expansion. Costco has proven they can do this pretty successfully and there are many good opportunities outside the U.S. with much less competitive activity. We have a real glut of retail in the U.S. but many of our retailers can’t seem to exit the U.S. very successfully. I guess retail isn’t fast food.

Ben Ball
Ben Ball
8 years ago

The last quarter was a blip. But there is a chink in Costco’s armor, and it is online, and it is called Amazon Prime. I am a very satisfied and loyal Costco customer, both for our small office and for our home needs. As a two person household most of our needs are for smaller quantities of higher-end items, gifts, entertaining at home and, of course, the treasure hunt.

Since joining Amazon Prime (including the 5 percent cash back Prime “Store Card”) almost all of the treasure hunt and gift purchases have shifted to Amazon. Also things we tend to buy (now order) in quantity like probiotics, K-cups and other daily needs.

This is emblematic of the major threat to brick-and-mortar retailers — especially the good ones like Costco — who have avoided other pitfalls. When the selection, quality and delivery time of products is equal (a la same-day delivery) and the convenience and price (or rewards) is greater — you will still lose.

Phil Rubin
Phil Rubin
8 years ago

Costco’s business is still relevant but their business model has limitations, namely its reliance on credit card partnerships to make their numbers. While this is not unique, Costco’s thin margins on a majority of its sales make it more vulnerable to softness in credit card revenues. The shift from American Express and the shut down of its card acquisition efforts are what, according to Galanti, impacted its EPS. For the sake of its shareholders, hopefully it’s got the right follow-up plans with its new credit card partnership.

Peter J. Charness
Peter J. Charness
8 years ago

Find me the retailer who has years and years of consistent quarters without ever having a bump. (other than say Costco up to this quarter … ). The Costco experience is quite different from Amazon, in that (for me anyways, and virtually everyone I see at checkout) it’s always a pretty large market basket of products always featuring some perishables and frozens. That’s just not something you can replicate on Amazon, and it isn’t the weekly trip to the grocery store either.

I think Costco has a business model that is quite sustainable and will endure. Adjustments needed? Bigger parking lots, that’s for sure.

Todd Hale
Todd Hale
8 years ago

Their business model still relevant, but like other retailers, keeping pace with the shift to e-commerce is a must.

Amazon, Amazon and then Amazon.

As a loyal Costco shopper for many years, I am actually thinking about moving to Sam’s Club as I have been an American Express card user for a much longer time.

Herb Sorensen, Ph.D.
Herb Sorensen, Ph.D.
8 years ago

Good grief! Costco is now the number two global retailer, and climbing still, and there is concern? Nothing much has gone wrong by my reading.

BTW, the future of global retail dominance is now a race between Costco and Amazon. Costco is the best example I have seen of “Selling Like Amazon… in Bricks & Mortar Stores!

Globally, many of the big head stores, Lidl, Aldi and others, are knocking the ball out of the park. Costco with 4000 SKUs is simply head of the pack there. Walmart and other long-tail stores bury their big-head merchandise in an indiscriminate sea of long-tail stuff, thinking this “hide and seek” strategy is anything but a massive sales-suppressive phenomena.

Amazon of course has an “infinite long tail” but ever and always focuses on the big head — defined as, “Our best information at this time and place is that THIS one thing is what THIS one shopper is most likely to buy.”

Costco has two real weaknesses: the lack of the long tail. NO brick-and-mortar retailer has properly integrated their online long tail with their brick-and-mortar stores. The other is that their fundamental siting strategy, giant stores, not “neighborhood friendly,” forestalls their participation in the growing global reversion of brick-and-mortar stores to “communal pantry” mode. Walmart is not exhibiting much commitment to their own neighborhood concept.

There is still room for a massive chain of oversized convenience stores, with the food service some are already providing, but with an “Amazonian” long tail integrated INTO the brick-and-mortar operation via clicks. A faint glimmer of this was Amazon Lockers at convenience stores. But retailers, including Amazon, just don’t seem to be able to comprehend the idea that bricks and clicks are NOT two different businesses. Amazon’s Seattle brick-and-mortar store is little improvement on the worst of the other brick-and-mortar retailers.

Anne Howe
Anne Howe
8 years ago

If Costco builds to match the more urban locations that Gen Y prefers to live in, their business model will survive just fine. Almost half of Millennials are now married and just over 40 percent have kids. While they love Uber and Lyft and shun owning cars compared to other generations, recent research indicates that 43 percent expect to buy a car in the next three to five years. It’s clear that public transportation to and from a Costco trip is not ideal for anyone. So as Gen Y reverts back to owning cars and raising kids, I predict Costco can count on being relevant and in the trip mix.

Li McClelland
Li McClelland
8 years ago

There are some business model issues for them to watch and adjust. First, I think the novelty of shopping at Costco has just diluted itself somewhat over the ensuing years as more and more locations have opened closer together. “We’re going to Costco!” just doesn’t carry quite the same excitement any more. Second, it’s a great company with solid products and pretty good prices. But you know the drill and some days and weeks you just don’t have the stamina or will to enter Costco’s big cavernous barns and spend an hour or more there when you can pick up your groceries at a regular supermarket with a manageable parking lot.

Mel Kleiman
Mel Kleiman
8 years ago

The number one outstanding question that I ask is, can they make the switch away from AMX work? We know they did it to save money, but sometimes we get penny wise and pound foolish.

The upside of the Costco story is that they now do some little business on the web. If they decide to move more aggressively into that channel, can they figure out how to leverage their present marketing strategy?

Larry Negrich
Larry Negrich
8 years ago

The credit card switch has definitely caused some confusion. Reducing the perception of length of wait at checkout would help. Like to see them create a membership level that includes a specific delivery radius to continue to leverage the .com and encourage shopping from time-starved shoppers.

Dick Seesel
Dick Seesel
8 years ago

I’m wondering if the drop in gas prices had an impact on Costco’s top line and therefore on its earnings. It’s a big part of their sales number. Just a thought.

Mike B
Mike B
8 years ago

The other thing is, the prices are Costco are not that great and I think that people doing some comparison shopping between Costco and Amazon on general merchandise are seeing that. People comparison shopping between Costco and various other grocers are also seeing that and I think the value proposition is starting to blur. I get better grocery prices shopping the ads of other stores; prices at Winco, various Kroger divisions, and on produce Sprouts and many ethnic grocers blow Costco out of the water. No member fee and you can buy just what you need too. Far better in-store experience.

Add to Millennials just not wanting so much stuff anymore (why want what you can’t afford?) and not having as much house to fill up as parents, and the treasure hunt aspect of the Costco trip loses relevance.

Also I think there is a difference in brands that appeal to Millennials vs. their parents and Costco is clearly focused on that upper middle income parent.

I stand behind my initial thought they would be better focusing on international expansion than trying to make giant changes in the US. They’ll still be a cash cow in the US for a long time but I think the growth opportunities in the US are limited. Better ROI elsewhere with less competitive activity.