Costco’s Challenge for CPG Vendors
By Tom Ryan
While the market potential for Costco is large, its SKU-constrained environment,
margin requirements, private label acumen, and regional buying prowess place
numerous challenges on CPG companies versus other channels, according to a
recent report from L.E.K. Consulting.
L.E.K. said many CPG companies focus their marketing and innovation planning
process around mass retail and grocery chains "with ‘alternative channels’
such as Costco addressed as afterthoughts. This orientation rarely leads to
success." Among the challenges for CPG vendors mentioned in the report:
1) Limited Selection: Costco’s focused SKU selection reduces
operational costs by streamlining its supply chain and simplifying in-store
management but this "limits the freedom available to CPG companies – many
of which are accustomed to owning prominent real estate in store aisles."
2) Price Conscious: While most other channels mark-up merchandise,
Costco can sell merchandise at close to break-even levels and gain a majority
of its profits through membership fees. L.E.K. said this results in Costco
placing relentless price pressure on CPG vendors to sell products at low profit
margins.
3) Private Label Power. Since Kirkland Signature was launched in 1995,
private label has grown to around 20 percent of its sales and its goal is to
reach 37 percent. In some cases, Kirkland Signature can command a premium in
specific categories through quality product. Wrote L.E.K, "If Kirkland
Signature leapfrogs a CPG company in perceived quality and associated premium
pricing, it becomes extremely difficult for the CPG vendor to reestablish category
momentum at Costco."
4) Distributed Purchasing. Costco puts a strong emphasis on addressing
regional preferences, such as a greater demand for salsa in the Southwest.
It also procures goods on a local basis and provides managers at each warehouse
with some discretion over what goods they carry. L.E.K. wrote that this "requires
CPG companies to sell to a myriad of Costco buyers across multiple levels,
which makes national clearance challenging for vendors."
L.E.K. then offered three tips to overcome common missteps. First, it advised
CPG makers to develop a "Costco-Specific Business Plan." L.E.K. wrote, "Costco
is a unique retailing environment and is probably among the most challenging
that CPG companies will face."
Second, CPG companies should focus on "margin dollars" over the "margin
percent" guideline it typically uses. Wrote L.E.K., "Costco will
never deliver the same gross margin as grocery or mass retailers, but it can
deliver large sales figures."
Finally, CPG companies should consider engaging club retailers early in the
product development phase and elicit feedback from them. More than other channels,
opportunities exist to be part of sampling programs. Wrote L.E.K. "Working
in conjunction with receptive warehouse club buyers, savvy CPG companies can
develop and trial warehouse products before launch to traditional channels
– the reverse of the common pattern between club retailers and CPGs."
Discussion Questions: What do you see as the unique challenges for CPG
companies in selling to Costco and other warehouse clubs? Would you add anything
to the suggestions offered in the article?
Warehouse Clubs do present unique challenges to consumer goods companies. I strongly believe that most can be overcome but here is my short list of considerations:
1. Special packs – most consumer goods, including HBC, need to be packaged in a very unique way not otherwise serviceable in other accounts or channels of trade.
2. Sizes – hernia sized packaging can be expensive to pack, warehouse, and ship. Keep in mind that only clubs will be buying these special sizes so forecasting and inventory needs to be “exact” to avoid losses and waste.
3. Forecasting – never easy when it comes to Club stores. Distribution is often sporadic and difficult to predict.
4. Shelf displays – in the world of HBC a special PDQ display box is often required. The needs are very specific and not the same for all Club accounts.
5. Terms – most club transactions require extended dating. Therefore, the supplier needs to make the investment long before payment materializes.
Overall, I think the trials and tribulations are worth the end result. Club Stores are a significant part of the CPG retail landscape today and consumers that shop there tend to be loyal to the brands they purchase.
I thought the suggestions from L.E.K were good. In particular I would expand on their idea of a CPG engaging COSTCO early in the R&D process. Advantages for doing this
COSTCO:
1)Gives COSTCO a chance to sell at a higher margin before other retailer have it in stock
2)COSTCO is known for its treasure hunt atmosphere. The launch of new flavors, sizes and packaging is a perfect fit
3)Competitive advantage
CPG:
1)COSTCO is a great location to try new items and tweak marketing messages and or the product itself
2)This approach would give a National CPG a chance to prove itself in store. If the launch his a huge success the item could be added to the normal assortment
COSTCO has a great business model and National Brands need to find ways to leverage their success.
Add this to David Biernbaum’s fine set of considerations. The club trait that makes forecasting difficult for manufacturers is one of the characteristics that keeps shoppers coming back–the thrill of the hunt. Shoppers recognize that they might not see the same products in club stores, even on consecutive visits. So, manufacturers could embrace this character trait and run with it, rather than wasting efforts trying to fight it.
It seems to me that suppliers to Costco could do a tougher job of negotiating. Some of the pack sizes are unnecessarily large. Take romaine lettuce: six heads to a pack for the price of what two or three would cost in a conventional store. Not many families can get through six heads of lettuce before they go rotten. I often hear shoppers say they feel wasteful throwing two or three heads away, even though they save money. It seems that a four-head pack (at the price of the six-pack) would be acceptable to consumers and provide better margins.
From my view, the difference between the market to Costco versus other retailers is that it has real ownership by Costco versus the mindset of CPG control over other retailers.
Costco’s entire focus is delivering what their customers want and not simply what CPC vendors might ‘want’ to market. Costco consistently focuses on their customer versus trying to determine that through what the CPG vendor might want to sell or dominate space with.
If you regularly shop Costco, you may, as I am, always be interested in ‘what’s new’. While consistently delivering the products that their customers expect from them, as a customer I am always drawn to walk the store and enjoy their ability to make nearly each visit new and fresh.
I would suggest that CPG vendors don’t understand that except within the mindset of space domination and that by sheer space fulfillment and chance, product sells. That is, if I put enough product in, dominate the eye, then by pure lack of choice it may produce sales. Lack of choice you say? The pure fact of limited selection is the magic of Costco. Get all the other noise out of the way and the consumer responds. If you don’t believe that, take a walk down a beverage aisle in a large supermarket today and scan through dozens upon dozens of flavors of soda just to find regular Diet Coke!
Other retailers seem all too willing to allow CPG vendors dictate, control and dominate their shelf space without any real insight into what their own customers really want. They essentially hand over ownership through the mindset of ‘time to shelf’ of every single new item possible. That mindset is one that CPG vendors love and have taken real advantage of over time. No wonder Costco is so successful. I believe they take the exact opposite view. If they determine over time that their customers want it, they will likely have it. In the mean time they won’t clutter the eye and make their customers sort through the clutter to find what it is they really came for in the first place.
Other types of retailers could learn a great deal from their approach. It doesn’t mean you have to be exactly the same. You can’t. They own their approach. You can, however, not so blindly let CPG vendors dictate what you deliver to your customer. You can control your selection and you can limit it. In today’s process, CPG vendors control over retailers is having the affect of actually driving their consumers to ‘need’ Costco. As a consumer, I do. They have what I want. Other retailers have moved what I want out of their stores to take on what CPG vendors say I ‘should’ want. If they haven’t done that, they have cluttered the eye to the extent that I can’t find it anyway.
There is true retailing magic going on at Costco. No wonder CPG vendors may be befuddled by it a bit. They can’t seem to blindly get them to do whatever they want as they can with others. It’s no surprise their same store sales continue to grow at unbelievable rates by comparison to most.
I think the article points out the necessary steps to integrate Costco in the overall marketing and distribution mix developed my manufacturers. We don’t think twice about a company’s need to take many factors into account for developing an efficient and effective media strategy. Why should we be surprised about the need to embody retailer differences in an overall plan of action? That Costco offers unique challenges only underlines the reality to recognize the differentiating factors required in accessing shoppers across all distribution channels.
Outside of the key issues that other panelists brought up (bulk sizes, limited SKU count, exclusives), it’s also important to keep in mind the particular challenges of doing business with warehouse clubs. As David pointed out, forecasting is a big issue, along with the logistics of bulk deliveries, etc. CPG companies that have put a lot of effort into supply-chain “partnership management” with their key discount, food and drug accounts would be wise to put some human resources behind warehouse clubs like Costco with rapidly growing market share.
A significant challenge for many CPG leaders lies in the fact that they are not taking a close enough look at the CONSUMER, and how they shop this channel, and cross-shop in others. By looking at the the world through the “eyes of the end consumer”, the CPG firms can more effectively work with Costco to sort through selection, packaging, pricing, and margin needs.
Start at the ‘END’, the ‘who’, ‘what’, ‘when’, ‘why’ and ‘how’–as well as the WHERE–COSTCO–that consumers are picking up the product.
There are two key challenges to working with Costco for CPG vendors. The first is the litany that David has cited above.
The second, and perhaps more vexing as well as more fundamental, is that Costco is one of the first retailers to have fully adopted a “retailer as marketer” mentality. And they still rank far ahead of most traditional Food/Drug/Mass retailers in their adherence to the principals and implementation of the theory of this strategy.
This presents a unique cultural challenge–particularly for U.S. vendors. Vendors feel they go through tremendous hoops to do business with Costco, working to understand and meet their needs. But I would go so far as to say that most vendors today do business with Costco because Costco allows them to–not because they present a compelling proposition that furthers Costco’s marketing strategy.
When we look outside the world of CPG, we can find examples of vendors who better understand. Vizio comes to mind in electronics. Some of the “outdoor living” vendors and apparel vendors are also good examples. But CPG vendors would be well served to study and learn this culture, because it is the future in the U.S. Not the club channel per se–but retailer as marketer.
[Note: look for a RetailWire/Dechert-Hampe RETAIL:NEXT survey on this subject in the near future.]
CPGs should sell to any resellers who can promptly pay their bills. One thing that would serve Costco and CPGs is a very active, in depth, product brand program. Retailers provide their suppliers/manufacturers with the place to sell their products and the shoppers to buy it. A lot!
This analysis should include a focus on selling at the shelves and perimeter. When this is well done (too infrequently), sales soar which benefits all parties.
The challenge as most have mentioned is to create specific value-added items to assortments or as product launches. The supermarket mentality of making a different flavor and gaining shelf space is not a strategy that has any value in a club environment.
Now hear this CPG companies: If you want to play with Costco (or any other club) understand that they set the rules. They don’t care what you think. They don’t care what your advertising does. They don’t care how many coupons you drop.
Costco cares about one thing, its customers. And, those customers are not the mass that CPGs market to. Costco’s customers go to Costco rather than the Kroger for a reason.
When the club stores first started in the ’80s, my company designed programs and products specifically for that channel. That design wasn’t only in the packout, but we included everything from supply chain to pricing. We were interested in moving merchandise as was the retailer. The channel was not a burden for us, but a huge opportunity.
I have two recommendations for CPG companies:
1. read “scanner’s” comments, above,
2. Assume there are no rules or constraints to the entire package you put together in concert with Costco.
Ben’s observation above is an important one. Costco is a rare retailer that knows what it wants, how it wants it, and why. Any attempt to maneuver Costco into a merchandising decision for the supplier’s convenience is likely to fail.
But that shouldn’t rule out fact-based conversations about such meaningful issues as pack sizes, flavor assortments, PL-brand price gaps, GMROII and other nuances of merchandising. Yes, you need Costco-specific analysis and strategy to talk this talk, but the sheer size of the prize justifies the effort. What other retailer displays a full pallet of your item at a time?
Costco and Sam’s Club remind me of what we used to say when we were children. This is my bat and ball. You can play if you want; but I make the rules. So if you don’t want to play with the big dogs, stay home.
I’d like to offer a summary of all the excellent comments above:
CPG companies that give Costco what they want, better than competitors, will win the business. Those that don’t will not win the business. So, CPG manufactures, be good marketers first and know what your customers want. Then decide if and how to deliver it better than your competitors.
I know this sounds pedantic for this group but, hey, this simple axiom is too often forgotten so it’s worth reemphasizing.
The Costco store near my home regularly turns $1 million per day in sales. As with Stew Leonard’s, I spend a lot of time thinking about the core business principles that allows this business to knock the ball out of the park. Just commenting on one of those:
“[It is] extremely difficult for the CPG vendor to reestablish category momentum at Costco.”
No wonder. Costco is NOT a category management company, but rather, and ITEM MANAGEMENT company:
“Well, we have never been a category company–that was decided long before I came…We look at it item by item. That doesn’t mean we don’t have a fair representation with a category. But usually it’s only the top five or six items in that category, and we look at them as items.” – Charlie Burnett, COSTCO
The importance of item management, NOT category management, is absolutely essential to their success. Any retailer or brand could profit mightily, not by abandoning category management, but by overlaying item management strategy on top of category management. This is the fastest route to double digit sales increases across the industry: channels, chains, brands–whatever.
It is time for CPG companies to wake up and smell the rot on their brands. At the present time they will sell to anybody and that limits the control they have over their brand’s perception. If one looks at soft-line brands such as Tommy Hilfiger and Ralph Lauren they limit their outlets to those that will enhance their brands.
Tommy Hilfiger has sued a large retailer who bought their product on the gray market. General Mills destroyed a great brand, Izod by selling it to cheap discount stores. One of the big market changes of Efficient Consumer Response was to hasten the demise of smaller stores and drive more buying power into the hands of the chains who now want complete dominance of the CPGs with private label.
Will the CPGs have the courage to tell retailer’s with incompatible images no? I doubt it.
Private label, here we come.
As far as the poll goes, I’m not sure if one of those is the BIGGEST challenge. It seems like a few of them are big challenges and related. However, the first one that came to mind was distributed purchasing.
In line with comments above, what are CPG companies doing to REALLY learn about Costco’s customers? I’m sure Costco knows exactly who shops there and what they buy. In Taiwan, it seems like a lot of the world’s second busiest Costco customers are business owners. So a lot of them might like the six-pack lettuce because of the value. So do they just care about price? Or are they also still concerned about a brand? Kirkland vodka or Grey Goose? But as an average consumer, I’m concerned about purchasing that 13-piece pots and pans set before it vanishes from the shelves. It really comes down to the consumer and the consumer that Costco wants to target.
Well, life isn’t fair at all, is it? A retailer is the connection to the consumer. Retailers rule. Tough luck, CPGs. If you want insights, play with Costco and every retailer, club or not. Additionally, try what P&G and others are doing with the direct to consumer websites.
I think L.E.K.’s second tip provides a BIG realization and isn’t getting much play in the comments. Is profit margin for a typical CPG structurally, fundamentally, and inevitably lower at Costco than other retailers?
Perhaps…but can nothing be done to capture adequate margin?
I think simply focusing on total profit dollars (i.e., bigger is better) will ultimately diminish a CPG’s efforts at Costco as general managers and account teams focus increasingly on profitability over volume.
Many good suggestions above that can improve CPG margin at Costco and feed the virtuous cycle. My take: don’t take your eyes off of Customer Profitability margin.
I agree with most of the comments above. I would just add that I think Costco should be adding more stores and trying to gain more market share.