What to expect when Costco comes to Australia
It's a compelling summary of a retail concept Americans, Canadians, British, Koreans, Taiwanese, Japanese – and inevitably Australians find a compelling retail offer.
Wholesale giant Costco, the world's 12th largest retailer, is about to redefine the way a small but significant percentage of Australia's urbanites shop for food, groceries and office supplies.
It's a retail concept that has attracted an enormous amount of media attention since Costco revealed definitive plans to bring its offer Down Under late last year. And it is a retail offer many suppliers and consumers are sure to embrace – at the expense of a number of established Australian retail operators.
"Costco exploits market inefficiencies,” says Bonanno, director of retail strategy at The Leading Edge. "A lot of retail leaders here are saying this is a highly competitive retail market. My perspective is – we're about to find out.”
Bonanno should know. He's just moved to Australia from the US where, for the last 15 years, he's analysed and advised on North American retail chains such as Wal-Mart, Whole Foods, Target, Kohl's and – you guessed it – Costco.
Customer loyalty to Costco in markets where it is already established borders on the unbelievable. Consumers have to sign up for a membership of Costco in order to shop there, at a cost of about $US50 for individuals and $US100 for small businesses, which comprise about half the membership. And the renewal rate: 85 per cent.
"They have a simple business model,” explains Bonanno. "It's effective and they stick to it. Sell a great product at an eye-popping price and people will come back.”
If you're unfamiliar with the Costco concept, here's how it works: Costco operates large warehouse style stores, typically around 11,000sqm, in areas where there is a strong middle to high income demographic and a concentration of about one million consumers within a 25 mile radius.
Each store carries a range of 3700 to 4500 stock keeping units (SKUs) and in the US, 30-40 per cent of those lines are exclusive to the chain. Its stock includes avocados, iPods, coffins and playground sets. They even negotiate best value deals on new cars via local dealer networks.
A typical US store will turn over around $120 million annually – 40 per cent more than a Wal-Mart of equivalent size. Profit is based on a 10 – 10 – 3 formula:– 10 per cent gross margin, 10 per cent operating costs and 3 per cent operating profit off their membership fees.
SKUs are typically larger than you'd find in a traditional supermarket – or noticeably different – part of a deliberate strategy to offer customers unique value.
Cases of beer will have more bottles, saving the customer a trip to a bottle shop; there might be special formulas of foods, unusual pack sizes. In the US, Costco sells iPods for example, at the same price as anyone else. Costco's value proposition might be that it comes with a $30 iTunes download voucher.
Explains Bonanno: "They (Costco) can be a very frustrating retail customer when you're a packaged goods manufacturer, and you want to sell more stuff coming off the line and where demand meets supply equals price optimisation.
"Now you've got a company saying 'I like your product but I want it in a different pack size'. Every one of these differences makes a massive amount of difference to the manufacturing process.
"At the same time, if I'm Costco and I sell the same stuff as Coles and Woolworths I'd go out of business because you don't have to pay to shop there.”
Costco also has its house brand – Kirkland – but in contrast to other fast moving consumer goods (FMCG) retailers, some products may be co-labelled; blank DVDs, for example, might carry both a Sony and Kirkland logo.
So why does Costco win? "They have a clearly differentiated strategy and they stick to it,” explains Robert Kinkade, a Sydney-based retail consultant with McMillan Doolittle, a leading Chicago-based retail consultancy. "They are not trying to be all things to all people; they know how to pick their punches and they execute very well.
"You will not find the broadest range in a category at Costco; they are not striving to be the most convenient and may not have the latest fashion. However, customers do expect to find the lowest prices on essentials and often find great special purchase items outside of the core range.”
Says Bonanno: "Costco eschews category management – it's just not part of the model. There are no loss-leaders, no special SKUs that sit on the shelf for a long time but have high margins. And there's not a lot of room for line extensions. Unlike many retailers, that have set periods for range review processes, Costco's range review is ongoing, every week.”
Kinkade adds: "Costco's model is all about efficiency and cost control, which keeps prices to a minimum. While Wal-Mart is often considered the world's most efficient retailer, Costco maintains a far lower cost base relative to sales.
"Virtually every aspect of their operating model supports this strategy, ranging from floor ready pallet deliveries requiring minimal handling, to the cost savings role of the membership fee. While revenue generating, it also keeps shrink to a minimum, resulting in around $500 million in annual savings relative to other formats".
It's easy to confuse the company's low price positioning with low-income, however the opposite is true – for a start, people on low incomes generally can't afford to spend $50 for the privilege to shop there.
"Costco's stores are typically adjacent to affluent communities. Value-driven business owners are a big percentage of Costco's customer base and they love the hunt and thrill of a bargain,” explains Kinkade.
Indeed, it is the small business market which Costco is tipped to target first when it open its first stores in Australia. Half its US business is selling to small businesses, from offices to restaurants – although a significant share of those sales are undoubtedly for business owners' personal use.
They're also an easier target to market to when establishing brand awareness. Says Robert Kinkade: "A planned trip to buy printer cartridges and office paper may also result in purchasing of two cases of premium wine. This benefits Costco, as other customers flock to the stores based on word of mouth, requiring less advertising spend which further supports the low-price strategy.”
Bonanno believes one of the main attractions of the Australian market to Costco is that retail here is a largely undifferentiated market. "The greatest differentiation of product lines comes in specialty retail. The biggest difference between the major retailers is their persistent push to use home brands to create differentiation.”
That represents a large canvas on which Costco can paint a picture of differentiation.
Bonanno says when Costco has entered a new market in the past they've offered a discount or free membership. They may or may not do that here – but they will rely largely on word of mouth.
"Costco's fortunate here because Australians travel – particularly to the US and the UK – so to many people, Costco is not an entirely new concept. Many people who've lived overseas and are back living here now will know the brand.”
Significantly, Costco has already entered South Korea, Japan, UK, Taiwan and Canada. Each of those countries has an entirely different culture, but Costco's approach has been uniform and the company has yet to fail anywhere.
"When you think about how discerning people are in markets like Japan – people here are going to say 'wow',” says Bonanno, who admits to being a Costco convert when it came to his own household spend in the US.
So which retailers will suffer most from Costco's debut in the capital cities? In contrast to the predictions of consumer media, supermarkets have little to fear, analysts agree.
"Costco is not a full replacement for a supermarket visit, rather it is typically seen by consumers as a complementary experience,” says Kinkade. "The monthly or fortnightly 'Costco Run' covers the essentials. Fresh items may be picked up through a more convenient format.”
Bonanno concurs: "They tend to take items off shopping lists rather than substitute a shopping trip entirely. Proximity is not where Costco wins, so there won't be any impact on neighbourhood supermarkets.”
In the US, the average customer will visit a Costco store about twice a month, but they'll spend two to three times on average what they spend on a normal supermarket visit.
Bonanno says numerous studies in the US have shown Costco's impact on grocery or mass merchandise retailers is not great. "You have to remember over half the volume is business to business.”
Thus Bonanno picks Officeworks and potentially Metcash's Campbells Cash & Carry chains as the first to notice any impact.
And where? Bonanno predicts Costco will hit all Australian state capitals and then select booming regions like North Queensland where there is sufficient population – and income levels – to make a store viable.
"They do need population density, so I'm not holding my breath for an Alice Springs Costco.”
Unlike most global retail giants, Costco doesn't have a rapid pipeline to profitability when it enters a new market. It typically takes seven years to get to a comparable volume threshold, and thus turn comparable profits.
Worldwide, some 50 million households are members of Costco, albeit many through business memberships. With a population of just 21 million, Australia is not going to boost that total greatly in the short term.
Robert Stockdill is co-publisher of Inside Retailing Magazine
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