Costco's dilemma - e-commerce is the future, but the business model is about the warehouses

Profile picture for user slauchlan By Stuart Lauchlan October 7, 2018
Summary:
Costco piles them high, sells them on out of huge warehouses. Trouble is, so does Amazon...

Costco
Every retailer watches out for the long shadow of Amazon being cast over it, but when your business model is ‘pile them high, sell them cheap’ in enormous offline warehouse, then that shadow is likely to be longer than most. After all, Amazon also piles up stock in its own warehouses and sells it on at hugely competitive rate - it just does the selling online rather than encouraging customers to wander the physical aisles in search of a bargain.

So if you’re Costco, striking the right omni-channel retail balance is (a) urgent and (b) complicated. The reality of the direction of travel is recognised by Chief Financial Officer Richard Galanti, who acknowledges also the need to get the channel mix right:

E-commerce is the way to go in a big way…We don’t see e-commerce taking over our brick and mortar. We’ve tried to figure out how to do some of the e-commerce or delivery-related activities that some members want and then we could provide savings too, but doing it our way. I think there is still plenty of low-hanging fruit.

But there’s an underlying truth that he has also to admit to:

We don’t want to get comfortable at just shopping at Costco online, unless there is not a Costco within 100 miles.

So, Costco reckons that e-commerce is going to become a bigger part of the business model, but the ‘pulling in people to the store’ aspect isn’t something that the firm wants to lose.

It’s a tricky one to pull off. Galanti says that e-commerce growth is coming in at 32.3% for the year, but total online sales still only account for around 5% of revenue. US customers account for the majority of that, although there is online activity coming from Canada, Mexico, Taiwan, Korea and the UK, with plans for an expansion into two other counties over the next 18 months.

Getting the online/offline mix correct has the potential to open up and retain new demographics for the firm, with Gen X and Gen Z customers cited by Galanti as a case in point. The omni-channel approach is also good for boosting loyalty, he adds:

The Executive member is more frequent, more loyal than a Gold Star member. An Executive member with a Citi Visa card comes more often and spends more and is more loyal than that. I would guess that somebody who is using it online, if they come from the warehouse and they are using online in addition to that, that’s more loyal than their respective groups of those other things.

Groceries

The increasingly competitive online grocery delivery space is one in which Costco is seeing increased traction, with ‘dry’ grocery two day delivery while same-day fresh deliveries are executed through third parties, such as Instacart and Shipt, and again fosters customer loyalty. But the emphasis again is ensuring people still come into the store, says Galati:

In terms of online two-day grocery, which is the right side, we’re generating sales in all 50 states including the 6 states where no physical Costcos are present, still relatively small to our company…This is anecdotal, not statistically valid, but when we looked at it, you take a group of loyal Costco members and then a group within that group who had like characteristics of average basket to shopping frequency and they’re loyal. Some of them will start using Instacart…They may reduce their annual shops by a few [or] increase [in] this way. The key for us though is making sure they still get into Costco occasionally.

What happens next is an expansion of what general merchandise is made available online and bolstering offerings such as Hot Buys and Buy Online, Pick-Up in Store, says Galanti:

Overall, all these efforts we feel are positively impacting our business, both online and in warehouse and are helping our sales increasing member awareness of our digital presence, as well as increased traffic that we’ve enjoyed in our warehouses.

He adds:

Within IT, we’ve got a lot of efforts going into fulfilment and sourcing and you name it. But, I think part of our long-term natural DNA is that we’re going to do what we feel comfortable doing and grow it nicely. We’ve got a lot of activities in that area. We’ve added brands, we’ve added some categories. But for us, doubling or tripling 3,000 or 4,000 SKUs to 8,000 or 9,000 is a lot for us.

We’re finding the ability to benefit not only with e-commerce, but using online and emails to drive traffic into the warehouse, again with Hot Buys and perhaps in some cases some targeted buys, and online and e-commerce to be able to sell some items that seasonally in nature we might only have for 8, 10, 12 weeks, notably, patio furniture and lawn and garden or furniture during the summer. Patio lawn and garden, we generally were in and out of that stuff for 10, 12 weeks. Now, we’re in 52 weeks online and there are some real sales to be had there.

As for BOPUS, Costco’s approach here has been to roll it out on a limited basis, focusing on things like jewellery, electronics items like tablets, and high-end handbags and the like. We have expanded it to some additional electronics items. The plan is to expand that inventory footprint and, again, use this to attract people into the warehouses where upsell opportunities will kick-in:

We still want to do it our way. We think that these are areas where we’ve been surprised that many people are buying it, because it’s convenient and then, they are going to come by to shop….while they are in there, over half of them are not just picking up the item they’re going into the shop [to get]. They frankly shop at a much higher average than the average shop.

My take

This is going to be a tricky one to pull off for Costco. There’s an understandable emphasis on the physical warehouse and from a customer PoV, there’s undeniably a ‘Costco-experience’ that comes from wandering the shelves. The comparison I’d make is with Ikea, where the online sales channel might be more convenient, but there’s something about a trip to Ikea (meatballs and all) that makes it part of the retail experience. But Amazon has its own warehouses and a superb logistics and supply-chain infrastructure in place. While I’ve always argued that retailers in the main shouldn’t become so focused on Amazon that they become operationally myopic, there are exceptions to every rule…