Costco: Breaking down the Bulk
By: Richard Wang & Eva Xu
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
An Aging Company
With 700 stores and more than 80 million members globally, Costco has gained an exclusive following with its iconic membership model and unbeatable prices. This has established the company as a dominant player in the warehouse club sector with annual revenues of $118 billion. However, despite Costco’s previous geographic and financial advancements, the company’s revenue growth over the past year has stagnated. The retailer reported flat quarterly comparable sales for the first time in six years, subsequently failing to meet analyst growth projections.
Changing Tides
Costco serves both retail and business clients. However, despite the company’s relatively strong retail membership base, millennials represent a small percentage of this group. This is due to a prohibitive membership system and problems with storing and finishing bulk quantities of perishables. As a result, the Costco model does not resonate with younger people who identify as individuals as opposed to families who prefer bulk buying: a survey of 175,000 shoppers conducted by InfoScout reveals that millennials spend the least at Costco compared to retailers like Whole Foods and Kroger, while Baby Boomers spend the most. CFO Richard Galanti has downplayed the urgency of the situation by advocating for incremental change: “We are not going to do anything rash but we are also not going to have our heads in the sand.” This inaction may be due to the fact that Costco’s membership has historically been replenished by the younger demographic as it ages, starts families, and purchases memberships. However, Costco should show more initiative in addressing the oncoming demographics challenge. While revenues from its current target market have been healthy, a significant problem lies over the horizon.
Costco’s challenges with the younger demographic may be exacerbated by the emergence of digital players, as the convenience provided by online platforms may push younger consumers towards these alternative purchasing channels. Costco’s hold on this future market is gradually slipping, and an unwillingness to act will leave it unable to adapt to a rapidly changing industry. It is critical that Costco takes initiative in capturing younger shoppers to protect its membership base.
The Race Against Digital Retailing
Certain retailers such as Walmart, Kroger, and Amazon have created digital offerings that have emerged as notable threats to Costco’s membership base. Amazon Prime in particular has revolutionized the delivery scene, more than doubling its membership among U.S. households in four years from 20.3 per cent to 44.3 per cent. As services like Prime gain popularity, households may begin to cancel memberships with the warehouse club.
Although Costco offers household perishables in bulk formats, Amazon’s Prime Pantry service now allows shoppers to have staple pantry items shipped directly to their homes for a small delivery charge; this convenience of delivery is attractive to millennials. Furthermore, Amazon caters specifically to this group by offering a Prime Student program, which provides a free trial for students followed by a 50-per-cent discount from the full $99 annual price. As young shoppers grow accustomed to the convenience of Amazon Prime, they become inclined to renew subscriptions even when they no longer qualify for the student discount, thereby threatening Costco’s ability to recruit members in this age group.
Nonetheless, what distinguishes the club retail giant is the classic Costco experience: walking amongst the wide expanse of product skids, taste-testing free samples, and ultimately having access to a diverse, tactile marketplace environment. As such, the wholesale giant emphasizes its shoppers as members rather than just customers, differentiating Costco’s model from those of online retailers. For many of the company’s 80 million members, this in-person shopping experience is something no online substitute can replace: the ability to curate a distinctive sense of community and customer involvement.
Delivering Another Perspective
At its core, Costco’s business model emphasizes group purchasing. Rather than altering this fundamental approach to attract the younger market, the company should leverage it. Costco must realize that millennials, although typically considered as individual actors, also belong to natural groups: they are roommates and teammates. To be successful, the company should purposely group millennials into the larger purchasing units that it is traditionally familiar with.
Through establishing these groups, the retailer would be able to redefine the Costco appeal to one not limited by bulk purchases, but a holistic shopping event that is engaging for a group of individuals. To achieve this, Costco must find a way to establish group dynamics while catering to individual purchasing preferences.
Costco currently cannot offer the same level of convenience as online retailers due to its warehouse-centered model. Despite the company’s engagements in experimental delivery partnerships with Instacart and Google Express in the U.S., these initiatives have been fragmented and distribution has been limited. Although delivery and convenience are intuitive problems for Costco, they should not be primary fronts that the company uses to differentiate itself, especially against a logistics giant like Amazon. Instead, Costco must focus on the holistic shopping experience.
Without a delivery arm, access to transportation remains a concern given the sparse distribution of warehouses and a volume-based purchase model. Still, this obstacle tends to be overstated. In large urban centres, where owning a vehicle is expensive and inconvenient, robust public transportation infrastructure and car-sharing services have made travelling easy for millennials. These alternatives to owning a vehicle are compatible with Costco’s warehouse model and place the retailer in a favorable position to capture the millennial market.
All In This Together
Costco’s membership model is what allows the company to be profitable in spite of its low margins. Its current standard membership costs $55 per year and allows for one additional spousal cardholder. Membership fees accounted for 72 per cent of operating income in fiscal 2016, indicating that profit is primarily driven by the number of members.
To continue growing its member base, Costco should consider a group membership tier aimed at individuals aged 18-29. This initiative lowers the barriers to entry for students and youth, allowing them to share the cost of the membership and shop together. The annual fee of the new millennial group membership should be fixed at $99, providing individuals with an incentive to maximize the size of their group. Additionally, Costco should offer discounts that scale with the total purchase amounts made by groups: each shopper could earn a discount if the group’s cart is more than $200, which promotes impulse buying. This would encourage group members to all shop together, ensuring that shopping trips are a more social experience. By extending membership access to this underserved demographic, Costco would not only increase current memberships, but also become well-positioned for long-term revenue growth as these individuals graduate from the millennial pricing system and adopt full-price memberships.
These millennial groups would buy collectively, adhering to Costco’s bulk purchasing model. However, unlike families, millennials are typically unable to make buying decisions on behalf of other group members; therefore, Costco needs to incentivize as many group members as possible to enter the warehouse for this recommendation to succeed.
A Little Something For Everyone
Costco should periodically hold quick, heavily discounted “fire sales” for millennials to purchase popular items at low prices. Although these items would be loss leaders, fire sales would be exciting, one-time marketing events propelled by word-of-mouth advertising through the millennial social network. With this initiative, Costco could draw the attention of millennials previously uninterested in bulk purchasing. Products, such as protein powder and electric razors, should appeal to young shoppers and be of reasonable value so that savings are material. In order to minimize the financial impact of these heavy discounts, the company should feature in-house “Kirkland Signature” branded products with higher margins. Additionally, Costco can discount older models of selected products: this way, despite a necessary loss on the SKU, the company will be able to clear up inventory to make room for new models.
A risk for the group purchasing model is that oftentimes, a group must make unanimous buying decisions. If one roommate wants to split a product but the others do not, this may discourage the first roommate and prevent purchases from being made. In the worst case, this may push a group to visit a traditional grocery store instead of Costco. As such, Costco should reserve a small portion of floor space for products to be sold as individual units at a higher margin. This section would help Costco cater to individual preferences, containing SKUs such as organic produce and speciality health products like vitamins. Cannibalization would likely be insignificant since traditional Costco customers would still prefer to purchase in bulk to maximize savings. Instead, this recommendation mitigates the concerns of millennials who are skeptical of the group buying platform.
Success In Groups
The impending demographic challenge is an underappreciated problem for Costco. The company must take action now to protect market share moving forward.
Currently, Costco is inaccessible to millennials due to the inconveniences of bulk purchasing and a restrictive membership policy. Rather than respond by adopting digital strategies like Amazon, Costco should instead focus on what it does best. With millennial memberships, group discounts and fire sales, Costco will be able to create a social shopping experience that is capable of reaching younger demographics. Millennials will be able to share the in-person shopping experience with friends while also making individual decisions, establishing Costco as an inclusive ecosystem. This strategy will push millennials to choose a Costco membership instead of digital alternatives once they age.
Demographic trends represent a further opportunity for Costco. The rate at which American suburbs are growing is faster than the rate in metropolitan areas, and urbanization has plateaued in the U.S. and Canada at one per cent in recent years, down from 2.2 per cent annual growth between 1950 and 1970; this number is projected to decline further to 0.8 per cent in the next two decades. As millennials age, many continue to gravitate towards suburbs, purchase homes and establish families. This process expands Costco’s target market over time.
Historically, Costco has managed to maintain annual renewal rates of more than 90 per cent due to conditioned buying habits and brand loyalty. By capturing millennials in their youth, the company would benefit as young shoppers graduate into regular memberships and form their own families. This forms a sustainable advantage for Costco over the digital competitors that lack the wholesale giant’s iconic in-store experience. By taking serious action today, Costco could secure a dominant share of the shoppers of tomorrow.