The Digitalization of Costco: A Necessity to Compete with Amazon and Walmart

In an era where consumers do more of their shopping online, Costco must get more comfortable with digital in order to compete with Amazon and Walmart

Introduction

Digitization is changing the way consumers shop, presenting a particularly large threat to Costco, the world’s second largest retailer.  Costco’s mission is “to continually provide members with quality goods and services at the lowest possible prices.1”  Historically, Costco’s strategy has been focused on driving customers into their stories by “offering items members need or prefer to buy in person — namely, cars, gasoline, and groceries.2”  Although effective in the past, digitization is changing the retail landscape and to remain competitive, Costco must increase their focus on purchasing online.  Costco’s CFO, Richard Galanti, mentioned the company has been “a little late to the game on purpose,3” in an interview April 2017 interview with the Wall Street Journal. “[They] recognize there are things we can do or should be doing.4”  A few months later, in June 2017, Amazon announced that it would be acquiring Whole Foods, presenting an imminent threat to Costco which relies on its grocery business as a key driver that gets customers into their stores.  Costco must adjust their business in the immediate future to remain competitive in this era of digitalization.

Short-Term

In the short-term, Costco is combatting pressure placed on their business by digitization by investing in their own digital capabilities.  In a recent move which could potentially protect Costco’s grocery business from the Amazon/Whole Foods merger, Costco strengthened its partnership with Instacart to better deliver directly from the Costco.com website.5  Currently, “only 7% of Americans buy groceries online.  Following the Amazon-Whole Foods deal, the $850 billion grocery market’s shift to online is certain to accelerate.”  During Costco’s 4Q 2017 earnings call, Richard Galanti, Chief Financial Officer, laid out Costco’s short-term strategy to win in e-commerce through “improved search, streamlined the checkout process, improved ability to track orders and automated much of the returns process.  [They] also improved our online merchandising efforts by adding high end and well-known brand names.6”  Although these actions allow Costco to remain competitive in the short-term, this alone will not be an effective enough strategy in years to come because Costco will not be able to replicate the expansive distribution and delivery capabilities of Amazon.

Medium Term

In the medium-term, Costco should focus on leveraging the digitalization trend to align with their core business strength of delivering the lowest possible price.  Their low prices are a competitive advantage and a recent study showed that “prices were 17% cheaper at Costco.com than they were at Amazon.7”  Selling products online slightly erodes Costco’s ability to offer customer’s the lowest possible price; however, they are trying to leverage online sales as a way of increasing their membership base which they can then leverage to drive traffic back into thee stores.  In order to accomplish this goal, Costco allows nonmembers buy most items it sells online, generally at a 5% upcharge8 in order to entice them to become members.

Recommendations for Management

Although I believe the steps which Costco is taking are certainly in the right direction, I would recommend that management move more quickly in establishing their presence in the online market.  McKinsey’s Case for Digital Reinvention showed that “the biggest payouts will go to those that initiate digital disruptions. Fast-followers with operational excellence and superior organizational health won’t be far behind.9”  Walmart has been investing more heavily on their e-commerce platform and their strategy is proving effective as their sales grew 63%10 in 1Q 2017 relative to Costco’s online growth of 10%11.  To have Costco most effectively harness the power of digitalization, I would advise they target their digital strategies on the part of their business where they are most vulnerable to competition from Amazon and Walmart which is their limited number of products offered.   By increasing their e-commerce, they will be able to expand their product offering far beyond what they are able to keep in stock within the store.

Additional Critical Questions

A critical question that will be important for Costco to monitor as the digitize their product offering and expand their e-commerce will be whether they can do so while maintaining their low prices which have always been their competitive edge.  When Costco recently announced that they were going to allow customers to place bulk orders online, their stork fell 6%12 reflecting investors’ concern around Costco’s ability to compete online with Amazon.  Furthermore, it is will be important to consider whether Costco will be able to execute on a plan to increase their online sales or if perhaps this deviates too far from their core strategy focused on delivering a great in-store experience at the lowest possible prices.

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Bibliography

[1] Costco Wholesale Corporation, “The Costco Story,” https://www.costco.ca/about-us.html, accessed November 2017

[2] Kate Taylor, “Costco is staying ‘Amazon-proof’ as other retailers crumble,” Business Insider, February 3, 2016, http://www.businessinsider.com/how-costco-is-staying-amazon-proof-2016-2, accessed November 2017

[3] Sarah Nassauer and Laura Stevens, “Why Costco Loves Store Sales: You Try Shipping a Tub of Mayo,” The Wall Street Journal Online, April 5, 2017, accessed November 2017

[4] Ibid.

[5] Biz Carson, “The Amazon-Whole Foods Deal Could Have Killed Instacart. Instead, The Startup Is Stronger Than Ever,” https://www.forbes.com/sites/bizcarson/2017/11/08/amazon-whole-foods-deal-future-of-instacart-grocery-delivery/#2f89814d6d5a, November 8, 2017, accessed November 2017

[6] Costco Quarterly Call, “Costco Wholesale Corporation’s (COST) CFO Richard Galanti on Q4 2017 Results – Earnings Call Transcript,” https://www.msn.com/en-us/money/news/costco-wholesale-corporations-cost-cfo-richard-galanti-on-q4-2017-results-earnings-call-transcript/ar-AAsYrss, October 10, 2017, accessed November 2017

[7] Brad Tuttle, “Are Prices Cheaper at Amazon, Walmart, Costco, or Jet.com?,” http://time.com/money/4835823/cheapest-prices-amazon-walmart-costco-aldi-jet-com/, June 29, 2017, accessed November 2017

[8] Sarah Nassauer and Laura Stevens, “Why Costco Loves Store Sales: You Try Shipping a Tub of Mayo,” The Wall Street Journal Online, April 5, 2017, accessed November 2017

[9] Jacques Bughin, Laura LaBerge, and Anette Mellbye, McKinsey & Company, Digital McKinsey Quarterly, “The case for digital reinvention,” https://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/the-case-for-digital-reinvention, February 2017, accessed November 2017

[10] Phil Wahba, “Walmart’s U.S. Online Sales Rise 63%,” http://fortune.com/2017/05/18/walmart-online/, May 18, 2017, accessed November 2017

[11] Sarah Nassauer and Laura Stevens, “Why Costco Loves Store Sales: You Try Shipping a Tub of Mayo,” The Wall Street Journal Online, April 5, 2017, accessed November 2017

[12] Emma Hinchliffe, “Costco will finally deliver all those giant bulk items with its new grocery service,” October 7, 2017, accessed November 2017

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8 thoughts on “The Digitalization of Costco: A Necessity to Compete with Amazon and Walmart

  1. The Costco/Amazon/Walmart comparison is really important, but beckons the question of whether it is in Costco’s long term interest to compete with Amazon and Walmart online directly. First, so much of Costco’s value proposition is based on selling in bulk, which translates to lower unit costs. However, in this model, the customer bears the cost of transportation of the good from the Costco warehouse to their home. Since many of these items are quite heavy, I am concerned that Costco may lose its price advantage (and, therefore, value proposition) if they had to cover shipping costs that don’t currently exist. Additionally, at least in my experience, a significant fraction of the items sold at Costco are not on the shopping list of the consumer when they enter the store. Rather, the stores are laid out in a manner very conducive to “impulse buys”, which greatly increase the overall cart value. Creating a similar model online is extremely difficult.

    I am also quite concerned about Costco’s strategy to sell to non-Costco members (for a premium) on their e-commerce platform. While it may be in Costco’s short term revenue interest to do so, I believe it deviates wildly from their current strategy. Further, if non-members are able to shop online, it disincentives these individuals from becoming a Costco member, and degrades the value of a Costco membership to all of its existing patrons.

    Overall, I think that Costco requires some sort of online strategy, but it will have to follow a model quite different than that of Amazon or Walmart.

  2. Thinking about digitalization for Costco is another example of a major retailer that will face challenges as online shopping becomes more and more prevalent. Amazon/Walmart (which acquired Jet.com, an online wholesaler) have leveraged their online presence and the logistics network to delivery all sort of items to customer. This shows that Costco has an opportunity to also build up their e-commerce presence, and to find unique ways to move its current customers online and gain new ones. Because many shoppers regularly purchase the same items from Costco in bulk (toilet paper, snacks, toiletries, etc.), Costco should take advantage of customer behavior and the data it can collect to put customers on subscription services for specific items. If Costco can regularly ship these items to its customers, and have them engage with the retailer online, it can shift their existing customers to buy from them online as well. The more data Costco can collect through online shopping behaviors, the better it can target customers with deals and attempt to up-sell them on items, taking some of the in-store sampling experience online. Costco should also increase it’s web presence by implementing online advertising and SEO tactics to gain new customers, especially those who already search and shop for items online that Costco also carries. Costco’s bulk pricing structure allows it to be competitive to other retailers, and it can still replicate this online since the e-commerce infrastructure is less capital intensive than building new stores. It’ll be interesting to see how Costco continues to adapt to the digitalization beyond Instacart and Google Shopping Express, because relying on third party services will always squeeze out their margins.

  3. I agree with LP’s comment above, that e-commerce can actually provide unique opportunities for Costco relative to its competitors. I think Costco’s focus on bulk, non-perishable goods lends itself quite well to e-commerce; customers don’t have to worry about carrying and transporting large items home from the grocery store, and can instead have these items delivered on a regular basis. Costco can also focus on selling its non-food & beverage items that it has in-store, such as electronics. Shoppers have become much more accustomed to buying these items online relative to groceries, so Costco can use these categories to get consumers onto their e-commerce platform. I do, however, worry about Triston’s point about Costco’s limited selection. I think this is an advantage for them in-store, but online shoppers are accustomed to comparing many options within a given category. I think Costco will have to balance this dynamic as they seek to build out their online presence.

  4. Very interesting article, Triston. One of the first quotes that stuck out to me was that of Costco’s CFO, saying that they were “a little late to the game on purpose”. In today’s economy, being late is extremely costly (as several taxi companies can attest to). The Whole Foods purchase by Amazon (and before that, the Jet.com purchase by Walmart) has put a lot of pressure on Costco moving forward. An interesting question to ponder: As Costco spends money to further their expertise in digital, will they be able to keep the low prices they have become known for? I think this will go a long way in deciding whether they can compete with Amazon moving forward. I’m also wondering if they will keep advertising the “bulk buying” that they have done in the past. Do consumers want to buy in bulk online? Personally, I do not. It will be interesting to keep an eye on this over the next several months.

  5. Thanks for an interesting read Tristan! I would push back that Costco actually needs to digitalize their core business as online grocery sales only make up 1.9% of all grocery sales (see article below). I think that in the short-term they should focus on their core mission of providing low prices to customers in bulk. I don’t think they should ramp up online sales infrastructure in the short-term as this while squeeze their margins and could cause prices to rise in store to make up in the difference.

    In the medium term when online grocery stores may actually become substantial, I think Costco should look for an acquisition that can enable them to quickly ramp up their online presence so that they then don’t see their sales erode. In particular, they should focus on building this presence and infrastructure in high metropolitan areas where car ownership is lower and therefore food delivery services are more widely used.

    https://www.washingtonpost.com/news/the-switch/wp/2015/01/20/the-staggering-challenges-of-the-online-grocery-business/?utm_term=.ca2da3945ade

  6. Tristan- I enjoyed your analysis of this existential question for Costco (and indeed, most brick & mortar retailers). I agree that Costco is challenged to adapt its business model to compete with the likes of WalMart (Sam’s Club having a nearly identical model to Costco, and Jet.com as Justin pointed out) and Amazon/Whole Foods.

    While I’m normally critical of incumbent businesses and their habit of failing to adapt to changing conditions, I actually believe Costco is at less risk than other retail businesses. While they should embrace a larger online presence, I think Costco’s customer base are far more “sticky” than retail consumers on average. This is because Costco customers tend to be more price-sensitive (hence shopping in bulk and not prioritizing brands), and plan purchases farther ahead (to obtain bulk items, travel to Costco location) than convenience shoppers who go to nearby retail locations or shop for convenience online. I think Costco faces a major challenge trying to shift their bulk model to online sales, as the shipping/delivery costs have to be baked in to prices and that erodes a major portion of Costco’s model- having large stores farther from urban centers that people are willing to plan and drive to to buy large amounts of items. Changing central pieces of this model will be difficult for Costco.

  7. Jet.com’s ability to compete directly with Amazon will be a tough. There are few advantages that Jet.com is offering that cannot be copied and better executed on by Amazon. For example, Jet.com’s strategy to pass on the savings generated from its “dynamic pricing system” is presently being offered through “Amazon No Rush Shipping,” which offers consumers compensation for opting in for a longer delivery timeline.

    Consumers are shopping for the best price. As a result, survival in the industry will be determined by the player who can most efficiently fulfill orders. Jet.com’s only path to success will be to leverage the cost efficiency produced by its parent company’s 4,700 stores, hundreds of distribution centers, and 6,200 trucks. [1] If anyone can take on the giant Amazon, it’s Wal-Mart; however, it won’t be an easy win.

    [1] Brad Stone and Matthew Boyle, “Can Wal-Mart’s Expensive New E-Commerce Operation Compete With Amazon?”, Bloomberg, March 2017, Accessed December 2017

  8. Great article Tristan! I would agree that Costco needs to innovate in this space and gain scale sooner than other competitors to stay relevant online. In the article you mentioned Costco’s strengthened partnership with Instacart, however, I wonder how Costco will compete with Amazon’s delivery / distribution network. In addition to Costco’s higher cost of delivery, they still need to maintain lower prices to stay true to their customer promise, further diminishing profit margins.

    I was also surprised at how far Costco is lagging behind Walmart, with 10% vs. 63% growth. This is a topic I would like to dig into more, and I wonder if acquisitions occurred at Walmart, leading to the large jump.

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