On 15th May 2014, the American chain Costco opened the doors of its first store in Spain, in the former ‘City of the Image’, Seville. The store is a warehouse club, a retail format in which customers form part of a kind of shopping association.
To fill the 140 employment positions at the Seville store, “148,000 candidates applied to the selection process”, says the director of Costco Spain, Diane Tucci (Ramírez, 2014). Before opening this first store, Costco had already directly created over 245 jobs in Seville and 60 in Madrid.
That day, not only were there thousands of curious onlookers observing the aisles of enormous shelves filled with products embracing American formats, but also queues of people waiting to pay the annual subscription of €30 that would allow them to start shopping there. Even before opening day, over 16,000 people had already become paid-up members.
All about Costco
Costco is not just any old company. In Deloitte’s 2014 league table, it ranked as the third leading retail company in the world (US$105.2 billion in 2013), with just Walmart and Tesco ahead of it. Its evolution and growth has been remarkable. Last year, it was the USA’s second biggest chain, and the sixth in the world, according to Deloitte.
James Sinegal, Costco’s former CEO, and Jeffrey Brotman, the company’s current chairman, co-founded the company in 1982. Sinegal was one of the brains and driving forces behind the concept of warehouse clubs.
On 15th September 1983, Costco opened its first warehouse club in Seattle and, in 1993, the company merged with Price Club. This union gave rise to PriceCostco, with 206 sales outlets across the USA and annual sales of 16 billion dollars. In 1997, all of the stores changed their name to Costco and, a year later, they launched their online sales platform, costco.com.
What is a warehouse club?
A warehouse club is a store of a size similar to a hypermarket (around 13,000m2) that offers a wide variety of product categories (food, homeware, electrical appliances, books, beauty, etc.), but with a very limited number of items per category. In total, they do not tend to have more than 4,000 lines of items, far fewer than an average hypermarket. Another key feature is the extremely low prices, almost at wholesale levels, as it is a no-frills store that aims to sell in bulk with margins no higher than 15%. However, not everybody can shop within this type of retail structure, only those that pay an annual membership fee.
This retail format is typically North American, with two large chains dominating the playing field: Costco, the market leader, and Sam’s Club, owned by Walmart.
The Costco formula and the challenges it presents
The definitive features of this formula are as follows:
- Really low prices. Costco often operates with a margin of just 10% (compared to the standard 20-30%), which is not popular with some of its shareholders, who believe that prices could be raised. This fact could deepen the price war in mass market retail in Spain (and particularly in a city as price sensitive as Seville), which is still reeling from the impact of Mercadona’s latest price drop this spring. Competitors will have to be extremely creative, strategically speaking, and even more so considering that the Spanish retail sector is one of the least productive in Europe.
- Their product range consists of known, reputable brands alongside their carefully developed own label (Kirkland Signature), which accounts for 15% of the product lines and 20% of sales. In fact, it is a ‘private brand’ (in other words, the product brand is not the same as the chain’s) but, just as in the case of Hacendado, it is linked to the brand in the customers’ minds, and it is greatly valued, with its reputation spreading by word of mouth. As such, advertising becomes less relevant.
- The fact that the product range within a category is fairly narrow is not a serious issue, if the lines available are relevant to the customers. A number of studies indicate that this minimizes confusion and avoids the categorization effect (Mogilner, Rudnick, & Iyengar, 2008). However, as food is a deeply cultural product, Costco will have to adjust its range to local tastes, which may initially limit not only its biggest selling point but also its economies of scale, as it will have to open itself up to new suppliers.
- A quarter of the range changes constantly, as is the case with Privalia and similar websites, in the form of special offers that are only valid for a limited period. These promotions focus on aspirational products, even to the extent of diamond rings. This involves the use of significant resources in terms of neuromarketing in retail: surprise and management of the imagination. Customers are drawn into the game of imagining what bargain they will be able to get their hands on next time they go.
- Two segments co-exist: the main segment of the general public, plus a secondary segment of small businesses. It is no surprise that this in particularly worrying for two chains (Carrefour and Macro), as it represents a direct challenge to them.
- In the USA, Costco sells to customers with higher purchasing power that Sam’s Club. In Seville, they will be faced with an official unemployment rate of 35% and a population that have become a lot poorer as a result of the economic crisis. In many countries facing economic difficulties, the public tend to buy in small amounts (for instances, two cigarettes), despite the unit price being significantly higher than if they bought in bulk, such as the formats sold in Costco. Nevertheless, there is the option of sharing a box of twelve units among several people.
- It takes great care of its clientele (facilitating the returns and complaints processes) and its employees, with salaries and benefits above the sector average. This policy was promoted by Jim Sinegal, who was convinced that paying workers well was a key factor of successfully executing Costco’s strategy (Thomson, 2009).
- This is not a matter of a type of store, but rather a business model. Costco earns 75% of its profit from its membership fees and 2% from its turnover, above the net margin of many Spanish retail chains. In other words, it starts the financial year with most of its profit already earned.
- Paying for the ‘right to shop’ may seem like an obvious obstacle to success, but the practice has two benefits: a) It differentiates the store from the crowd, helping to overcome the great similarity that reigns in the sector; b) If a customer pays to shop, this membership fee becomes a stimulus to go back: “I have already paid, I should take advantage of it”. There are two facts that validate this theory. Firstly, in the USA, the membership renewal rate is 90%. Secondly, Amazon Prime increases sales to customers who have paid for that service.
- However, front end cannot work with out an effective back end. Costco asks Spanish suppliers to adapt to the American way of doing things and, in some cases, different product formats. This results in inefficiency, complexity and, therefore, additional cost for suppliers, who have to work out whether it is worth bearing this extra burden for the chance of having a customer of this scale.
Costco is not an opportunistic company, but rather it steadily opens stores on a constant basis, with a long-term strategy, allocating resources wherever they may be needed, and with a great deal of patience. The initial losses that the company will face in Spain, due to its learning curve in a new market, are unlikely to concern the company’s executives in my opinion, or even Wall Street. At the heart of the matter, Spain is a rolling target, a step on route to the overall goal of Europe.
Mogilner, C.; Rudnick, T. & Iyengar, S. (2008) “The Mere Categorization Effect: How the presence of categories increases choosers’ perceptions of assortment variety and outcome satisfaction” Journal of Consumer Research, Vol. 35: pp 202 – 215.
National Retail Federation (2012) Top 100 retailers 2013.
Ramírez, V. (May 2014), “Costco inaugura su primer centro en Europa”. Available on: diariosevilla.
Thomson, A. (2009) “Costco Wholesale Corporation: Mission, Business Model and Strategy”. McGraw Hill Case Studies.
Source: Código 84, nº 180.