Costco Finally Embraces Ecommerce

In October 2017, Costco launched CostcoGrocery, a service that provides two-day delivery on about 500 nonperishable items.

While Walmart, Amazon, Kroger, and Albertson’s compete for online supremacy in groceries and household goods, Costco has until recently remained aloof, firmly committed to serving customers at its physical stores. The company, which operates on a membership basis, has 49.9 million member households. Of its 714 warehouses, 541 are in the U.S. Its business model is built around a store experience, not ecommerce. The company relies on impulse purchasing and believes that customers buy more than they intended once they cruise the warehouse aisles.

However, after Amazon acquired Whole Foods last August, financial analysts expressed concern that Costco would be vulnerable to Amazon’s continuing expansion in the grocery market. Costco’s stock price dipped, putting pressure on the company to respond. Analysts suggested that Costco’s consumers might defect to Amazon to purchase groceries that could be delivered in one or two days.

Costco and Amazon customers are quite similar in terms of income and demographics. Fifty-seven percent of Costco’s members are also Amazon Prime members, according to research firm MoffettNathanson.

Remaining Competitive

Costco executives have started to view ecommerce as a necessary component of the company. To become an online seller, Costco had to implement a competitive delivery program. Walmart and large grocery chains are offering same-day delivery, two-day delivery, and in-store pickup for orders placed online.

This month Walmart announced that it would deliver grocery items to 40 percent of U.S. homes by the end of the year. Currently, Walmart delivers online grocery orders to only six markets but plans to expand to 100 new markets by the end of 2018. The delivery service costs $9.95 per order and requires a $30 minimum purchase. Until now, Walmart focused on pickup of online grocery orders at outdoor stations at its stores. Amazon has in-store pickup at Whole Foods stores.

In October 2017, Costco launched CostcoGrocery, a service that provides two-day delivery on about 500 nonperishable items with free shipping on orders over $75. It also expanded its same-day online grocery delivery program through Instacart for about 1,700 items — including perishables — to more locations. The minimum order value is $35, and Instacart charges a service fee. Currently, 376 U.S. Costco stores participate. Costco has given its store associates tablets to facilitate online orders in approximately 195 stores.

Financial Performance

Costco executives make the case that the company has not experienced any negative impact from Amazon’s price cuts at Whole Foods. For the quarter ended February 18, 2018, Costco posted net sales of $32.28 billion, an increase of 10.8 percent year-over-year. Quarterly income rose 36 percent to $701 million year-over-year. Earnings per share rose 17 cents due to a net income tax benefit of $74 million, reflecting the new tax laws. Costco’s ecommerce sales grew 28.5 percent over the same 2017 quarter, to $1.5 billion, outpacing the company’s overall growth,

On Costco’s earnings call earlier this month C.F.O. Richard Gallanti responded to a question about the company’s ecommerce efforts.

The roll out of online grocery is a very small piece of it [ecommerce] as that’s just started — but it is driving traffic. I think the biggest things are awareness and cross-marketing, doing more activities in store to let people know what’s online and a better job of getting people to open their emails. We’re building some ecommerce fulfillment centers, in part because we’re running out of room in some of the depots where we did that.

Gallanti admitted that the company might have excess inventory and extra costs now because it is still calibrating the right mix as Costco manages same day deliveries.

Costco has also lowered prices to increase both in-store and online sales. “The average price per item has come down — we’ve done a lot to drive greater value,” explained Gallanti. He stated that lower prices have accelerated sales among Costco’s member shoppers, who are spending on both new and existing categories. “That’s nudged higher total sales and more margin dollars at the chain, largely due to negotiating better deals with suppliers.”

Costco’s Strengths

The company’s stock price has recovered from its decline in late 2017. Executives believe Costco can maintain its margins even while lowering prices because of the negotiating clout the company has with suppliers. It also gets much of its revenue from membership fees. In 2017 the company raised its basic membership fee to $60 from $55, the first increase since 2011. Higher rates exist for executive memberships that come with rebates.

With the addition of online shopping and delivery services, Costco has fortified its market position and is well positioned to compete with Amazon and other grocery retailers.