Trading with Costco

Identifying how it plans to win and the supplier opportunities

February 17

Stewart Samuel Based in North America, Stewart Program Director, IGD Canada heads up all of IGD's research and coverage on the region. He regularly [email protected] travels across the US and Canada, @Stewart_IGD visiting stores, and meeting with senior retail and supplier teams.

Costco continues to be one of the most successful retailers globally. For several years it has delivered consistent sales and profit growth, in the US and across its international markets. Currently it is the second largest retailer globally based on sales. At a time when other retailers have been testing and developing new store formats and aggressively pursuing ecommerce and digital initiatives, Costco has remained focused on its core offer. However, the retailer is making a more determined push with ecommerce and is set to expand its presence into two new markets this year. In this report we look at how the retailer plans to grow and develop over the next five years, and the opportunities for suppliers to engage in key markets.

Costco today and tomorrow

Costco in key markets

Strategic priorities

Supplier opportunities

© IGD 2017 Page 3 Costco operates over 700 clubs across nine countries, with over 86m members. It Costco today plans to open its first clubs in France and Iceland this year. It also sells in China through its online Tmall store. While many of its existing markets offer significant expansion opportunities, regions such as Latin America and the Middle East and Africa could, over the long-term, be a source of future growth.

Current markets

Future markets

Ecommerce only

Country $m 2016 $m 2021 CAGR % Clubs 2016 Clubs 2021 USA 86,579 109,865 4.9% 501 585 Canada 16,756 21,690 5.3% 91 110 Mexico 2,670 3,570 6.0% 36 41 UK 2,749 3,693 6.1% 28 33 Japan 2,611 3,131 3.7% 25 29 Australia 1,116 2,012 12.5% 8 15 South Korea 1,323 1,880 7.3% 12 17 Taiwan 1,165 1,746 8.4% 12 17 Spain 244 524 16.5% 2 6 Total 115,214 148,113 5.2% 715 853

Strengths Weaknesses

• Successful operating model focused on the intersection of • Significantly invested in ‘big-box’ retailing; its model contrasts quality and value with the shift towards smaller formats • Demonstrated success with single core format, which has strong • Costco maintains a relative conservative approach to new store appeal globally growth • Continues to invest in developing its Kirkland Signature private • Current expansion plans are focused on tough and mature label range, offering further headroom for growth European markets

Opportunities Threats

• The retailer could significantly increase the pace of international • A change in leadership at Sam’s Club, and the ongoing expansion; Costco has no exposure in South America or the investment in digital initiatives could pose a stronger threat Middle East within its home market • Although it is increasing the pace of ecommerce investment, this • The development of alternative wholesale formats in Latin is an area where it could move even more quickly America could limit further opportunities for Costco in the region and in Mexico • Auto replenishment and online subscription services for commodity items

© IGD 2017 Source: IGD Research Page 6 With operations across nine markets, soon to be 11, we review Costco’s priorities Key markets to across four of its current operations, and its future entry into the competitive French market. watch

USA

Canada

China

France

Costco’s home market represents 75% of all of its sales, making success here essential in Sales 2017-2021f determining the overall performance of the 120,000 company. While Costco faces a significant competitor in 100,000 the form of Walmart’s Sam’s Club operation, its growth has outpaced this business for 80,000 several years. 60,000 However, with a number of new initiatives launched to re-position Sam’s Club, and $m US 40,000 channel leadership established with its digital and ecommerce programs, Costco could see 20,000 a more formidable competitor emerge. 0 2017 2018 2019 2020 2021 Club Online

The US market leads Costco’s ecommerce The US market accounts for around initiatives, particularly in terms of half of all Costco’s new store openings partnerships with third-party companies each year. The retailer continues to which deliver its in-club offer. Success here see significant scope for further could lead to similar partnerships being set expansion both with its core model up in other markets. and its Business Centres.

Canada has been one of Costco’s most successful international markets for a Sales 2017-2021f number of years. 35,000 In addition to developing a proposition which 30,000 has resonated strongly with Canadian shoppers, the retailer has faced limited 25,000 competition in the channel. 20,000 However, more recently Loblaw has started to place an increased focus on its Wholesale 15,000 Club format, although the offer remains more $m CAD 10,000 focused on business owners, compared to Costco which benefits from a solid base of 5,000 individual shoppers. 0 2017 2018 2019 2020 2021 Club Online

As Costco approaches 100 clubs in Canada, Costco will open seven new clubs in it is getting close to its headroom. However, the current financial year, including its there is potentially room for more sites than first Business Centre outside of the initially anticipated in order to relieve US. This represents a significant pressures on existing locations. Expect to ramping up of new space as it looks to also see a stronger focus on ecommerce. build on its existing success in the market.

Costco launched in the UK in 1991, and now has 28 warehouses in the market, making it Sales 2017-2021f Costco’s fourth largest national operation, and the biggest outside of the Americas. 3,500 Owing to trading regulations, Costco UK has 3,000 a stronger ‘trade’ focus than other markets, 2,500 specifically targeting independent retailers and caterers, both with discounted 2,000 membership and longer warehouse opening 1,500 hours. Sales £m Sales 1,000 The online offer was launched in 2012 and has grown quickly (now worth almost 3% of 500 total sales). It is also rolling out gas stations to expand its warehouse offer, with four now 0 operating and more in development. 2017 2018 2019 2020 2021 Expansion in the UK has been steady rather Club Online than spectacular, slowed by restrictions in development regulation. However, Costco New space is forecast to drive around opens 1-2 sites each year, and sees overall half of total sales growth ongoing. As potential for up to 40 in the market. well as adding new services, Costco UK has successfully driven like-for-like Future growth will also be supported by sales with ongoing improvements and online development, as well as adding Price-marked packs for resale, targeting independent retail customers. promotional activity focused in its food services like gas stations to existing sites. and sundries categories.

Costco first entered the Australian market in 2009, with the initial stores among the most Sales 2017-2021f successful it has opened globally. Since then 3,000 the retailer has gone on to grow its estate and attract new shoppers to its proposition; it is estimated to have around 150,000 2,500 members. 2,000 It continues to leverage its advantage as the only retailer with a complete food, general 1,500 merchandise and clothing offer under one roof. AUS $m AUS 1,000

500

0 2017 2018 2019 2020 2021 The main aim for Costco Australia is to build Costco is expected to open two further scale in major cities before embarking on the clubs in 2017, with its sales expected roll-out of the brand to smaller cities. The to break the $2bn barrier in 2018. market holds significant potential for the retailer to continue growing share through a run rate of one to two new clubs each year.

Costco entered China in 2015 through its strategic partnership with Alibaba’s Tmall. While this has been a major success for Costco, no decision has yet been made with regards to building a physical presence. The partnership has enabled it to leverage Tmall’s existing customer base and logistics infrastructure. Walmart continues to generate strong appeal with its club format, Sam’s Club, both through its physical stores and, more recently, online through its partnership with JD.com in China. Although this suggests a solid growth opportunity for Costco, the forecasted growth for the online channel in China provides the retailer with a solid run-way for growth through continuing to grow the product range.

To maintain hypermarkets and, albeit France is a price-focused market. to a lesser degree, supermarkets’ Leclerc maintains price leadership, Costco is expected to open its first club in relevance to today’s shoppers, with this accentuated by other’s recent France this year. This has been in retailers in France have been strongly financing of price cuts, which has development for a number of years as the investing in their stores to make them been enabled by buying alliances at a retailer has focused on securing the right more welcoming. This will contrast national and regional level. In this location for its launch. with Costco’s relatively austere in- setting, Costco’s membership model This builds on its entry into the Spanish store shopping environment. may be harder to land with shoppers. market in 2014. Costco will also open its first club in Iceland this year. Costco will open into an intensively competitive market in France, with global retailers – Carrefour, Casino and Auchan – and price focused retailers Leclerc and Lidl likely to be well prepared for its debut. While retailers in France will look to compete on price – especially Leclerc, which aims to be price leader in the country – all are also investing in their stores to make them more As retailers have invested in the price French retailers are more focused on attractive places to shop, which will of branded items, so private label’s their proximity stores, to offset slower differentiate them from Costco. share has fallen in volume and value growth in larger stores and as pick-up Costco will struggle to expand quickly in terms. The strength of brands and points for online orders. This has seen France, with the building of new stores their investment in marketing and the stores become more shopper and strictly controlled. This could limit pricing could affect a key differentiator mission-focused. Given Costco’s out- opportunities to build its brand with local for Costco, namely its Kirkland of-town store mode, this may limit shoppers in the country. Signature private label ranges. opportunities to attract shoppers.

Drive top-line growth through improving club productivity

Improve ecommerce and digital capabilities

Expand its international footprint

Investing in the food supply chain

© IGD 2017 Source: IGD Research Page 14 With over 700 clubs, Costco can add significantly to the top line through improving Drive club the sales productivity of each club. The retailer is aiming to do this through reviewing the categories and broader productivity services that it offers. In particular the retailer is focusing on building stronger appeal with younger shoppers.

Fresh foods Private brand Services

Costco is prioritising fresh food Costco aims to grow its Kirkland While Costco offers a broad range of development, with a number of new Signature range to around 35% of services which help to drive club products being added through its sales over the medium term, up from traffic, the roll-out of its fuel offer is ancillary service areas, including 27% to 28% currently. The retailer is taking priority. The retailer is currently bakery, deli, fresh meat and seafood. focused on pursuing opportunities in focusing on the US, Canada, Australia It has also been adding multi-deck new and existing categories through and the UK. With little brand loyalty in chillers to increase holding and display developing products with a higher the fuel segment, the retailer is capacities in clubs. quality perception than the brand attracting new shoppers with its equivalent, at a lower price point. consistent low-price approach.

© IGD 2017 Source: IGD Research, Costco Page 15 Costco’s ecommerce sales account for 4.7% of its total sales and continue to grow Improve strongly. The majority of these are generated in the US. The retailer has been a relative laggard in the channel, with the senior leadership ecommerce concerned with the impact on club traffic. However, recent investments in IT and related infrastructure, along with on-going channel partnerships, indicate that Costco is planning for ecommerce to be a more significant contributor to growth going capabilities forward.

Product offer Customer experience Supply chain

Its online offer has been developed as The investments which Costco has Beyond its partnerships in the US, complementary to its club offer and is made also support a better online Costco operates a delivery to home non-food focused. We expect to see it experience, including better search model. However, it is likely to offer more of its club offer online; in capability, faster checkout and complement this with a club pick-up the US it is partnering with Instacart, shipping, and online returns option as part of its focus on the Google Express, Shipt and Dolly to processing. However, further customer experience and optimising the enable customers to purchase its in- investment will be required as the profitability of the channel. The retailer club ranges. digital environment continues to is also adding a further dedicated evolve. distribution centre in the US.

© IGD 2017 Source: IGD Research, Costco Page 16 International markets account for around half of its new store openings each year Expand its (10-15 clubs internationally), although this is expected to increase as the US market becomes more saturated and the number of international markets grow. international Beyond its physical clubs, Costco is expected to deploy its ecommerce operation into existing markets. footprint

Core clubs Business Center Ecommerce

With two new markets planned for This year, the retailer will undertake its Over recent years Costco has 2017, we do not expect Costco to first international expansion with its expanded its online operations to six enter any additional markets over the Business Center model, opening in markets where it operates clubs, and short term. Many of its existing Canada. This format is focused more China. We expect to see the retailer markets offer significant opportunities on small business owners, including develop online offers in Japan and for further expansion, and sustain its restaurants, convenience stores and Australia to complement its physical current opening run-rate. food trucks. Success in Canada could locations. raise the prospect of testing in other international markets.

Developing a broader natural and organics offer is a priority for Costco, with its core target customer group demonstrating a high propensity to purchase these types of products. It has undertaken a number of initiatives to support this, including investing in the food supply chain, particularly in the US. It has been working with farmers to help them acquire land and equipment to grow organic products - demand continues to outstrip supply in a number of product categories. In order to win a greater share of its customers’ food spending, ensuring reliable availability of these products is essential for Costco. The retailer is also in the process of developing its own poultry farm, which will eventually supply one-third of all its chicken products. The retailer has been moving towards offering more antibiotic-free and cage-free chickens.

© IGD 2017 Source: IGD Research 2017 Page 19 We are bullish on Costco’s growth prospects Supplier A retailer to back over the next five years, driven by continued for growth space growth, food expansion, ecommerce initiatives and the robustness of its value implications proposition through different economic cycles.

Kirkland Signature will continue to be a Private brand is formidable competitor for many national on the rise brands given its focus on pricing and quality. Its premium positioning in some categories makes it hard to defend against on quality.

Support its Costco will soon have three relatively new international markets to manage and balance. Look for ventures opportunities to support and grow the global distribution of your products.

Costco is aiming to win with millennials, and will Align with a continue to evolve its product offer in line with shifting customer this. Review your product portfolio to see if there target base are additional opportunities to supply, and where you may be challenged by this shift.

Partner for The retailer is increasing the pace of ecommerce as investment in ecommerce. Lok for club offer shifts opportunities to build sales through this online channel with Costco, particularly as it makes more of its in-club offer available online.

What next?

Looking for more insight on the Want to know more about retail Planning a visit to see the latest US market? innovation? formats in North America? Click here to visit our retailer hub Click here to see the Top 20 Click here to read about our Retail Innovations of 2016 Safari programs