With over 100 million members worldwide and over 90% renewal rate, how did Costco achieve this success?

In the retail market, membership-based supermarkets have achieved remarkable success with their unique advantages. This article takes Costco as an example to analyze how it has formed unique competitiveness through ultra-low-priced products, refined product selection management model and strong private brands. These strategies have not only brought great success to Costco, but also provided valuable reference for other membership-based supermarkets.

From low prices to high quality, what is the operating secret of membership-based supermarkets?

While HEMA in China is still hesitating about its membership system and pondering how to balance the membership system with discount strategies, Costco, a pioneer in the industry, has already had 130 million members worldwide, which means that one out of every 80 people is a member.

This membership-based retail store, founded in Seattle in 1983, attracted a large number of middle-class people who were affected by economic stagflation and reduced income at that time and began to seek high-cost consumption. Before that, these people were only keen on patronizing large department stores such as Walmart and Macy's.

The membership stores that were established in the same year as Costco include Sam's Club under Walmart and various other unknown supermarkets of the same type. However, in the following decades, Sam's Club, backed by Walmart's strong supply chain system and financial foundation, expanded rapidly in North America, and Costco also expanded its market share through acquisitions and mergers. The market structure of membership retail stores gradually evolved into a three-way competition among Costco, Sam's Club and BJ's Club.

It is worth noting that after 2008, Costco has survived two global economic fluctuations and its performance has continued to rise against the trend, even surpassing the share of Sam's Club. To this day, Costco's market advantage continues. Not only is the number of stores in the United States comparable to Sam's, but its annual revenue is even close to twice that of Sam's. In the most recent fiscal year, Sam's Club's net sales were $86.2 billion, while Costco's net sales in its U.S. stores were as high as $176.6 billion.

Today, Costco has a market share of over 60% in the global market, while Sam's Club has a market share of less than 30%. People attribute the reason to Costco's continuous global expansion and its continuous optimization and innovation of its business model. This is also the point we want to clarify. At a time when competition in the membership retail industry is becoming increasingly fierce, what exactly did Costco do right?

01 Where do super low-priced products come from?

In the last century, hypermarkets such as Wal-Mart lowered their purchase prices by purchasing in large quantities. In order to be more competitive in terms of price, membership-based companies further streamlined their purchase categories, reducing them from 30,000 to less than 10,000. Compared with ordinary supermarkets, with the same number of consumers, membership-based companies purchase larger quantities of each product, thus gaining higher bargaining power with suppliers.

Currently, Sam's Club has about 5,500 SKUs, while Costco has further reduced it to 3,800. As the number of Costco stores expands, the supply of a single SKU is also increasing. Today, Costco has 871 stores worldwide, and the annual sales of a single SKU is as high as 59.42 million US dollars, which is far more than Sam's Club's 15.33 million US dollars.

With highly streamlined SKUs, each category usually has only 2-3 optional products. Faced with limited product selection and a large membership base, Costco's annual inventory turnover rate is very high, more than 12 times according to statistics. This means that within only 30 days, Costco can sell all its inventory and settle the payment to suppliers in a timely manner. In contrast, Walmart's inventory turnover days are usually kept at around 45 days.

With its huge supply volume and extremely short settlement cycle, Costco has a very high bargaining power with suppliers. This not only allows them to require suppliers to supply goods at prices lower than the industry average, but also allows well-known brands to customize products for them. For example, at Costco, customers often see products sold in larger packaging specifications and at lower prices.

Costco only adds a very low gross profit margin to the purchase price for sales. Founder Jim Singer once publicly promised that the company's gross profit margin would not exceed 15%. In fact, Costco's gross profit margin has long remained at around 11%, far lower than Walmart's 25%.

So the question is, why is Costco's gross profit margin set so far below the market average?

Costco's historical operating data

According to the financial reports of previous years, Costco's annual operating costs plus taxes account for about 10% of its sales, which is equivalent to its gross profit margin. This means that almost all of Costco's profits from selling goods are used to subsidize daily operating expenses. This strategy actually reflects the core concept of the membership retail system: it does not make profits by selling goods themselves, but relies on membership fees as the main source of profit.

In addition, each product category selected by Costco is packaged in large volumes, so that after the supplier delivers the goods to the store, it can be directly placed on the shelf with a forklift, eliminating the need for additional sorting work and thus reducing labor costs. In addition, since the store also serves as a warehouse, the storage cost is reduced, which can be passed on to customers in the form of a lower gross profit margin.

02 How to ensure quality while keeping the price low

Compared with membership-based supermarkets, traditional retail supermarkets are often less demanding on quality when selecting products. With a large number of SKUs, more than 10 brands will be available in each category. Consumers select the products they need in the store, and the sales data generated will guide the subsequent listing of new products and the elimination of old products. This product selection method has a relatively high tolerance rate. Even if consumers are not satisfied with a brand of product, it will not have much impact on the store's short-term turnover and customer return rate.

However, for membership retail stores that require paid admission, the selection of each category is compressed to only 2-3 brands, and the success of product selection is directly related to the store's revenue and member satisfaction. Therefore, the purchasing department of membership retail stores needs to accurately capture the preferences of target customers and then actively find the best and most suitable products for them.

Costco adopts a refined product selection management model. Costco will set up procurement teams for different categories. The leaders of this team are usually promoted from experienced internal employees. They are divided into two categories: one is people who have a deep understanding of the purchased goods and can see into future consumption trends; the other is experts with rich experience in the procurement field. They are responsible for formulating the product selection principles.

In addition to the person in charge, Costco also equipped the team with more than 100 high-paid buyers, and clearly assigned the selection, tracking and adjustment tasks of each single product to these professionals. With a product library of 3,800 SKUs, each buyer is only responsible for less than 38 products, so they can analyze market trends more attentively and meticulously, query and analyze customer consumption records, and record the sales of each single product, so as to more accurately determine which products can be put on the shelves or adjusted.

In addition, each buyer is responsible for updating 3-15 categories every year. According to online feedback, the shelf life of many of Costco's products is only 2-3 weeks, and many best-selling products and seasonal products are only put on the shelves once. This not only increases the sense of freshness for shoppers, but also enhances Costco's market adaptability and competitiveness.

This selective supply model of Costco was later borrowed by Hema Fresh and improved into the "buyer system": they hired more than a dozen experienced buyers from home and abroad to go to the core production areas of the goods, select those niche, distinctive and quality-guaranteed products, and supply them directly to the stores.

However, after years of accumulation, Costco's global product supply system has been very complete. Currently, Costco has 871 stores around the world, covering many core markets.

In addition, every time they enter a new market, the team will select and introduce high-quality local suppliers to continuously enrich and improve their supply chain system. At the monthly exchange meeting of the procurement team, each buyer will also share the popular products in their market for other buyers to refer to and introduce. This scale barrier is difficult to break through in the short term.

03 Private brands form unique competitiveness

In the last century, it was not easy to select a large number of distinctive and high-quality products for stores. In the United States, popular categories such as Coca-Cola already have mature brands that do not rely on large-scale purchases by a single supermarket to expand sales, nor do they reduce product prices to a level that satisfies the purchasing team.

In order to compete with these famous brand products, major supermarket chains in the United States began to launch lower-priced private-label products in the early 20th century. These products were generally produced by third parties, and some were produced by supermarkets’ own factories. These products initially competed with mature brands with the advantages of homogeneity but low prices, but later gradually gave up the requirements for quality and won with ultra-low prices. It was not until the second half of the 20th century that this trend gradually reversed. In the 1990s, even higher-end private-label products began to appear.

Costco's own brand was also born at this time. In the process of expanding into overseas markets, in order to stand out in the fiercely competitive British and Canadian markets, Costco's CEO Singh wrote to suppliers, hoping to create a private brand that could replicate the quality of overseas brands and provide consumers with a lower price. In fact, Costco was already selling more than 30 kinds of its own products with various styles at that time, but there was no unified logo and the recognition among consumers was not high.

In 1995, Costco unified its existing private label products under the brand name Kirkland, which was named after the address of Costco's original corporate headquarters.

In order to ensure the quality of its own-brand products, Kirkland usually establishes partnerships with well-known manufacturers around the world, which are often the production lines of the leading brands in the market. In this way, Kirkland ensures that its products are comparable to well-known brands in quality while maintaining competitive prices.

For membership stores, private brands are the core of their unique value proposition. These stores are able to customize products according to their market positioning and the specific needs of their customers, and even if these products have relatively low profit margins, they can still achieve profit growth through large-scale sales. Therefore, many membership stores have launched private brands to meet the expectations of members and consolidate their market position.

In this case, membership stores’ requirements for their own brands do not just remain at the basic level of low price and high quality, but need to highlight the uniqueness of the brand in order to maintain user stickiness.

Take Hema X Membership Store as an example. It can be regarded as an "aggressive player". Since its opening in 2020, Hema X Membership Store has successively launched Hema Garden, Hema X18 Wine Cellar, Hema Bakery and other businesses, trying to enhance the recognition of its own brand by building life scenes.

In contrast, Sam's Club continues to upgrade its own brand Member's Mark, optimize its quality, permanently reduce the price of some products, and gradually increase the proportion of this brand's products in the total products to further occupy the minds of users.

Many people believe that this is to cope with the competitive pressure from Costco stores. In contrast, Kirkland has only more than 200 kinds of goods, which is a lower proportion, but its sales account for a larger share, reaching 25%. This also confirms that Costco's own brand may have entered the mature stage earlier than them.

Author: Zhang Xue

Editor｜Lu Yao