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JULY 2010

Costco's Challenge for CPG Vendors
By Tom Ryan, Managing Editor, RetailWire

While the market potential for Costco is large, its SKU-constrained environment, margin requirements, private label acumen, and regional buying prowess place numerous challenges on CPG companies versus other channels, according to a recent report from L.E.K. Consulting.

L.E.K. said many CPG companies focus their marketing and innovation planning process around mass retail and grocery chains "with 'alternative channels' such as Costco addressed as afterthoughts. This orientation rarely leads to success." Among the challenges for CPG vendors mentioned in the report:

1) Limited Selection: Costco's focused SKU selection reduces operational costs by streamlining its supply chain and simplifying in-store management but this "limits the freedom available to CPG companies - many of which are accustomed to owning prominent real estate in store aisles."

2) Price Conscious: While most other channels mark-up merchandise, Costco can sell merchandise at close to break-even levels and gain a majority of its profits through membership fees. L.E.K. said this results in Costco placing relentless price pressure on CPG vendors to sell products at low profit margins.

3) Private Label Power: Since Kirkland Signature was launched in 1995, private label has grown to around 20 percent of its sales and its goal is to reach 37 percent. In some cases, Kirkland Signature can command a premium in specific categories through quality product. Wrote L.E.K, "If Kirkland Signature leapfrogs a CPG company in perceived quality and associated premium pricing, it becomes extremely difficult for the CPG vendor to reestablish category momentum at Costco."

4) Distributed Purchasing: Costco puts a strong emphasis on addressing regional preferences, such as a greater demand for salsa in the Southwest. It also procures goods on
a local basis and provides managers at each warehouse with some discretion over what goods they carry. L.E.K. wrote that this "requires CPG companies to sell to a myriad of Costco buyers across multiple levels, which makes national clearance challenging for vendors."

L.E.K. then offered three tips to overcome common missteps. First, it advised CPG makers to develop a "Costco-Specific Business Plan." L.E.K. wrote, "Costco is a unique retailing environment and is probably among the most challenging that CPG companies will face."

Second, CPG companies should focus on "margin dollars" over the "margin percent" guideline it typically uses. Wrote L.E.K., "Costco will never deliver the same gross margin as grocery or mass retailers, but it can deliver large sales figures."

Finally, CPG companies should consider engaging club retailers early in the product development phase and elicit feedback from them. More than other channels, opportunities exist to be part of sampling programs. Wrote L.E.K. "Working in conjunction with receptive warehouse club buyers, savvy CPG companies can develop and trial warehouse products before launch to traditional channels - the reverse of the common pattern between club retailers and CPGs."

Discussion Questions: What do you see as the unique challenges for CPG companies in selling to Costco and other warehouse clubs? Would you add anything to the suggestions offered in the article?

RetailWire Instant Poll Results:

RetailWire BrainTrust Comments:

Warehouse Clubs do present unique challenges to consumer goods companies. I strongly believe that most can be overcome but here is my short list of considerations:

1. Special packs - most consumer goods, including HBC, need to be packaged in a very unique way not otherwise serviceable in other accounts or channels of trade.

2. Sizes - hernia sized packaging can be expensive to pack, warehouse, and ship. Keep in mind that only clubs will be buying these special sizes so forecasting and inventory needs to be "exact" to avoid losses and waste.

3. Forecasting - never easy when it comes to Club stores. Distribution is often sporadic and difficult to predict.

4. Shelf displays - in the world of HBC a special PDQ display box is often required. The needs are very specific and not the same for all Club accounts.

5. Terms - most club transactions require extended dating. Therefore, the supplier needs to make the investment long before payment materializes.

Overall, I think the trials and tribulations are worth the end result. Club Stores are a significant part of the CPG retail landscape today and consumers that shop there tend to be loyal to the brands they purchase.
David Biernbaum, Senior Marketing and Business Development Consultant,
David Biernbaum Associates

Add this to David Biernbaum's fine set of considerations. The club trait that makes forecasting difficult for manufacturers is one of the characteristics that keeps shoppers coming back--the thrill of the hunt. Shoppers recognize that they might not see the same products in club stores, even on consecutive visits. So, manufacturers could embrace this character trait and run with it, rather than wasting efforts trying to fight it.
Dan Raftery, President, Raftery Resource Network

Outside of the key issues that other panelists brought up (bulk sizes, limited SKU count, exclusives), it's also important to keep in mind the particular challenges of doing business with warehouse clubs. As David pointed out, forecasting is a big issue, along with the logistics of bulk deliveries, etc. CPG companies that have put a lot of effort into supply-chain "partnership management" with their key discount, food and drug accounts would be wise to put some human resources behind warehouse clubs like Costco with rapidly growing market share.
Richard Seesel, Principal, Retailing In Focus LLC

There are two key challenges to working with Costco for CPG vendors. The first is the litany that David has cited above.

The second, and perhaps more vexing as well as more fundamental, is that Costco is one of the first retailers to have fully adopted a "retailer as marketer" mentality. And they still rank far ahead of most traditional Food/Drug/Mass retailers in their adherence to the principals and implementation of the theory of this strategy.

This presents a unique cultural challenge--particularly for U.S. vendors. Vendors feel they go through tremendous hoops to do business with Costco, working to understand and meet their needs. But I would go so far as to say that most vendors today do business with Costco because Costco allows them to--not because they present a compelling proposition that furthers Costco's marketing strategy.
Ben Ball, Senior Vice President, Dechert-Hampe

The challenge, as most have mentioned, is to create specific value-added items to assortments or as product launches. The supermarket mentality of making a different flavor and gaining shelf space is not a strategy that has any value in a club environment.
Charlie Moro, President, CFS Consulting Group, LLC

Now hear this CPG companies: If you want to play with Costco (or any other club) understand that they set the rules. They don't care what you think. They don't care what your advertising does. They don't care how many coupons you drop.

Costco cares about one thing, its customers. And, those customers are not the mass that CPGs market to. Costco's customers go to Costco rather than the Kroger for a reason.

When the club stores first started in the '80s, my company designed programs and products specifically for that channel. That design wasn't only in the packout, but we included everything from supply chain to pricing. We were interested in moving merchandise, as was the retailer. The channel was not a burden for us, but a huge opportunity.
Gene Detroyer, Entrepreneur, Advisor, Consultant, Counselor, Independent

Ben's observation above is an important one. Costco is a rare retailer that knows what it wants, how it wants it, and why. Any attempt to maneuver Costco into a merchandising decision for the supplier's convenience is likely to fail.

But that shouldn't rule out fact-based conversations about such meaningful issues as pack sizes, flavor assortments, PL-brand price gaps, GMROII and other nuances of merchandising. Yes, you need Costco-specific analysis and strategy to talk this talk, but the sheer size of the prize justifies the effort. What other retailer displays a full pallet of your item at a time?
James Tenser, Principal, VSN Strategies

The Costco store near my home regularly turns $1 million per day in sales. As with Stew Leonard's, I spend a lot of time thinking about the core business principles that allows this business to knock the ball out of the park. Just commenting on one of those:

"[It is] extremely difficult for the CPG vendor to reestablish category momentum at Costco."

No wonder. Costco is NOT a category management company, but rather, and ITEM MANAGEMENT company:

"Well, we have never been a category company--that was decided long before I came...We look at it item by item. That doesn't mean we don't have a fair representation with a category. But usually it's only the top five or six items in that category, and we look at them as items." - Charlie Burnett, COSTCO

The importance of item management, NOT category management, is absolutely essential to their success. Any retailer or brand could profit mightily, not by abandoning category management, but by overlaying item management strategy on top of category management. This is the fastest route to double digit sales increases across the industry: channels, chains, brands--whatever.
Herb Sorensen, ScientificAdvisor, TNS Global Retail & Shopper Practice

Read the entire story and RetailWire discussion at:


Costco's Challenge for CPG Vendors
August 2010
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