Warehouse giant Costco (NASDAQ:COST), which has operations in nine countries, including the U.S. and Mexico, still does not have any concrete plans for China. This is somewhat surprising considering that China is the second largest economy in the world with a huge retail market that stands well over $2 trillion and is growing at a robust pace. The region has been among the most preferred international expansion options for several retailers, apparel players and consumer electronic chains, but Costco has shown no significant interest in the market. The reason behind the warehouse retailer’s lack of interest in China is that foreign retailers have struggled to adapt themselves to the Chinese market. Retail giant Wal-Mart (NYSE:WMT), home improvement retailer Home Depot (NYSE:HD) and electronics chain Best Buy (NYSE:BBY) have had a hard time selling their products to discerning Chinese shoppers.
Costco’s CEO believes that the company does not need to focus on China at the moment since its operations in other Asian countries are going very well. At the moment, there appears no lack of growth for the company in domestic as well as international markets, which is why it has set China aside for later. It seems that Costco does not want to enter a market that hasn’t done much good for U.S. retailers so far.
Last year, there was a report in The Southern Metropolis Daily (a Chinese Newspaper based in Guangzhou) that Costco is looking for a local partner to launch e-commerce operations in China. While the report indicated that the company is finally looking to set its foot in China, launching only e-commerce websites might not be the best idea. Costco’s core value proposition isn’t limited to its low priced products, but also includes the shopping experience. While the company can offer cheaper products over the Internet, it cannot replicate the enticing store environment where shoppers have access to several ancillary services. With absence of those services, Costco may find it hard to make a strong first impression in the unforgiving Chinese retail market.
Our price estimate for Costco stands at $123, implying a premium of less than 5% to the market price.
See our complete analysis for Costco
The Chinese Retail Market Hasn’t Been Fruitful For U.S. Retailers
Chinese consumers are very cautious and their buying decisions aren’t always price driven. They are more inclined towards tailor-made products and a shopping environment that reflects local touch. Along with prices, Chinese buyers are concerned about authenticity and quality of products. Due to these factors, U.S. retailers entering the region haven’t been able to adapt themselves to the local environment, which has resulted in sluggish growth. Moreover, the Chinese retail market has a number of established local players who have outperformed their foreign counterparts with a better understanding of consumer behavior.
Despite offering lowest prices in the market, retail giant Wal-Mart hasn’t been able to attract customers. Chinese shoppers are accustomed to buying their groceries at local outdoor markets and Wal-Mart has been unable to customize its stores accordingly. On the other hand, its local counterpart, Sun-Art, has successfully recreated that environment with fishing tanks, in-store noodle stands, fresh seafood displayed on table tops, etc. One of the largest electronics retail chain in the U.S., Best Buy, has struggled in China due to its premium prices and tough competition from local electronics chains such as Suning and Gome. Best Buy opened stores in China that were similar in infrastructure to its U.S. stores, which provided a better shopping environment than Suning and Gome. However, this did not work in Best Buy’s favor since Chinese buyers are used to shopping for electronics in warehouse-style stores, which Suning and Gome have exploited to good effect. Best Buy’s store environment turned out alien to Chinese buyers and its products were perceived as expensive.
The Chinese retail market has been unrelenting to even slightly different retailing environments and Costco is a different retail concept altogether. While the warehouse retailer can offer good quality products at low prices, customer response to its store format cannot be predicted, which increases the risks involved in investing in China.
No Concrete Plans For China
In an interview last year, Costco CEO Craig Jelinek stated that the company doesn’t feel the need to enter China yet as its other Asian business is doing very well. He believes that there are a lot of opportunities available in countries such as Japan, Taiwan and Korea, and expanding in China might turn out to be a risky move. Jelinek stated that Costco does not want to stretch its business beyond the management’s control and China will be a good expansion option even after 10-15 years.
It appears that the company doesn’t feel the need to expand in China as it has no growth problems in the U.S. or its current international locations. We believe that once Costco runs out of growth room in the U.S., it will consider China as the next destination for store expansion. The company’s warehouse concept has gained significant traction in Taiwan, where consumer behavior is somewhat similar to China. Even with a small number of stores, Costco’s brand popularity in Taiwan has grown tremendously. We believe that a pleasing customer response in Taiwan is an indication that Costco can be successful in China as well, if the company decides to open its stores there.
Speculations Of E-Commerce Expansion
About a year back, there was a report in a Chinese newspaper that Costco is planning to expand its e-commerce operations in the country and is looking for a local partner. While the company hasn’t confirmed the news yet, we believe that Costco will look for e-commerce expansion in the region before opening its physical outlets. The idea behind this strategy is not to invest too much in a market that hasn’t been conducive for U.S. retailers and to explore China’s huge e-commerce space ($194 billion in 2012) before expanding its retail footprint.
However, an online store will lack Costco’s traditional store characteristics that have played a crucial role in its success. At Costco, shopping is not just about prices but the shopping experience as well, which includes a “treasure hunt” experience where shoppers walking around the isles always find something new. Also, they have access to several ancillary services such as food court, photo-center, pharmacy, gas station, etc.
With only online launch in China, Costco won’t we able to provide these social experiences. Even if the company alters between its brands in order to recreate the “treasure hunt” experience over the Internet, its ancillary services will be absent. A deep analysis of Costco’s sales in the U.S. suggests that while average spending per customer on merchandise has grown slowly over the past four-five years, their spending on ancillary services has increased at a hefty pace. Hence, by not providing these services in China from the outset, Costco’s first impression on buyers will not be too strong. This can make it difficult for the company to elevate its brand image in the future.
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