There was a report in The Southern Metropolis Daily (a Chinese newspaper based in Guangzhou) in 2013, that Costco is looking for a local partner to launch e-commerce operations in China. In October last year, the company announced that it has partnered with Alibaba (NYSE:BABA) in China, and will launch an online store on Alibaba’s Tmall e-commerce platform. Recently, the Chinese e-commerce behemoth reported that Costco generated $3.5 million in revenues on November 11, during Alibaba Group’s 11.11 shopping festival. What makes this figure look even more pleasing is the fact that Costco launched only a limited variety of merchandise in the market, and was still able to garner significant customer attention. Overall, the warehouse retailer clocked up $6.4 million in revenues during the first month of its e-commerce operations.
Costco, which has operations in nine countries, including the U.S. and Mexico, was initially reluctant to expand into China, despite its enormous retail market size ($2 trillion). The region has been among the most preferred international expansion options for a good number of retailers, apparel players and consumer electronic chains, but Costco had shown no significant interest in the market. Costco’s CEO had said in the past that the company does not need to focus on China at the moment, since its operations in other Asian countries are going very well and there is no lack of growth in the domestic market. However, after this promising start, the company might reconsider its stand on China. The warehouse retailer recently stated that the management was “shocked” by this performance, and it is gearing up to revamp its product portfolio and shopping experience in 2015.
While Costco’s first experience with the Chinese retail market has been exceptionally good, a bigger issue will be just how the company plans its expansion from here on. Historically, retailers such as Wal-Mart (NYSE:WMT), Home Depot (NYSE:HD) and Best Buy (NYSE:BBY) have had a hard time selling their products to discerning Chinese shoppers. Although Costco has started well in the market, it will have to deal with shrewd consumer behavior and intense competition from local players, to work its way up.
Our price estimate for Costco stands at $130, implying a discount of less than 10% to the current market price.
Not Easy Serving Chinese Buyers
Chinese consumers are very cautious and their buying decisions are not 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 have not always adapted well 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 the lowest prices in the market, retail giant Wal-Mart has not been able to attract customers as much as hoped. 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.
An Online Store Isn’t Costco’s Best Bet
It is almost certain that Costco will step into the Chinese retail market with an e-commerce channel before setting up a retail store network. 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 marketplace ($194 billion in 2012) before targeting its brick-and-mortar counterpart. Although the company’s performance in the first month has been very good, its initial success cannot be regarded as a testament to the long term sustainability.
An online store lacks Costco’s traditional store characteristics that have played a crucial role in its success in the U.S. and abroad. 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 an online launch in China, Costco will not be able to provide these social experiences. Even if the company varies its online merchandise 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, 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 might not be too strong. Costco is a warehouse retailer and with only online operations, it might come off as just an affordable place to shop.
Retail Store Expansion Still Seems Far Off
In an interview in 2013, Costco CEO Craig Jelinek stated that the company does not feel the need to enter China yet, as its their 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 does not 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 might 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. Its initial results have somewhat confirmed this, but not much can be said unless the company launches a few test stores in the world’s second largest economy.