Should Costco Increase Focus On Its E-commerce Initiatives?

In its recent earnings call,  Costco‘s (NYSE:COST) management stated that the company’s e-commerce operating margins are higher than its in-store margins and these high margins are sustainable given substantially low selling and general administrative expenses (SG&A) for this segment.  However, the company’s revenues from online sales are estimated to be less than 5% of its total revenues. The e-commerce segment witnessed a revenue growth of 19% in Q2 2016 and the company has an online presence in six countries.  That said, Costco is not pursuing an aggressive e-commerce growth strategy. The company is slowly expanding the categories its sells online and does not plan to focus on omni-channel initiatives to drive store traffic. Costco’s efficient business model and strong member loyalty provide it with an edge over other retailers including e-commerce players such as Amazon. However the company is experiencing slower comparable sales growth and we believe focus on e-commerce initiatives can enable the company to improve its profitability and accelerate growth.

Strong Business Model But Ecommerce Can Drive Future Revenues

Costco’s model consists of selling food and home goods in bulk at minimally marked up prices.  It is clearly working in the company’s favor.  Analysts believe that, by becoming one of the best-value option for items that shoppers want to buy in physical stores, Costco is able to compete against e-commerce companies such as Amazon.  Costco’s management  believes that people who shop in the store  purchase more than those buying online. While its average online transaction size is higher than that in the store visit, this is primarily due to the fact that the company has made only big ticket items available online. Costco does not look at omni-channel initiatives to drive in-store sales. The company is not looking to provide store pick up option for its online sales in the near future since it believes that it has enough traffic in its stores and it would look at other strategies to drive store traffic. The company’s membership renewal rates remain strong and for Q2 2016 these stood at 91% in the U.S. and Canada and 88% worldwide. This indicates the loyalty of its customers, which is reflected in store traffic.

However falling gasoline prices is impacting Costco’s sales growth negatively. The company’s comparable store sales were flat for the 4 weeks ending February 2016, but would have been up 4% if the negative impact of gasoline price deflation and foreign exchange were excluded. This trend has been evident  since the beginning of January 2015 and continues to impact the growth of the company.

We believe that while Costco has a loyal customer base and has established itself as a strong player for goods bought via brick and mortar stores, it is experiencing slower growth.  A focus on e-commerce initiatives and integration of online and offline experience can enable the company to  accelerate its growth while improving profitability.

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