RETAILING NEWS: Consumer Packaged Goods Manufacturers Failing to Orient to Large Stores Like Costco

Seems hard to imagine consumer product manufacturers regarding an operation as large as Costco to be a mere "alternative" channel or an afterthought.

Repackaging Big Box Consumer Packaged Goods

Costco's Challenge for CPG Vendors

By Tom Ryan

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."

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