Amazon is credited for scaling online retail like no other pulling off incredibly complicated logistics covering an infinite assortment of goods conveniently delivered to customers’ doorsteps at low cost. Yet, this article argues that Costco, the champion of brick and mortar retail is a better exemplar of logistical efficiency.
“Two companies have emerged with ideal-type business models that dramatize the different economies at each end of this spectrum: Amazon and Costco. Late to the e-commerce game, minimally invested in their distribution network, and committed as ever to an artificially-limited assortment, Costco is the anti-Amazon. It embodies the precise opposite of everything imagined by the e-commerce futurists—and yet somehow its revenue has grown by an average of more than 10 percent every year for the last five years.”
Yes, Costco provides limited options for its customer compared to any of its competitors let alone the infinite options that Amazon provides. But in general, more options don’t necessarily mean value: “…scrolling through options and reading through reviews online for every consumption choice is overwhelming and anxiety-producing…
…One brilliant feature of the Costco experience is, paradoxically, the constraint: as opposed to Amazon, with its near infinite assortment, or even Walmart, which has approximately 130,000 SKUs (stock keeping units, or distinct items) in the average Supercenter, any given Costco will only hold 4,000 SKUs to choose from. While most retailers today assume that consumers want ever greater assortment, Costco’s popularity speaks to a countervailing desire for less choice. Indeed, the pre-selection of items for sale in their warehouses is part of the value proposition: not only are you going to get a lot of a particular thing for a good price, but you also won’t have to deliberate over micro-differences in a more robust assortment.
In other words, winnowing selection is a service, not a limitation—especially with Costco’s product catalog. Costco is not known for having the cheapest goods, but it is known for having the cheapest price on its goods, and that is because its buying team has closer relationships with suppliers than any other big retailer. Such scrutiny and communication point away from low-road suppliers. This is a structural effect of Costco’s conscious choice to offer a low SKU count: fewer products to investigate means more time to investigate each product, and a natural gravitation away from the bargain basement. That its member-customers have come to expect a certain quality of everything in their stores reinforces this dynamic.
The low SKU count also allows Costco naturally to do something that Amazon does by squeezing suppliers: a low or even negative cash conversion cycle (CCC). The CCC is a corporate finance measure of how long it takes to turn inventory into cash through sales. Amazon often negotiates delayed payment terms with suppliers, leaning on them to allow payment windows longer than the thirty-day industry norm. Meanwhile, given the speed of its e-commerce business, Amazon is often receiving payment from consumers way before it has to pay suppliers, essentially giving the retailer interest-free cash. Costco enjoys the same benefit of a short or negative CCC, but without having to anger suppliers simply because fewer SKUs means a faster-moving inventory for the SKUs that they do carry. In other words, when a Costco store receives a shipment of a particular item from a supplier, it is often going to sell every unit in that shipment in less than a month, thanks to its scale and the simple fact that that particular item is going to be the only variety in store.”
Even the customer experience is anything but ‘convenient’: “Shopping at Costco is always somewhat harried: no shopper can avoid lines at the registers or traffic jams in the aisles, even on the weekdays. It is the precise opposite of e-commerce convenience. And yet members not only don’t seem to mind the nuisance, they positively embrace it. Costco notably spends very little on advertising, but it doesn’t really need to, given the remarkable amount of free attention it gets by word of mouth and on social media from enthusiastic shoppers “talkin’ deals.” Costco has become a retail destination with a very loyal membership base (its annual membership renewal rate is typically above 90 percent) while offering a sparse, no-frills retail experience.”
The author argues that while at the individual level, Amazon’s logistical supremacy stands out, at a societal level, the Costco model still delivers better: “At the social level, logistical success can be measured in terms of cost efficiency. This cost can be understood in accounting terms as overhead: the warehouses, the vehicle fleet, fuel costs, forklifts. An enterprise is more efficient when it can spread these costs over a larger volume of goods. A cost-efficient operation is also simple, in that it’s reliable and not prone to disruption. The more complicated an operation, the more likely it is to fail. A simple operation also puts fewer demands on transportation infrastructure—an urgent question in congested urban environments.
To put it crudely, having someone in a Sprinter van deliver a recently-purchased toothbrush to your doorstep is simply not a universalizable action, from either a business or logistical standpoint. It is a modern feat that Amazon is capable of doing this, but that it can be done does not mean that it should, nor even that it can be done writ large. For most consumption, it is far more efficient for people to handle the “last-mile delivery” themselves by going to stores and buying a good amount of stuff when they do so. This keeps delivery vans off the road, and it minimizes car trips for necessary purchases. For the retailers, it suppresses unnecessary mark-up both by keeping overhead costs low and by simplifying overall logistical operations.
…it’s ironic that Jeff Bezos originally got the idea for Prime, Amazon’s membership model, from former Costco CEO Jim Sinegal. Prime entitles members to free two-day delivery on over 300 million products (in addition to streaming services). With such a wide range of possible single-item orders, free delivery encourages less bundling of customer purchases. Whereas Costco membership helps to reduce overhead, Amazon membership increases it. Meeting two-day delivery demand requires dramatic investments in their distribution network, which is reflected in the higher share of sales accounted for by Amazon’s delivery costs.”
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Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.
