In My Opinion
Costco Corners Champagne Market
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By Gregory DeFelice (a.k.a. gdefelice)
December 3, 2001
[Editor's Note: One of our favorite things about the Fool discussion boards is the fact that so many people are networked together and so much good information is shared that you'd never be able to attain alone. The following is one great example of how a member of the community turned an innocent phone call with a friend into some great investment insight.]
I just got off the phone with a very good friend of mine. He works for a one of the largest (or maybe the largest) distributors of wine and champagne on the West Coast. As many of you know, Costco (Nasdaq: COST) has now become the largest seller of wine in the nation. He knows my interest in Costco and while talking to him today he relayed the following story, as knew it would be of interest to me:
He said that he received a call yesterday from Trader Joe's, a specialty retailer of food and spirits, also on the West Coast. They're not anywhere near as large as Costco -- they serve a niche, mid- to high-end market. Anyway, they called to make a large purchase order for Veuve Cliquot champagne. My friend, Pete, said Veuve is THE hot champagne and will soon be the bestseller in the U.S.
Trader Joe's wanted to buy 2000 cases of it (a case holds 12 bottles). Pete said that prior to Costco being in the market, that would have been a huge order for my friend's company, but not anymore. Trader Joe's wanted to pay $320 per case or $640,000 which works out to $26.67 per bottle. Pete's company would sell a single case to a liquor store for $368 or $30.67 a bottle.
Costco, which buys and sells more Veuve than anyone, pays Pete's company $336 per case (or $28.00 per bottle) and buys in large quantities, of course. Pete said that Costco is not aggressive in trying to lower that price "for some reason." Pete said that Costco then retails Veuve at $29.95. You'll note here that the Costco member who buys a single bottle of Veuve at Costco pays less than the liquor store that buys a case directly from Pete's company. (Note that certain laws prevent the liquor store from buying too much [or any?] liquor from Costco -- though, Pete advises liquor store clients to do so if they're looking for just a case).
Pete said his company turned down Trader Joe's offer. Trader Joe's declined to offer a higher price. Pete said that before they had a customer like Costco, they would have "jumped at the opportunity" to close such a big order.
But, he said, if they were to sell to Trader Joe's at a lower price than they do to Costco and if Costco got wind of it, they'd be pricing themselves down even though their biggest customer is willing to pay more. As he said, "It would just be stupid to take that order." Pete said that Trader Joe's said they would have to sell it for more than $30.00 a bottle if they paid Pete's company more than $320 per case -- thus, they couldn't beat Costco's price if they paid more than $320.
Before I discuss the above, I'll add one final thing. Pete said that normally when a grocery chain like Trader Joe's or Safeway buys Veuve (or other wine and champagne) from them, Trader Joe's or Safeway sends one of their own trucks to pick it up from Pete's company. Then they take it to a distribution center and then from there it is delivered to individual stores. But with Costco (and only with Costco -- because they're such a big customer), Pete's company delivers wine and Champagne directly to individual Costco stores (which also serve as their warehouses).
Now, an analysis of the above. I think the main and most salient issue to discuss is the following: Why doesn't Costco try to get a lower price, as Pete said they could if they aggressively negotiated?
Because, before they do that (and they will, I think, down the road), they're going to drive other major retailers out of the liquor business by buying at a price that their competitors cannot make money at. Or, at least, they'll push their competitors' sales of these liquor products to a low enough level that if they choose to sell something like Veuve, they'll have to do it for $40 a bottle to turn a profit. When that happens, Costco can push their sales price up, say to $31.95 AND they simultaneously negotiate with Pete's company to pay less than the $28 they're paying now, say $26 a bottle (Pete said they could "easily get it at $26 from us). So, their margin goes from $1.95 (or $29.95 - $28.00) to $5.95 (or $31.95 - $26.00).
I asked Pete if he thought that scenario was possible. He said that Costco has so much power now in their business that they could virtually dictate prices on things like Veuve. I said I thought they would someday and he agreed.
I hope you all find this interesting. I had never thought about Costco "paying more than they have to" but it makes a lot of sense as a long-term strategy because, in the short term, they could clearly realize higher earnings now if they negotiated a lower purchase price on the champagne.
This post originally appeared on the Berkshire Hathaway discussion board on November 21, 2001. Charlie Munger of Berkshire Hathaway is on Costco's Board of Directors.
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