Costco's Global Expansion... With a Twist

Costco is delivering stellar results around the world, but growth will eventually slow in the United States. This ties into Costco’s global expansion strategy, but like most other things Costco, it’s far from a strategy that follows the herd.

Jul 14, 2014 at 6:00PM


Costco Wholesale (NASDAQ:COST) is a rare breed in the retail world today. It's one of the few physical retailers delivering consistent revenue and net income growth. Over the past five years, revenue and net income have grown at 53.46% and 82.14%, respectively. What's most impressive is that Costco relies heavily on its domestic operations (for now). Part of the reason for Costco's domestic success is that it targets a higher-end consumer than, say, a Sam's Club. However, Costco's future growth is likely to come from international operations, and the company's international strategy is unique.

Selective international growth
Costco operates in nine countries, but internationally, it's primarily focused on Japan, Taiwan, and Korea. It might surprise you that China isn't on this list. More on that soon. For now, there are some interesting trends to ponder.

According to Costco's Chief Executive Officer Richard Galanti's comments on the company's most recent conference call, there are distinct differences in membership signups depending on where a warehouse opens.

For example, in the first eight to 12 weeks, a warehouse in a big city like New York or Los Angeles might see 3,000-4,000 signups. In a smaller market like New Orleans, Knoxville, or Baton Rouge, a warehouse is likely to see closer to 8,000-1,200 membership signups. This might sound backward, but it's a supply and demand story. Smaller markets are more excited to see a new concept like Costco enter the area. But the real big membership signups have been in Asia, which have seen an average of 30,000-40,000 signups in the first eight to 12 weeks. Once again, it's the excitement factor, and Costco is seen as fresh to most Asian consumers.

With these kind of numbers, you might be wondering why Costco is avoiding China. A lot of it has to do with the past "failures" of other American retailers. However, these failures are often overhyped by the media.

Mild success in China
As you might already know, Best Buy failed in China. Chinese consumers didn't take to the American store formats, and they found the items to be too expensive. This failure, however, might have helped other retailers.

It's often stated that Wal-Mart Stores (NYSE:WMT) is struggling in China, but this isn't entirely true, and you need to look ahead, not backward.

Most people will look at Wal-Mart's first-quarter comps decline of 2.5% year over year in China and declare the retailer as "struggling in China." But this poor performance was primarily due to an earlier Chinese New Year, which meant most of the holiday spending was recorded in the previous quarter. If you exclude the calendar impact, then Wal-Mart comps came in flat. That still might not seem good, but operating income increased 26.2% year over year. Additionally, Wal-Mart's Business Transformation program is allowing for improvements in margins and reduced expenses in China.

If you look at the bigger picture in China, Wal-Mart is opening supercenters in tier-three and tier-four cities so it can grow with the population and spending ability. Wal-Mart thinks this might take 10-15 years, but it's taking the slow and steady approach -- often a good sign for investors. 

That's one example of mild success in China, but if you really want to see how American brands are capable of succeeding in China, then look at Starbucks (NASDAQ:SBUX).

Exceptional performance in China 
Starbucks has nailed it in China. It has learned that it's all about localization. In other words, Starbucks is now building its stores (not just in China) to fit local customs and history by city. This has led to increased foot traffic, which has then led to increased sales. In fact, China and Asia-Pacific second-quarter comps grew at a 7% clip year over year. Looking at the bigger picture, Starbucks has seen growth for the fiscal year for all three of the following key metrics: sales (9%), transactions (7%), and ticket (2%).

At the moment, China and Asia-Pacific only accounts for 6% of Starbucks' total revenue, but it plans on increasing its store base to 1,500 (from 1,200) by 2015.

The point here is that Costco will likely pay attention to Starbucks' success in China thanks to localization and implement a similar strategy at one point down the road.  

Costco in China?
Costco is being very cautious with China for a very simple reason: it's performing well everywhere else. Why expand into unknown territory if known territories are performing well? Eventually, Costco might see cannibalization in the United States, which would then force Costco to accelerate its international growth. China will be a likely landing spot.

Taiwanese consumers are the closest to Chinese consumers in countries where Costco operates. And Costco reports Taiwan as very strong thus far. Therefore, a small open in China – keeping supply extremely low to drive excitement – could pay dividends. However, if Costco continues to wait, it can watch how other retailers like Wal-Mart and Starbucks adapt to the Chinese consumer, then implement some of those strategies into its own entry into the country.

The bottom line
Costco is performing well around the world, both on the top and bottom lines. And if growth slows in the United States, then it has a growth avenue overseas. At the moment, Japan, Taiwan, and Korea, are strong, but those countries don't have nearly as much potential as China. As Costco waits, it also watches, likely planning a strategic entry into China at some point in the future. Fortunately, China isn't going anywhere.

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale and Starbucks. The Motley Fool owns shares of Costco Wholesale and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Jun 12, 2015 at 5:01PM

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