For many years, Sam's Club has trailed warehouse club leader Costco Wholesale (NASDAQ:COST) in terms of sales and profitability. Wal-Mart (NYSE:WMT) has finally admitted that the status quo isn't viable, and the company recently decided to close about 10% of the domestic Sam's Club fleet.

In this episode of Industry Focus: Consumer Goods, Vincent Shen welcomes senior contributor Adam Levine-Weinberg to the show as they investigate why Sam's Club is pulling back in the U.S. Stiff competition from Costco has definitely been a key problem -- and Costco is now poised to reap a big windfall as Sam's Club downsizes.

A full transcript follows the video.

This video was recorded on Jan. 16, 2018.

Vincent Shen: That brings us to the last topic for this episode, it's a related story that has made a lot of headlines in the past week. On January 11th, Wal-Mart made multiple announcements regarding improved pay and benefits to Wal-Mart employees, a one-time bonus, and also the potential effects of the new tax legislation. But I think management was hoping that the good news would offset the announcement that they are closing 63 Sam's Club locations in the country. That's about 10% of its U.S. store base. Can you give us some of the details here, Adam?

Adam Levine-Weinberg: Sam's Club has always been the smaller part of that Wal-Mart business -- not really as big of a focus for the company as the traditional Wal-Mart business, or even Walmart's international business. It's just struggled along. They never really found their identity. Initially, they definitely went for the lower-income demographic that was closer to the traditional Wal-Mart customer, rather than the higher-income demographic that Costco caters to. The problem is, those people obviously haven't been doing nearly as well with the current economic climate, which has been great for high earners and not as great for low earners. So you've seen very sluggish results, whereas Costco has been growing very quickly in the last decade, and honestly, in the last three decades. Wal-Mart more recently changed the Sam's Club strategy to try to pick up more of the shoppers from Costco, putting more organic products and upscale things. It just doesn't have that kind of brand power that Costco does, and its association with Wal-Mart probably doesn't help, in terms of trying to get consumers who have $100,000-plus household incomes.

Anyway, whatever the cause, Wal-Mart decided that there's just too many Sam's Club locations and some of them aren't profitable. You've had basically a mix of those two different things going on here. In some metro areas, they built more clubs than there was demand for. Sam's Club is just thinning out the number of warehouse clubs that they operate. You're seeing this in Chicago. There's six different warehouse clubs in the Chicago suburbs that are all going to be closing in the coming weeks. That's about a third of what Sam's Club operated in that area. In most cases, Sam's Club customers will still have a location that's relatively close by that they can continue to go to. Although, I definitely think that Costco will pick up some business from people who now find that Costco is more convenient to them than Sam's Club.

But what you've also seen is, there's entire markets where Sam's Club seems to have decided it can't compete. One of the most interesting ones is Seattle. They're closing all of their Seattle area warehouses, that's three of them. That's Costco's home market, so it's not surprising that they're in the worst position there. Costco now basically has a monopoly on that warehouse club model in Seattle. Also, Alaska, they decided to exit. They had three stores there, two in Anchorage and one in Fairbanks. Those are all going to be closing. Again, that'll give Costco some room to expand. Then, in the Northeast, just to start out, Sam's Club was a lot smaller than Costco, and now it's pulling back even more. Pulling out of Syracuse and Rochester, New York, Upstate New York. It's closing its only location in Massachusetts, two of its three Connecticut warehouses, among others in that Northeast corridor area, so really thinning out its position there. Sam's Club warehouses traditionally haven't been able to generate the same level of sales volume as Costco warehouses, so having them in these far-flung locations with only a few here and there wasn't really working from logistics perspective, given that the margins in that warehouse business are very tight to begin with, even more so than in Wal-Mart's discount store supermarket business.

Shen: Not surprisingly, if you read between the lines, it seems like some of these stores were cannibalizing each other. I read a comment somewhere that said the company realized that the population growth in some of these weaker markets that they had forecasted just didn't live up to those expectations, it couldn't sustain the supply of stores they had there. We've spoken previously on the Industry Focus about greater competition with consumers' grocery budgets. If you look at Sam's Club's main rival, you mentioned Costco, for November and December, they reported 8% and 9% comparable sales growth in those months respectively. They, too, have turned their attention to e-commerce. Over 30% e-commerce growth for the company in those periods, too.

I think that number is significant, because it also adds some context to the decision. One the one hand, you have these store closures. On the other hand, Wal-Mart mentioned they're converting 12 of these club locations into e-commerce fulfillment centers. I think the recent holiday season may have been encouraging for a lot of traditional retailers, but bubbling beneath that is still this shift with consumer spending to online digital channels, and a lot of these investments and turnaround plans and long-term strategies for companies in this industry prioritize that shift. Wrapping up here, any final comments from you, Adam, before we roll off?

Levine-Weinberg: I would just say that it'll be really interesting to watch Costco's sales results over the next few months, just to see if they see a noticeable bump from the Sam's Club closures. Particularly because Costco has been reporting really strong comp sales results, as you mentioned, but it's had pretty easy year-over-year comparisons, because it wasn't doing that well in 2016 and early 2017. So now that the comparisons are getting harder, it'll definitely help Costco to now have this Sam's Club traffic that it can pick up. The other thing that I would look for is to see whether Costco decides to pick up any of these Sam's Club locations that are closing, if it sees them as suitable sites for new Costco warehouses, or if they announce new sites elsewhere in those metro areas to try to gain even more market share from these Sam's Club closures.

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