Berkshire Hathaway's Charlie Munger said that Amazon.com (NASDAQ:AMZN) has more to worry about from Costco (NASDAQ:COST) than Costco does from Amazon. That's because he believes that Costco has a better system of warehouses and a higher level of human trust. That network of warehouses would allow the company to switch its model to home delivery if it needed to. Both companies currently co-exist, and they make their money in different ways but they could be on an eventual collision course.
In this segment, host Nick Sciple talks Amazon, Berkshire, and Costco with Fool contributor Dan Kline. To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
This video was recorded on May 7, 2019.
Nick Sciple: All right, Dan, on the back half of the show, I want to unpack this quote we got from Charlie Munger over the weekend. He sat down for an interview with Jason Zweig of The Wall Street Journal. We got a nice little nugget out of there that I want to break apart. We'll read it to you then we'll break it down. Jason Zweig asked, "Do any companies have a sustainable moat against competition from the likes of Amazon? Who is Amazon-proof?" And Mr. Munger replied, "I think Amazon has more to fear from Costco than Costco has to fear from Amazon, because Costco has a better warehouse situation, much cheaper, plus a public that totally believes anything they sell will be high-quality and low-price. They're the sleeping giant. They're coming late to any sort of delivery system, but in the end, they'll be more efficient, and they're already more trusted. So I would say the figures show that Costco has nothing to fear from Amazon."
Dan, just off the top, what was your immediate reaction when I sent you over this quote as we got ready for this episode?
Dan Kline: I've written about this many times, that Amazon and Costco pretty much coexist. If you go to Costco, physically, it's not to buy one thing. You might jump on Amazon because you need a pen or paper towels or whatever it is. When you go to Costco, it tends to be for a large purchase. But what Munger is saying is something I never really thought about. There are 570-something Costco locations in the U.S. and Puerto Rico. That covers a huge amount of the country. While most of their business is people going into the store -- the warehouses, they call them -- and bringing items out, they have the ability to very quickly ramp up a delivery operation. To put it in context, Amazon has like 45 or 50 warehouses; Costco has 10X as many. So their coverage, their ability to adapt -- if people say, "I'm not leaving my home, I want a robot drone to deliver and I want Costco to sell me one item at a time," their ability to do that... it'll take Amazon a really long time to get there. Their holdings -- Whole Foods is not a great facility to modify. Whereas 150,000 square foot bear warehouse, you could easily take 20,000 square feet of every Costco and make a robot-based fulfillment center, which is actually technology we saw at Shoptalk this year. There's off-the-shelf stuff they could buy where they could cut into Amazon, though, historically, they've been a very non-aggressive company. They move very, very slowly.
Sciple: Right. Another thing when we're talking about comparing Amazon and Costco that I really want to call out is, we have to compare like for like. AWS, really, there's no comp for that on the side of Costco. When you think about Amazon's business from a profitability point of view, it drives substantially all the bottom line for the company. If AWS was out there by itself, that company on its own would be many hundreds of billion in market cap. But when you compare them like for like on the retail side, the comparison really starts to lean Costco's way a little bit. Core Amazon is profitable, but by a thread. You compare that to Costco, almost 100% of the profitability of the business is driven by the membership fees that the company generates. They're very reliably profitable year over year. Compare those markets, both of them have very, very high renewal rates for their membership programs, but a little bit of a different style there. When you compare the different strategies there, Dan, what do you think are the pros and cons of each approach for the businesses?
Kline: Costco makes about 75% of its money from memberships. Their goal is to take every single cost out of the items they're selling you. It's a limited selection, the stores aren't pretty, you don't get a bag, there's not a lot of people working on the floor. It's pretty much every lack of frill you could possibly have. Amazon takes a "we will sell you anything, everything." And they've only just begun culling their merchandise for things that are hard to ship and hard to sell. But both of them work hard to engender loyalty. Costco doesn't care if you only go there once or twice a year. But when you go there, it has to be a good enough experience that when it comes time to renew your membership, you're willing to do that. It's not just value. It's also the fun of seeing something -- maybe you're not going to buy the 10 foot teddy bear for your girlfriend, but it's fun to talk about it. Maybe it's looking at the samples, maybe it's a cheap hot dog. Costco has built an experience that fuels you renewing your membership, whereas Amazon actually wants you to use the service multiple times a week, and that's where your bond is. It's really two different takes on how to build loyalty.
Sciple: Sure, yeah. In my own personal habits on Amazon, folks talk about how Amazon's the first place people go when they're looking to buy a product online. It's, at least for me, a very surgical approach to when I buy on Amazon. When I'm in Costco, I'm just walking around googly eyed, "Oh, look at this over here, look at this over there." And I always end up with three or four more things in my basket than I ever planned. I think both strategies work, and both strategies have built trust with customers. When I go to Costco, I'll tell you, I don't price check, I just assume it's going to be the cheapest price. When I go to Amazon, I assume it's going to give me the fastest delivery time, going to be the most convenient way to get it to me. I think both these companies have done an outstanding job of, when a customer thinks of them, they know exactly what to expect and they more often than not get what they're looking for.
Kline: There's been a lot of studies on price, and which is cheaper. It really depends how you look at it. If you're willing to buy 800 aspirin, your per-aspirin price is probably cheaper at Costco. If that's impractical for you -- it's impractical for most people -- Amazon might be a cheaper price, even though it's actually a slightly higher price. It really depends on your needs. I shop at both. For our main home here in West Palm Beach, Florida, I don't have room to store a pallet of paper towels just to save a couple of bucks. Whereas we have a vacation home, where I have a shed that I could literally put a two-year supply of something -- I'm pointing as if the shed is right over there -- a two-year supply of cleaning supplies and other things that don't go bad, just so I don't have to worry about, do I have toilet paper, when I visit once a month.
Sciple: Right. I also am a member of both, I also use both. I have a big dog, so I get all my dog food at Costco, and that sort of thing. Maybe one of these days, these companies will be much more and antagonistic than they are today. Charlie Munger's prediction there, that they really will be at odds with one another, whether Costco will have the advantage or not, we'll see. Today, you pulled a stat for me from the Seattle Times and Morgan Stanley that suggests that 45% of Costco members are also Amazon Prime members. Both you and I would be in that category. It seems to be that neither of those groups are looking to spend more at one than the other. They serve different needs for the population. They're great at it.
Kline: It's absolutely a different need. Amazon is my every day. I am walking around the house, I see that I'm out of the flavor of tea I like, or I'm down to the last one, I jump on and I order on Amazon. Costco is an event. Once a month, you go to Costco, you bring the kid, you bring your wife -- in your case, your girlfriend, and you don't have a kid -- and maybe you have lunch there, maybe you buy a bag of candy you otherwise wouldn't have because they had samples on the floor. Maybe they have books or a kayak. It's definitely part entertainment, part shopping. Where these two companies become antagonistic is if consumer behavior changes. Costco has stand-alone stores. It's not affected by mall traffic. And they have not shown a drop in traffic. In fact, they've shown increases in traffic, during this whole retail apocalypse. But if consumers decide, "I don't leave my house for shopping," or set a much higher bar for that, then the company has to change its experience. And that might mean figuring out how to get you those values and delivering. And they have the real estate for that, they have the infrastructure for that. But they're not going to make a change until it's absolutely demanded. Everyone would argue that they waited maybe two or three years too late to go into delivery. But their numbers don't reflect that. They've maintained an 89-90% renewal rate for year over year for a very long time. That includes raising prices a couple of years ago. So, as long as that metric stays the same, there's no incentive for Costco to make big, expensive changes.