To the question of what's the most feared competitor in retail, the answer is simple.

Amazon (AMZN 0.16%) has demonstrated time and again its desire to disrupt as many corners of the retail industry has possible, and Wall Street tends to give the tech giant a wide berth. For instance, when Amazon acquired Whole Foods Market in 2017, supermarket stocks fell broadly, including Sprouts, Supervalu, Walmart, and Costco (COST 0.24%), as investors feared that the industry was about to experience the "Amazon effect."

When the tech giant enters a new market, it often does so by undercutting competitors on price in an attempt to gain market share, and by leveraging its Amazon Prime loyalty program. However, Amazon's takeover of Whole Foods hasn't brought a reckoning in the grocery industry the way many expected, and recently there have been signs that Amazon is favoring other vehicles, like its new Fresh supermarket, moving Whole Foods from the spotlight.  

Costco has long been one of the companies in Amazon's sights. The big box chain's supremacy in the warehouse retail segment has at times looked jeopardized by Amazon, especially the Prime loyalty program, which offers benefits similar to Costco's membership program.

A parking lot outside of a Costco

Image source: Costco.

Costco adjusts and adapts

In 2016, Costco seemed to be showing signs of fatigue as Amazon continued to gain market share across retail. The buy-in-bulk specialist's U.S. comparable sales slowed to 1% in fiscal 2016, and global comparable sales excluding fuel sales and foreign exchange rose just 4%, down from 7% the year before. Earnings per share that year actually fell slightly from $5.37 to $5.33.

However, the following year the company responded to the e-commerce threats and shifting consumer habits by launching same-day delivery on perishables, partnering with Instacart, and offering free two-day delivery with a $75 order minimum on two-day perishables.

Since then, comparable sales growth has accelerated and Costco has delivered solid profit increases, and those online offerings have likely helped with member growth and retention. Costco's investments have paid off handsomely during the pandemic as e-commerce sales jumped 91% in its most recent quarter, helping to push comparable sales up 14%.

Moats, we've got a few

Amazon has built an impressive network of competitive advantages with Prime, one-day shipping, and its third-party marketplace. However, Costco has its own competitive advantages as well. Like Amazon, its membership model helps lock in customers and incentivizes frequent visits and spending in its stores, and even Amazon can't beat Costco's bargain prices. The no-frills retailer sells goods nearly at cost, making most of its profit from membership fees.

Costco's combination of low prices, quality products, well-paid employees, and great value help make the company among the top-rated retailers in customer satisfaction, with scores similar to Amazon, which in turn helps it deliver high retention rates. For fiscal 2020, Costco's member renewal rate was 91% in North America and 88% globally, which shows that customers are overwhelmingly pleased with Costco's offerings.

Amazon and Costco are competitors, but there is also significant overlap in member bases between the two. Both Costco and Amazon Prime tend to cater to higher-income customers, unlike Walmart, for example. In other words, Amazon and Costco can coexist even as they compete for wallet share. 

While Amazon continues to put up blockbuster growth, Costco appears to be one of the retailers best insulated from the threat, especially since a majority of its sales come from groceries, a traditional weak spot for Amazon. Costco's membership base and high retention rates act as an economic moat, and its focus on low-margin bulk goods would be essentially impossible for Amazon to replicate entirely through e-commerce.

Costco stock has more than doubled over the last three years, since it rolled out its e-commerce offering, showing that investors believe its future is brighter than it has been in a long time. Costco has passed the Amazon test, and it looks set to be one of the few retailers that will thrive for the duration of the pandemic and its aftermath.