3 Winners in Discount Retail: Costco, TJX, and Amazon.com

Costco, TJX, and Amazon are particularly well positioned to thrive in the discount retail industry. Here's why.

Andrés Cardenal
Andrés Cardenal
Apr 19, 2014 at 8:30AM
Consumer Goods

The retail business has become remarkably competitive lately, especially for companies operating in the low end of the pricing spectrum. Costco (NASDAQ:COST), TJX (NYSE:TJX), and Amazon.com (NASDAQ:AMZN) are positioned to win in this environment by delivering spectacularly low prices for their products thanks to their effective business models.

Costco is one of a kind
Costco benefits from a smart and differentiated business model. As opposed to margins on sales, the company makes most of its profits from membership fees, and this means that Costco gets to sell its products at cost, generating big savings for customers.

Source: Costco.

Not only that, but the company implements multiple other strategies to minimize purchase prices, like prioritizing cost savings over inventory variety when making purchasing decisions. Costco buys big amounts from suppliers, and it leverages its scale to obtain better purchasing conditions, which it translates into price savings for customers.

In addition, as the company grows in size, it spreads fixed costs across a bigger amount of products, which reduces the impact of fixed costs per unit.

This business model resonates remarkably well among consumers. In such a dynamic and competitive industry like discount retail, Costco benefits from extraordinary customer loyalty. Retention rates are usually above 85% at the company level, with main markets like the U.S. and Canada delivering retention rates that are consistently above 90%.

Costco announced rock-solid sales figures for March. Comparable-store sales excluding the effect of gasoline prices and exchange rate fluctuations increased by 6% in the U.S. and 9% in international markets, for a total increase of 7% during the month.

This is materially above the performance investors can expect from competitors in the industry, and a sign of continued strength from Costco as the company seems to be smoothly recovering from the negative impact of an unusually harsh winter.

TJX for trendy bargain hunters
TJX is an off-price retailer of apparel and home fashions operating 3,050 stores in the U.S., Canada, and Europe under brands such as T.J. Maxx, Marshalls, HomeGoods, Winners, and T.K. Maxx, among others.

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Source: TJX.

TJX has a leadership position in off-price retail, and it relies on a buying force of 800 employees sourcing for products from more than 16,000 vendors in over 60 countries. Its scale advantages, global presence, and effective inventory management system mean that TJX is uniquely positioned to purchase and manage large volumes and disperse merchandise across different geographies to target specific markets.

TJX purchases excess inventory from department stores at favorable terms; the company is willing to buy less-than-full assortments of items, it pays promptly, and it usually doesn't ask for typical retail concessions like advertising, promotional, or return allowance.

This gives TJX significant bargaining power with suppliers, which it translates into pricing discounts of between 20% and 60% off traditional retail prices.

Customers seem to really appreciate these bargains; TJX has delivered growing comparable-store sales over the past 17 consecutive years, quite an extraordinary achievement in a such cyclical and challenging business.

Amazon and the power of disruption
If there's a company that's been a powerful disruptive force in the retail industry over the past several years, it's unquestioningly Amazon. The company founded and led by Jeff Bezos has grown from an online bookstore to a global juggernaut making more than $60.9 billion in sales and growing at a 22% annual rate in 2013.

Source: Amazon.com.

Amazon has important cost advantages over brick-and mortar stores in items such as real estate, inventory, and salary expenses. On the other hand, the company is actively investing in areas such as building its distribution network, digital content, and hardware manufacturing, so expenses have been on the rise in recent years.

Importantly, Amazon is willing to price its products at aggressively low levels, even if that means eroding profit margins. In Jeff Bezos' words: "Your margin is my opportunity."

A position in Amazon means investing in a company with razor-thin, or sometimes even negative, profit margins. This is a considerable risk and source of uncertainty for shareholders. On the other hand, Amazon offers a fairly unique opportunity to position your portfolio for growth in one of the most disruptive and innovative companies on the planet.

Bottom line
For many retailers, price competition is the name of the game lately. Costco, TJX, and Amazon are exceptionally well positioned to compete in that area, and that says a lot about these companies and their chances to succeed in the years ahead.