This Costco Store Closure Spells Trouble... for Staples Inc.

When one threat closes, another opens, as the office supply market remains in turmoil

Rich Duprey
Rich Duprey
Oct 5, 2015 at 2:00PM
Consumer Goods

Just because one Costco store is closing doesn't mean there's not still a potent threat to Staples.

Costco (NASDAQ:COST) is closing its Hackensack, N.J. store on October 13, and opening a new, bigger warehouse the following day just a few miles away. It's not the larger location that should worry office supplies leader Staples (NASDAQ:SPLS), as store openings and closings are part of the ebb and flow of business; but rather it's what will be going into the old store closing its doors that should be a cause for concern.

In its just-released fiscal fourth-quarter earnings, Costco said it plans to add an additional 12 new warehouses (including the relocation of the Hackensack store) to the existing portfolio of 484 warehouses in the U.S. and Puerto Rico. Staples itself has 212 stores in North America since the beginning of 2014.

What Costco doesn't say, though, is what some of those new stores really are, because the retailer doesn't just operate the usual warehouse clubs where you can buy toilet paper by the pallet. It also operates Costco Business Centers, and that strikes right at the heart of Staples' survival.

A dramatically altered landscape
The office-supplies retailer is in the midst of an attempted merger with rival Office Depot, which is still digesting its own acquisition of OfficeMax. The marketplace has changed radically during the past few years, and the two retailers can no longer afford to have thousands of physical stores between them. Merging together and winnowing the field will allow the business to survive, if not thrive.

But the deal is coming in for some heavy scrutiny from federal regulators, who may be worried more about the impact the merger will have on the commercial and contract end of their operations than in the main retail business we're more familiar with. There are plenty of places where people can buy paper, pencils, and ink cartridges, whether it's, Wal-Mart, or even Costco. What there isn't a lot of is alternatives for their business contract operations, from which both Staples and Office Depot derive about 40% of their revenues.

That's why Costco's new Business Center that it will be opening in Hackensack -- as well as another one that will be opening soon in Denver -- ought to worry Staples. It represents what could be a new, significant threat to its business.

The business of these Costcos is business
Business Centers are a different breed of warehouse for Costco. While open to all members, the locations don't sell clothes, groceries, jewelry, toys, or sporting goods, and don't have opticians, pharmacies, photo centers, or many of the other assortment of goods and services you'd expect to find. Instead, they cater to the needs of small businesses, like convenience stores and food services businesses, and typically offer cleaning supplies, print and paper supplies, office furniture, etc., that are used by businesses, hotels, hospitals, and restaurants.

Right now, there are just 10 Costco Business Centers dotting the country, and Costco has taken its sweet time in rolling them out. It will have taken more than 20 years to get just 12 stores up and running by the end of this calendar year.

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While that's a glacial pace in an arena that can see concepts come, grow, morph, and then die in just half that time or less, it appears Costco is actually quickening its step, and we may see the warehouse chain open many more Business Center stores in the future.

The first business center opened in 1992, and during the following decade, Costco opened just three more stores; but in the last six years, it opened five more, not including the two it's opening now. Costco could sense opportunity in the niche, and that might not bode well for Staples.

Delivery accounts for half of all the business a Costco Business Center generates. Photo: torbakhopper.

Maybe they should call them money centers
For one, the stores are more valuable to Costco than the typical warehouse club. They run around 115,000 square feet compared to 150,000 for the traditional store, and though just 1,000 customers visit a business center daily versus 6,000 to 8,000, the average sale made is two-and-a-half to three times greater at the business store than at the regular warehouse.

The stores are able to accommodate fewer customers because half of a center's sales are delivery. That's what makes it so dangerous for Staples. The majority of its sales come from delivery, which, coupled with many of those orders originating online, accounts for Staples being one of the biggest Internet resellers in the world. It's also the reason accelerating growth in its delivery business is one of its top priorities.

A dozen Costco Business Centers compared to more than 1,400 Staples locations seems like a lopsided disparity, but because most business sales aren't occurring in a physical store, but derive from online sales that are delivered, Costco's renewed interest in its business customer spells trouble for Staples.