Costco has built one of the most unusual business models in American retail.
Unlike traditional supermarkets, which compete for shoppers with extensive product selections and weekly promotions, Costco asks customers to pay an annual membership fee for the privilege of shopping in its warehouses.
It then encourages members to buy products in bulk while offering a relatively limited assortment and relying on high sales volumes and low prices to keep customers coming back.
That strategy is proving remarkably effective.
Costco has now overtaken Kroger in a grocery market-share ranking, signaling that the warehouse club is capturing more consumer food spending than the largest traditional supermarket chain in the United States.
Costco’s business model is winning over grocery shoppers
Costco accounted for 8.4% of U.S. food and beverage spending, compared with Kroger’s 8.2%, according to Numerator’s quarterly Retailer Market Share update as reported by Supermarket News.
Within the grocery category, Costco is now the U.S.’s second-largest retailer by spending share.
Walmart remains the dominant grocery retailer, capturing 20.8% of spending.
However, Costco’s move into second place is particularly noteworthy because it demonstrates how much ground a membership-based warehouse retailer can gain against a conventional supermarket operator.
Costco’s rise is especially interesting because its business model asks consumers to make several concessions that traditional supermarkets generally try to avoid.
Shoppers must pay an annual membership fee, purchase many products in larger quantities, and accept a smaller selection than they would find at a conventional grocery store.
Costco also emphasizes a relatively streamlined assortment, offering about 4,000 SKUs (stock keeping units) compared to the 30,000 found at most supermarkets.
Yet consumers continue to embrace the model. And the reason comes down to perceived value.
Costco has cultivated a reputation for offering competitive prices. Its private-label Kirkland Signature brand also gives shoppers a reason to believe they’re getting quality products at attractive prices.
The membership structure adds another layer to the business. Rather than relying exclusively on product sales, Costco collects recurring membership revenue, creating an additional source of income and an incentive to keep prices low and maintain customer loyalty.
“Think about this for a minute. Costco charges people to shop there, makes them buy quantities they may not need, and has a fraction of the selection of a traditional supermarket. And somehow it’s beating Kroger,” said Dominick Miserandino, CEO of RTM Nexus.
“That should tell you something about how much consumers value the feeling that they’re getting a good deal. Kroger has to work a lot harder to give shoppers a reason to come back.”
Shutterstock
Kroger faces another challenge as competition intensifies
For Kroger, losing the second-place grocery spending position to Costco represents another competitive challenge.
The supermarket operator has an extensive traditional grocery footprint, with stores offering fresh produce, meat, bakery items, prepared foods, and a much broader selection of everyday products than a typical Costco warehouse.
However, based on the aforementioned data, having more products and locations does not necessarily translate into capturing a larger share of consumer spending.
Kroger has already acknowledged the importance of price competition. The company announced plans to invest $5 billion in lower prices as it works to regain competitive ground.
But Costco’s performance suggests that competing on price alone may not be enough. The warehouse club has turned its membership model, limited assortment, and bulk-buying experience into a compelling value proposition.
For traditional supermarkets, the challenge is no longer simply convincing shoppers that they have the products customers need. It’s convincing them that shopping there delivers enough value to justify coming back.
At a time when grocery prices are up 1.8% year over year, according to the most recent Consumer Price Index, retailers like Kroger are now going to have to work even harder to get shoppers in the door.
“Kroger can’t win. People want better prices, and Costco can beat it every time,” retail expert and TheStreet co-editor-in-chief Daniel Kline said. “For Kroger to remain a viable business it needs to find ways to offer value that aren’t based on offering the lowest prices.”
Maurie Backman owns shares of Costco.
Related: Costco’s latest coffee offering hones in on emerging trend