COSTCO Grows in Organics, and Organically

When analysts at BMO Capital Markets notedrecently that Costco might now be the biggest retailer of organic groceries in the U.S. by sales volume, it was an acknowledgement of a couple of realities.

One was the explosive growth of club stores in general, and Costco in particular. Club-store sales have grown more than tenfold since 1992, to $420 billion. Costco, the top U.S. club store chain (and the second largest U.S. retailer, by revenue, overall), has nearly doubled its sales since 2000, reaching $113.7 billion in the last fiscal year.

The second was Costco's relatively new emphasis on organic products. Sales of organic products have doubled in just the last couple of years, and are expected to reach $4 billion this year, CFO Richard Galanti said in an earnings call last spring. While that would be only 3.5 percent of Costco's overall sales, it would surpass Whole Foods Market for the top spot in organics, and would constitute roughly a 10 percent share of total U.S. sales of organic food.

This growth is partly a function of Costco's sheer sales volume and basket size. But it's also the result of Costco realizing that its shoppers, while bargain-hunters, are just as interested in organic food as anyone else.

"Costco seems to be operating with an insight that many of its shoppers have the means to pay a little more to feed their organic consciousness," says James Tenser, principal at VSN Strategies.

Costco's approach to organics encompasses both adding organic alternatives to Kirkland, its flagship private label line, and carefully curating its organic product portfolio overall.

"I think virtually everything Costco does is the result of a deliberate and carefully planned strategy, including the way it has systematically increased its assortment of organic products," Tenser says. "Nobody would ever mistake it for a health-food store, but on the most popular items it may even choose to offer only the more profitable organic option. Why not? Its customers can afford it, and the value is evident."

Many big-box retailers use food as a traffic driver, if not a loss leader. At Costco, as at most club stores, everything is a "traffic driver." More of Costco's profit comes from its annual $55 membership fee than from actual sales. Costco can thus afford to sell products, especially name brands (as opposed to Kirkland products), at a far lower profit margin than a pure grocer, or even a pure big-box retailer like Target.

This model provides a secure source of income through the subscription fees, as long as renewal rates stay high–and Costco's are at 91 percent in North America. Beyond that, the high volume means that stock often gets turned faster than the suppliers' payments come due, which is like getting an interest-free loan.

"In effect, that means it is buying with its vendors' money," Tenser says. "Grocery, beverage and office supply products lend themselves especially to this strategy since they are consumption-oriented and drive repeat traffic."

Costco also succeeds through good customer service, which it is in position to offer largely by treating its employees well. A Costco worker in the U.S. earns an average of $21 an hour, as well as health care, good vacation benefits and a 401(k) match. Costco got a lot of good publicity the last couple of years by sticking to its policy of closing on Thanksgiving, eschewing the lead of Walmart and others, so that workers could spend the day with their families.

Photo courtesy of Costco