The Strategic Opportunity for Costco in China

Source: Kevin Holmsten, Wednesday, Oct 18, 2017

As China continues to expand its influence in global retail, international retailers and brands are looking for a point of entry into China as a new source for growth. Costco is establishing its digital presence on Tmall and here we outline a path for Costco B&M expansion. 

Size of Opportunity 

Global retail brands with growth ambitions have great potential in China. It is the second-largest market in total consumer spending in 2017, which trails the US but is greater than the sum of third and fourth-largest markets (Japan and Germany). While chain retail in China is rapidly growing, China’s addressable population, those that typically participate in the modern trade, is 816 million shoppers in 2017, representing only 59% of consumers in the market. As income growth and urbanisation bring more shoppers into the formal economy, the growing addressable population will fuel further chain retail growth.

Costco and Tmall 

Costco remains primarily focused on its store-based operations in the US and other international markets, but first entered China in 2014 with a digital presence when it began selling on Tmall Global, Alibaba’s cross-border B2C platform designed to sell international products to Chinese consumers. Costco found success on the B2C platform with its assortment of American goods and the strength of its private label Kirkland Signature brand and was recognised on Singles Day 2015 as the retailer with the highest sales volume. In September 2017, Costco opened a storefront on the Tmall platform, the B2C platform for local retail operations. On the local platform, Costco will augment its current assortment of food, health & beauty and clothing, by expanding to new categories including consumer electronics and wine. The move to the local platform signals Costco is licensed to operate fully in the market by Chinese regulators and are also legally able to open bricks and mortar stores in the country.

One local media report suggested Costco will open a warehouse club in Shanghai, though no timeframe was reported. On the earnings call in October, Costco executives would not comment on potential B&M locations in the market. Expansion to smaller cities in China presents a stronger bricks and mortar opportunity for Costco than developing (big-box) B&M locations in tier 1 cities with large, densely populated, and tech-driven metros that are well served by Costco and other retailers through digital retail platforms. 

Alibaba’s Grocery Priority 

Alibaba continues to expand its retail digital ecosystem, to serve consumers with partnerships through traditional retail, retail-adjacent (e.g. delivery services), payment and non-retail activities (e.g. social media and travel services). Alibaba has an asset-light approach to its partnerships, preferring to partner businesses that own retail or logistics assets, instead of directly investing in retail infrastructure. Alibaba is beginning to turn to grocery and, via the Tmall platform, club stores have a B2B opportunity with small stores in Alibaba's ecosystem in China.

A priority for Alibaba is to expand its retail service by improving the experience of consumers buying groceries on its platforms. In August, it was reported that Alibaba is looking to integrate its Tmall platform with thousands of independent proximity stores in tier 3-6 cities throughout China, expecting 10,000 stores to be licensed by the end of 2017. Tmall will provide assistance with payment and inventory software, logistics support, marketing targeted to local shoppers and curated assortment displays of best-selling items on Tmall. 10,000 locations are only a small portion of a much larger opportunity, as Alibaba is targeting the market’s 6 million community grocery stores, mostly located in these smaller cities.

Last year, Alibaba also partnered with Sanjiang, a warehouse club with 160 locations specialising in discount grocery with a strong B2B offer. With thousands of convenience stores partnering with the Tmall platform, there is additional opportunity for B2B warehouse operators in the Alibaba digital ecosystem to meet the demand of these c-stores.

Experience with bulk purchases of packaged and fresh grocery would be necessary to support the network of stores. Access to international (American) brands and a private label popular with consumers in China would be an added benefit to a potential partnership in a network of Costco warehouses in China. 

Opportunity for Costco 

There is a massive potential opportunity for a physical retailer to become a major supplier for Alibaba’s O2O convenience store network in China. And Costco has the foundations for seizing this opportunity in place.

Costco has an expertise in running B&M warehouse retail for fresh, packaged and non-grocery categories. In the US, and other markets, B2B shoppers are an important segment for Costco, and aligned to its core offering of bulk merchandise that are packed to be resold by smaller merchants. These features of Costco would meet the needs of convenience stores in Tier 3-6 cities in China.

The existing partnership with Alibaba helps open the door to the market. Compared to other international cash & carry and club retailers, Costco has a head start on timing to enter the market, having secured the necessary licenses to operate on Tmall and B&M stores in the market. 

Recommendations for Non-Costco Retailers and Brands 

Costco is a successful B&M retailer, but it has not moved aggressively on expanding to additional markets or on digital innovation. While expanding a B&M presence across China with a primary objective of B2B sales to convenience and small format retailers aligns with Costco’s strengths, we do not consider it likely that Costco would execute this blueprint, but it could be an opportunity for a more aggressively expanding retailer. Carrefour could adapt its Atacadão Cash & Carry model from Brazil, and connect consumers with products from a range of international markets. It would be futile for an international cash & carry B&M model to try to enter the market to serve a network of independent c-stores that are operating outside of the Alibaba or platforms.

Alibaba can use its analytical power and trove of customer shopping data to help a B&M retailer analyse demand and merchandise decisions metro-by-metro during expansion. Partnering with one or both leading retail ecosystems presents a faster route to market in China than expanding organically.

Brands can use retailers to enter emerging markets. Expanding to tier-3-tier 6 cities in China alone would be difficult. But preparing a strategy to enter these cities along with a non-China warehouse retailer is an opportunity to enter China, expand beyond the international gateways, and in retail channels outside of Tmall and