Costco Goes to China

The first store in that country exceeded expectations, even in the early stages Continue reading... Read More...

Last August, the world’s third-largest retailer entered the most populous country in the world.

Perhaps there was some trepidation among senior executives at Costco Wholesale Corp. (NASDAQ:COST) as they made the commitment to invest in China. The company noted in its most recent 10-K filing: “We intend to continue to open warehouses in new markets, including China. Associated risks include difficulties in attracting members due to a lack of familiarity with us”.

Apparently, the people of Shanghai did not get the message. On Aug. 27, 2019, they turned out by the thousands to see the first Costco in China, forcing the store/warehouse to close for four hours while it got the crowds under control. Customers liked what they saw–in mid-December the company reported it had sold more than 240,000 memberships. That’s more than triple the average 68,000 per location for the company as a whole.

So more locations will be added in China. The Reuters news agency quoted state media in reporting that land has been purchased for a store in Suzhou, which is near Shanghai. And there is word that it will add a second store in Shanghai, a city of some 25 million people.

What’s behind this interest? Mostly demographics; for example, McKinsey & Co. wrote in a 2019 report, “The explosive growth of China’s emerging middle class has brought sweeping economic change and social transformation–and it’s not over yet.” The size of the Chinese middle class could reach 550 million in a few years, and the authors of the report thought it possible that middle-class income could double in the three years between 2019 and 2022.

Previously, Costco had partnered with Alibaba (NYSE:BABA) to run an online store for the Chinese market, and it had taken initiatives in several other Asian countries, including Taiwan. Incidentally, Costco took a group of Taiwanese managers to help launch the new Shanghai location.

Walmart (NYSE:WMT), the world’s biggest retailer, arrived in China much earlier, in 1996. According to Walmart China, it now operates 438 retail units, made up of 404 supercenters, 26 Sam’s Clubs and eight Neighborhood Markets.

Amazon.com (NASDAQ:AMZN) is going in the opposite direction; last year it shut down its Chinese domestic e-commerce business. It found it could not compete with Alibaba and JD.com (NASDAQ:JD).

Doing business in other countries isn’t a simple matter. In addition to cultural differences, there are also supply chain and logistics challenges. Several questions on the December earnings call focused on the company’s experience in China. One analyst asked how many stores it would take in that country for it to reach breakeven or become profitable. Chief Financial Officer Richard A. Galanti responded that it would likely take seven to 10 locations.

Tariffs are also an issue in any international presence or expansion, and when the other country is China, the complications are multiplied. At the time of the earnings call, the U.S. and China were working through another round of tariff considerations and, at that point, little had been concluded.

In response to a question about the effect of tariffs on Chinese goods coming into the U.S., Galanti noted that they had generally been able to pass along the extra costs to their customers. In addition, since Costco has the flexibility to change its product lineup, it can shift out of items that become too costly because of tariffs and into others that are affordable.

Currency exchange rates also matter when doing business internationally. Given that it buys significant amounts of products from China, it was already exposed to some of that risk. Adding revenue brings another dimension to the issue.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Conclusion” data-reactid=”30″>Conclusion

It’s not easy entering a new country, especially one that is so culturally and economically different. As we’ve seen, there are many areas where a company might get tripped up or trip over its own shoelaces. Costco, by taking its time, apparently has managed to successfully get past the hazards so far.

The reward for taking on these additional challenges is in the size of the opportunity. If China’s middle class grows to 500 million or more, that’s more than the total population in the U.S., Canada and Mexico combined. That would also be greater than the size of the European Union. For a company that intends to keep growing, there’s probably no better target now than China.

Disclosure: This article is for information purposes only and investors must do their own due diligence. I do not own shares in any company named and do not expect to buy any in the next 72 hours.