October 16, 2014 / 9:39 PM / 3 years ago

Costco seeks China path that avoids Wal-Mart's potholes

CHICAGO (Reuters) - By selling directly to Chinese consumers on Alibaba’s platform, a move announced Tuesday, Costco Wholesale Corp. (COST.O) aims to employ local knowledge and a low-cost structure to avoid missteps that caused even the world’s largest retailer, Wal-Mart Stores Inc. (WMT.N), to stumble.

Shoppers leave Costco in Fairfax, Virginia, January 7, 2010. REUTERS/Larry Downing

Many global retailers opening in China have struggled to find product mixes and store designs favored by local customers. Besides Wal-Mart, Best Buy (BBY.N), eBay (EBAY.O) and others have fallen short of expectations in one of the fastest-growing consumer markets.

Costco’s virtual storefront on Alibaba Group Holding’s (BABA.N) Tmall is designed to help the warehouse store operator study consumer shopping habits with no brick-and-mortar costs and fewer risks, signaling a new approach to expanding in China.

“This shows Costco has learned from the mistakes made by companies like Wal-Mart and also those who were forced to exit the market like Home Depot (HD.N),” said Anjee Solanki, national director of retail services at Colliers International.

Wal-Mart’s China sales in the second quarter grew 1.1 percent, but same-store sales, a key figure, declined 1.6 percent. David Cheesewright, head of Wal-Mart’s international division, acknowledged at the company’s investor conference Wednesday that China remains tough even after 17 years. “We are still very much focused on building our foundations,” he said.

Early steps at times have been shaky. Wal-Mart stuck with its big-box format even though Chinese consumers prefer neighborhood stores. And its stores in China, including Sam’s Club warehouses, offered few high margin private-label goods until as recently as last year.

Even Wal-Mart’s “Everyday Low Prices” slogan backfired. Chinese consumers equate inexpensive with unsafe and value quality as much as bargain prices, retail consultants said.

Supply-chain problems came to a head in January when Wal-Mart recalled its popular “Five Spice” donkey meat after tests showed traces of fox meat. The recall followed episodes involving tainted milk and recycled “gutter oil” sold as cooking oil in the market.

Despite the difficulties, Wal-Mart has become China’s third-largest retailer, behind Sun Art Retail Group Ltd and state-backed China Resources Enterprise Ltd, according to consultant Kantar Retail.

Wal-Mart has made adjustments, too. Last December it announced plans to boost private-label sales to a 20 percent share within a decade, and Wal-Mart has built its own distribution centers to manage product quality.

“We’ve done a lot of work on building trust,” Cheesewright said.

TESTING THE WATERS

Costco’s decision to partner with Alibaba is designed to bring local credibility to the Issaquah, Washington-based retailer. China-based iResearch in July forecast sales of 2.76 trillion yuan ($446.6 billion) for the year, up 45.8 percent from 2013.

Virtual storefronts are a growing business on Tmall, one of the world’s fastest-growing business-to-consumer marketplaces, with a 50 percent share in China. Tmall lists more than 100,000 brands, about 2,000 of them foreign-made.

“Digital storefronts are a powerful tool to help shape what a retailer might want to do with a physical store,” said Marcie Merriman, executive director of retail strategy and customer engagement at EY.

Costco is opening in China with its well-regarded and high-margin private-label Kirkland brand, which sells everything from men’s shirts to laundry detergents, aimed at quality-conscious Chinese consumers.

Even so, price competition likely will be fierce with Yihaodian, a website in which Wal-Mart is majority owner. As part of an introductory “Shopping Spree” on Tmall, Costco offered four packs of Sensodyne toothpaste at 145 yuan, or $23.68, compared with 109 yuan on Yihaodian.

Partnering with Alibaba, a symbol of China’s economic maturation, may even provide political benefit, a concern at a time when foreign companies have found themselves jousting with the Chinese government.

“We believe (Costco‘s) worry has always been that if they got it right in China, and returns exceeded the cost of capital, they would quickly gain a new partner in the Chinese government,” Janney Capital Markets said in a note.

LOGISTICS CONCERNS

The tie-up with Alibaba is not without risk.

Costco’s plan to rely on Tmall warehouses to reduce logistics costs and shorten delivery times may risk creating logistics problems similar to those Wal-Mart has faced.

“Letting Alibaba handle a lot of their supply chain is a good short-term solution,” said Colliers’ Solanki. “But (product) safety is a big issue with supply chains in China, and that has to be managed well.”

Rob Howard, chief executive officer of San Francisco-based local delivery firm Grand Junction, said the Alibaba partnership could put Costco in a system that often favors local players.

“It’s more of a cobbled-together, relationship-driven infrastructure,” he said. “It’s hard for an external person to tap into that effectively, and Alibaba has that all nailed.”

Additional reporting by Nathan Layne in Arkansas, Deepa Seetharaman in San Francisco and Adam Jourdan in Shanghai, Editing by David Greising and Douglas Royalty

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