Against The Grain

The conventional thinking about what makes a retail chain`s web site successful is that the site needs to complement the merchandise in the store and it needs to grab shoppers` attention through engaging graphics and content. Costco Wholesale Corp. has built a successful online strategy defying those norms.

For starters, few retailers offer products on their web sites that are so completely different from what they offer in their stores as Costco. Rather than use its web site as simply an adjunct to what it sells in other channels, Costco uses its web site to expand its product lines as well as to offer items and services that it is unable to stock in its warehouse stores. The biggest similarity between the two sales channels is that both follow Costco`s strategy of maintaining low overhead so it can offer products at prices below the norm. And both are directed to a members-only customer base.

Bare bones

And like its bare-bones stores, Costco`s web site is not very fancy. Instead of using sophisticated web tools to highlight features of its merchandise, Costco pretty much just puts its merchandise out there. Then it relies on low prices to bring in the sales. "Costco`s site is rather primitive," says analyst Ed Weller of San Francisco-based Think Equity Partners, an equities research company that follows Costco. "But what is striking is how successful it is."

The most notable feature of the web site is how different the products are from the warehouse stores. Indeed, the overlap in products offered by both the online sales channel and the warehouse stores is less than 10%, according to Ginnie Roeglin, senior vice president of e-commerce and publishing.

The biggest example of how different the product offerings are can be seen in groceries. About 50% of the sales in Costco warehouse stores come from grocery sales. Meanwhile, the web site offers no general grocery items. The only edible items offered online are gourmet gift baskets and wine.

So while Costco customers can`t order a box of cereal or a can of peas online, they can purchase an unusually wide range of products and services from the Internet site--from electronics to caskets to hot tubs. Customers can even purchase vacation packages, order tickets to amusement parks or museums, take out insurance policies or apply for a small business loan at Costco`s web page. But forget about ordering bakery items or produce.

Same strategy

"We follow the same strategy in that we are offering exceptional value and high-end goods to cost-conscious customers. The biggest difference is that we can offer our customers additional products beyond what we can keep in a warehouse," Roeglin says.

Another example: While Costco warehouse stores carry a limited line of in-season outdoor furniture and related items--such as patio furniture, spas and swing sets--it offers a full line of such products year-round on its web site.

The ability to offer a broader line is important to Costco`s low overhead strategy. "Unlike Wal-Mart which carries more than 10,000 products in a store, Costco usually can only keep about 4,000 products in each store, so having a web site that can offer a full-line of merchandise is important," says analyst Weller. "Rather than put all that merchandise in each store, it can keep a wide range of merchandise available in one store and ship it out. And even then, it doesn`t stock a lot of the heavier merchandise at all. Most of the time, it relies on the vendors to store and ship much of the larger merchandise."

Costco`s online offerings also often reflect the demands of the higher-income customers who simply want a good deal, including offering high-end electronics such as a $1,500 digital camera or one-of-a-kind pieces of jewelry. And finally, there are custom orders such as built-to-order computers where consumers can choose the added features they want in a computer before having it shipped.

Beyond basic product items, the online sales channel allows Costco to expand its presence in the service industry. While its warehouse store personnel hand out brochures that promote vacation packages that customer cans order by calling an 800-number, the web site sells a full line of vacation packages direct. Likewise, while insurance and business loans are promoted in stores with brochures to call a number and talk to a sales rep, insurance packages can be purchased through Costco.com directly. Small businesses can even apply online for a business loan through a Costco subsidiary. And consumers can purchase a wide range of tickets online, including tickets to museums, sporting events and tourist attractions.

Unusual products

Costco isn`t afraid to tackle the unusual product array, as evidenced by its online sales of caskets, allowing consumers to avoid the high mark-up associated with purchasing caskets through funeral homes. The chain is testing the sale of caskets in a few stores, but the online channel makes it easier for customers to purchase directly and it makes the product available nationally.

Another item that can be purchased online that some might find unusual for a mass merchant is fine art. In recent offerings, for example, two color lithographs of works by Marc Chagall were offered at prices over $1,000 a piece.

Despite these unusual items, the big online sellers at Costco are electronics and jewelry. "We sell a lot of digital cameras, TVs, computers and computer memory cards. Dell computers and iPODs are selling especially well online. We`re doing a fair amount of furniture sales and we`re selling a lot of jewelry," Roeglin says.

But while the products offered online may look different from what customers will find in the warehouse stores, the customers themselves aren`t different. Online customers must still be members of Costco, which requires them to pay an annual fee. Roeglin says there appears to be some consumers--about 100,000 of total 34 million members--who have applied online for Costco membership just to shop online, but most online shoppers are warehouse shoppers who are looking online for more deals.

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Because the online and the store customers are mostly the same, there are some cross promotions between the two sales channels. The Costco web site has a store locator feature and, while customers can`t order general merchandise items online to be picked up at a store, they can return items purchased online to the warehouse stores--even items that are not sold in the stores.

Little advertising

There are some notable exceptions to the prohibition against ordering online and picking up at the warehouse. Customers can pick up at the store prescription refills ordered online. They can also check online the status of a prescription being filled at a warehouse pharmacy. Also, customers can download images from their digital cameras online and pick up prints at warehouse stores in Washington, Oregon, Texas, Northern California and Utah.

Costco also puts its monthly fliers on its web site which show what is new at Costco and highlight special sales and events at the warehouse stores.

Because Costco is selling primarily to existing customers--as well as having a commitment to keeping low overhead--it doesn`t engage in many of the online marketing methods that other retailers use; promotions are direct to existing members. "Our low margins do not allow us to do a lot of advertising, so we don`t pay for sponsored advertisements on search engines or pay for our products to show up on searches," Roeglin says.

Costco, does however have an opt-in e-mail marketing program for members. The e-mails include hyperlinks direct to the pages where a customer can buy the item. But Costco keeps limits even on the e-mail program. "We try not to overdo the e-mails and overload our customers with messages," Roeglin says. "We only notify them about valuable offerings and hot buy specials. During the heavy shopping season, such as the major holidays, we might send out one e-mail campaign a week, but most of the year it is more like one every other week."

A feature recently added is a section on the web site that highlights new products so that regular shoppers can see what is new before searching around the web site for deals.

Work in progress

Beyond these limited online features, Costco has not invested heavily in navigational tools or fancy online features. "We`re still a work in progress," says Roeglin. "We realize there is a lot more we can do to improve our web site and we have a long list of things we want to work on. But for now, we`re relying on our great deals on high-end items to attract customers to our site."

Indeed, analyst Weller notes that most online retailers utilize advanced features to show multiple views of merchandise or allow consumers to zoom in on features. Costco shows one shot of each item and lets the price prevail. "Most other retailers try to romance the consumer by showing them how attractive the merchandise is. Costco doesn`t go in for a lot of romance. It lets the price sell the merchandise," Weller says. Additionally, Costco has such strong credibility with its customer base regarding the quality of its merchandise, it doesn`t have to sell the customers as much on the merchandise itself, Weller adds.

One feature recently added is the ability for customers to submit rebates directly so that they don`t have to mail in the rebate offers later on. That feature is particularly popular with Costco`s price-sensitive shoppers.

But even though Costco hasn`t invested in a lot of razzle-dazzle, it has seen significant sales growth. In the fiscal year ending Sept. 1, 2004, Costco`s online sales of $376 million were up 60% from the prior year. The company is expecting sales to grow another 45% this year to exceed $500 million.

But that still only equals the sales of two to three warehouses at a company that has 335 warehouse stores in the U.S. and 450 worldwide. "Ultimately we`d like our online sales to mirror what we would see in an entire region so while we`re growing rapidly, we have a lot more potential," Roeglin says.

Indeed, while analyst Weller estimates Costco`s online sales amount to only about 1% of total sales, he notes that $500 million is still significant. And he projects that online sales will grow much faster than warehouse sales in the next few years. "I don`t think you can call $500 million in added sales anything other than significant," Weller says.

Deploying kiosks

One strategy that Costco is exploring to increase online sales is to locate kiosks in warehouse stores so customers can shop online while they are in the store. That way, customers who can`t find exactly what they want in the store can check the web site to see a broader product range and place the order right then and there. Costco has been testing this concept in six stores for just over a year and plans to expand the test to another 20 stores soon, Roeglin says. She adds that it is too early to tell if the store kiosks are successful in spurring online sales.

Whether it is through in-store kiosks connected to the Internet, even more expanded products or more sophisticated navigation features, Costco continues to develop its online strategy. But one thing remains the same: It won`t veer from the path that made it a successful retailer to begin with. "We plan to follow the same strategy online that we follow in our warehouses--offering exceptional values to our cost-conscious customers," says Roeglin.

Lauri Giesen is a Libertyville, Ill.-based freelance business writer.