Costco Strikes Big on China Debut: Can it Sustain Momentum?

Defying the tense undercurrents between two of the largest economic powerhouses of the world, U.S. discount store Costco Wholesale Corporation COST witnessed a gala opening of its first brick-and-mortar store in China. As soon as the gates were opened to the public, the Shanghai store was swamped by huge pool of bargain hunters. The overwhelming customer response took management by surprise and nearly led to a law-and-order problem, forcing the company to untimely pull down its shutters in the afternoon.

Notably, U.S. store closures have surged to 7,922 so far this year (per data from Coresight Research). In this backdrop, such a grand debut on overseas terrain has surely caught the fancy of investors as reflected by a 13.9% rise in share price yesterday. The stock also hit a 52-week high of $293.44 during intra-day trading, before eventually closing at $292.38. Whether Costco can sustain this healthy growth momentum and capitalize on the huge market traction remains to be seen.

What Worked in Costco’s Favor?

Through its partnership with Chinese e-commerce firm Alibaba Group Holding Limited BABA, Costco had an online presence in the communist nation for the past five years. This helped the company to have a feel of the pulse of the market and primed it for the launch of a physical store in the country. In addition, Costco priced its annual membership program, which accounts for the lion’s share of its profit, at a much cheaper price for Chinese customers at $42 (299 yuan) compared with $60 for its U.S. counterparts. This seemingly struck a right chord with the large population of middle-class families that look for premium branded products at discount prices as the economy is witnessing a downtrend with waning GDP growth.

Experts widely believe that much of Costco’s success was due to its unique business concept that resonated with the penchant for trying out new ideas in a mature Chinese retail market. The company’s strategy to sell products at heavily discounted prices has helped it to remain on growth track as cash-strapped customers consider it a viable option for low-cost necessities. This perhaps led to huge customer frenzy as people virtually jostled for space and outran each other for items that flew thick and fast from the shelves.

How Other Retailers Fared?

What makes Costco’s reception all the more appealing is the fact that other Western retailers have not met with much success in China. French hypermarket chain Carrefour SA CRRFY was forced to sell 80% of its business to local retailer Suning after a string of loses, while German wholesaler Metro AG is in the process of winding down its Chinese operations. Grocery retailer Tesco PLC TSCDY also withdrew from China in 2013 after failing to garner sufficient customer response.

Greg Portell, a retail consultant at A.T. Kearney, observed, “Just being the third or fourth store with items on the shelf, that’s not enough anymore. You have to have reasons for consumers to pick you over other options. To do that in a crowded and sophisticated marketplace, you have to have some sort of newness in the concept.”

One-Day Hype or Seasoned Pro?

Despite the initial euphoria, the long-term success of the company depends on how well it adapts to China’s dynamic retail landscape, rapid economic changes and flourishing online retail industry. Costco has a huge market potential with its value-for-money strategy perfectly fitting the bill for China’s middle-class segment, which has recorded exponential growth in the past couple of years. However, the company has to prove its mettle to ensure long-term survival with stiff competition from global retail behemoths Walmart Inc. WMT and Alibaba.

No matter what the future has in store for the company, an overwhelming customer response on market debut amid prevailing bitter bilateral trade relationships speaks volumes for the novel business model. This Zacks Rank #3 (Hold) firm will surely hope to extend its Chinese sojourn and capitalize on the huge money-minting opportunities. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Bai Ming, a research fellow at MOFCOM's Chinese Academy of International Trade and Economic Cooperation perfectly summed up, "This shows the reality that US companies cannot resist the massive Chinese market of 1.4 billion people… As long as there is a big market, they will not turn away."

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