IKEA & Costco


How Costco and IKEA are Surviving in the ‘Age of Amazon’
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I. Story of two retailers who have maintained strong growth even as Amazon continues to upend the retail industry

With the “Amazon Effect,” dominant retail giants like Walmart, Macys, Sears, Barnes and Noble, and Toys R Us, are [1] teetering on the brink.

  • Walmart: Walmart rose to the top by developing the “Every day low price” strategy and an innovative logistics system. However, growth slowed in the early 2000s as price sensitive consumers began to choose Amazon over the company. Struggling, Walmart [2] hit a new low in 2016 when annual revenue fell for the first time in 35 years of the company’s history. The company has been attempting to come back by doubling down on online retail channels (with acquisitions of ModCloth, Jet, Bonobos, and Shoebuy). In spite of these efforts, share prices dove 5% after Amazon acquired Whole Foods Market (Premium foods American supermarket chain).
  • Macys and Sears: Once America’s largest shopping mall, Macys closed 100 of its 700 locations in 2016. Similarly, the Sears Group (which operates Sears and Kmart) decided to close 150 offline locations and focus on online sales. The struggles were brought on by a massive flight of consumers from malls to Amazon and other offline retail alternatives.
  • Barnes and Noble: Once America’s largest offline bookstore, Barnes and Noble experienced sharp decline in the early 2000s after Amazon began to dominate both online book sales and the ebooks market. The company’s offline locations continue to close their doors, and their ebook product has been unable to compete with Amazon’s Kindle and Apple’s ibooks. Barnes and Noble finds itself completely besieged now that Amazon has entered the offline bookstore market with “Amazon Books”
  • Toys “R” Us: Another victim is Toys “R” Us, the undisputed leader in the toy and juvenile-products market until the mid 2000s which operated over 1,600 store locations worldwide. This all began to change with the rise of Amazon and large department stores. The company could not compete and eventually filed for chapter 11 bankruptcy protection in 2017. Toys “R” Us lost out to Amazon, which was offering wider variety products at lower prices and free delivery.

However, in spite of the damage of the “Amazon Effect” on the offline retail industry, Costco and IKEA have experienced sustained growth, generating revenues and profits comparable to that of Amazon.

  • Costco: The global membership only warehouse retailer continues to have strong growth, reporting revenue growth of 6-8% last year. When word began to spread that “Costco has the best meat, fish, and produce for the lowest price,” customers flocked to Costco. Costco boasted strong numbers for the 2016 fiscal year: 90 million members and $135 BN in revenue.
  • IKEA: World’s largest furniture retailer and a dominant player in the global furniture market. IKEA experienced top line growth of 7-8% last year with $43 BN in revenue and approximately 800 million visitors to its warehouse-sized stores. People worldwide say “when buying furniture, you have to go to IKEA” and this has been key to the company’s strong retention and repurchase rates.

How have Costco and IKEA survived when Amazon is taking over the retail industry and upending once dominant offline giants? How exactly are they able to sustain their strong growth?

II. Costco’s Success Strategy

The global membership-only warehouse retailer with the mission to continually provide members with quality goods at the lowest possible prices

  • Vision statement: “a place where efficient buying and operating practices give members access to unmatched savings”
  • Mission statement: “to continually provide our members with quality goods and services at the lowest possible prices”
  • Product mix and business model: Costco’s huge warehouse-style stores (located in the suburbs) have a product selection of over 3,000 items including groceries / household items and over 1,000 promotional products (including televisions, massage chairs, wedding dresses, etc.). The number of products is much fewer than Walmart’s 100,000, but the majority of the items in stock are sold at the lowest possible prices for each category.
  • Revenue / Profit: Costco reported revenues of $135 BN and $4.5 BN in operating income for fiscal year 2016. It has a market capitalization of $80 BN (which is a 60-70% growth from five years ago).
  • Number of stores: the company maintains and operates 730 warehouse locations worldwide, strategically focusing on 11 markets (508 in the United States, 94 in Canada, 37 in Mexico, 28 in the UK, 25 in Japan, 13 in Korea, 13 in Taiwan, 8 in Australia, 2 in Spain, 1 in Iceland, and 1 in France).

After opening its first store location in Seattle, US in 1983, Costco expanded its offline big box retail locations targeting North America and East Asia.

  • Costco’s founding: Founder James Sinegal at age 18 worked a part time job at big box retailer FedMart, loading and unloading mattresses. At FedMart, he worked his way up to executive vice president in charge of merchandising. Sinegal eventually joined the founding team of Price Club, the first-ever warehouse club in the world, following the sale of FedMart by founder Sol Price (the man considered to be the father of the warehouse store concept). Seven years later in 1983 Sinegal opened Costco’s first warehouse store with cofounder Jeffrey H. Brotman.
  • Early growth: Costco experienced rapid growth in the domestic market, becoming the first retailer in US history to achieve $3.5 BN in revenue in just 6 years after its founding.
  • Inflection point (The “PriceCostco” Merger): The fast growing Costco announced a merger with PriceClub in 1993, which was similar in size. Although first approached by Walmart about a merger, PriceClub went with Costco because its founding principles, vision, and operating structure were more aligned. The rationale was that the alignment of founding principles would allow for synergies and generate huge value for its customer base. The company was renamed “PriceCostco” with both Sinegal and Price both leading the management of the company. However, after the Price family decided to leave the merged entity in 1994, the company returned to using Costco as its name.
  • Present: Costco is behind Walmart as the world’s second largest offline retailer. However, unlike Walmart which is battling Amazon and new offline retailers, Costco has unparalleled dominance in the food and produce market and is growing steadily. According to reports, 80% of Americans have claimed that “They purchase all food and household items at Costco”.

The success of Costco lies in the company’s ability to provide “quality goods at the lowest possible prices”. Costco has a methodically designed business model in place to ensure this goal.

  • Small product selection is key. Costco sells a variety of products, but will only put on its shelves 1-2 “fast-selling” items for each product line (according to its annual report).
  • Take sugar as an example. Whereas the customer will find various sugar products on shelves of other supermarkets, at Costco, the customer will only find 5kg-size white and dark brown sugar items (apply that to different categories and it makes sense why Walmart has a selection of 100,000 versus Costco’s smaller 4,000).
  • Costco will bulk purchase the 1-2 top selling products in each category and drive down the cost of goods with the mindset of “we are going to buy up all of the targeted products off the market”. Then, Costco employs a low-price high-volume strategy to sell these goods to customers.
  • Costco works to keep prices low by buying in huge quantities and never marking up any product more than 15 percent, less than the typical 25 percent margin at a supermarket or 50 percent at a department store.
  • Minimizing operational expenses has been critical to Costco’s success. Costco only accepts one type of card because it means paying less in fees. The warehouse-style store locations are in relatively cheap suburban areas, which drives down capital expenditures (land and property) and logistical costs. Moreover, the no-frills warehouse design means low interior design expenses. Costco also employs a no plastic bags policy (which saves related expenses) and at checkout, customer purchases are bagged in bulk with sturdy handles. Inventory costs are minimized by mass-stocking items in warehouses and selling them at highly competitive prices.
  • “Annual Membership fees” are a big part of Costco’s revenue stream. Revenue per customer from annual memberships is approximately 100,000 KRW (profit from annual membership fees totaled over $2 BN in 2016, which accounts for 70 – 80% of total profit)
  • The company primarily relies on word of mouth marketing by their membership base, who receive discount coupons for large purchases (a strategy that hugely reduces marketing costs).
  • Labor costs are optimized by paying their employees double the industry standard, which in turn maximizes workforce productivity and minimizes employee turnover.

→ In one sentence, Costco’s secret to success is “Lowest possible prices through massive simplification.” This is in striking contrast to Amazon’s mission to “be a place…to discover anything they might want to buy.”

James Sinegal’s passion and discipline has also been critical to why Costco has stayed true to its founding principles for over 30 years.

  • As mentioned above, Sinegal started with a part-time job at Sol Price’s (legendary father of the warehouse store concept) FedMart and worked his way up to executive vice president.
  • He is an entrepreneurial leader who never stopped thinking about cost optimization, to the point where he actually memorized all 4,000 items on Costco’s product selection.
  • Sinegal led by example and was big on financial discipline. He learned to be frugal growing up as a poor child in an orphanage, and this became the core of how Costco became the “most financially disciplined organization in the world.” Although he pays his employees generously, Sinegal pays himself $350,000 (approximately 400 million KRW) which is one of the lowest CEO salaries among Fortune 500 companies.

III. IKEA’s Success Strategy

IKEA is another warehouse-style retailer that sells high quality and well-designed ready-to-assemble furniture at affordable prices.

  • Vision: To better the everyday life of many people.
  • Mission statement: “We shall offer a wide range of well-designed, functional home furnishing products at low prices/ so that as many people as possible will be able to afford them.
  • Product mix and business model: Through its sprawling suburban stores, IKEA sells its famously modernistic and high quality furniture for low prices. It is the world’s number one furniture retailer with a wide variety of products. Among the 10,000 furniture items sold in each of its store locations, customers will not find products from famous furniture makers. IKEA finds and partners with smaller and lesser known high quality manufacturers from around the world and sells furniture characterized by simplicity and function, a style that has come to be known as “Scandinavian Design.” IKEA offers these quality products at low prices by mass producing one product (hence driving down cost of goods) and selling DIY (“Do It Yourself”) ready-to-assemble furniture, which does away with delivery and labor costs.
  • Revenue/ profit: IKEA reported $43BN in revenue and $5.5BN in operating income (operating profit margin of 12%) for fiscal year 2016. IKEA is a private company. It has an estimated valuation of 50-70BN.
  • Number of stores: IKEA maintains and operates over 400 large warehouse stores in 49 countries worldwide, with over 800 million store visits annually.

IKEA began in 1943 in Sweden as a mail-order sales business and opened its first furniture store in 1958. Since then it has begun expanding internationally, regularly opening locations in a new country every 1-2 years to eventually become the largest furniture retailer that it is today.

  • IKEA’s founding: Founder Ingvar Kamprad started IKEA as a mail-order general store that sent product brochures to customers via mail (and delivered ordered items).
  • IKEA product mix and business model: IKEA added furniture to its selection for the first time in 1948 and in 1951 published its first annual catalogue containing affordable furniture products. The famous “IKEA catalogue” marketing strategy was first validated then. When competitors began pressuring furniture suppliers to “stop supplying products to IKEA,” Kamprad began to design and manufacture products in-house and invented “ready to assemble” furniture. The first store, opened in Älmhult, was at the time the largest store in the Scandinavian Peninsula.
  • Growth: From 1963 IKEA began quickly expanding across the Scandinavian Peninsula and neighboring countries, regularly opening locations in new markets every 1-2 years. Stores opened in Norway (1936), Denmark (1969), Switzerland (1973), Germany (1973), Japan (1974), Australia / Canada / Hong Kong (1975), Singapore (1978), France / Spain (1981), Belgium (1984), United States (1985), United Kingdom (1987), and Italy (1989). The expansion was accompanied by an aggressive search for the best furniture manufacturers to partner with in order to stock its warehouses with high quality products quickly and at lower cost.
  • Present: IKEA’s revenues jumped threefold in the last ten years, [3] growing at a breakneck pace. Its growth in Germany is especially noteworthy, with 50 store locations, with United States coming close with 45 stores. In 2014, the company opened the world’s largest IKEA Store in Gwangmyung, South Korea. IKEA plans to expand to 6 other locations in the greater Seoul area, Daejeon, and Busan by 2020.

The success of IKEA also lies in the company’s ability to provide “quality goods at lowest possible prices”, a philosophy built into the company’s business model.

  • IKEA implements a standardized production process that allows for low cost mass manufacturing and product designs that cut down on delivery and labor costs. You can see Scandinavian design elements in their soft colored furniture products which embody simplicity and function. These signature products are mass produced and sold at very affordable prices to its customers. IKEA has dubbed this “Democratic Design”, which embodies the principle “instead of expensive furniture for a minority, design cheaper products for the majority.”
  • Instead of big brand name furniture makers, IKEA relies on its network of long-term partnerships with more than 1,000 third-party manufacturers across 50 countries. The company invests in highly-automated distribution centers located around the world in order to optimize every step of the supply chain (namely warehousing and transportation). This system allows for mass production and transportation of products that meet strict design requirements, quickly and cheaply.
  • As mentioned, IKEA sells ready-to-assemble products instead of assembled furniture items as a way to cut down on transportation and cost of goods. Purchasers have the added benefit of having a “fun assemble-it-yourself experience.” Research shows that adult purchasers who assemble the products at home are reminded of playing with toys when they were kids.
  • The warehouse-style store locations are in relatively cheap suburban areas, which drives down land and property capital expenditures and logistical costs.
  • The IKEA Catalogue is the company’s main marketing tool and it rejects mass media advertising. The beautiful 300 page catalogues are designed to make readers want to open their wallets and are distributed by mail. This low cost high return marketing strategy has been the core of IKEA’s marketing since its founding.
  • Yet, IKEA spends generously on employee welfare as a way to maximize workforce productivity.
  • For example, IKEA provides equal maternity and paternity leave for its employees. Every store location has a kids’ area for working parents. The working environment, which is very friendly to employees with children, allows them to consistently create value for the company.
  • When it comes to global expansion, IKEA invests a lot of time into localization strategy to minimize errors and make successful inroads into new markets while staying true to IKEA’s brand and core principles.
  • For example, for seven years leading up to its expansion into Korea, IKEA performed extensive research on regulations on consumers, furniture manufactures, land and property. Field research included visiting over 100 homes of middle class Korean households to observe patterns on how they use furniture.
  • Insights drawn from observational studies were used to identify products that Korean customers use most frequently so that they could be placed on storefront displays, while maintaining the global IKEA brand user experience.

Like Sinegal and Costco, Kamprad’s leading by example lifestyle has been critical to how IKEA has been able to stay true to its founding principles, provide quality furniture products for its customers, and ultimately bring about the company’s success.

  • Founder Ingvar Kamprad in 1976 said in a message to employees, “Innovate a better lifestyle for many people. To this end, create products with the best designs and features. But, they have to be affordable so that we can serve as many people as possible. We’re on the side of the majority.” This message became the fundamental value of the IKEA retail concept and identity (from A Testament of a Furniture Dealer, 1976).
  • Kamprad personally embodies the core values detailed above by living a life of frugality and by always reminding himself to be “financially disciplined for the customer.” Even though he is wealthy, Kampard famously reuses tea bags and always flies coach (or economy section). His values flow over into company operations: in overseas business trips, employees must always fly coach and find cheap hotels; most supplies are recycled items.

IV. Similarities between Costco and IKEA

We have identified six similarities between the two companies that have been critical to their survival in the retail world in the “Age of Amazon”

Similarity 1_The key to retail is not “location strategy or accessibility”, but “selling high quality products at low prices”

  • Costco and IKEA’s customers still seek out the stores despite them not being located in city centers for their “quality products offered at the lowest possible prices.”

Similarity 2_ Embrace the “Category Killer Strategy” to maximize value created to customers

  • “Category Killer Strategy” is to become masters at production, distribution, product categories, and maximizing the customer experience. For Costco, that category was “groceries and household items” and for IKEA, that was “well-designed furniture.”
  • Cut down your product selection to the best products in every category, purchase them in bulk and sell to customers for the lowest possible prices

Similarity 3_Implement extreme cost cutting strategies (to compete with online retailers)

  • Purchase in mass quantities from a few select vendors to drive down cost of goods and provide customers with the most affordable products.
  • At the same time, simplify operations and eliminate unnecessary expenses to optimize operational costs.

Similarity 4_Generously invest in people and your employees

  • Both companies, by treating and compensating their employees well, enhanced workforce productivity and minimized employee turnover. In the long run, this strategy has been a great way to optimize efficiency.

Similarity 5_Engage in slow but deliberate international expansion.

  • When expanding abroad, the top priority for both Costco and IKEA has been “understanding local customers” instead of “rapid expansion”. Years of extensive target market research always came before opening a new location.

Similarity 6_As founders, never lose sight of the company’s founding principles, and lead by example.

  • The founders, Sinegal and Kamprad, both embodied financial discipline and never lost sight of the mission “to offer quality goods at the lowest possible price.” They continually communicated this mission successfully within their respective firms to drive the companies to success.

V. Key takeaways for Korean retailers

Outlined below are what Korean retailers can learn from Costco and IKEA.

  • The key to success in retail lies in selling high quality products at low prices, not good location strategy.
  • Focus on long term success when opening new stores, even if it means retreating in the short term. Premature scaling can actually hurt their growth.
  • A clear alignment of the value proposition within all parts of the company is more important than improving the top-line.
  • Invest in your people and compensate employees well. That is the key to cost reduction in the long run.
  • The leader of the company must [4] lead by example.

Once-dominant retail giants are teetering on the brink due to the “Amazon Effect”, but Costco and IKEA have maintained strong growth. What are your thoughts on this? Also, what are some key takeaways from these companies?

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