Seattle-based Amazon.com (AMZN) has a cross-town retail rival in Costco Wholesale (COST), located in nearby Issaquah, Wash., and the histories of the companies are interestingly intertwined. During Amazon’s formative years, founder Jeff Bezos got some key advice from his Costco counterpart, Jim Sinegal. And Amazon Prime, the two-day shipping club, was inspired in part by Costco’s membership fees and the psychological inclination of shoppers to maximize the benefits of a club they have already paid to join.
As I was researching the connections between the companies last year for my upcoming book on Amazon, I called Sinegal and left a message asking if he could talk. He called back on a Saturday and left his cell phone number, then invited me to Costco’s headquarters for a one-on-one visit. That kind of availability and transparency is extremely unusual for the leader of a Fortune 500 company, and the conversation lead to my story in this week’s Bloomberg Businessweek about the company’s bizarro corporate culture and Sinegal’s like-minded successor, Craig Jelinek.
Costco is thriving, but Amazons’s relentless expansion looms over the second-largest retailer in the U.S., as it does every other retailer. The online giant is moving rapidly into apparel and is reportedly set to expand AmazonFresh, its Seattle-only grocery delivery business—two categories that are key to the continued vibrancy of big-box behemoths such as Wal-Mart Stores (WMT), Costco, and Target (TGT). Last year, I wrote that Amazon was poised to extend grocery delivery beyond Seattle, and on Wednesday the company quietly rolled out the service in Los Angeles.
Costco executives watch Amazon closely and believe the companies share a lot of cultural values, such as frugality and an interest in building for the long term. Like everyone else, they also marvel over the fact that Wall Street allows Amazon to get away with nearly nonexistent profit margins. “At some point people have to make some profits,” says Jelinek. “It is fashionable to make a lot of money these days.”
Jeff Brotman, Costco’s co-founder and chairman, says Bezos “doesn’t have to make a profit or break even on” services like Amazon Prime and AmazonFresh. “He’s building great loyalty with that, as we have with our executive membership,” which costs $110 a year and entitles members to additional benefits. Like other Costco executives, Brotman was skeptical that home grocery delivery could be profitable, but he notes that Amazon doesn’t really have to make it work perfectly in the short term: “He can spend a billion dollars experimenting and putting televisions on a truck and delivering them the same day with apples and oranges. That’s a research and development experiment that competitors and normal online businesses can’t do.”
So is Costco (and, for that matter, Wal-Mart) doomed if Amazon figures out home delivery of perishables and other sundries? Costco executives certainly don’t think so, and I agree. As others have noted, Amazon still has a lot of work to do to make home grocery delivery an economical option. And Costco members, attracted in part by its low prices, are exceedingly loyal, as its recent earnings reports have demonstrated.
Costco executives are not blind to the Amazon threat, and they talk in vague terms about evolving to meet the challenge. “It’s obviously a huge point of discussion around here,” says Paul Latham, vice president in charge of membership, marketing, and services. “We view Amazon as one of our primary competitors in almost every category. We all believe we are going to have to adapt in some form.” Latham also adds that “there’s a recognition that at some point Amazon has to start making money. They can’t continue on their current path of just pouring everything back into more infrastructure.”