FD Buyer: Costco Makes SKU Rationalization a Fine Art
Through a special arrangement, presented here for discussion is a summary of a current article from Frozen & Dairy Buyer magazine.
Beyond low margins, limited assortment also plays an important role in Costco’s success. While all the leading club chains expanded their assortments during the past five years, Costco’s grew the least and its SKU count remains by far the skimpiest.
According to Ginny Valkenburgh, SVP, Kantar Retail, Costco’s total of about 3,950 SKUs pales in comparison to Sam’s Club’s 5,250 and B.J.’s 6,890.
"Customers think they want more variety, but too many choices actually makes shopping more difficult," she explains. Its frozen departments carry an average of just 105 SKUs vs. 197 at Sam’s and 275 at BJ’s; its dairy departments, just 69 vs. 97 at Sam’s and 148 at BJ’s, according to Warehouse Club Focus.
The low count helps prevent stock-outs.
How does Costco determine which items warrant that kind of space? According to Jim Degen, president of J.M. Degen & Co., "Every item competes with every other item in the department," not just every other item in its particular category. So, if refrigerated biscuit dough doesn’t sell as well as, say, cream cheese, Costco won’t carry it.
"Costco only offers what sells," continues Mr. Degen, citing the old 80/20 rule.
Only in Costco’s case, it doesn’t bother with the other 80 percent.
During our visit to the Costco store in Bucks County, PA, we found only one SKU of vanilla ice cream, under the Kirkland Signature label. In fact, the entire ice cream category had just eight SKUs; the frozen breakfast section, six; and the frozen vegetable section, six. Even the yogurt section, expanded in recent years, offered only 10 SKUs.
However, we counted 10 SKUs of frozen appetizers (bacon wrapped dates, cocktail franks, etc.) and almost as many frozen snacks (mini tacos, bagel bites, etc.) — no surprise given the party planning in the club channel. But Costco also offers a wide assortment of frozen seafood — we counted a whopping 26 SKUs — and a fair amount of frozen chicken, frozen ground meat and frozen Asian foods.
Although Costco works closely with its partners to create successful products, "It’s also quick to eliminate a rotational item if it doesn’t immediately hit a certain threshold," says one manufacturer. It also has a brief 13-week commitment to new items.
Costco’s willingness to pull the plug on items that aren’t performing, combined with its commitment to new products, means that, although SKU counts remain fairly stable, individual items are frequently switched out. This helps create the "treasure hunt" atmosphere for which Costco has become known.
Many customers love it ("you never know what you might find…") but "it can also get a little irritating when a product you like is suddenly discontinued," says Paula Rosenblum, managing partner at Retail Systems Research.
Discussion Questions
Discussion Questions: What are the pros and cons of Costco’s limited assortment strategy? Should or can other food retailers replicate some of Costco’s SKU rationalization tactics?
I wouldn’t call this SKU rationalization — I’d call it shelf management. Costco has a simple premise — large sizes, good quality, great prices. This plays for some people, not for others. We don’t go there for the variety, we go there for specific product categories because price is the most important feature to us for these categories (and their lox is great). If our Kroger or Publix took the same strategy, we’d be ex-shoppers.
Costco does what they do because it is very successful. They have no equal to their business model. The customers are extremely loyal, and Costco out performs everyone, so the SKU assortment in their stores is tweaked to perfection. I admire what they do, because no other chain could duplicate it successfully.
After your first visit to a Costco or Sam’s or BJ’s you know what you are in for. It’s bulk buying and low risk sampling for consumables that you ordinarily wouldn’t dream of taking a flier on if offered at your traditional grocer. Costco is all about bulk, high volume and for the most part, high quality. If items are discontinued or if you want something brought in, forget about it — your voice doesn’t matter. As a member of a “club,” you are ruled by what the buyers decide is/isn’t in season. What is America’s favorite ice cream flavor? Call it vanilla and for the price pick up a few gallons to enjoy during this crazy hot Spring season. I was at my favorite Costco yesterday and Chicago was the high temp in the nation — you bet the vanilla was flying out of the case!
Other food retailers can replicate some of Costco’s SKU rationalization tactics but only at their own peril. They can’t try to be Costco without doing all the many other things that make Costco successful.
Costco’s business model has been built — and grown — on a limited assortment strategy of quality products that the majority of their customers buy … combined with well-selected and trained employees, clean well-organized operations and prompt attention to customers desires in every corner of the store.
Costco does not intend to be the only store consumers shop at by having every item available. They intend to bring consumers back with a treasurer hunt experience (not all items will be available all the time) and very low prices for items purchased in large quantities. If the item is something to be used by a business (supplies or items for an open house) they are more likely to be found, but not every choice per item. This works for Costco’s mission. Other stores with different missions will not have the same assortment, nor should they.
As noted in the article as well in most media, Costco has been very successful for a variety of reasons. However, the one differentiating factor is its customer knowledge and focus. It’s SKU count and assortment reflect its customers’ needs. To a certain extent, the bloat of SKUs at traditional food retailers gives a message to the customer, “we really don’t know what you really want so we have stocked everything, simply go find it.” To which I might add, “good luck.”
SKU rationalization can be carried too far: Just look at Walmart’s experience a few years ago when it reduced its SKU count so dramatically that it lost sales along with its competitive edge. But in Costco’s case, the idea of “doing less better” makes perfect sense. Regular shoppers still perceive plenty of choices inside a Costco store, but not to the point where it makes the store difficult to navigate. And Costco’s commitment to fresh assortments — not just in food but throughout the store — keeps consumers coming back with more frequency, despite the bulk packaging found throughout the store.
Costco’s approach is based on driving turn. Limiting assortment focuses the customer’s dollars on fewer items, thus driving turnover. In a low margin environment, turnover is king.
Pros: They are carrying what sells and that reduces shrink, which lowers the cost of inventory acquisition and handling, makes the stores easier to shop and helps control costs.
Cons: If you only sell what you can sell it’s hard to give new — potentially more popular — products enough time to prove themselves, customers may become annoyed when they can’t find an item and it is easy to fall into a selection “death spiral” where overall sales decrease while satisfaction among a few customers stays constant or improves.
As for other retailers — I’d say an emphatic “YES”! There’s just not enough inventory discipline in retail today — in almost any channel.
It works … for Costco. Would it work for Sam’s or BJ’s? Probably not. Each has developed a loyal customer following based on its offer.
Frankly, we are fortunate that there is a Costco and a Sam’s within no more than 10 minutes from our house. We are aware of what both carry, and use each for the items we want. There is no question that Costco has far more PL (Kirkland) items and so when we want fancy mixed nuts we’ll buy the Planter brand at Sam’s.
As several have noted, this strategy wouldn’t work for just any supermarket and I think we all remember what happened to Walmart when they over rationalized their assortment. People have expectations regarding where they shop and just because it works for Costco doesn’t mean it would work for anyone else.
Costco’s formula is a great success and they lead the limited “Club” format. (Note we don’t consider them to be a limited assortment format, e.g. ALDI, like some of you indicated here.) As a Club they can do the very thing mentioned: create a distinct environment where shopping is entertainment and the hunt for deals (better buy now or it’ll be gone!) a great motivator. Who ever leaves there spending less than $200?
Valkenburgh said what I’ve been saying for DECADES: “Customers think they want more variety, but too many choices actually makes shopping more difficult.” Profound, when you think about it. Take the emotion out of assortment and go with the cold, hard numbers. Especially in a limited SKU format, of course.
The ONLY exceptions to the rule are in deeper-assortment formats where the item is unique and cannot be reasonably substituted with a higher-volume item.
I agree that Costco does a great job providing members with low prices on a limited assortment of fast-moving items. However, my feeling is they could freshen things up a bit by adding more in and out items, such as having a monthly special item in each category. They would sell enough to make it worth the manufacturers’ while. At this point, I’d say there is a pretty stale assortment on the food side, that could use a bit of freshening up.
Pros of the limited assortment strategy is the treasure hunt aspect of shopping at Costco. It also has to work well for focus: fewer slots in the warehouse + fewer items to forecast + better buying of SKUs you do have = better focus.
Cons are the destination products/brands that consumers made the trip for are not in the assortment, causing frustrated customers.
To understand Costco, and I think a few have touched upon this in some fashion, you have to understand that Costco doesn’t sell SKUs, or Brands, or Categories. Costco sells attributes. Take Vanilla Ice Cream (yes, that is Kirkland Signature). It’s cold, it’s creamy, it tastes good and people buy it. How can I offer this “attribute” that is good quality at a good price? Well, this time around, Kirkland Signature wins out.
I remember a few years ago, Costco delisted the nation’s #1 Salty Snack/Potato Chip. Costco then opened up the regions to bring in their own selection of lesser known regional brands. Why? They offered “attributes” — peeled, fried, salted potatoes in a bag…oh yeah, for a good price. Guess what? Costco grew their category in the absence of that leading national potato chip.
Members pay to shop at Costco and inherently believe in Costco to balance the price/value/quality equation for them. Costco has built the right to do this over time because they unconditionally guarantee your purchase. You don’t like it, bring it back for a full refund, no receipt, no questions — you’re important to us.
It is true that customers think they have more assortment while the actual assortment is reduced at Costco. The difference is that Costco only carries the fast selling items in the bigger sizes and a huge discount. So Costco can satisfy 90 to 95 percent of a consumers needs and leaves only fill in products to standard grocery chain. The key is the customer finds most of the items they need at a discount.
Which explains the big smile on their face when they find that bargain.
A standard grocery store with 50,000 items will only have about 4,000 fast selling items. The remaining items only clutter the shelf and only satisfy the customer occasionally.
Costco has put up a series of successful growth numbers over the past 5 to 10 years, which clearly suggests that SKU proliferation is not a critical success factor in the club channel. The increasing commoditization of packaged goods items, combined with the value message that club stores bring convince consumers to make purchases of items they need or want regardless of the brand.
SKU proliferation brings with it a host of complications in terms of buying, inventory management and expired product. By avoiding those issues, Costco is able to deliver high-value to their customers while delivering high financial returns at the same time.
The supermarket/Walmart model of massive SKUs in a “grid” style store is seriously broken, and only survives because it so dominates the store count/availability across the country. Plus, brand suppliers are locked in mortal combat (competition) geared to paying for this model.
In many ways, a Costco is a stealth Stew Leonard’s — both super performing concepts. Costco has about twice the SKU count that Stew Leonard’s has, with probably twice the space and twice the category range — tires, sporting goods, furniture, jewelry, home electronics, etc. (BTW, Costco is the number one seller of fine jewelry in America!)
The main difference, other than category range, between Costco and Stew Leonard’s is that Stew Leonard’s has a FORCED dominant path, with its serpentine single path through the store, while Costco has a non-obvious, STEALTH dominant path — the wide aisle U-turn from the entry side of the store to the back, across the back and returning to the front on the other side of the large open space — bounded by racks to the ceiling on the perimeter. Probably few shoppers realize how Costco is leading them down a dominant path, in much the same way as Stew Leonard does, because with Costco it is intuitive, not forced.
Both the SKU count (Sell to Their “Shopping Lists”) and the dominant path (The “Path-to-Purchase” Ought to Be a U-Turn) I have discussed elsewhere.
I believe Costco’s cross-category SKU optimization strategy is a best practice for the Club Channel. Costco understands that shopper insights-driven strategies must transcend any one category. Costco’s thought leadership contributes to its superior buyer conversion across categories and larger basket sizes. Thank you for the opportunity to contribute to this discussion!