How Costco Australia will change Australian retail

What it means for suppliers

Bonnano says another feature of Costco's excursions into new markets is its willingness to anchor its range with local brands.

In late April and early March, Noone invited potential SME suppliers in Melbourne and Sydney to town hall-style meetings to learn more about the Costco model and how the company's supply chain works.

Noone won't reveal details about who or how many Australian SMEs he is in discussions with, but says he and his team is in the process of formulating supply agreements right now.

"We've talked to a large number of suppliers and right now we are formulating a lot of agreements. The discussions continue about items and packaging and timing, and that's all on going.

"Do we want more, better, lower-priced suppliers? Absolutely. But I am comfortable with where we are."

While every grocery manufacturer will be thrilled with the fact another potential customer is entering the Australian market, Costco probably won't be the easiest partner to deal with.

For starters, Costco's super-sized business model means many suppliers are going to have to make changes to their packaging processes so they can pump out products in larger sizes.

"What we try to do is reduce the packaging to improve the value," Noone says. He says suppliers who are already manufacturing a retail size for the local supermarket and a trade size for wholesalers or food service customers shouldn't have too much trouble with the meeting Costco's needs. "They might only need to redo the graphics," Noone says.

But for other suppliers that don't make trade-size packaging, supplying Costco could be costly.

"There certainly is an upfront cost of doing business because they are just so different in terms of pack size, packaging, pallet orientation. If you are an SME that could prove to be a challenge," Bonnano says.

He sees a few other challenges for would-be suppliers. One is what he calls "sales velocity" - that is, Costco gets through so much stock that manufacturers can struggle to keep pumping it out.

The second potential challenge is around pricing. If a supplier does a good deal of bulk work for Costco, which then sells those goods at a bargain price, how will other supermarkets react? Will other supermarkets want discounts too, thereby denting the supplier's margins?

"The suppliers are going to have a lot to answer for when the buyers at Woolworths and Coles see really low prices on some of those goods at Costco," Bonnano says.

But overall, he says the benefits for a supplier doing business with Costco outweigh the negatives. Not only are will suppliers gain a new customer, but some will also be able to tap into Costco's global supply chain and export to Costco stores overseas.

How will the competition react?

One of the most interesting questions for retail analysts concerns the potential reaction of competitors, particularly Woolworths, Coles and Aldi.

Rob Lake, retail analyst with Brandish, doesn't expect too much reaction initially.

"The models are so different. Coles and Woolies are going down a fresh food line, which is not where Costco wants to be. In a sense, Costco is a different battle ground."

Bonnano agrees, but argues that as Costco Australia grows, Coles and Woolworths may be forced to react to certain Costco specials and certain times. For example, say Costco has Vegemite on special for a price well below the major supermarket. Coles and Woolworths may be forced to drop their prices, either by taking a loss themselves or putting pressure on the supplier.

"The intensity of the trade negations between with major supermarkets and their suppliers is as strong as it has been in a very long time. This could throw another log on the fire."

Crossmark's Kevin Moore says local retailers in the area surrounding the Costco store could be in for a shock.

"When a Costco opens it touches every facet of retailing within a 50 kilometre radius, whether they are a major retailer or a small corner store. If they perform as normal they will take $200 million out of the retailing environment in that area per year."

And it won't just be supermarkets feeling the pinch. Moore points out that Costco is the biggest seller of diamonds in North America, which means even local jewellery stores will have to defend their patch.

Lake says the market participants that will feel the most pressure from Costco Australia's arrival are grocery wholesalers, which might find their customers flocking to Costco for cheaper prices particularly if these customers can reduce their transport fees.

"I think it may hurt the wholesalers most," Lake says. "It's even quite possible that a little IGA supermarket will be able to buy cheaper at Costco than they can from the IGA wholesaler, which is Metcash."