Costco Wholesale Corp. has opened its second and third Australian stores in the midst of the country’s worst retail downturn for more than 10 years.

Sue Mitchell, Costco Wholesale Corp., Australian, Costco chief executive officer Jim Sinegal, Costco Australia’s managing director Patrick Noone, Woolworths Ltd., Sydney, Melbourne

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Inside This Issue - News

Costco expands presence in Australia

September 19th, 2011
by Sue Mitchell

SYDNEY, Australia – Costco Wholesale Corp. has opened its second and third Australian stores in the midst of the country’s worst retail downturn for more than 10 years.

However, Costco chief executive officer Jim Sinegal and Costco Australia’s managing director, Patrick Noone, are confident the Sydney store will perform at least as well as the first store in Melbourne, which holds the retailer’s sales record for the best store in a new market. "We think it certainly should do as well as our Melbourne location, and Melbourne was a very successful opening for us, one of our top tier warehouses in the world," Sinegal said at the opening of the Sydney store on July 20.

Noone expects the Sydney store to eventually outperform the two-year-old Melbourne store, which achieved sales of $165 million ($178 million U.S.) in its first full year — eclipsing the average turnover of a U.S. store — and is tipped to turn over almost $200 million (Australian) this year. Melbourne now has over 100,000 ­members.

The Sydney warehouse is about 8% smaller than the Melbourne store but is located in the geographic and demographic heart of Sydney and is better served by road transport links, making it easier for shoppers to reach the store from the north, south, east and west of Australia‘s largest city. "The catchment area is bigger than Melbourne, so it should trade well, providing we offer the right product at the right price," said Noone. "I think it should eventually trade a bit bigger than Melbourne."

Weak retail trading conditions have prompted almost half a dozen major retailers, including Woolworths Ltd., the David Jones department store chain and Specialty Fashion Group Ltd., to downgrade their 2011 profit guidance in the last seven months. Retail sales fell 0.6% in May, and annual sales growth has slowed to 2.3%, less than half the average annual growth rate over the last 20 years.

While unemployment remains near record lows, the confidence of Australian consumers has been dealt a blow by rising living costs, soft house prices, continued volatility on equity markets and political uncertainty. In early July consumer sentiment posted its sharpest fall since September 2008, and it is now at its lowest level for more than two years.

Sinegal acknowledged the poor retail trading conditions but said the Australian economy is healthier than that in many parts of the United States and Western Europe. "Obviously the consumer is always concerned about the economy, but we’re all about value and, in general, we’ll have a more affluent customer — that’s true in just about every market," he said. "Traditionally our customer is not as affected by downturns. As long as we’re doing the right job and customers believe in our product they’ll vote with their feet."

Costco’s Australian stores are similar to its U.S. stores, although they carry a narrower product offering (between 3,400 and 3,700 SKUs) and a higher proportion of locally sourced merchandise. The product mix is about 50% food (including meat, dairy, seafood, baked goods and fresh produce) and 50% general merchandise, compared with a 30:70 food/general merchandise split in the United States.

The Sydney store has a selling area of around 133,000 square feet, compared with 144,000 square feet in Melbourne, and has a catchment of 4.5 million consumers within an hour’s drive, compared with 4.1 million in Melbourne. Costco also opened a store in Canberra in July, which serves a catchment of 360,000 consumers.

Sales are expected to reach $2 billion in five years if Costco achieves its aim of opening 10 stores generating sales of $200 million each. Investment bank Linwar Securities estimates that Costco needs to establish five or six stores in Australia to defray head office costs before it becomes profitable.

The retailer’s foray into Australia has been impeded by strict zoning laws and a lack of suitable sites. It took Costco two years to secure approval for and build the Melbourne store and four years to approve and build the two-level Sydney store.

However, Noone, an Australian who worked with Costco in North America for more than 17 years, believes the approval process will become easier as the format becomes more familiar to local and state government authorities. "In the next few years we’ll be able to add a number of new units to get that critical mass," Noone said.

Costco is also looking at potential store sites in Queensland and South Australia and may open a distribution center later this year to provide a single delivery point for suppliers and to reduce transport costs.

Sue Mitchell covers the retail and food and beverage industries for the Australian Financial Review and is based in Sydney.