How Will Kill Costco

I have a colleague who is an (NASDAQ:AMZN) junkie. He’s signed up for Amazon Prime and buys everything from deodorant to a gas grill on the web retailing powerhouse because he gets free two-day shipping (after the $79 annual fee for the service) and a great deal due to the pricing power of AMZN.

Which got me thinking: Many investors might be speculating on Amazon’s long-term potential based on its e-book business or its potential to fend off Apple (NASDAQ:AAPL) as the gadget giant is rumored to be launching a $299 iPad mini. And while those high-tech hijinks factor into the equation, the real long-play trend here might be the rather unsexy fact that Amazon is the big-box retailer of the future.

It’s only a matter of time before this digital discounter puts Costco (NASDAQ:COST) out of business.

Consider how Costco rose to power, and its positioning in the retail landscape.

  • It offers everything you can think of in the world — from ground beef to clothing to basketball hoops — at rock-bottom prices. Minus the perishable foods (and the funeral section — can’t forget Costco caskets), Amazon’s in the same boat.
  • It refused to be pigeonholed into the lowbrow corner of retail, adding high-end items like jewelry and electronics and putting the squeeze on traditional competitors like Best Buy (NYSE:BBY). Same for Amazon.
  • As cash-strapped consumers become disenchanted with other retailers including Wal-Mart (NYSE:WMT) that promised low prices, it has become a go-to resource for what little cash Americans are willing to part with. Sounds like Amazon again.
  • It uses a nominal annual membership of about $50 in exchange for access. Amazon doesn’t charge you to get in its virtual showroom, but Prime is roughly the same thing since it gives you access to prompt shipping.

Clearly the two businesses are on equal footing when it comes to their retail positioning. The only question, then, is who better serves their customers and who can win the war for the lowest prices under the sun.

For starters, Amazon has a unique advantage when it comes to shopping — the ability to avoid any crowds or driving. And presuming you know what you are looking for and can use the search box properly, there’s no hassle with browsing online as opposed to elbowing through the aisles at a crowded Costco warehouse. Especially for familiar goods like diapers where there’s no need to try something on or eyeball the finish, this is a huge plus. There’s also the advantage of not having to find a physical location, which could involve your time and gas money.

Advantage: Amazon.

And while we’re talking about a lack of physical shopping space, let’s address the competitive advantage Amazon has when it comes to commercial real estate and labor costs. There is a Costco across town from my office in Arlington, Va. Real estate prices there are exorbitant. There’s a Costco in Brooklyn and on116th Street in Manhattan. Amazon’s distribution centers are in rural America where costs are cheap not just for the facilities but for the labor. Read this rather disturbing profile in Mother Jones and its companion, a rather bleak follow-up, about life working in an online shopping warehouse somewhere in Mississippi and you’ll get the gist of the wage advantage, too. This lack of cost will result in a better bottom line — or, undercutting the competition at prices they cannot hope to match.

Advantage: Amazon again.

Then you have the high-tech edge that most investors are obsessed with. The e-book, music and movie delivery AMZN offers are advantages when it comes to future sales. Its Cloud Drive service and streaming through Prime are also a plus on the service front, as is its fledgling Android app store. A physical Costco still might be able to offer a host of services Amazon can’t in the virtual world, such as auto service or custom shoe orthotics … but it’s hard to believe there’s growth in those segments like there is for Amazon’s digital service lineup.

This is not to say Costco will crash tomorrow. The stock is up 19% in the last 12 months, significantly better than the S&P 500’s 3% gains and the 2% gains for AMZN stock in the same period.

Also, COST is tracking fiscal 2012 earnings of $3.86 a share, 17% over last year, and riding 11 year-over-year increases in quarterly revenue. Meanwhile, Amazon has bet the farm on its Kindle, bleeding down 2011 and most of 2012 earnings on subsidizing the gadget.

And if you think Costco is rich at a forward P/E of 21, the measure is over 80 for Amazon. That nosebleed level still gives many investors pause.

But long term, I think it’s hard to imagine Amazon losing the discount war. Costco effectively put the screws to Wal-Mart during the recession, eating its low-priced lunch along with smaller discounters like Dollar General (NYSE:DG) and Family Dollar (NYSE:FDO). It appeared that even the scale and powerful brand of WMT were not unshakeable.

Costco investors should take note. Because if the post-PC world is reshaping the tech industry, the post-brick-and-mortar world is reshaping retail in an equally compelling way.

And Amazon is poised to stand at the top of the heap.

Jeff Reeves is the editor of, and author of “The Frugal Investor’s Guide to Buying Great Stocks.” Write him at, follow him on Twitter via @JeffReevesIP. As of this writing, he owned a long position in Alcoa but none of the other aforementioned stocks.

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