Costco is an American wholesaler, with operations worldwide. Costco’s main objective of selling the highest quality products at the lowest possible prices is quite a simple, but effective one. This is demonstrated by Costco’s lack of failure or exit from any of its foreign markets. A contributing factor to this success is its firm-specific advantages which include strong bargaining power, a differentiated method of sales, and strong connections with its suppliers, both domestic and foreign. Costco does possess a few weaknesses however, such as its narrow product line and its low mark-up on products.
This report will examine India as a potential market for Costco to expand its operations. The Indian economy is classified as low-income, but its middle class is growing at an extremely rapid rate, with some reports suggesting that the middle class will comprise almost 50% of the economy by 2025. This presents an immense opportunity for Costco and its potential Indian operations. India is also quite different than the U.S. in terms of culture, and this will be an aspect that must be taken into considerations as well. The sheer size of the Indian population alone makes the Indian market extremely attractive to multinational enterprises such as Costco, giving it a large market to work with and appeal to. Its economy is also growing at a rapid rate as well, and this is largely due to the Indian government’s welcoming attitude toward foreign direct investment (FDI). However, there are some restrictions on this FDI that must be taken into consideration as well. India’s political climate is also relatively stable compared to previous years, making the market even more appealing. There is also a high amount of bureaucracy present, which may pose some challenges to Costco’s business operations.
The retail industry in India is organized mainly into two sectors, the unorganized sector and the organized sector. The organized sector comprises of 10% of the retail industry. Risk of Entry into India is moderate for an organized retailer. This is due to India’s lack of infrastructure, making it difficult to create an efficient supply chain within the country. Its lack of rules and regulations will also pose problems to business operations. Bargaining power of buyers is quite high in India, especially in rural areas, where unorganized retailers are prevalent. Supplier bargaining power is low, as large organized retail companies get their products from a number of different suppliers in order to offer diversified goods. The threat of substitutes is also quite high, because these small stores appeal more to Indian cultural practices such as offering credit, and selling in smaller quantities. The intensity of rivalry is high because many foreign retailers have already entered the Indian market with large expansion within the country already underway. Domestic retailers also comprise much of the market as well. Cash-and-carry wholesale retailers also already exist in India.
This report will suggest that Costco enter the Indian market mostly due to its firm-specific advantages and the positive appeal of the Indian market due to the reasons specified. The mode of entry will be through a joint venture so that Costco can gain knowledge of the Indian market, share costs with its partner, and the partner will aid in building political relationships. The medium level of control provided through the joint venture will be satisfactory as Costco must be flexible in order to fulfill the needs of global concentration and the need to adapt to local preferences in India. Costco will greatly benefit from its entry into India.
The very first Costco warehouse was established in Seattle, Washington in 1983. Costco quickly became the first and only company to grow from zero to three billion dollars in sales in less than six years. Costco currently operates 562 warehouses world-wide, with a majority of its operation in the United States. Costco’s operations are present in seven other countries, which includes 77 warehouses in Canada, 32 in Mexico, 21 in the United Kingdom, seven in South Korea, six in Taiwan, nine in Japan, and one in Australia (Datamonitor, 2010). Not only is Costco Wholesale Corporation the largest warehouse club chain in the United States, it has also established itself in seven other countries and is the ninth largest retailer worldwide. Costco sees innovation as an intellectual feat, essential to maintain customer loyalty. Unlike many other retailers, whose innovation came to no avail, Costco’s “treasure-hunting” scheme is regarded by many experts as a core competency that surpasses all other retailers (Costco Connection, 2006).
The business model for Costco is quite simple: it aims to sell the highest quality products for the lowest possible price. This is made possible by using plain spaces to sell products in bulk, at high discounts. According to Jim Sinegal, CEO of Costco Wholesale Corporation, Costco is able to lower its prices by removing the additional costs associated with salespeople, attractive buildings, delivery, billing and accounts receivable; allowing it better control its operations and lower total overhead costs (Datamonitor, 2010). This enables Costco to pass on savings to consumers.
Goods at Costco are sold in bulk, enabling Costco to attain lower prices when purchasing products. Furthermore, Costco sells a narrow choice of products in a broad range. By doing this, it has been able to increase sales volume and provide customers with even lower prices. If Costco is unable to reduce the price of a particular product, it stops supplying the product. For example, when Costco was unable to reach a price agreement with Coca-Cola, it stopped carrying Coca-Cola products because Costco members do not benefit from the best possible price (Fredrix & Skidmore, 2009). Aside from offering brand-name products, Costco possesses a brand of its own, Kirkland. The Kirkland brand carries a variety of products ranging from clothing to food, and it strictly follows the concept of high quality at low prices.
Costco has a very strong market position in the U.S. which has allowed for strong bargaining power with suppliers and consequently competitive prices for consumers (Datamonitor, 2010). Costco’s innovation has created a differentiated method of sales. Certain items in the warehouse are available for limited periods of time, creating a ‘treasure-hunt atmosphere’ where customers are instilled with the idea of ‘buy it now’ (Costco Connection, 2006). Costco’s participation in the global market has allowed it to develop a network of global suppliers which it uses to make direct bulk purchases for domestic and international products (Marketwatch, 2009). This extensive supply chain has allowed it to benefit from economies of scale on a global level. Additionally, suppliers benefit from good relations with Costco as it provides them with a means for entering international markets (Coriolis, 2004). Costco has strong connections with its suppliers, allowing it to impose low mark-up on its goods, and thus high returns on low margins. A final strength for Costco has been its stable financial success over the past years of operations. It has benefited from positive net income over the last 5 years, giving it a strong position to base future expansion from (Costco Wholesale Report, 2009).
One of Costco’s weaknesses lies in its narrow product line. On average, a Costco store offers approximately 4000 products at any given time, where other competitors carry ten times the amount; giving customers less product choice overall (Datamonitor, 2010). Another weakness for Costco is that it has a low mark-up on all of its products (Datamonitor, 2010). This means that Costco operates at a lower margin than its competitors. Since higher margins give companies room for buffering negative factors on sales, Costco has very little leeway when encountering unanticipated threats. Costco’s method of operating creates another weakness. As it requires a large space to achieve necessary economies of scale with its store operations, this need for space can be a hindrance to available locations.
Costco’s past mode of entry was through establishing wholly-owned subsidiaries to benefit from directly transferring its standardized operation procedures. Nonetheless, Costco is flexible in terms of the structure of its operations (Datamonitor, 2010). For example, Costco maintains its membership policy throughout the world, but the interior of each Costco warehouse is significantly different. Since food accounts for a significant amount of total retail sales in Australia, Costco has increased the number of food products available in Australian warehouses (Datamonitor, 2010).
Costco has been very successful in both domestic and international operations. Japan, Korea and Taiwan are an example of these operations. According to Costco Wholesale’s Annual Report 2009, these three countries had the highest opening day sales of $700,000 per warehouse in each country (Costco Wholesale Report, 2009). Furthermore, illustrating Costco Taiwan’s success is the fact that it earned $73 billion dollars in retail sales in 2009, and is expected to have a 10% growth rate in its retail sales for the 2010 fiscal year (Cheng, 2010). Another one of Costco’s successes involves the opening of the first Costco in Melbourne, Australia. It was Costco’s best opening day ever and $841,000 US in sales (Costco Wholesale Report, 2009). This clearly shows that Costco has achieved a high amount of success in international expansions thus far.
Costco has expanded rapidly on a global scale and has seemed to be quite successful in these countries. There is limited information on whether there has been market entry break down or major business failure. The lack of big business failure could be due to the fact that Costco has always been very cautious when entering a new country. For example, Costco did thorough research about Australia’s market before entering. Costco learned that Australia had many high average income families and small businesses, which presented a challenge to Costco’s wholesale strategy (Marshall, 2009). Costco also realized that Australian consumers are not used to the idea of saving money at the wholesale price; therefore, Costco had to educate consumers about the benefit of wholesale pricing (Marshall, 2009). Another challenge Costco faced in Australia was due to its requirement for large lot space to operate warehouses in the conventional way. Despite these challenges, Costco has been able to gain a foothold in the Australian retail industry.
Country Analysis – India
India has been classified as low income economy by the World Bank (EconomyWatch, 2008). Despite this, India is one of the fastest growing economies in the world. It is argued that one of the main reasons India has been able to grow so rapidly is due to the enabling mixed economy where both the private and public sectors are highly active (EconomyWatch, 2008). Although a mixed economy aided in initial growth India did not begin to prosper until the 1990s, when a number of economic reforms increased accessibility for foreign direct investment (EconomyWatch, 2008). Goldman Sachs’ future prediction is that India’s 2020 GDP will be four times what it was in 2007 (EconomyWatch, 2008). Although India may appear to be a promising country for investment, analysis through Hofstede’s cultural dimensions and a political and economic overview will provide a better context for viewing the country’s investment environment.
Hofstede’s cultural dimensions provide a good sense of the cultural distance that exists between American culture, where Costco’s headquarters are situated, and Indian culture. As the Appendix shows, there are some extreme cultural differences between the U.S. and India. If Costco decides to enter India it needs to take into consideration that Indian employees, with high long term orientation, will place higher emphasis on building relationships, as opposed to the American employee being more focused on short term considerations. Furthermore, Costco has to accommodate the fact that Indians are used to more supervision in the workplace as a result of higher power distance being prevalent in the culture. Also, decision-making is more of a group process due to a higher degree of collectivism.
In addition, Costco would have to acknowledge that the notions of time, time management, and punctuality are not as high of a priority in Indian culture as they are in American (Trade Chakra, 2008). If Costco was to work with another company or hire Indian employees, it may have to deal with meetings that are postponed, rescheduled, cancelled or organized at a very short notice. Furthermore, if Costco was to work with a partner company in India it would have to recognize some cultural differences, such as a higher concern for politeness and a difficulty saying no. Sound knowledge of India’s cultural practices would not only demonstrate a respect for Indian culture but will also create positive associations from customers and the organizations Costco may work with.
Another difference between Americans and Indians is that Indians have a preference for fresh food over processed, but due to the increasing population that work away from home, processed foods are recently gaining in popularity (Bullis, 1997). Due to India’s large market size, strong demand for consumer products, and developing infrastructure, the retail industry’s future is promising.
Political and Legal Environment
India’s 28 states are governed by elected local governments that are free from interference of the Central Government, however, both work together to advance India’s growth (Trade Chakra, 2008). Since 1999, India has had a strong coalition government and the country as a whole does not have any real threats of revolutionary movement; therefore, the chance of political uprising is minimal (Trade Chakra, 2008). In addition, economic liberalization is seen as essential by all political parties, including the Communist Party of India, and therefore inviting to foreign investors (Trade Chakra, 2008). Although India’s politics are relatively stable, foreign investors have to realize that the laid back approach to government work could result in delays in processing and overload of paperwork (Trade Chakra, 2008); therefore, immense patience is required for government dealings. Furthermore, the Indian government imposes some strict FDI restrictions on the retail trading sector which makes it hard for foreign companies to establish wholly owned subsidiaries in India (MapofIndia.com, 2010). As will be explained in the industry analysis below, there are specific regulations on establishing foreign retail businesses within India.
India is one of the fastest growing economies in the world. Despite this, India has the world’s largest number of low income earners living in a single country (Trade Chakra, 2008). Out of its total population of more than 1 billion, 350 to 400 million people are living below the poverty line and nearly 75% of them are in rural areas (Trade Chakra 2008). Some encouraging news is that India is seeing an increasing trend in per capita income. In 2002-03, the per capita income in India was RS 19040 while in 2008-2009, the per capita income rose to RS 37490; equivalent to 410 USD rising to 806 USD (Trade Chakra, 2008). The middle class is expected to grow to 25% of the population by 2015, and 48% by 2025, controlling 44% and 58% of the country’s disposable income by 2015 and 2025 respectively (Sharma, A., et al.). This buying power will greatly assist with the expansion of the organized retail sector within India.
Other economic facts to consider include India achieving a growth rate of 7.1% in 2008-2009; the inflation ended at a low of 0.61% in the week ended May 9, 2009 after reaching a 16 year high of 12.91% in August 2008 (Trade Chakra, 2008). This shows that even though inflation is very prevalent, policymakers have efforts in place to limit its effects. India’s policymakers have also done away with price controls and aim to create 70 million new jobs by 2012 (Trade Chakra, 2008). These efforts make India a promising destination for foreign investment.
Although the retail industry accounts for about 10% of India’s GDP and 8% of total employment in the country, a significant portion of the Indian retail industry is only made up of small, unorganized retailers (Dhanabhakyam & Shanthi, 2007). The large hypermarket and supermarket retailers that are so prevalent in developed countries will only account for about 8-9% of the industry in India by 2010 (Sharma, A., et al.). Since these organized retailers do business through such different venues than unorganized retailers, the following analysis will only focus on the aspects and conditions affecting the organized retail industry in India.
Porter’s Five Forces
Risk of Entry
With the second highest population in the world and an ever increasing middle class, India is fast becoming an attractive market for retail business. However, limiting this attractiveness are some considerable barriers to entry. As an organized retail company trying to enter India, there are some limitations to the economies of scale needed to be successful. This mainly arises from an extremely underdeveloped infrastructure, making the necessary transportation between and to retail locations difficult. Creating a supply chain to service retail operations is a very difficult endeavour due to poorly developed highways, a lack of cold storage facilities, and hard to overcome bureaucracy (Kacheria & Thathoo, 2005) Creating the necessary supply chain can turn out to be quite expensive as the accommodation level experienced in developed markets, such as developed infrastructure systems and multitude of transportation companies, cannot be expected; although it is gradually improving as more foreign investment enters the country (Euromonitor, 2008) . Another hindrance to establishing retail operations in India is government restrictions and regulations. The type of investment allowed in India is currently limited as the only foreign retailers allowed to enter directly are those selling a single brand (Sharma, A., et al.). This forces foreign retail companies to find a local Indian partner that will join in a venture project. Finding a suitable match is a difficult process and cannot be guaranteed. Restrictions on the investment approval are quite high and there are also regulations limiting property and real estate purchases (Sharma, A., et al.). Due to its excessive bureaucracy, India has ranked low in the World Bank’s Ease of Doing Business reports and the country ranked 133rd out of 183 economies in the 2010 report (Euromonitor, 2010) . Even with the above barriers to entry in the Indian market, the fact that India presents one of the most attractive consumer markets in the world cannot be overlooked. As some foreign retailers may not have the ability to handle the start up costs and available entry modes presented by the Indian retail industry, there are other retailers that won’t overlook the potential of this market. It is for that reason that there is an understandably moderate risk of entry by potential competitors in this industry.
Bargaining Power of Buyers
With India’s large population, retail companies have a wide and fragmented customer base to support operations. Although this provides demand for retailers’ goods, the very low switching costs in this industry gives consumers power. Indian consumers are able to easily switch between competing retailers for the products they desire while driving down prices. The low possibility of forward integration for buyers does ensure that demand will be present, but the ability of buyers to access competing retailers gives them a lot of power. This buying power is clear as 70% of organized retail business is concentrated in 6 cities, where 15% of the Indian middle-class lives (Sharma, A., et al.). Buyers have even higher bargaining power outside of these main cities, which is why highly responsive unorganized retailers dominate this area of the Indian market.
Bargaining Power of Suppliers
As large organized retail companies get their products from a number of different suppliers in order to offer diversified goods, there is not much bargaining power available for suppliers. The tendency of large retailers to backward integrate and form extensive supply chains in order to attain economies of scale also adds to the lack of power for Indian suppliers. However, as these supply chains prove to be harder to establish and maintain in the market, suppliers do stand to have some power on occasion. Overall, the type of business that organized retail presents, gives suppliers very low bargaining power.
Threat of Substitutes
Even though the organized retail sector is growing at a rapid pace, the unorganized retail sector still accounts for approximately 90% of retail sales in India. This sector in general can act as a substitute for large retailers. Traditionally, small “mom-and-pop” stores accounted for the major share of food sales in India. There are close to 5 million local grocers all over the country, known as kiranas (Euromonitor, 2010). They appeal to Indian people because they provide informal credit, deliver goods to homes, and sell products in smaller quantities in order to help the poor who cannot afford to buy in large quantities. For example, these stores will sell 100 grams of lentils, a quarter kilogram of wheat flour or small sachets of shampoo and pickles, where organised food retail would deal only in half-kilogram and kilo-sized packs (Euromonitor, 2010). In small towns and rural areas, storekeepers often keep monthly accounts for regular neighbourhood customers and the principal earner makes the payments once a month, but purchases can be made by the wife or child as well. This system was practiced before the introduction of credit cards and it continues to work well for these stores and their customers; integrating this unorganized method of retail business into Indian culture. Another form of unorganized retail in India is the local outdoor markets. These markets are usually referred to as bazaars, and vendors sell everything from shoes, clothes, flowers, and of course, food. Depending on the area in which they operate, the vendors will alter their prices in order to remain responsive to local needs (Euromonitor, 2010).
Even though these substitutes are not direct competitors organized retailers, they will still pose a significant threat. Most organized retailers would not be able to provide informal credit as the kiranas do. Therefore, people without credit cards will be less inclined to shop at large retail stores. As mentioned above, many people in India must buy in small quantities because they cannot afford large purchases, making wholesale retail method less attractive. Based on this information, the threat of substitutes for Costco in India is high.
Intensity of Rivalry
If Costco enters the Indian retail market, it will face many competitors. These competitors include large retailers such as Carrefour and Tesco, which are foreign MNEs that have already invested in India and set up operations in the form of supermarkets and hypermarkets. Other competitors include large Indian retailers that have set up operations in the same form such as Pantaloon Ltd. and Spencer’s Retail (Euromonitor, 2010). In fact, in March 2009, the Retailers’ Association of India predicted a 15-20% revenue growth for chain retailers (Euromonitor, 2010). The Ministry of Commerce and Industry, in the 2007 India Retail Report, expects the value of the organised retail sector in India to be about US$45 billion by 2010. The organised retail sector is also expected to generate 10-15 million jobs over the next five years (Euromonitor, 2010). According to the report, food and grocery retail constitutes the largest proportion, estimated to be worth Rs7,439 billion. The share of the organised sector within this number is still extremely small, but it was expected to grow at a rate of 42% in 2008 (Euromonitor, 2010). Moreover, with an increase in the adoption of credit cards and personal vehicles, middle-class Indians are turning more to the organised retail format for their food shopping. Retailers are prevalent in every major Indian city, and a current trend is that of buying in bulk from supermarkets, so as to take advantage of special deals and promotions (Euromonitor, 2010).
There exist also cash-and-carry wholesale outlets in India, which are more comparable to Costco’s business model. However, this concept is relatively new in India, which started with Metro, the first cash-and carry wholesale operation in India. Metro opened in 2003, with Pantaloon soon following with its “Big Bazaar” wholesale clubs. Wal-Mart soon followed in 2009 with its Best Price Modern Wholesale stores. It has announced that it hopes to open 10-15 stores between 2009 and 2016 (Euromonitor, 2010) Membership is obligatory for both Metro Cash and Carry and also for Big Bazaar Wholesale Club. Entry to Metro is limited to those carrying its membership card, which is given only to those representing registered businesses, including retailers and hoteliers. For Big Bazaar Wholesale Club, on the other hand, anyone can become a member, whether as an individual or as a group (Euromonitor, 2010). With the relatively recent emergence of cash-and-carry operations in India, Costco still has the opportunity to establish itself as a major player in the retail industry. However, since these cash and carry retailers have benefited from a first-mover advantage, they may have created customer loyalty already, and it will be difficult for Costco to take these customers away.
With the existence of many competitors, both foreign and domestic, Costco faces some rigid competition. The rapid growth of the organized retail industry keeps competition tense, as many more retailers will be emerging, as described. Whether existing organizations will be opening up new stores, or whether new MNEs will be trying to enter India, the industry will only keep growing. In addition, these retailers are also offering very similar products; therefore, it will be extremely hard for Costco to differentiate itself from its many competitors, especially with the existing cash-and carry operations. Since these competitors are offering such similar products, the switching costs from one retailer to another are quite low, so Costco may have an opportunity to lure customers away from the competitors. However, since these switching costs are low, Costco will have to deal with intense rivalry from these competitors, especially in the marketing aspect, where competitors will try to retain their customers by keeping prices low and offering special promotions. The above factors indicate a high intensity of rivalry in the Indian organized retail industry.
Should Costco Enter India?
Drawing from the implications of the above analysis, we recommend that Costco enter India. We make this recommendation, first, because India is an emerging market with huge market potential. Secondly, India is flourishing and therefore it is essential that Costco captures a market share before saturation occurs. Third, the Indian government has gradually been encouraging more foreign investment, thus the political environment is increasingly more welcoming. Finally, the purchasing power of the general population, along with a growing middle class, is increasing. As a result of these many factors, the popularity of organised retail is increasing greatly itself and more firms are beginning to position themselves in a way to experience this potential. Given the above reasons, India is becoming an ever more attractive market for organized retail; making it imperative for Costco to act quickly in order to capitalize on this opportunity.
According to the OLI Paradigm, from Dunning’s eclectic theory of MNEs, a company needs advantages in ownership, location and internalization in order for it to succeed in a country; Costco will possess all three while operating in India (Rugman & Collinson, 2009). Costco has an ownership advantage through its developed network of international suppliers and large volume deals, which will assist in the purchase and distribution of products through a more efficient manner. Also, will benefit from a location-specific advantage in India because of three reasons: economic, political and social. The Indian economy and population have significantly increasing trends in growth and disposable income. These facts coupled with a huge potential market base make India an ideal market to enter. In addition, political instability is much lower than in previous years, the government has increasingly encouraged foreign investment and tariffs and quotas for imports have been greatly reduced. India’s movement towards more open markets will be beneficial to international corporations such as Costco. Finally, Costco will benefit from internalization of its processes. By having some control over its firm-specific advantages, it will be more able to transfer these to the Indian market. The network advantages mentioned above will prove to be more beneficial when managed by Costco.
How Should Costco Enter India?
Using a joint venture will allow Costco to overcome some of the entry barriers it faces in India and build more sustainable operations in the long run. One major benefit of this entry mode is that it will assist in overcoming the high cultural distance which exists between the two countries. Costco will be able to rely on the partner to facilitate its understanding of local preferences and practices. This knowledge acquisition will improve Costco’s managers’ ability to engage in Indian business processes. This adaptation will surely transfer over to future expansions that Costco makes in a global context. Secondly, a joint-venture will aid with building political relationships with Indian state and national governments. This political connection will help Costco overcome the bureaucracy inherent in India and help handle any political instability that may arise in the future. The Indian partner will be a great aid in facilitating these political relationships. Finally, this entry mode will reduce Costco’s vulnerability as benefits will arise from resource and cost sharing. Costco’s total resource commitment to the market will be lower as its partner will be contributing resources as well. Any costs associated with establishing stores and supply chains will also be shared between the partners depending on the agreement. Although there will be benefits in overcoming cultural distance with a local partner, this distance may lead to conflict within the partnership. Preparing Costco’s management for Indian business etiquette and cultural understanding will go a long way in ensuring the success of a joint venture. Establishing a governance structure based on trust will also aid with this internal uncertainty, although an effort must be made to avoid the strategic blindness that may occur with India’s environmental uncertainty (Krishnan, Martin, & Noorderhaven, 2006).
To further defend the decision of a joint venture, the application of the eclectic theory by Hill, Hwang, and Kim (1990) will be used. Firstly, Costco benefits greatly from attaining economies of scale on a global level. However, this need for global concentration is partnered with a need to adapt to local preferences in the markets it operates in. The medium level of control provided through joint venture will be satisfactory as it must be flexible in order to see these two needs fulfilled. Secondly, although Costco has a lot of experience in international markets, the Indian culture presents a new cultural challenge. Costco has no direct experience in this market and lowering its resource commitment with a joint venture partner will be beneficial. This lower commitment will also reduce its risk in facing any political instability. Although this has improved recently, India has a history of instability affecting foreign multi-national enterprises. Finally, with an emphasis on its internal management processes for distinct competencies Costco does not have much valuable technological know-how. Costco is not in the business of offering highly proprietary products, nor does it offer unstructured, poorly understood products that are customized to a particular user. Costco offers a broad range of everyday use general consumer products; therefore, transaction-specific assets are not emphasized and the lower control inherent in a joint venture will suffice and greatly reduce the possibility of dissemination risk.
Given the above analysis and overview of a possible entry mode, there is a clear indication that Costco will benefit from entry into India. As the organized retail market is still growing, implementing an entry strategy in the short term will allow Costco to establish a position in India with more ease. Building a large market position early will be vital in fending off the future competition that will surely arise with the emergence of a stronger Indian economy.
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