It's not uncommon for major supermarkets to have a house brand for their products, but few if any can match the brand loyalty or market share of Costco's (NASDAQ: COST) Kirkland brand. The company has turned Kirkland into an $86 billion retail powerhouse that offers an incredibly diverse product line that ranges from dress shirts to high-end liquor. The Wall Street Journal detailed how Costco turned what seemed like a big gamble into a master stroke.
The business model for most retail grocery outlets' house brands has typically revolved around offering a lower-priced option than major brands, but with a few notable trade-offs. For example, generic cola at your typical grocery store is cheaper than Coca-Cola (NYSE: KO), but it would probably not win a blind taste test against the major brand. Kirkland has defied that convention, and its products are on par with many major brands in terms of quality.
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There have long been rumors that Kirkland cuts private deals with major brands to supply its products, and many cocktail enthusiasts believe that Kirkland's French Vodka is Grey Goose in disguise. The Journal said that Kirkland now accounts for almost a third of Costco's total sales, but says Costco's original decision to create the brand 30 years ago carried a lot of risk.
That's because in the early 1990s, most of the world's biggest brands were segmented by product type. A soda brand like Coca-Cola makes sugary beverages and snack foods. It had strong brand recognition in that product sector, but the company never sought to branch out into household goods like laundry detergent and batteries.
Costco pressed ahead anyway and settled on "Kirkland" because the company is headquartered in Kirkland, Washington. Today, Kirkland has over 350 products on Costco shelves and generated $86 billion in sales last year. Incidentally, the presence of Kirkland products has also increased Costco's leverage in price negotiations on other products. What seemed like a big risk at the time turned into a master stroke, and Costco's stockholders are reaping the benefits.
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Costco's co-founder, Jim Sinegal told the Journal that the company's original business model was to offer a carefully curated set of brands in each consumer category at a discount and move the products in high volume. Sinegal said, "One of the significant disciplines in our business was to offer limited selection." CEO Ron Vachris added, "We weren't going to offer all the SKUs the other retailers carried. We were only going to carry the highest quality goods."
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It was a good plan, but there was a big stumbling block. Prices on the branded products continued to increase even though the major brand's production prices were decreasing. Sinegal explained to the Journal, "Every year, they had to continue to raise their price to satisfy Wall Street." Then Costco's brain trust noticed a Forbes article indicating that European consumers were gravitating away from higher-priced brands and towards less expensive private label brands. It was a Eureka moment for Costco.
This idea intrigued Sinegal, who "wrote a whole bunch of observations on this article and then asked his executives to initial them to acknowledge that they had read it. It's this moment when you can see his wheels turning about, ‘Look, their price increases are our opportunity.'" She said Costco decided to limit its price mark-up on its private label products to 14%.
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That was significantly less than the industry standard of a 24%-30% markup. The key to the deal was Costco's ability to control its production costs by working directly with private label companies to provide products. "We allowed a private label to take one percentage point higher in a markup," Sinegal said. This led to an avalanche of private-label products in Costco stores until Sinegal had another Eureka moment.
"I was in one of our warehouses down in Los Angeles, and I asked the warehouse manager, ‘Did you get the new legal tablet that we had in a private label?'" The manager said he didn't believe so. Upon further inspection, Sinegal found the tablets and showed them to the warehouse manager. The tablets were being sold under the "Pinnacle" brand, and the warehouse manager told Singal he had no idea that Pinnacle was a Costco brand.
Sinega told the Journal, "It was like a bell. If we don't understand within our organization what we are doing with our label, how are the customers going to? We decided we needed to get one name." That sounds perfectly logical today, it was unheard of at that time. Putting every private label product in your store under one name ran against the grain of all the existing logic on private label product marketing and brand recognition.
Yet, that's exactly what Costco did, and they have turned Kirkland into a powerhouse. The brand is not only synonymous with Costo, but also with high quality. There is also the added benefit of Kirkland products being so affordably priced that the national brands who sell in Costco must also price their products competitively. For all these reasons, the Kirkland brand has been the ultimate win-win situation for Costco.
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