Discount retail woes: a quick tour

February 6, 2009, 1:04 AM UTC
Fortune

by Mina Kimes

While Wal-Mart rules–its January same-store sales were up, beating expectations–other discount retailers are stumbling. Target reported a 3.3% decline. Costco Wholesale’s January comp sales were flat in the U.S. and down 9% abroad. That news yesterday–along with a warning by Costco management that second-quarter earnings would fall “substantially below” consensus–sunk the stock 7%. And while it’s up slightly today, the shares are trading at their lowest level since 2005.

The culprit behind Costco’s profit woes is management’s strategy to drive prices down and pick up market share from competitors. Short-term pain for long-term gain is the big idea. It’s too early to know whether the strategy will pay off. But I saw this plan in action last week when I visited Costco’s headquarters in Issaquah, Wash., and stopped by its store right across the street. There I found a Costco employee who, like CEO Jim Sinegal, is on the hot seat: Louie Silveira.

The day I visited, Silveira, a company veteran who manages one of the 25 busiest of Costco’s 550 members-only warehouse stores, was scurrying around, fist bumping employees and directing customers through his maze of merchandise. Sales have weakened–particularly sales of discretionary merchandise, he said. “Food is doing great. “Non food…,” he added, his voice trailing off as he issued an order into his walkie-talkie.

Silveira doesn’t have a lot of power to change customer behavior, but he can tweak sales by adjusting store design. After he noticed that more customers were buying produce (as consumers dine out less, they cook more), he expanded that section’s footprint, or sales area. Showing me a floor map that he had penciled on a piece of cardboard, he gushed, “Things like shopping patterns, people flow—I dream about that stuff.”

For what it’s worth, Costco is getting better access than usual to big-ticket items like $80 Starbucks gift cards–the coffee retailer’s method of pumping up its own sagging sales without discounting in its own outlets. Silveira says he has sold $1 million worth of the Starbucks cards. He’s also offering an array of flat-screen TVs. Low prices squeeze Costco’s TV margins, but the company is gaining market share in an important category.

Silveira is aiming to poach upper-middle-class shoppers from department stores, electronics boutiques, and even luxury goods retailers. Just as he was boasting about his inability to keep bottles of Bordeaux on store shelves, an employee interrupted him to point out a new arrival in the wine section: Cristal champagne. The price: $219.99. That’s a good deal for an upscale brand, but in this environment, will budget-minded shoppers be game to pay up for it?