Costco Challenges Coke and the Stakes Could Be High

Last Updated Nov 21, 2009 7:07 PM EST

Costco (Cost) is no longer restocking Coca-Cola (KO) products in a shot across the beverage maker's bow on pricing, one that could have some significant ramifications

As Bruce Watson of Daily Finance pointed out in a blog post last week, Walmart pressure on Coke for better pricing is the root of the dispute.

Walmart has hammered away at soft drink makers for decades. Even 20 years ago, before it had shifted over to supercenter operations, it wasn't unusual to see a pair of massive Coke and Pepsi (PEP) end caps in Walmart discount stores bracketing an even more massive double end cap of Sam's Cola. But if the Coke and Pepsi already were priced low, 89 cents or so in 99-cent markets, the Sam's Cola always was substantially lower. The retailer even used the display strategy outside the store, where Coke and Pepsi vending machines bracketed a pair of Sam's machines. Again, Coke and Pepsi would have a price lower than might be typically found in the market, but Sam's would be cheaper still and substantially so. Oh, and all the vending machines had conspicuous price signs that were easily viewed from the road going by the store.

Pairing the Coke and Pepsi prices drove each supplier to keep prices in line. In the meantime, the lower Sam's price weighed against opening a larger gap between the cost for their products and Sam's, a move that might drive consumers to the private label. So the display strategy pressured the soft drink suppliers on price and certainly provoked other retailers into insisting Coke and Pepsi provide prices in line with Walmart's.

Costco is in a relatively strong position in the dispute. With its limited assortment approach to food, the warehouse club chain operates in the knowledge that members don't expect it to have everything on their grocery list. In parts of the country where Coca-Cola is particularly favored, a supermarket not having its products might lose customers who felt inconvenienced by its absence. Costco knows its members also are shopping supermarkets and can pick up the beverage there. Or at Walmart. And there's the point. If Costco can't compete on a similar cost basis with Walmart, it's losing out financially and not making any points with its members, which means no extra traffic or market share based on Coca-Cola's presence. Coca-Cola and retailers have gotten into disputes on pricing before, and this one probably will be resolved. Yet, if it isn't, what follows could be interesting. Over the years, greater competition has forced retailers to narrow the assortments they carry and to focus on fewer popular items to boost store and distribution efficiencies. As a result, the range of products available in stores has narrowed. Of course, the entire warehouse club concept is based on this approach and many other alternative retail concepts, including Save-A-Lot and Aldi, count on it as the basis for the cost savings they offer. Traditional supermarkets are going this route, too, employing a process called SKU rationalization to increase efficiency. Walmart, although already renown for its efficiency, has embraced the strategy as an element in its program to develop smaller, more cost-effective supercenters.

In the course of these developments, consumers have become less reliant on food retailers that carry everything on their shopping lists all the time. Under the circumstances, the retailers have an increasing advantage over their vendors in price negotiations.

A Costco that determines it doesn't need Coca-Cola anymore is in a stronger position with all the branded product companies that supply it. Like big restaurant chains that only carry one soft drink line, they can play Coke and Pepsi against each other more effectively in price discussions. As they have had to compete more for business, vendors enhanced sales support and customization programs to satisfy more demanding retailers. If Costco boots Coke, they're faced with a marketplace where any product can be replaced and survival means becoming even more deferential to retailer demands.