At What Price, Costco?

Bob Laman is steamed.The vice president of operations at Packasport, a Bend, Oregon manufacturer of deluxe cartop carriers, is outraged. Business isn't bad; in fact, the 25-employee company that was once known only to a cult following of devoted customers is starting to carve a niche for itself on a national level.So why is Laman so upset?"They're just a parasite," he says. "They won't take no for an answer." Laman is talking about Costco, the most successful retailing phenomenon in the United States. And he's mad at Costco for what may seem like an odd reason.The discount chain sells his product.There must be someone, somewhere, in America who's never shopped at a Costco store, but those people are members of an ever-shrinking minority. In the 13 years since the Kirkland, Washington, company built its first warehouse in the Portland, Oregon, Costco has sprouted throughout the United States like blackberry bushes in the spring. Using the Portland as an example, company officials estimate that each week, 133,000 people visit its four warehouse centers in the area, spending about $530 million a year. Company execs say that the Northeast Portland warehouse ranks second out of the 262 PriceCostco warehouse centers in terms of sales volume. (PriceCostco was created in 1993 after Costco merged with its predecessor, Price Club.) The warehouse stores have taken much of the Western Hemisphere by storm -- they've sprung up across the United States and in Canada, Mexico and Guam.In 1983, Costco's revenues were $1 million. Last year, revenues rang in at just less than $18 billion, making the company the eighth-largest retailer in the country.Costco is perhaps the most successful and visible member of what are known in the industry as "power boxes," enormous discount stores that have appeared in the past decade and rearranged the picture of retailing. The theory behind power boxes is simple: Lower prices by decimating overhead costs. The less-is-more concept was fueled by specialized power boxes called "category killers" -- Office Depot, Home Base, Circuit City -- that offer no-frills customer service in an environment that makes shopping as much an experience as an errand.In fact, a consumer's first visit to a Costco can be, well, disorienting. The 160,000-square-foot stores have little in the way of amenities but offer a wide selection of goods. One customer wheeling an oversized orange cart filled with five- gallon jugs of olive oil might meet another customer carrying a canoe. Mothers sifting through stacks of Calvin Klein jeans might see their children weaving through the jewelry display to watch the Saturday cartoons playing on an endless stream of Sony TVs.All of Costco's products are there at a discount. And many are there against the wishes of the manufacturers.When Bob Laman's company started out seven years ago, it sold the rooftop carriers through a toll-free phone service. Within months, Laman says, Packasport had developed a small but loyal group of customers, who loved the luxury item and its wide variety of options. As sales grew, the company began to sell the storage systems at automotive outlets and high-end sporting goods stores. These retailers were chosen, Laman says, because they could maintain attractive floor displays of the six Packasport models and afford to train customer service representatives in the finer points about the features and custom work available with each carrier.In January 1995, a Costco buyer approached Packasport and asked to carry the company's rooftop storage systems in its warehouse stores, Laman says. Packasport refused, giving two reasons. First, the company was concerned that Costco couldn't provide adequate customer service for the specialized equipment. Second, Costco admitted that it would sell the cartop carriers below the manufacturer's suggested retail price. This, in Packasport's mind, could sully the product's reputation and anger its regular retailers. Those retailers would be so upset about Costco offering the same product at a discount, Laman says, that they might decide it wasn't worth the effort to order any more Packasport merchandise. "For a small company, [selling to Costco] destroys the market," he says. "The last place we'd sell to is Costco." Laman thought that was the end of the conversation. He was wrong."Telling Costco you won't sell directly to them," he says, "is never the end of the story."Soon after Costco's inquiry, Packasport received a large order request from a small sporting goods shop in Seattle, which Laman won't identify. The size of the order seemed out of place given the size of the store. "It raised an immediate red flag in my mind," Laman says.Laman was so curious that he asked one of his other retailers to call the shop's owner, who confirmed that Costco had approached him about getting Packasport's basic model and that the products his store had ordered would indeed end up on Costco's shelves Packasport refused to fill the shop's order.Several months later, the Bend manufacturer received an order from New Delhi-based Indian Distributors for 104 carriers. Suspicious, Packasport made the small export company sign a contract stipulating that the Indian firm would not sell any Packasport products to any stores in the United States. The cartop carriers were to be picked up at Packasport's small Ohio manufacturing plant, loaded onto semitrailers and trucked to Los Angeles, where the shipment would go through customs and end up in India.The shipment, however, never arrived at customs. Within three days after the products left Ohio, the Packasport System 90 rooftop carrier was on shelves at Costco warehouses in Oregon and five other Western states. Laman didn't find out right away. It was only after handfuls of warranty response cards, which accompany each Packasport cartop carrier, started pouring into the Bend office from destinations as far away as Wyoming and Montana. "It was kind of like a little mystery," he says.Even though he suspected Costco right away, Laman was baffled. His company had done everything within its power to keep Packasport products away from the discount chain. He drove to the Bend Costco and walked straight down the automotive aisle. There, sandwiched between haphazardly stacked truck storage boxes and an occasional radial tire, sat his product-only partially displayed and still in the original shipping boxes. He stood motionless on the cement floor as he stared at the price tag: $499.99, almost 33 percent below the suggested retail price of $745. He took a minute to remind himself that this wasn't a personal attack, just a business technique. But still, he says, "They're not the kind of business partner I'd like to have."Costco officials won't comment specifically about their dealings with Packasport, but top brass don't deny that their company often obtains products by using what it euphemistically calls "diversion." "Our goal is to bring high-quality products to consumers at the lowest price," says Richard Galanti, Costco executive vice president and chief financial officer, from his Issaquah, Wash., office. "We try to buy directly from manufacturers, but in instances where they refuse, we buy through a third party -- legally." Galanti estimates that about 4 percent of the goods in Costco are diverted, but a number of retailers are convinced that the figure is closer to 12 percent. At an average of 4,000 products per warehouse store, that means that anywhere from 160 to 480 brand-name products on Costco's shelves at any given time are there without the express approval of their manufacturers.Tigard, Oregon, Costco store manager Steve Marcy, a 12-year Costco employee, understands that manufacturers whose goods are diverted might be upset. But the store's mission is to treat the consumer as king."I don't know how we go about getting [name-brand products]," Marcy says. "But if customers want it, Costco will try to get it. "I worked in [menswear] retail for nine years," he continues. "The markup was sometimes 100 percent." Costco execs say their average markup is 9 percent."Costco is in this business to bring the treasure to consumers at a good price," Marcy says. "It seems almost selfish not to."Manufacturers and retailers, however, say that Costco is the selfish one. Packasport is just one example of a regional manufacturer that's been burned by Costco's diversion of goods. In Seattle, Washington, more than 20 federal lawsuits have been filed against the Washington-based discount giant, with allegations ranging from unfair business practice to trademark infringement. Almost all have been unsuccessful. Deckers Outdoor Corp., the company that manufactures Teva sports sandals, filed one such suit in 1993. Deckers executive vice president Ron Page says his company learned that the all-terrain sports sandals were being sold in Costcos across the country, including in Teva's biggest market, New England. Like Packasport, Teva had no idea how its products ended up at the warehouses. "[Costco] works in the gray shadows of the law," Page says. But the company didn't want its sandals there, so Deckers dispatched employees with vans to buy whatever Teva products they found at Costco, just to get the discounted items off the shelves. "To us," Page says, "diversion is illegal. It's no different than if Costco said, 'We'll steal a Rolex and sell it to you for less. If you steal something that's a quality item -- what's the quality in that?"Teva lost its suit in a summary judgment decision.The list of name-brand companies who have had goods diverted by Costco reads like a Who's Who of the retail industry: Rollerblade, NordicTrack, Cannondale, Rossignol, Oakley. Most lawsuits have been unsuccessful because their allegations hinge on the circumstances surrounding the actual diversion of goods, which although ethically questionable has been repeatedly upheld by courts as a legal practice. "It's not against the law to buy products through third parties," Oregon assistant attorney general Jan Margosian says.One company found a way to strike back at Costco. Bicycle manufacturer Trek was losing its battles with the discount chain, until Trek executives decided to focus on Costco's unauthorized assembly of the bikes, which could increase the potential for injury and constitute a flagrant disregard for the consumer's best interests. Trek's semi-successful suit didn't prevent Costco from buying the company's bikes and selling them without authorization. But it did put the legal burden on Costco to pay for any consumer claims arising from accidents involving Trek bikes purchased at the discount stores.Another bicycle manufacturer is trying to win a Costco settlement by going to court with a claim of unfair business practice. GT Bicycles' lawsuit against the discount chain is in the discovery stage in a California district court. GT attorney Pat Carroll says the suit arose after the manufacturer sold 2,600 bikes to a Russian distributor, Polaris International, last fall. Although the bikes were shipped to Russia, they somehow returned to U.S. Costco stores.The biggest Oregon company having problems with Costco is Columbia Sportswear, the $300-million-a-year Portland manufacturer of specialty outdoor clothing. Starting around 1992, the company noticed that its most popular jacket, the Bugaboo, was showing up in Costco stores. Columbia's attorneys considered going after the discount giant in court but soon realized that they were without legal precedent. Instead, national sales manager Bob Masin says, Columbia resorted to marking popular merchandise that it thought Costco might try to divert. That way, when the Bugaboo jacket turns up at Costco warehouses, Columbia can tell exactly which company sold it to the discounter. Masin wouldn't disclose how the items are marked, but he says it's a painstaking method that uses clothing sizes, colors, genders and styles to trace the items back to a single retail company. "Then we drop the retailer," Masin says. Columbia says it has refused to fill more than three dozen large orders, partly because of the results of the marking system but also because of lingering paranoia. "Costco seems to have an endless supply of [people] who will divert to them," Masin says.Manufacturers aren't the only ones upset about Costco's tactics. Many retailers worry that the discounter's reputation for diverting name brands and then slashing prices undercuts their business and is irresponsible to the consumer. "There's a reason [some] products belong in a certain environment," says Richard Humphrey, owner of the Oregon Mountain Community store in Portland, which sells high-end outdoor gear."[Certain] equipment needs specialized salespeople to match customer needs with products."Costco doesn't deny that it skimps on customer service. "We only have expert help in the tire department, because that's a matter of life and death," Tigard Costco manager Marcy says. "If I'm on the floor, I only tell them what I know. I'll be honest and tell them if I don't know anything about [the product]."Humphrey and other retailers say that most consumers don't realize the importance of customer service."Costco has good buys if you buy the right product," Humphrey says. "But we want people to have a good time, and they're more likely to have fun if they use [products] properly." His shop's prices are higher than Costco's because the volume of goods is much smaller, but also because Humphrey employs trained sales representatives who often spend more than an hour with a customer.Oregon Mountain Community protests Costco's tactics in its own way by eliminating products sold at Costco from its store. When the North Face ventilator tent showed up at the discount warehouses, Oregon Mountain Community decided not to reorder the product. North Face officials say their company tried to buy the tents back from Costco, but by that time some retailers had already stopped ordering them. The ventilator tents are still on the shelves at Costco's North Portland and Tigard stores. This kind of story should send shivers up manufacturers' spines, according to G.I. Joe's president Norm Daniels. "Costco could ruin Packasport," Daniels says, because stores like his chain will boycott many goods that Costco carries. "If you sell to Costco," Daniels tells manufacturers, "we won't buy from you."Although other power boxes are said to practice diversion, local retailers say none is as tenacious as Costco. "[Costco is] the most aggressive diverter that we know of," Deckers exec Page says. Costco says it's simply trying to bring name-brand merchandise to its customers at the lowest price. In an age of ever-shrinking resources, many consumers are more than willing to sacrifice fancy decor and intricate product displays in order to save a few bucks. Even Packasport's Bob Laman admits that he shops at the discount chain. "Hey, this is America," Laman says. "One day I'm a manufacturer, the next I'm a consumer. -- Costco is a hero to consumers."Page disagrees. "Costco's OK for things like toilet paper and soap powders," he says, but the discounter's habit of holding itself up as the answer for every customer need is irresponsible. "Certain kinds of complex products must be retailed in a sophisticated environment. We don't see [unauthorized selling] as heroism.-- The cheapest price is often the dearest price in the end."SIDEBAR: It's a Steal!These popular products recently graced the shelves of local Costco warehouses, even though the manufacturers say they don't want them there. Product Competition price* Costco price Packasport System 90 $745 $499.99North Face Ventilator Tent $250 $164.77Oakley Razorblade Sunglasses $95 $49.99 Rollerblade Coolblade ABT $214 $184.99NordicTrack $499.95 $450 *based on the average price obtained from a random sample of Portland, Oregon retailers

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