Costco’s Growth Is Bad News for TV and Newspapers

The phenomenal growth of Costco Wholesale (NASDAQ: COST), which is now America’s second largest retailer, is a threat to traditional media companies that depend on advertising revenue, such as CBS (NYSE: CBS) and Gannett (NYSE: GCI). Costco is a threat to old media companies because it famously does not buy advertising, yet its sales are booming.

Costco’s sales in the third quarter of 2014 were 7.4% higher than for the same period in 2013. The club store giant also reported a quarterly year to year revenue growth rate of 7.39% for the third quarter of 2014. Costco reported a TTM revenue of $106.46 billion in November 2013 that grew to $114.49 billion in November 2014, and it did it without buying a single television or newspaper ad.

This represents a sea change in American retail and media—a gigantic retailer that does not advertise. Instead, Costco relies on word of mouth and direct marketing to its members to drum up business a strategy that is clearly working.

Costco Drive Sales without Advertising

What should even be more worrying for media companies like CBS, Gannett and McClatchy (NYSE: MNI) is that the sales growth at retailers that advertise heavily was tiny. Wal-Mart Stores Inc. (NYSE: WMT) reported a paltry .5% increase in sales for third quarter 2014, while Target (NYSE: TGT) reported a 1.2% increase for the same period.

Costco’s business strategy is working, which indicates a major change in consumer behavior. Advertising seems to have less and less effect upon shoppers. That, of course, demonstrates how Costco threatens traditional media. It does not buy ads and, worse, gives other retailers a strong incentive not to advertise.

The threat to broadcasters from this is obvious; Wal-Mart alone spent $70.7 million on TV advertising during the 2014 holidays, and Target spent $61.6 million on holiday advertising, according to The Media Post. Yet both retailers reported small sales increases when compared to Costco.

When Will Retail Dump Print and Broadcast Advertising

One has to wonder when executives at other retailers will look at those figures and start questioning why they are buying so much advertising. Some of them may even ask the dreaded question: “Why are we even buying advertising at all?” Others will wonder if they should transfer their advertising dollars to digital.

After all, more and more people are turning to streaming video for their entertainment. Variety reported that even CBS’s chief research officer, David F. Poltrack, admitted that his company now makes more online than on television. Poltrack noted that CBS makes 10% to 20% more ad dollars online than it does from broadcast operations. That might explain the rise in CBS’s revenue over the past year; in September 2013 CBS reported a TTM revenue of $14.41 billion that grew to $15.26 billion in September 2014.

Costco’s growth comes at a bad time for television advertising sales. Researchers are predicting a dismal year for TV ad sales next year. Poltrack told Variety that he expects TV ad sales to increase by around 2% next year. Magna Global, a media services firm, predicted that U.S. TV ad spending will fall 1.4% in 2015, while digital advertising spending will increase by 15.5% in 2014.

Variety also reported that Poltrack actually came out and asked attendees at a UBS conference in early December not to finance new digital marketing with cuts in the TV ad budget. It sounds as if Mr. Poltrack is worried about next year’s revenue.

He might have some reason to worry; CBS’s TTM revenue fell slightly over the course of 2014. It started the year at $15.56 billion in December but fell to $15.26 billion in September.

Steady Decline in Revenues

One group that might even have more to worry about here is the owners of TV stations, such as Gannett and E. W. Scripps (NYSE: SSP); after all, they do not have streaming video to fall back upon. Their revenues are a mixed bag right now.

Gannett’s TTM revenues rose from $5.321 in September 2013 to $5.67 billion in September 2014. EW Scripps’ TTM revenue fell from $855.79 million in September 2013 to $844.17 million in September 2014.

The real worry for broadcasters is that their advertising revenues will steadily decline, much like newspaper operators’ revenues have. McClatchy’s TTM revenue has fallen from $1.367 billion in September 2012 to $1.26 billion in September 2013 to $1.222 billion in September 2014. At Lee Enterprises (NYSE: LEE), TTM revenues fell from $707.86 million in September 2012 to $674.74 million in September 2013 to $656.7 million in September 2014.

The newspaper business provides us with a picture of where broadcasters and TV networks might be going. One of their first moves will probably be to spin broadcast operations off into separate companies as Gannet is doing with its newspapers.

We may even see such moves next year if Costco has a really good holiday season, which looks likely, and companies like Wal-Mart do not. If that happens, we’re likely to see massive cuts in the broadcast advertising budget at big retailers. The next logical step will be for media companies to start moving away from television, much as they are already moving out of print.