Why Costco’s entry into the petrol market won’t fuel a revolution

In a new twist in the long-running Australian petrol wars, Costco is preparing to join the discount petrol market.

Sydney’s second Costco outlet, scheduled to open later this year, will reportedly sell heavily discounted fuel.

Costco is already a big petrol retailer in the United States and Canada, but is now extending petrol retailing to Australia and the UK. It aims to set up petrol outlets at new Australian stores where space and regulations allow. This follows Costco’s US model, but is very different from the “shopper dockets” approach used by Coles and Woolworths.

In the US, Costco sells petrol at its store sites and uses petrol to, literally, drive customers to the stores. It makes razor-thin margins on petrol with huge turnover. In general, Costco only sells petrol to members. Here in Australia, standard Gold Star Costco membership is A$60 per year and internationally the retailer makes a lot of its profit from membership revenues. As one Canadian journalist recently asked:

“Is Costco opening their gas bar to make money from selling gas or to make money from selling more memberships?”

So what does this mean for Australian motorists?

In the big picture, not much. Australia is a net petrol importer and the retail price of petrol is dominated by two factors – the price (in US dollars) of Singapore refined fuel and the Australian dollar exchange rate. The Australian Competition and Consumer Commission (ACCC) 2012 petrol report showed that our retail petrol prices and the international petrol price follow each other like a pair of ballroom dancers. And the exchange rate is be much more important than Costco when it comes to filling your petrol tank.

But petrol prices are emotive. Even a few cents per litre matters. And Costco in the US is regularly the cheapest retailer in the market.

But unless you are a regular Costco shopper, it is unlikely to be worthwhile driving to a Costco store just to fill up. Only 20 stores in total are planned for Australia, and not all of those can fit a petrol outlet alongside. So for most motorists, Costco outlets will be few and far between.

Also, paying a $60 membership up front means you have to buy a lot of fuel, or buy other Costco products, to save money. Even a saving of 4 cents per litre on a 50 litre tank will require 30 “fills” to break even.

In short, don’t expect a retail petrol revolution.

Costco’s model probably raises fewer concerns for the competition regulator than the Coles and Woolworths “shopper docket” schemes. Costco is simply co-locating its warehouse stores and its retail petrol outlets. In contrast, Coles and Woolworths use “shopper dockets” to link geographically separate outlets. Despite the discount printed at the bottom of your grocery receipt, it is far from clear that the Coles and Woolworths schemes really benefit consumers.

Joshua Gans and I looked at this issue about a decade ago when Coles joined Woolworths in offering a discount on petrol when you purchase groceries. Our analysis showed why this could raise profits for one retailer, but only until the other retailer copied it. And while prices dropped to consumers, transaction costs rose, as consumers travelled to less convenient, but bundled, pairs of retailers. Put simply, if you use an extra litre of fuel going to and from the ‘paired’ grocery and petrol retailers, you have pretty much spent all your shopper docket savings!

The ACCC has been investigating whether the Coles’ and Woolworths’ shopper docket schemes breach competition laws. As it states in its 2012 petrol report:

“The ACCC is also currently examining the effects of shopper docket discounting schemes on competition and long-term consumer welfare having regard to the size (value), frequency and duration of these offers.”

The entry of Costco will make the competition issues even murkier and will undoubtedly lead to ACCC scrutiny. Costco has previously been subject to a legal challenge in the US on its petrol pricing, with claims that it had illegally sold petrol below cost. Costco denied these claims.

The real story behind Costco’s expansion, however, is not petrol but groceries. The success of both Aldi and Costco in Australia has shown our retail grocery market was ripe for a shake-up. Coles and Woolworths compete like Tweedledum and Tweedledee. Despite all the noise, they look and sound the same. Costco and Aldi have shown that a significant number of Australian consumers want something different in their supermarkets. And they are voting with their wallets.

Stephen King is a Professor of Economics and former Dean at Monash University in Melbourne, Australia.

This article was originally published at The Conversation. Read the original article.