Walmart (NYSE: WMT) is reportedly abandoning its plans to launch a streaming video service. Walmart had been in talks with media executive Mark Greenberg since last summer, but the retailer wasn't comfortable with the large investment it would need to make in streaming content, according to CNBC.
Meanwhile, Costco (NASDAQ: COST) is still pursuing its own plans to launch a streaming video service despite an increasing number of competitors in the space including big media companies and deep-pocketed tech giants.
In October, I wrote "With so many great options available already, [Walmart and Costco will] have to come out the gate with a quality product, which means spending a lot of money." Here's why Costco might be able to afford a big investment, while Walmart can't.
Image source: Getty Images.
Costco sells subscriptions, Walmart's Vudu doesn't
Costco uses a membership model to subsidize its low pricing. In fact, practically all of Costco's profits come from membership sales, not the actual goods it sells in its warehouses. And Costco is really good at selling memberships. As of the end of November, Costco had 52.2 million members and 95.4 million cardholders.
Meanwhile, Walmart has struggled to build memberships outside of Sam's Club. It tried to offer an expedited shipping subscription service, but it failed to catch on before Walmart decided to ditch it and offer free 2-day shipping to all of its online customers.
Costco's streaming plans can be tied to its warehouse membership, just as Amazon (NASDAQ: AMZN) ties Prime Video to its unlimited shipping program. In particular, Costco could tie its streaming service to its higher-tier Executive membership, which costs $120 per year. Executive members have proven more loyal shoppers to Costco than standard members, just as Prime members are more loyal Amazon shoppers than non-members.
Costco is lapping the impact of its last membership fee increase, and the impact will practically disappear by the end of its fiscal year. It's done a good job growing its Executive memberships, which total 19.7 million as of the end of last quarter, but continuing to migrate customers from its standard membership to the higher-tier will be what drives its profits going forward.
If Walmart were to compete in streaming, it would make sense for it to follow the model put forth by Amazon and Costco, tying it to its high-tier Sam's Club membership. The company has been able to grow its Plus Sam's Club membership tier by offering additional perks, including free shipping with no minimum purchase for online orders. Sam's Club sales still only account for about 12% of Walmart's overall revenue.
Walmart is focused on other things
While Walmart has billions in free cash flow coming in every quarter, its investments are more focused on developing its core business.
It's spending heavily on online grocery pickup and delivery services, rapidly expanding its presence to hundreds more stores every quarter. Walmart has even surpassed Amazon in online grocery shopping by some measures as it expands to areas Amazon doesn't serve.
Grocery sales make up more than half of Walmart's revenue, so it's much more important to the retailer's business than pursuing an opportunity in streaming video.
Walmart is also investing in its pricing in order to ensure it stays competitive with Amazon and other retailers as more shopping moves online. That has put pressure on its gross margin in the U.S., which fell 28 basis points year over year last quarter.
Walmart stands to gain much more from focusing on its core retail business than from expanding to a premium streaming video service. It can still make smaller content investments with its Vudu property and continue experimenting with ad-supported streaming. There's no need for Walmart to dive into the deep end with a streaming service, as it won't support its retail operations. Costco's model, on the other hand, could drive higher average membership rates, which would have a much bigger impact on its bottom line.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.