The Brands on the Next PalletThin moat

The strangest competitive relationship in this company is the one conducted inside its own building. Roughly a third of Costco's sales now carry the Kirkland Signature label¹, which means the national brands supplying the other two-thirds are simultaneously Costco's partners and the party losing share to it — frequently while manufacturing the Kirkland version themselves.

The 10-K states the economics without embarrassment: Kirkland products are "offered at prices that are generally lower than national brands, and help lower costs, differentiate our merchandise offerings, and generally earn higher margins," and Costco expects "to continue to increase the sales penetration of our private-label items"². Costco's merchandising chief has described the brand this way: "I see it as a tremendous negotiating tool", which names the primary use precisely.

The leverage is a function of the assortment. In a warehouse with fewer than 4,000 items³, a category has one slot. A brand that declines Costco's price does not get a smaller order; it gets no order, and watches a Kirkland product take the pallet. And because Kirkland is manufactured under contract, the brand refusing the private-label work can be replaced by a competitor accepting it — so the supplier's options are to accept a lower price, accept the contract manufacturing, or lose an enormous block of volume in one conversation.

This is the least sympathetic part of Costco's story and it is also why the member price is what it is. The margin taken out of the branded goods is handed on rather than kept, which is what the flat gross margin over a decade demonstrates.

The limit is quality and it is real: the 10-K warns that if the Kirkland brand "experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected". Costco has bet a third of its revenue on its own name.

The leverage has a limit, and the 10-K names it: "any supplier has the ability to change the terms upon which they sell to us or discontinue selling to us," alternatives "may be of a lesser quality or more expensive," and for high-quality food items in particular "the large volumes we demand may not be consistently available"⁴. With one slot per category, losing a supplier is disproportionately visible on the floor — which is the cost of the same discipline that produces the bargaining power.

Read Kirkland penetration against the headline gross margin. Rising penetration with a flat margin means the leverage is reaching members. Rising penetration with an expanding margin means it is not.