In 2008, Costco achieved sales of around $71 billion. These sales were spread across its 544 warehouses located in different states, Puerto Rico, Canada, the United Kingdom, Taiwan, Japan, Korea, and Mexico. Among these warehouses, over 50 stores had annual sales exceeding $200 million. Notably, two stores even surpassed $300 million in sales.
On average, each store generated approximately $130 million in yearly sales. This amount was about 75 percent higher than the sales of Sam’s Club – Costco’s main competitor in the membership warehouse retail industry.
The concept of a membership warehouse originated from Sol Price who had expertise in discount merchandising. He established the original Price Club in San Diego back in 1976.
Originally designed as a platform for local businesses to access cost-effective merchandise, Sol Price quickly realized that his expanding Price Club enterprise had the potential to boost sales and secure more favorable agreements with suppliers by extending membership to individuals. This strategic decision made by Price played a crucial role in fueling the swift expansion of the discount warehouse club industry. In no time, Sol Price’s Price Club stores emerged as the dominant force in member warehouse retailing, primarily concentrated on the West Coast.
The wholesale club and warehouse sector of retailing in the U.S. had a value of $120 billion in 2008, growing at a rate 20% faster than the overall retail industry. There were over 1,200 warehouse locations in the U.S. and Canada combined, with most major cities having at least one warehouse club. The main competitors in this market were Costco Wholesale, Sam’s Club, and BJ’s Wholesale.
Sam’s Club had 713 warehouses across six countries: the U.S., Canada, Brazil, Mexico, China, and Puerto Rico. On the other hand,BJ’s Wholesale had 177 locations spread across16 states. Among these three major players,Costco held the largest market share with almost53% of sales inthe warehouse club sector.
S. and Canada, with Sam’s Club (a division of Wal-Mart) having approximately a 37% share and BJ’s Wholesale and several small warehouse club competitors having around a 10% share. Competition between warehouse clubs was influenced by price, merchandise quality and selection, location, and member service. However, warehouse clubs also faced competition from various other retailers such as retail discounters like Wal-Mart and Dollar General, supermarkets, general merchandise chains, specialty chains, gasoline stations, and even Internet retailers.
Wal-Mart, the largest retailer globally, not only directly competed with Costco through its Sam’s Club subsidiary but also sold similar merchandise at appealingly low prices through its Wal-Mart Supercenters. Target and Kohl’s had also emerged as major competitors in specific merchandise categories. Low-cost retailers specializing in single or limited product ranges, such as Lowe’s, Home Depot, Office Depot, Staples, Best Buy, Circuit City, PetSmart, and Barnes & Noble, held significant market share in their respective product categories.
Costco was established in 1983 by Jim Sinegal and Seattle entrepreneur Jeff Brotman, who is now the chairman of the board of directors. It opened its first store in Seattle in the same year that Wal-Mart introduced its warehouse membership format known as Sam’s Club. As of the end of 1984, there were 9 Costco stores across five states, catering to more than 200,000 members. In December 1985, Costco became a publicly traded company, offering shares to the public and generating additional funding for expansion. Notably, Costco achieved the milestone of attaining $1 billion in sales within less than 6 years.
Jim Sinegal became CEO of Costco and The Price Company in October 1993, resulting in 206 PriceCostco locations generating $16 billion in annual sales. The company then relocated its headquarters from Delaware to Issaquah, Washington by August 1999 and changed its name to Costco Wholesale Corporation. In the membership warehouse business, Costco aimed to provide members with quality goods and services at the lowest possible prices.
They employed a business model that focused on high sales volumes and fast inventory turnover. This was achieved by offering members low prices on a limited selection of nationally branded and private label products across various merchandise categories. Through volume purchasing, efficient distribution, and streamlined operations in self-service warehouse facilities, Costco operated profitably despite having lower gross margins compared to traditional wholesalers, mass merchandisers, supermarkets, and supercenters.
Costco generated an incredible volume of sales, including selling 110,000 carats of diamonds in 2007, 40 million rotisserie chickens in 2008, 40 percent of Tuscan olive oil purchased in the U.S., 29 million prescriptions in 2007, 150 million croissants in 2007, 100 million pounds of ground beef in 2007, and 1 million pumpkin pies during Thanksgiving week in 2007. Additionally, they had annual gasoline sales of $4.6 billion in 2007 and sold 1.5 million $1.50 hot dog/soda pop combinations per week. Costco was also the world’s largest seller of fine wines, making $499 million out of the total 2007 wine sales of $1.1 billion. One of Costco’s largest volume stores had annual sales of $285 million and 232,000 members. At this store, they sold 283,000 rotisserie chickens, 375,000 gallons of milk, and 8.4 million rolls of toilet paper annually. The average customer bill per trip was $150. Costco’s business model of high sales volume and rapid inventory turnover allowed them to sell and receive payment for inventory before having to pay many merchandise vendors, even when they took advantage of early payment discounts.
Costco relied on vendors’ payment terms to finance a significant portion of its merchandise inventory, rather than maintaining a large working capital. This allowed them to make timely payments to suppliers without needing extensive funds on hand. Costco’s strategy revolved around low prices, a limited product line, a selective assortment, and a unique shopping experience known as the “treasure hunt.” The focus of this case is on Costco’s business model, strategy, and operations, which are intriguing for various reasons. Despite criticism from Wall Street analysts who believed Costco should charge higher prices to maximize profits for shareholders, the company maintained incredibly low markups and prices. While typical supermarkets and large retailers like Wal-Mart and Target offered tens or hundreds of thousands of products, Costco deliberately limited its selection to around 4,000 items for members to choose from.
Approximately 25% of Costco’s products were continuously shifting and primarily included “treasure hunt” specials. The company’s buyers were always searching for unique items that would attract customers and sell out rapidly. Many of these products were high-end or well-known brands with expensive price tags, such as large-screen HDTVs priced between $1,000 and $2,500 and leather sofas worth $800. The objective was to entice shoppers into spending more by providing irresistible discounts on luxurious items.
Costco did not typically acquire luxury products directly from high-end manufacturers such as Calvin Klein or Waterford. Instead, they searched for opportunities to obtain these items legally on the gray market from other wholesalers or distressed retailers. This allowed Costco to offer merchandise at deep discounts that would otherwise not be marketed by these luxury brands. This strategy led to a variety of treasure hunt specials, ranging from high-end espresso machines and Italian-made shirts to Movado watches and Coach bags. Costco’s ability to offer such products attracted a wealthy customer base, with an average individual member income of approximately $75,000. Many of these affluent customers lived in upscale neighborhoods close to Costco warehouses. The driving force behind Costco’s success was Jim Sinegal, the CEO known for his exceptional merchandising skills. Sinegal had a keen eye for identifying popular products and determining their optimal placement on the sales floor to maximize sales volume.Sinegal, a 70-year old grandfatherly figure, had a laid-back and unaffected fashion sense. Whether he was going to the office or visiting Costco stores, he would commonly be seen wearing an open-collared cotton shirt that he found on sale at a Costco bargain rack. Accompanying his simple attire was a regular employee name tag that stated “Jim.” Sinegal dedicated a considerable amount of his schedule to touring various Costco stores. To efficiently cover multiple locations, he would often utilize the company plane for transportation, sometimes visiting up to 10 stores in a day (with a record-breaking 12 stores visited in one day).
When Sinegal visited a store, it quickly became known that “Jim’s in the store”. He made it a priority to personally greet employees and emphasized the significance of this gesture by stating, “The employees know that I want to say hello to them, because I like them. We have said from the very beginning: ‘We’re going to be a company that’s on a first-name basis with everyone.'”
At Costco, employee compensation was higher compared to Sam’s Club. In 2008, new Costco employees were paid starting wages ranging from $10.50 to $11 per hour. The median pay for experienced Costco employees (with five or more years of experience) varied between $17 and $21 per hour based on their job classification. Warehouse workers at Costco received time-and-a-half pay for Sundays and double time if they worked over 12 hours in one shift.
Furthermore, managerial positions at Costco warehouses had median salaries ranging from $55,000 to $75,000.
Employees at Costco enjoyed a comprehensive range of benefits. Jim Sinegal firmly believed that having a well-paid workforce was crucial for the successful execution of Costco’s strategy. He emphasized that offering competitive wages and retaining employees was not only advantageous but also sound business practice. Additionally, unlike many other major corporations in recent years, Costco’s executives did not receive exorbitant salaries.
Assignment Questions
What is Costco’s business model?
- Is the company’s business model appealing? Why or why not?
- What are the chief elements of Costco’s strategy? How good is the strategy?
- Do you think Jim Sinegal is an effective CEO?
- What grades would you give him in leading the process of crafting and executing Costco’s strategy? What support can you offer for these grades? Refer to Figure 2. 1 in Chapter 2 in developing your answers.
- How well is Costco performing from a strategic perspective? Does Costco enjoy a competitive advantage over Sam’s Club? Over BJ’s Wholesale?
- If so, what is the nature of its competitive advantage? Does Costco have a winning strategy? Why or why not?
- Are Costco’s prices too low? Why or why not?
- Does Costco pay its employees too much? Does it make sense for Costco to compensate its employees so much better than the employees at Wal-Mart/Sam’s Club? Why or why not?
- What recommendations would you make to Jim Sinegal regarding the actions that Costco management needs to take to sustain the company’s growth and improve its financial performance?
