In 2008, Costco’s sales totaled almost $71 billion at 544 warehouses in 40 states, Puerto Rico, Canada, the United Kingdom, Taiwan, Japan, Korea, and Mexico. More than 50 of Costco’s warehouses generated sales exceeding $200 million annually and 2 stores had sales exceeding $300 million. Sales per store averaged $130 million annually, about 75 percent more than the $75 million per store average at Sam’s Club, Costco’s chief competitor in the membership warehouse retail segment. The membership warehouse concept was pioneering by discount merchandising sage Sol Price who opened the first Price Club in San Diego in 1976.
Originally conceived as a place where small local business members could obtain needed merchandise at very economical prices, Sol Price soon concluded that his fledgling Price Club operation could achieve far greater sales volumes and gain buying clout with suppliers by also granting membership to individuals—Price’s decision to add individual memberships was the trigger that launched the deep discount warehouse club industry on a steep growth curve. Within a few years, Sol Price’s Price Club stores emerged as the unchallenged leader in member warehouse retailing, operating primarily on the West Coast.
The wholesale club and warehouse segment of retailing in 2008 was estimated to be a $120 billion business in the U. S. , and it was growing about 20 percent faster than retailing as a whole. There were 1,200-plus warehouse locations across the U. S. and Canada; most every major metropolitan area had one, if not several, warehouse club operations. The three main competitors were Costco Wholesale, Sam’s Club (713 warehouses in six countries— the U. S. , Canada, Brazil, Mexico, China, and Puerto Rico), and BJ’s Wholesale (177 locations in 16 states). Costco had close to a 53 percent share of warehouse club sales across the U.
S. and Canada, with Sam’s Club (a division of Wal-Mart) having roughly a 37 percent share and BJ’s Wholesale and several small warehouse club competitors having about a 10 percent share. Competition among the warehouse clubs was based on such factors as price, merchandise quality and selection, location, and member service. However, warehouse clubs also competed with a wide range of other types of retailers, including retail discounters like Wal-Mart and Dollar General, supermarkets, general merchandise chains, specialty chains, gasoline stations, as well as Internet retailers.
Wal-Mart, the world’s largest retailer, not only competed directly with Costco via its Sam’s Club subsidiary but its Wal-Mart Supercenters sold many of the same types of merchandise at attractively low prices as well. Target and Kohl’s had emerged as significant retail competitors in certain merchandise categories. Low-cost operators selling a single category or narrow range of merchandise, such as Lowe’s, Home Depot, Office Depot, Staples, Best Buy, Circuit City, PetSmart, and Barnes & Noble, had significant market share in their respective product categories.
Costco was founded in 1983 by Jim Sinegal and Seattle entrepreneur Jeff Brotman (now chairman of the board of directors). The first Costco store began operations in Seattle in 1983, the same year that Wal-Mart launched its warehouse membership format called Sam’s Club. By the end of 1984 there were 9 Costco stores in five states serving over 200,000 members. In December 1985 Costco became a public company, selling shares to the public and raising additional capital for expansion. Costco became the first company to reach $1 billion in sales in less than 6 years.
In October 1993, Costco merged with The Price Company. When the two companies merged in 1993, Jim Sinegal became CEO, presiding over 206 PriceCostco locations generating $16 billion in annual sales. When the company reincorporated from Delaware to Washington in August 1999, the name was changed to Costco Wholesale Corporation. The company’s headquarters was in Issaquah, Washington, not far from Seattle. Costco’s mission in the membership warehouse business was “To continually provide our members with quality goods and services at the lowest possible prices. The company’s business model was to generate high sales volumes and rapid inventory turnover by offering members very low prices on a limited selection of nationally branded and selected private label products in a wide range of merchandise categories. Management believed that rapid inventory turnover, when combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, enabled Costco to operate profitably at significantly lower gross margins than traditional wholesalers, mass merchandisers, supermarkets, and supercenters.
Examples of the incredible volume that Costco generated included selling 110,000 carats of diamonds (2007), 40 million rotisserie chickens (2008), 40 percent of the Tuscan olive oil bought in the U. S. , 29 million prescriptions (2007), 150 million croissants (2007), 100 million pounds of ground beef (2007), 1 million pumpkin pies during Thanksgiving week (2007), annual gasoline sales of $4. 6 billion (2007), and 1. 5 million $1. 50 hot dog/soda pop combinations per week; Costco was also the largest seller of fine wines in the world ($499 million out of total 2007 wine sales of $1. 1 billion). At one of Costco’s largest volume stores, which had annual sales of $285 million and 232,000 members, annual volume ran 283,000 rotisserie chickens, 375,000 gallons of milk, and 8. 4 million rolls of toilet paper—this store had an average customer bill per trip of $150. Costco’s high sales volume-rapid inventory turnover business model allowed it to sell and receive cash for inventory before it had to pay many of its merchandise vendors, even when vendor payments were made in time to take advantage of early payment discounts.
Thus Costco was able to finance a big percentage of its merchandise inventory through the payment terms provided by vendors rather than by having to maintain sizable working capital (defined as current assets minus current liabilities) to facilitate timely payment of suppliers. The cornerstones of Costco’s strategy were low prices, a limited product line and limited selection, and a “treasure hunt” shopping environment. The focus of the case is on Costco’s business model, strategy, and operations. The company is interesting in several important respects: Costco’s markups and prices were so low that Wall Street analysts had criticized Costco management for going all out to please customers at the expense of charging prices that would increase profits for shareholders—retailing and investment analysts believed that Costco could charge more for a lot of the items it sold. •Whereas typical supermarkets stocked about 40,000 items and a Wal-Mart Supercenter or Super Target might have as many as 150,000 items for shoppers to choose from, Costco’s merchandising strategy was to provide members with a selection of only about 4,000 items.
About one-fourth of Costco’s product offerings were constantly changing and consisted mainly of “treasure hunt” specials. Costco’s merchandise buyers were constantly on the lookout to make one-time purchases of items that would appeal to the company’s clientele and that would sell out quickly. A sizable number of these items were high-end or name brand products that carried big price tags—like big-screen HDTVs selling for $1,000 to $2,500 and $800 leather sofas. The idea was to entice shoppers to spend more than they might by offering irresistible deals on luxury items.
In many cases, Costco did not obtain its luxury offerings directly from high-end manufacturers like Calvin Klein or Waterford (who were unlikely to want their merchandise marketed at deep discounts at places like Costco); rather Costco buyers searched for opportunities to source such items legally on the gray market from other wholesalers or distressed retailers looking to get rid of excess or slow-selling inventory. Examples of treasure hunt specials included $800 espresso machines, Italian-made Hathaway shirts priced at $29. 9, Movado watches, exotic cheeses, Coach bags, $5,000 necklaces, cashmere sports coats, $1500 digital pianos, and Dom Perignon champagne. •?Costco attracted the most affluent customers in discount retailing—the average income of individual members was about $75,000, with over 30 percent having incomes of $100,000 or more annually. Many members were affluent urbanites, living in nice neighborhoods not far from where Costco warehouses were located. •?Jim Sinegal, the company’s CEO and driving force behind Costco’s 23-year march to become the 4th largest retailer in the U.S. and the 8th largest in the world, was far from a stereotypical CEO. Sinegal was regarded as an exceptionally savvy merchandiser, with a keen eye for what would sell and where it ought to be located on the sales fl oor to generate maximum volume. A grandfatherly 70-year old, Sinegal dressed casually and unpretentiously, often going to the offi ce or touring Costco stores wearing an open-collared cotton shirt that came from a Costco bargain rack and sporting a standard employee name tag that said “Jim. Sinegal spent much of his time touring Costco stores, using the company plane to fly from location to location and sometimes visiting 8 to 10 stores daily (the record for a single day was 12).
Treated like a celebrity when he appeared at a store (news that “Jim’s in the store” spread quickly), Sinegal made a point of greeting store employees, observing “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. ’ ?Employee compensation at Costco was higher than at Sam’s Club. Starting wages for new Costco employees were in the $10. 50-$11 range in 2008. Depending on the job classification, the median pay scales for Costco employees with five or more years experience were in the $17-$21 per hour range. Warehouse employees received time-and-a-half pay for working on Sundays and were paid double time in the event they were called on to work more than 12 hours in a given shift. Median salaries for managerial positions at Costco warehouses were in the $55,000 to $75,000 range.
Employees enjoyed the full spectrum of benefits. Jim Sinegal was convinced that having a well-compensated workforce was very important to executing Costco’s strategy successfully. He said, “It has to be a signifi cant advantage for you….. paying good wages and keeping your people working with you is very good business. ” Moreover, executives at Costco did not earn the outlandish salaries that had become customary over the past decade at most large corporations.
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?