Costco Case Study

Costco Case Study



In a time of global financial turmoil and shifting demographics, Costco must find ways to attract and retain customers to maintain market share and profitability. In the last 27 years Costco has become the fourth largest retailer in the United States and the eight largest in the world. By the end of 2009 it had 413 stores in the USA, 77 in Canada and 21 in the UK, 9 in Japan and 7 in Korea Australia has one and Taiwan has six (not including joint ventures in Mexico). The American and Canadian operations supply 93% of their net consolidated sales in 2008 and 2009 and 92% of the operating income. Declines in California or in Canada would be a serious blow to the company’s bottom line. The economy is taxing and retail sales are down for all major retailers. Costco must continue to respond effectively to all competitive pressures and adapt to changes in the industry. With higher interest rates, higher consumer debt loads, energy costs, inflation, cost to find and retain employees, and reduced consumer confidence in the market Costco faces a tough economic environment which can affect demand for their products and services. In addition, commodity prices like gasoline and food can shift dramatically. Costco has no assurance of vendor supply for merchandise and thus they are vulnerable to changes in the terms of sale, pricing and access to new products is not guaranteed. Out of stock positions can lead to loss of sales and consumer trust. Costco faces strong competition from a variety of retailers and warehouse club operators including internet-based retailers. Walmart/ Sam’s Club is still rated number one by suppliers and they have better access to merchandise. The price of gas is reducing the number of shopping trips that consumers are taking and reducing their overall level of spending. This Case Study recommends ways for Costco to strategically address these issues for a profitable future.

History

Originally based on the model of The Price club where Costco’s founder Jim Senegal had worked for a number of years before starting Costco, this company opened its first store in 1983. With the basic strategy of lowest prices for high quality merchandise in a low frills membership environment the business took off. Senegal implemented the lessons learned from Sol Price and paid attention to detail, kept overhead and operating costs low, and ensured quick turnover of stock. Costco holds to a 14% mark up on all goods except for its Kirkland brand private label for which it takes a 15% margin. It became a public company in 1985 and according to an interview with Senegal, Costco was the first American business to exceed one billion in sales within 6 years of its start. In 1993, Costco became Price Costco by buying out The Price Club and that year it generated 16 billion in sales. In 1997 it spun off most of its non-warehouse assets to Price Enterprises and became Costco Companies Ltd. In 1999 it changed its name once again to Costco Wholesale Corporation when it reincorporated in Washington.

From 2000 to 2008, it went from $1.037 billion in Operating Income to $1,969 and reduced the number of its shares from 475.6 million to 444.2 million as stock holder equity rose from 4,240 to 9,192. The number of warehouses went from 313 to 512 in that same period while memberships rose from a total of 17.1 (both types) to 56 million.

Costco’s strategies are low prices, limited product lines and selection, and a “treasure hunt” shopping experience. Value is their watchword. Even at its highest margin, 15% for Kirkland private brand, the products were 20% lower than comparable brand name products. Its business model was “To continually provide our members with quality goods and services at the lowest possible prices” and even when Wall Street critics bewailed their needlessly low profit margins they stood their ground. Senegal cited the example of Sears Roebuck and publically stated that they would not prepare for a future where the same outcome could befall Costco. The business model included turnover on a limited number of products (only 4,000 compared to the 16,000-150,000 items stocked by many competitors) combined with operating efficiencies achieved through volume purchasing, efficient distribution practices and reduced handling of merchandise. Their practices often allowed them to receive the cash for products before they had to pay their suppliers enabling them to secure early payment discounts often allowing them to be financed by vendors rather than working capital.

They enter a market by selling memberships to employed individuals in major companies and to small business owners thus capturing the highest income demographic in discount retailing. Beyond the campaigns for new warehouse openings, they use very little advertising relying instead on actual customer experience and satisfaction to drive their sales. One fourth of the 4000 products on the floor at a given time are always changing as opportunities for exciting purchases on the grey market bring stock that will excite their customers to the attention of Costco buyers. With limited quantities and low prices they create urgency that drives the consumer from intension to action. Costco does use direct mailings to customers to promote selected merchandise.

Costco’s three growth strategies are: open more new warehouses, build and ever larger and loyal membership base and use well-executed merchandising techniques to lure customers to the store more frequently and to buy more each trip. The first is an ongoing strategy with more stores opening each year in areas that are not saturated. This strategy has been engaged internationally as well. The ever increasing membership base those loyalty is a surety of future revenue streams is also working quite well but during times of recession the third strategy is difficult to execute.

The growth strategies have three components as well. Many of the products in Costco stores are practical, frequently used items that people will buy in bulk to save money. In fact the Kirkland brand items, like spices, toilet paper, cleaning supplies are steadily increasing from 400 to 600 in 2009 and more are expected to take advantage of this tendency. The second component is the treasure hunting bargain reward. These items purchased on the grey market allow the aspirational consumer to satisfy a need for status or dream fulfillment. The third component is enticing the customers to shop in the warehouse at least twice a month to ensure that they do not miss out on the bargains.

Product Categories


Sundries (including candy, snack foods, tobacco, alcoholic 2009` 2008 2007

and nonalcoholic beverages and cleaning and institutional

supplies) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23% 22% 23%

Hardlines (including major appliances, electronics, health and

beauty aids, hardware, office supplies, garden and patio,

sporting goods, furniture, and automotive supplies) . . . . . . . . 19% 19% 21%

Food (including dry and institutionally packaged foods) . . . . . . 21% 20% 19%

Softlines (including apparel, domestics, jewelry, housewares,

media, home furnishings, cameras and small appliances) . . . . 10% 10% 11%

Fresh Food (including meat, bakery, deli and produce) . . . . . . 12% 12% 12%

Ancillary and Other (including gas stations, pharmacy, food

court, optical, one-hour photo, hearing aid and travel) . . . . . 15% 17% 14%



Electronic commerce businesses, costco.com in the U.S. and costco.ca in Canada, provide members additional products generally not found in the warehouses, in addition to services such as digital photo processing, pharmacy, travel, and membership services.



The following table indicates the number of ancillary

businesses in operation at fiscal year end:

2009 2008 2007

Food Court and Hot Dog Stands . . . . . . . . . . . . . . . . . . . . . . . . 521 506 482

One-Hour Photo Centers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 518 504 480

Optical Dispensing Centers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509 496 472

Pharmacies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .464 451 429

Gas Stations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .323 307 279

Hearing-Aid Centers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303 274 237

Print Shops and Copy Centers . . . . . . . . . . . . . . . . . . . . . . . . . 10 7 8

Car Washes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2 1

Number of warehouses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 527 512 488

Current Business Climate and situation

Costco Compared with Major Retailers



Business Wire Retail Report on May 2010 Retail Sales Figures


GENERAL MERCH.

MO.

2010

FULL$ MO.

2009

FULL$ MO.

2010

FULL% YTD

2010

FULL$ YTD

2009

FULL$ YTD

2010

FULL% MO.

2010

COMP% MO.

2009

COMP% YTD

2010

COMP% YTD

2009

COMP%

BJ’s

872 783 11.3 3.42B 3.04B 12.5 6.8 (6.8) 7.5 (2.9)

(NYSE:BJ)

Bon-Ton

187 189 (1.3) 848 834 1.7 (1.1) (12.1) 2 (9.4)

(Nasdaq:BONT)

Costco

6.09B 5.47B 11 57.2B 52.2B 10 9 (7) 7 (3)

(Nasdaq:COST)

Dillard’s

426 430 (1) 1.86B 1.85B 1 FLAT (12) 2 (13)

(NYSE:DDS)

Fred’s

142 135 5 613 593 3 3.5 0.2 3.5 2.1

(Nasdaq:FRED)

J.C. Penney

1.23B 1.25B (2.1) 5.16B 5.14B 0.4 (1.8) (8.2) 0.6 (7.7)

(NYSE:JCP)

Kohl’s

1.34B 1.26B 6.6 5.37B 4.89B 9.8 3.5 (0.4) 6.4 (3.2)

(NYSE:KSS)

Macy’s Inc.

1.79B 1.74B 2.6 7.36B 6.94B 6.1 1.4 (9.1) 4.4 (9.1)

(NYSE:M)

Stage Stores

116 117 (0.6) 456 450 1.3 (2.9) (7.2) (1.2) (8.6)

(NYSE:SSI)

SteinMart

99 105 (6.3) 400 425 (5.9) (4.5) 0.2 (4) (6.1)

(Nasdaq:SMRT)

Target Corp.

4.62B 4.46B 3.7 19.8B 18.8B 5.1 1.3 (6.1) 2.5 (4.2)

(NYSE:TGT)

Key Problems

The key problems for Costco involve the current global financial conditions, demographics, the ability to keep market share in North America and the ability to find ongoing and reliable sources of merchandise.

The current economy is showing substantial declines in consumer durable spending as people defer such purchases as furniture and large appliances. In addition, according to the MasterCard financial report for May 2010, purchases of apparel have declined 6% for women and 10% for men with marginal increases for children’s apparel. The product categories for these two types of products encompass 29% of Costco’s business. Even though Costco is showing only a 3% decline this month over the same month in 2009, it is a worrying trend. They are, however, making up ground in products that tend to be more recession proof such as fine wines, snack foods and tobacco.

Demographics are troubling for Costco’s business model of large volume single size packaging of goods in order to minimize handling and restocking. With an aging population, more single and divorced people and smaller sized families, there are fewer and fewer people who need or want the huge sizes that are offered by Costco. I found it a wonderful boon when I was feeding a family with five children but now that I am on my own I no longer shop at Costco.

If we pair this problem with the problem of on going concerns for reliable supplies of merchandise we have a larger problem. According to Porter’s Five Factor Model of Forces, suppliers and competitors are gaining power over Costco. For example Proctor and Gamble finds Walmart/Sam’s Club to be their preferred merchandiser. Walmart/Sam’s Club has superior logistics and inventory management and they purchase ongoing supplies of P&G products in a variety of sizes. In addition, they stock a complete inventory of P&G products. This ensures that when production of merchandise is limited Walmart will be the preferred customer and others will wait or go without. Costco on the other hand, tries to purchase stock on the grey market where possible, handles only one size of P&G products in sizes that are not as lucrative for P&G and Costco has fewer ongoing commitments for their products. Walmart has engaged P&G in a more win/win relationship than has Costco.

Another key problem is that in a time when gas prices have risen as much as 30% people tend to shop less frequently and purchase less per trip because of frugality forced upon them by the financial climate. When people shop, they may love the bargains but they are less likely to make two trips, one for the necessities of life and another for Costco’s treasure hunt items. They would prefer to be able to shop where more of their needs are accommodated such as Sam’s Club with 16,000 products rather than Costco with 4,000. This might be partially solved by expanding their well accepted Kirkland private brand products beyond the approximately 600 products now available. It would reduce reliance on other manufacturers and ensure a good profit margin while keeping prices lower.



Proposed Solutions and Recommendations

Costco has done an excellent job of adapting to this difficult financial environment. Of the billion dollar per month retailers, they are showing the smallest decline in profitability this month and the best showing year to date. They have done a superior job of bringing customers into the warehouse with ancillary services which are accounting for more and more of their product sales. In particular, the idea of selling gas at the warehouse at very reasonable prices has not only raised the ire of gasoline stations but has brought in the customers who tend to combine trips.

I think it is important to play your own business strategy rather than trying to play the competitions’ strategies but in the case of Costco, strategy adaptation is necessary for the long range profitability of the company.

The most important thing that they should consider is package sizes in the face of the changing demographics. Many of baby boomers, who have been their largest group of customers, are on the brink of retirement. Even though it has always been the Costco business model to stock only large sizes, introducing some products in a second more moderate size will help them stay relevant to their customer. Even though they have a demographic of well employed people, most people live in smaller spaces with fewer people than in the past and stocking up for a year with one purchase is not attractive to most people especially in a time when they are making choices among purchases. This adaptation could also lead to more win/win relationships with manufacturers. If Costco adopted Walmart style logistics and placed orders based consumption on a just in time basis, manufacturers would be able to better predict ordering and they would have a greater incentive to cooperate with Costco ensuring timely supply.

The issue of ongoing supply might not be as crucial in International markets where the population is younger and at an earlier stage of market consumption but in North America it is particularly pertinent. With 93% of Costco’s revenue derived from North America where the population demographics are very compelling in terms of aging, singleness and stage of market consumption, meeting of need of the people who are encountering these changes could mean the difference between maintaining market share and losing ground. Costco has made smart moves by drawing this population segment in with ancillary services like glasses and hearing aids. Products for affluent aging people are important but unless Costco recognizes their vulnerability with package, loss of customer loyalty could be the result. It is a small adjustment because the products could still be delivered by the skid load but with more units per skid.

A final suggestion is that when they consider additional international expansion, Costco should consider placing more warehouses in Canada where they have been extremely well received. In fact, if we consider the data on page c-39 of the case study, it is evident that with less than 10% of the population of the United States, Canadian Costco stores are generating over one sixth of the revenue in comparison with the US with only 75 stores. Canada provides a stable environment with low levels of risk for the company in comparison with other nations. This would increase volumes for manufacturers as well. In many ways it forms and extension of the American market with many similar laws and identical products.

Costco’s business strategies have worked extremely well. They take care of their customers, their employees and shareholders. These are challenging times in the retail market but Costco has found a way to compete with distinction. They could ensure their future prosperity if they would adopt the recommendations that I have made above. Smaller sizes would meet the needs of customers in evolving demographic groups and investing in Canada is a safe and profitable bet. Continuing to understand the needs of financially comfortable but aging baby boomers is just good business as is continually seeking mass market products that address aging bodies, and slower lifestyles. If they consider these issues, I am convinced that Costco will be in business for many years to come.

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Thompson, A.A, Strickland, A.J., Gamble, J.E. (2010) Crafting and Executing Strategy: The quest for Competitive Advantage 17th editio