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Costco Wholesale is the nation’s second largest retailer and owes its success to their strategy of being thrifty, economical, investing in their employees and separating themselves from their competitors with good moral ethical standards. Costco is able to remain the low cost price leader on many goods due to the price breaks they receive from buying in bulk from its suppliers. However, because Costco only marks up their products by a maximum of 15 percent, after accounting for variable and fixed costs, Costco make little to no profit on many of its products. Eighty percent of Costco’s gross profits result from membership fees, which helps the company keep the prices on goods low. While some of Costco’s techniques may not be the standard in the industry, they have found a system that works well for them and is very successful.
Costco Wholesale is the second largest retailer in the nation, only falling behind Walmart; the difference between the two companies is that Walmart has recently found itself with problems such as labor issues, poor customer service, empty shelves and declining sales. At the same time Costco has been enjoying a plethora of positive press while the latest (July 2013) quarterly earnings report shows an eight percent increase in sales, and a nineteen percent increase compared to last year. (Costco, 2013) Costco’s success in a down economy is due to a variety of business strategies.
Costco is best known for being a store that customers use to buy goods and supplies in bulk amounts; Costco in return receives a bulk discount from its suppliers, allowing Costco to be the low cost price leader on many products. Each Costco warehouse holds roughly 4,000 different products, all of which, under Costco policy, are sold at a maximum fifteen percent above cost. After accounting for variable and fixed costs such as real estate and wages, Costco barely makes a profit on many of its products; instead Costco relies on their membership fees.
Memberships and their fees are an essential cog to the Costco business, accounting for roughly eighty percent of Costco’s gross profit; the lower the prices on the goods at Costco, the more memberships that will be obtained. In order to keep prices low, Costco continuously swaps out their products if they find an alternative with lower costs; by keeping prices continuously low the company adheres to the law of demand, creating an increase in demand and quantity; by using this strategy the company is attempting to find the perfect equilibrium price and quantity.
Perks of a Costco membership are separated into three differentiating levels with basic membership (gold star level) costing 55 dollars a year and intended for personal use. Other levels available are the “Business Membership” which allows for businesses to purchase items at Costco for resale use while also running 55 dollars a year and “Executive Membership” which runs 110 dollars a year, but has the added perk of receiving a two percent annual award on Costco purchases. Having multiple tiers of membership levels is a form of price discrimination that is intended to entice and reward the consumers who buy in bulk. The executive membership’s two percent annual return is an incentive to buy more and more often at Costco using price breaks that non-executive members do not have access to, while driving Costco’s total revenue upward due to the higher membership fee.
Like its competitors in the retail oligopoly market, Costco maintains low prices that remain stable so not to provoke a competitor to lower prices even further, reducing or even eliminating the profit margin for both companies. What makes Costco differentiate between their competitors is their willingness to invest into their employees. Despite the weak economy Costco pays their hourly workers an average of twenty dollars and eighty-nine cents an hour, compared to Walmart who pays an average of twelve dollars and sixty-seven cents an hour. (Stone, 2013) Additionally, eighty eight percent of Costco employees are covered by the company health insurance, while Walmart only covers half their employees.
Costco believes that investing in their employees with higher pay and benefits will result in a happier work environment and a more profitable company. The opportunity cost of such a strategy is that Costco loses the ability to hire cheaper labor, such as part time and seasonal positions which reduce the total cost of doing business. However, by investing into their employees, Costco reduces the turnover rate of employees, leaving them with employees who are more committed, loyal and have the added experience necessary to improve employee productivity, while reducing the cost of recruiting and training new employees.
Costco is able to keep their variable and fixed costs to a minimum by being thrifty in some of their practices; Costco sacrifices cosmetic looks for efficiency by only using industrial shelving, or by leaving stock directly on pallets, while advertisements are kept to a minimum inside the store. Costco is different from their competitors all the way up to the Chief Executive Officer, Craig Jelinek, who breaks the industries norm of Chief Executive Officers receiving high bonuses and salaries (relatively, of course) that many times are unearned. Jelinek’s salary in 2012 was 650,000 dollars in base pay, plus 200,000 dollars in bonuses; compared to Walmart’s Chief Executive Officer, Mike Duke, who made 1.3 million dollars in salary to go along with his 4.4 million dollar bonus, while posting a loss of roughly four percent. (Forbes 500, 2012)
The success achieved by Costco is due in part to their thrifty and efficient nature, allowing the company to minimize variable and fixed costs. Costco adheres to a strong ethical standard and invests in their employees as they believe it maximizes employee output. While some of Costco’s techniques may be unconventional compared to their competitors in the retail industry, it is truly a blueprint of success that is working for them.
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