Analysis of Costco’s Business Strategy and Its Key Limitations

Introduction and Background

Costco Wholesale is a multi-billion dollar wholesale retailer with hundreds of membership warehouse clubs across eight countries worldwide. Costco’s long-standing success is the product of the combined efforts and aspirations of Costco’s co-founders Jim Sinegal and Jeff Brotman and Sinegal’s mentor, Sol Price. Price, previously the founder of FedMart (a chain of discount department stores) founded Price Club, the world’s first membership warehouse club, in San Diego, CA in 1976. At Price Club, Sinegal was Price’s Executive Vice President of Merchandising, Distribution, and Marketing, and was instrumental in fine-tuning merchandise and marketing strategies. Sinegal eventually left Price Club and teamed up with Brotman to co-found Costco Wholesale in Seattle, WA in 1983. Although Price felt hurt by Sinegal’s decision to leave Price Club to start Costco, Price considered Sinegal and Costco as “extended family,” united in their battle against competitor Sam’s Club. In 1993, Price Club and Costco merged and went on to become the world’s most successful warehouse club. Price said of the merger, “We were good at innovating, but when it came to expanding and controlling, we weren’t so good. Now, Jim has done a pretty damned remarkable job. He puts a great emphasis on quality and has moved into the food business and other new lines. We were very good at creating, but Jim was very good at developing.”

Sinegal and Price’s protégé and mentor relationship made for an easy merge in terms of corporate culture and the two companies shared similar vision, mission, and values. In a joint Price/Costco statement released at the time of the merger the companies stated, “No two merchandising companies could be more alike in terms of their merchandising philosophies, corporate cultures, determination to offer high quality products at great value to the consumers and commitment to their employees.”

The concept behind Price Club was a business that was both retail and wholesale that served small businesses needing convenient and economical products but at less volume than a whole truckload. In a December 1988 article, the New York Times wrote, “Price was convinced that if he could keep prices down and yet put everything a small business customer needed under one roof, he’d have a winning formula.” Membership to Price Club was initially limited to businesses and individuals of select groups (e.g. government, hospital, or bank employees), creating exclusivity and company commitment. By pre-selecting members, Price Club was able to thereby pre-select its customer base demographics without extensive research. Price Club also only accepted cash or checks to lower risk. By screening its customers via the membership application (which requested customers’ personal information, including SSN), the store was able to lessen the risk of receiving bad checks and reduce customer theft and pilferage.

Costco provides value to its members by offering products at a much lower cost than typically available to retail customers. Sinegal explaining the low cost, low price model, “Costco is able to offer lower prices and better values by eliminating virtually all the frills and costs historically associated with conventional wholesalers and retailers, including salespeople, fancy buildings, delivery, billing and accounts receivable. We run a tight operation with extremely low overhead, which enables us to pass on dramatic savings to our members.”

Costco believes that its product, people, and code of ethics are what separate the company from its competitors. Costco’s mission statement is “to continually provide our members with quality goods and services at the lowest possible prices.” The products Costco offers to both its business and household customers, are high quality goods with mass appeal, thereby appealing to a high-end demographic. The Kirkland Signature brand rivals name brand products in terms of both quality and notable cost savings. Costco offers its members a wide variety of products and services including: fresh baked goods, fresh and frozen foods, alcohol, books, jewelry, electronics, household and office supplies, life insurance, home and auto insurance, motor vehicles for purchase, tire service, mortgages, vacation packages, apparel, bottled water delivery, business phone service, pharmacy, vision care, photo printing, gas station, caskets, and more!

Costco boasts a diverse and inclusive work environment for employees. Considering employees as the company’s “most important asset,” it is well-known that Costco pays considerably higher wages compared to its competitors and even offers benefits to its employees. Costco also stresses the importance of internal promotions, with over 90% of its managers worldwide (70% of U.S. warehouse managers) and executives having started out in hourly positions as cart pushers or inventory stock workers. “Our founders always said, if you hire the right people, pay them good waves, involve them in the business, then good things will happen,” asserts Russ Miller, Senior Vice President of Western Canada Operations. U.S. Costco employees average nearly nine years of employment at the company, with more than 60% of employees at the company for over five years and over a third having spent over 10 years with Costco. Worldwide, Costco has more than 13,000 employees that have served the company for over 25 years.

Costco asserts that it cannot survive without its members. As stated in the Costco Code of Ethics, “Our members are our reason for being – the key to our success. If we don’t keep our members happy, little else that we do will make a difference.”Andrée Brien, Senior Vice President and Senior General Merchandise Manager, considers the Costco Code of Ethics, established by Costco’s founders, to be “the foundation of the company and the cornerstone of its success.” Customer satisfaction is undeniably evident in the 90% membership renewal rate of Costco’s 93 million members.

Business Strategy

Costco’s strategy has two stipulations: requiring a paid membership card for entry and no advertising, so it requires a few steps to attract and retain customers. The company must get customers to return to Costco, visit frequently, and also spend more time in the store.

In order for customers to want to return to the store and spend more on products, Costco needs to supply them with a variety of exciting reasons. The more sound and more desirable the attraction, the more customers will return. Such attractions include:

• Best quality: Costco sells only the best quality. It is one of the largest sellers of fine wines in the world. In addition, the growing range of its great value, high quality, unique Kirkland Signature private label products (ranging from clothing to food items), adds to its strong brand and value and, gives the customer a compelling reason to return.
• Low prices: Costco is committed to having the lowest prices on all the products and services it offers on a reliable basis. Costco sells packaged products in bulk, therefore the cost per unit is less than at any food retailers. Also, Costco has a lower gross profit percentage. When a retailer negotiates the lowest cost and has a very low gross profit percentage, customers notice that Costco has the best prices in town.

Costco also puts its membership fees back into the products the company sells in order to further lower prices. The strategy behind this is that Costco’s low price offerings will get members to return. Costco also saves costs and can provide its members with low prices because of its high inventory turnover at high sales volumes. The company does this by supplying its customers with fewer brands and products that are sold quickly. While big-box retailers, such as competitor Wal-Mart, typically sell over 100,000 products, Costco only offers its customers an average of 3,800 items. Rival BJ’s Wholesale Club sells over 7,000 items, which hinders its capability to compete in terms of value.

• Guarantee policy: Every product is guaranteed and has a return policy.
• Return & refund policy: Goods can be refunded until the last day it expires. This increases the value and builds trust between the customers and Costco.
• Free samples during visits: Tasting the free samples of new products also excites the customers and gives a wonderful motivation for them to return.
• Retrieving membership fee: Existing and new members know that they can make savings by shopping at Costco. Members have an interest in coming back to shop to earn the fee back over the year by saving at Costco.

Beyond convincing customers to return to Costco, increasing visits per month is more important because there is an immediate relationship between customer frequency and yearly total spending. Additionally, the more customers spend at Costco, the more likely those customers will renew their membership. In order to increase visit frequency, Costco offers:

• Low price gasoline: Most Costco warehouses have an adjoining gas station, priced each day to be the lowest gas price in the area. Vehicles are generally refilled every week, and this offering has turned out to be a highly successful driver of visits (pun intended).
• Loss leaders: Costco’s biggest loss leaders are its $4.99 rotisserie chicken and its $1.50 hot dog and drink combo. Costco refuses to raise the price on its rotisserie chicken and hot dog. The strategy is not to make a profit from these items, but to attract additional visits. Members looking for a cheap lunch at Costco will often venture into the store to shop. The rotisserie chicken is placed all the way in the back of the warehouse to get members to walk through the entire length of the store, prompting more impulse purchases.
• Coupons: A booklet of coupons is mailed to all members monthly. The coupons are valid for 25 days in the coming month.
• • Treasure hunt: To create urgency and a need to visit more often, Costco supplies a flow of products that change consistently throughout the year, customers feel that they must purchase right now because the item may not be there the following week. The more frequently a customer revisits, the more ‘treasures’ the customer finds.
• Costco Anywhere Visa card: Costco, in partnership with Citibank, provides members a no-fee credit card which compensates the customers with increased spending at Costco, like, 4% money back on Costco gas purchases and 2% back on Costco purchases. Members also get 3% back on restaurants and travel and 1% back on all other purchases.

Finally, Costco must show its members the value of how spending more in its stores actually saves them more. Costco does this by supplying:

• Executive Memberships: A regular membership is $60 annually for the essential cardholder. Executive membership is offered for $120, which has added benefits and also includes a 2% annual purchase rebate. It compensates the higher spending members while motivating all members to experiment with other Costco products and services (e.g. travel offers and lower-cost insurance). Generally, executive members spend more than other members and their share of sales grows continuously because of it.
• Large sizes: Items are sold in bulk to lower the cost per unit. Customers end up spending more on the larger quantities, but still feel the higher value from a cheaper per unit cost.
• Costco.com: Costco’s website features some 20 distinct categories that include selected in-store items with many available only online. These buys are qualified for any suitable Costco purchase rebate program the member is enrolled in. This motivates the customers to consider Costco first while looking for anything.

Costco employs a low cost strategy. The way in which Costco cuts costs in its value chain (e.g. warehouse model) adds to the store’s uniqueness amidst a sea of retail competitors. However, its differentiated model is not actually the company’s strategy. This strategy demands maintaining the lowest feasible prices for its members by keeping costs as low as possible. Costco’s low cost strategy may seem easy to imitate, but history proves very few who have entered the wholesale club battle survived. Since its inception, Price Club/Costco have faced a multitude of clones; however, only two other wholesale clubs remain: Sam’s Club and BJ’s Wholesale Club.

Key Limitations

Costco has a number of advantages, but there are also some disadvantages. There are some challenges that Costco currently faces, which could become potential problems in the future. Things like memberships, omnichannel experiences, consumer preferences, and bulk buying, are all likely to affect the value chain of Costco.

One of the biggest problems with Costco’s business model is its dependence on memberships. This strategy works well as long as its members keep coming back and continue purchasing items in bulk as they have historically, but several issues could affect that trend. Customers could choose to move their memberships to a competitor, such as Wal-Mart’s Sam’s Club. The only notable difference between the two wholesale clubs is selection, which is tied to consumer preference. If the range of products changes, Costco could lose out. Also, Costco competes against specialty retailers, such as Office Depot, PetSmart and Whole Foods. Customers looking for these products may prefer those retailers’ products over those of Costco. More broadly, Costco’s competitors also include: Sam’s Club (Wal-Mart), BJ’s Wholesale Club, Wal-Mart, Amazon, Home Depot, The Kroger Company, Target, Kmart, Lowe’s, Best Buy, and Aldi. According to Brotman, “In virtually every market we’re competing with someone.”

Currently, most retailers are adopting an omnichannel focus. Customers use different connected devices to shop online, research products, and compare prices. While Costco’s emphasis on the warehouse allows the bulk discount retailer to keep prices low, it does not translate well to the type of omnichannel experience many customers expect. Costco is making some investments towards that goal, but there is no guarantee that those efforts will be successful or that the changes will be implemented in time for the company to remain competitive.

Changing consumer preferences could affect Costco as well. The company uses a warehouse approach. It buys certain items in large quantities and tries to get them sold as quickly as possible, but it only works if it can maintain those high volumes. If customer preferences change, Costco could be left with large amounts of unwanted, and possibly perishable, goods.

When buying in bulk, transporting everything home may be a problem for some. For people in urban areas who may be unable to park near their buildings or for families with young children who may find transporting bulk goods too much to handle, it can be a real issue. Costco offers some online services, but there are other discount bulk providers such as Amazon’s Prime service and the newcomer, Jet (owned by Wal-Mart), that offer similar deals and free shipping. Amazon offers free two-day shipping and a Prime Pantry service for $99 per year (in addition to other benefits, such as streaming video), while Jet does not have a membership fee and has many deals that are similar to Amazon’s offerings.

The problem that Costco faces, and is a big risk going forward, is that people are shopping in stores less and less. Eventually it is possible, maybe even probable, that Costco’s immunity to this trend, which has impacted so many other retailers, will end. Consumers have begun to invest in digital platforms because they are easy and convenient. Because of this, a number of chains, including Sports Authority, Linens-N-Things, Borders Books, Circuit City, and others, have gone out of business over the past few years, while a handful of top names are teetering on the edge in 2018. Costco has always tried to keep its costs low and the company could improve its social media presence by hiring a social media manager.

To tackle these major problems, Costco had to increase spending on everything from sampling to making sure its in-house restaurants remain an enticingly cheap way to eat a meal or snack. The chain expanded its focus on making people want to visit its stores because, as they buy more and more online, it could become harder to get them to leave the house just to shop.

In my analysis, Costco has no major strategic issues facing them at this moment. Its business model is appealing in the sense that the company has rapid inventory turnover, operating efficiencies, and profit at a very low gross margin. Such success has come its way due to factors such as internet sales, ongoing effort to cut costs, only stock bargains, treasure-hunt merchandise, no-hassle return policy, and word of mouth advertising.

Costco employs a cost strategy that aims to penetrate pricing and a diversion buying strategy that gives customers a treasure hunt shopping experience. Of these strategies that Costco utilizes, the chief elements of low costs, low prices, limited products, and a treasure hunt environment are the main ingredients that put themselves above all competitors.

In 2017, Bloomberg Businessweek wrote an article cautioning Costco about its slow approach to e-commerce. Costco launched its website in 1998, the same year Amazon.com launched, prior to Target and Wal-Mart’s ventures online. By 2017, Amazon.com was dominating e-commerce, and both Target and Wal-Mart had invested billions towards website development. Costco’s web presence lacked elements that were offered by competing web retailers, including in-store order pickup and an active social media presence. Bloomberg admitted that Costco seemed to be doing fine as overall revenue growth had surpassed competitor Sam’s Club for the prior five years, but warned that Costco’s “laissez-faire approach to online could prove a dangerous long-term game”. “On the one hand, “they have a business model that is working, so why break it?” says Robin Sherk, an analyst at consultant Kantar Retail. Yet “if Costco waits too long, they might find themselves too far behind.”

Although Costco does offer more items online compared to in-store (10,000 vs. 4,000, respectively), Costco knows that customers are more often than not compelled to purchase more than intended by the in-store free samples, its in-store treasure hunt experience, and other impulse buys. Costco also knows that most of its members are on the older side and are less technology dependent. However, half of Costco’s members are also Amazon Prime members, a stark increase from 14% five years prior. At the time of the article, Amazon began offering a variety of goods in bulk at prices rivaling Costco’s and Amazon’s acquisition of Whole Foods Market was pending. Bloomberg was thusly concerned Costco would lose customer’s purchases to Amazon. Grocery shopping is how Costco stayed ahead of Amazon as 93% of members purchased groceries at Costco, whereas only 18% of Amazon users used the website to purchase food. The Whole Foods acquisition may present some notable competition to Costco.

The year prior to the article, Wal-Mart purchased Jet.com, an online shopping retailer. Bloomberg’s suggestion was for Costco to consider a similar acquisition. Others suggested that Costco would benefit by offering online ordering with in-store pickup. Costco has taken small steps by working with third-party distributors Instacard, Shipt, and Google Express to help with processing costs of online orders. Costco also introduced bridal and baby gift registries for members. Although investment research analyst, Brandon Fletcher (of Sanford C. Bernstein) thought that it was not necessary for Costco to ramp up its e-commerce operations, Bloomberg noted that although Costco saw an 11% growth rate for digital sales, it still lagged behind the overall e-commerce market which was expanding at a rate of roughly 15% annually.

By February 2019, Bloomberg Businessweek had changed its tune, declaring that Costco had beat out Amazon as a consumer favorite. Costco’s slow and steady e-commerce growth proved triumphant as Costco bested Amazon, the reigning champion of customer satisfaction in the internet retail category for seven years straight, by just a single point on the 2018 annual American Customer Satisfaction Index (ACSI). This was an impressive feat as this was Costco’s first appearance on the list. Rather than radically revamping its business strategy to compete with Amazon, as many other retailers were doing, Costco stuck to what it knew and proceeded to “perfect what’s been working for four decades.” Costco held onto its advantage in food market by embracing internet retail. In addition to its partnership with Instacart, Costco also introduced CostcoGrocery. While Instacart provides same-day delivery to both members and non-members alike, CostcoGrocery provides members with two-day delivery on “shelf-stable” products web orders. Members would also receive free shipping on purchases exceeding $75 or choose free in-store pickup. By expanding its online offerings, Costco saw an online sales increase of 21% since July 2018. ACSI applauded Costco for not only leading the pack in in-store customer satisfaction but succeeding in the e-commerce space as well.

Recommendation for Costco

It is important that Costco takes advantage of the social media resources available, so that the company can keep in touch with younger generations. Costco does not need to join every social networking platform in order to achieve a social media presence. Costco does not want to spend money on advertising, however most popular social media platforms are free to use.

The company should focus on one or two social networking sites in order to enhance its relationship with customers online. Costco could benefit from are Facebook and YouTube. Facebook can be an essential tool for companies like Costco that strive to make connections with its customers. Costco will need to adjust the type of content it posts on Facebook so that it engages users. This can help strengthen the relationship between the consumer and organization. YouTube is another useful social network that can benefit Costco. Sam’s Club, Costco’s main competition, uses YouTube to post videos of its products. Costco could use similar video networking strategies to educate members on products being offered, and drive people to its website. As seen on Costco’s website, the company invests in making promotional videos. Uploading such videos to YouTube would not require any additional costs. Whether Costco chooses to use social media or not, it will be very important for its business to keep a watchful eye on the latest trends and technologies so that the company does not fall too far behind.

Costco otherwise seems to have a solid handle on its other key limitations, as proven by the most recent Bloomberg article and ACSI ranking. Although there are some concerns that Costco may fall behind by not immediately conforming to changing consumer demands, the company’s stability and success come from knowing its business model and sticking to it. Costco should keep a close eye on changes in consumer preferences, as unpopular items will remain on shelves and high inventory turnover is essential to its business strategy to keep costs and prices low. The company knows that keeping the costs of the value chain as low as possible is the only way to keep prices low, and those stellar low prices are the key to customer loyalty. Clear vision, mission, and values are to credit for Costco’s exceptionally loyal members and workforce.

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