Analysis of Costco's Business Strategy

Costco's Business Model and Overall Strategy

Two critical elements make the Costco business model effective and efficient. First, Costco uses a subscription business model where customers become members or subscribers of the wholesaler club by purchasing a membership. As members, customers receive low prices on limited high quality national and private branded products. Second, Costco generates a high sales volume and rapid inventory turnover that generally allows it to take advantage of selling and receiving cash for inventory and getting payment discounts (Thompson, Peteraf, Gamble, & Strickland, C-30).

Overall, the Costco business model is very appealing for its two vital elements. The most prominent critique of Costco’s business model centers on Costco’s first element. Costco depends greatly on membership fees. In 2016, membership fees grossed over $2.5 billion. This membership only model may be unappealing and be a barrier to some customers who do not have the capabilities to pay the membership fee. There could be membership discounts offered to those who need or deserve them (e.g., military discount). Also, what happens if members stop paying their fees? Granted, Costco seems to have an impenetrable business model in all types of economies, as will be further discussed in question five, but Costco could then be in a stressful financial situation. As a result of their ultra-low prices with small margins, Costco relies a lot on the revenue from their membership fees. A possible solution would be to raise prices on some items to increase their net sales, which would be an adjustment to their strategy.

Costco employs a low-cost leader strategy that includes five essential elements. The first element is Costco’s ultra-low pricing. It is Costco's philosophy to keep prices low to generate large sales volumes (Thompson, C-30). Costco keeps their markup low at 14 percent to provide members with low prices, compared to the 20 to 50 percent markup of competitors. The second element is Costco's limited product selection. Costco keeps its product selection to approximately 3,700 compared to its competitors that have 40,000+ in their stores. It is important to note that Costco offers a broad range of limited brands for each product category. These limited items are all high quality, with 85 percent being name-brands and 15 percent being their private-label (Kirkland Signature). The third element is Costco's treasure-hunt merchandising. Costco keeps 20 to 25 percent of its items unique by not always stocking them. This encourages the bargain-hunters to spend more on the unique and enticing deals more frequently. The fourth element is Costco’s low-cost emphasis. Costco eliminates the luxuries (e.g., bags, expensive marketing materials, etc.) that would raise their prices like their competitors. With the lack of luxuries, there is a very low overhead that allows savings to pass to the members. The final element is Costco’s growth strategy. Costco plans for stores to incur a five percent growth in sales and to grow and establish more stores both domestically (United States) and in foreign markets. As mentioned in the case, a critique of Costco’s pricing strategy was that the margins are so small that it deprives shareholders. This critique is a valid concern as shareholders provide the necessary funds to the company to grow and expand. It is not a financially sound decision to limit the shareholders their money. Given that statement, the shareholders are not losing money; they could just be making more. As mentioned previously, with the membership fee critique in the business model, a solution would be to increase prices.

Both Costco’s business model and strategy align with the company’s mission and vision. Costco’s mission statement is “to continually provide our members with quality goods and services at the lowest possible prices.” This mission indicates Costco's purpose and ties in elements of Costco's strategy by emphasizing low prices for quality products and supports their vision. While Costco does not have an official stated vision on its website, research shows its implied vision is to give its members "a place where efficient buying and operating practices give members access to unmatched savings” (IMP, 2018). It would be recommended for Costco to officially create a vision statement and share it with employees, members, and shareholders as it provides direction. The implied vision also ties in elements of Costco's strategy by mentioning efficiency and savings that allude to low prices and great deals. Given this analysis, it is easy to state that Costco's strategic choices are aligned with its mission and vision. Overall, Costco’s strategy is working as it has been ranked as one of America’s largest retailers (Thompson, C-26). As the saying goes, ‘if it ain’t broke, don’t fix it.’ There could be some adjustments made for improvements, but they are not necessary right now for Costco to continue to grow, expand, and dominate the wholesale club industry.

Full Value Chain Analysis for Costco

Costco’s value chain begins with the supply chain that includes the activities and costs of purchasing goods from various manufacturers/vendors. The goods are transported to either a warehouse or one of Costco's 23 cross-docking depots that distribute to stores or members' personal addresses for online orders within 24 hours generally. Once goods arrive at the warehouse, they are put on the sales food for members to buy from. This supply differs from the traditional supply chain as the goods are not transported from the manufacturer, distributor, warehouse, and retailer. Costco’s unique supply chain is what gives it a competitive advantage over competitors as it limits the possession of the goods. The shorter inventory turnover highlights the success of Costco’s business model and strategy. The competitors are losing money by holding onto their goods longer. Costco's operation activities and costs include the management of the Costco stores and online sales, both nationally and internationally. Costco's distribution includes the transporting activities and costs of the goods (e.g., moving goods to sales food via trucks, forklifts, and pallets).

Costco’s sales and marketing strategy include in-store advertisements (e.g., sampling and signs). There are monthly coupon mailers and weekly emails to members, and for special occasions, there are direct mailings to campaign for new members. Lastly, Costco’s support activities include the activities and costs associated with human resources, such as hiring and training. Costco pays its employees well with wages above minimum wage and benefits. This high compensation has resulted in low employee turnover. Costco's competitive advantage is sustainable as, according to chapter four; it has been proven durable against all its competitors' efforts (Thompson, 2018).  Costco has conquered the wholesaler industry as it held 59 percent of the industry’s sales in 2016. Costco continues to dominate, as it is now the largest wholesale club in 2019 (Vault, 2019).

North American Wholesale Club Industry Porter's 5 Forces

A representative five-forces diagram for Costco (see Figure 1) is followed by an assessment of each force’s strength or weakness.  

Figure 1. Representative five-forces diagram for Costco.

Costco Porter's 5 Forces

Industry Competition

Several factors intensify the rivalry among wholesale competitors. First, Costco's main competitors, Sam's Club and BJ's Wholesale, are similar in their capabilities. All three are similar as they have low prices, have multi-level memberships for both individuals and businesses, limited but high-quality brand products (e.g., appliances, electronics, clothing, jewelry). They all also offer specialty services (e.g., gas stations, pharmacies, food courts, photo centers, etc.). As there are so many similar features of the wholesale club competitors that there is a weak differentiation between them that increases the risk of members switching between and among the wholesale club competitors. Members may switch based on convenience and which wholesale club is offering the best deals. To combat the odds of members leaving Costco for its competitors, Costco should differentiate itself by possibly offering a better selection and lowering prices of individual items and more in-store promotions.

Entry Barriers

The entry barriers into the wholesale industry are relatively high. This industry is a large-scale operation and has sizable economies, and thus for a new entry, it would require a large amount of capital to be able to compete with Costco, Sam's Club, and BJ's Wholesale Club. The incumbents have cost advantages against new entries as well (e.g., exclusive suppliers and fixed costs). However, as will be discussed in question five, there are new entrants, who have found a foothold in the niche market of online wholesale clubs that are prospering using a focused low-cost strategy. It would be recommended for Costco to strengthen its competitive advantage against these new entrants and current competitors by increasing its online sales presence (e.g., offering exclusive online promotions).

Availability of Substitutes

The products sold at the wholesale clubs are comparable and readily available among each other and at other stores and with a large selection of products to choose from (e.g., supermarkets and convenience stores). Therefore, a customer will compare the price of a product that is precisely the same or similar at other competitors to get the best price as the price for switching is low for customers. It would be recommended for Costco to monitor its main competitors to ensure that the company has better deals and promotions.

Bargaining Power of Suppliers

Suppliers, even large companies in concentrated industries, do not have strong bargaining power for wholesaler clubs, especially Costco. Costco does not depend on a specific supplier. As mentioned in the case, if one item became unavailable from a supplier, Costco would have no problem switching to another supplier as it would not have a substantial effect on business (Thompson, C-35). The supplier switching costs are low for this wholesale industry. There is no recommendation for this competitive force.

Bargaining Power of Customers

Members do not have the power to leverage better prices from the wholesale club industry as the buyer demand is strong. Even though product differentiation is weak, and the cost of switching is low, the members are relatively small and do not have strong bargaining power in the wholesale club industry. If a member decides to switch to one of Costco’s competitors, it will not negatively affect Costco. There is no recommendation for this competitive force.

Costco Opportunities and Threats

Opportunities

Costco has several market opportunities to grow and expand into. Costco can expand and grow its online sales. There is a growing market segment for online wholesalers, as briefly mentioned earlier. By expanding its reach, Costco would be making the barriers of entry harder to overcome and eliminate the threat of e-commerce wholesalers. It is recommended that Costco do more online marketing and selling. Costco has opportunities in foreign markets. As will be discussed in more detail in question 5, Costco has been able to enter and sustain in markets successfully (e.g., Japan) that were thought to be impossible. Costco has a strategy that is a global phenomenon. It is recommended for Costco to research other foreign markets to put stores in (e.g., South America, Asia, Africa).

Threats

There are a couple of threats facing Costco that include other wholesale clubs, supermarkets, convenience stores, and e-commerce retailers/wholesalers. These competitors can either individually or collectively offer Costco members better prices, selections, convenience, or amenities. It would be recommended for Costco to monitor its competitors to ensure that they still have a competitive edge in the industry. Overall, the collective strength of the five competitive forces is attractive. Rivalry and competition from substitutes are the two strong competitive forces facing the wholesaler clubs in North America. To weaken these competitive forces, Costco should monitor its competitors and explore different market opportunities to expand and better differentiate itself from competitors to gain a higher competitive advantage. The threat of new entry, supplier bargaining power, and wholesale club member bargaining power are all weak competitive forces. These competitive forces indicate that the industry is average. The wholesale clubs can make a nice profit by keeping prices low and keeping the barriers for new entrants low.

Costco Financial Performance

Since 2000, Costco’s financial performance has been remarkably good. Even when the United States was in the recession (2008-2011), Costco reported positively stable numbers and quickly progressed after the recession ended. For example, Net sales increased from $31.6 billion in 2000 to $87,048 in 2011 and proceeded to grow to $113.6 billion in 2015. Total revenue from membership fees increased from $32.1 billion in 2000 to $88.9 billion in 2011 and climbed to $112.2 billion in 2015. Net income increased from $631 million in 2000 to $1.4 billion in 2011 to $2.3 billion in 2015, which is a 277% increase. Financially, it did not seem that Costco was significantly affected by the recession, even though most of Costco's stores are in the United States.

Profitability Ratios

As shown in Table 1, there has been overall favorable increases. Gross profit margin had a favorable increase from 11.95% in 2000 to 13.02% in 2015. The net profit margin had a favorable increase from 1.96% in 2000 to 2.05% in 2015. Return on stockholder’s equity (ROE) had a favorable increase from 14.88% in 2000 to 21.92% in 2015. Shareholders were receiving a steady increase in returns from 2013 to 2015. The fact that Costco has steadily increased its above-average ROE, even though the recession is a high selling point for new and potential investors and shareholders.

Liquidity Ratios

The current ratio has relatively stayed the same since 2000, as shown in Table 1. However, the current ratio in 2015 (1.05) was a sharp decrease from the year previous (1.22). This ratio does not negatively reflect upon the company as it is a reasonable ratio, as it indicates Costco can pay its current liabilities with current assets. The working capital had a favorable increase from $66 million in 2000 to $759 million in 2015.

Leverage Ratios

The long-term debt-to-equity ratio increased significantly from 19% in 2000 to 45% in 2015, as shown in Table 1. This ratio indicates that as Costco has grown and expanded, so has its debt. Costco's long-term debt-to-equity ratio is high, but it is reasonable as the company's time-interest earned ratio is high. This high ratio indicates that Costco has been able to meet their payments and has good credit. It would be recommended to lower the long-term debt-to-equity ratio. Ways to reduce long-term debt would include better inventory management, but Costco already had a remarkable handle on this area of operations, as will be discussed next. Costco could increase prices a small percentage on a select number of items to pay off any or some of the long-term debt. Another way would be for Costco to limit its store openings and make a push for more online sales.

Activity Ratios

Costco’s inventory turnover has remained the same from 11.37 in 2000 to 11.35 in 2015, as shown in Table 1. The high inventory turnover reflects positively upon the company as it indicates the company is selling items quickly, and they are not in Costco's possession long as indicated by their days of inventory. Costco's low rate of days of inventory has also steadily remained the same from 32.09 in 2000 to 32.17 in 2015. As mentioned earlier, Costco's inventory management is the best in the wholesale industry with its use of retail space, store, and distribution warehouse locations. Overall, Costco has had steady financial growth from 2000 to 2015. Costco reported positive numbers even in the recession. Costco’s net sales, total revenue, and total income have all steadily increased. Costco’s inventory management has also increased and is the best in the industry with high inventory and low days of inventory. To keep this growth, it is recommended that Costco should keep their operations and management as they are. However, Costco could improve in some areas, as mentioned earlier, with Costco's high long-term debt-to-equity ratio. Table 1 Costco Performance Ratios (2000-2015)

Example Articles about Costco published since 2016

• Loftsdottir, K., & Wolfgana Mixa, M. (2017). The opening of Costco in Iceland: Unexpected meanings of globalized phenomenon. Stjournal.

The Icelandic food retailer, Bonus, dominated all over Iceland due to the abolishment of currency restrictions and the diminishment of wholesaler monopolies. As learned from Managerial Economics, monopolies have almost or total control over a sector or industry. The price for food remained high. In fact, on average, Iceland's food prices were 50% higher than in other countries within the European Union. Iceland experienced the 2008 economic crash, and it along with the Panama files revelation, it changed the Icelander’s view towards foreign businesses. This article focuses on the effect Costco had in Iceland when it opened its doors in 2017. Before Costco even opened its doors in Reykjavik, Iceland, there was much excitement in the community and country. On opening day, there was a smaller crowd than Costco's management anticipated. This was hypothesized to be the result of the Icelander's negative view towards foreign businesses. A few days after the grand opening, there was a national holiday where the store was crowded and packed with customers. Word had gotten around the community by mouth and with the help of the media.

The Icelandic media was very interested in the arrival of Costco. Three main topics related to Costco dominated media discussions. First, Costco’s fuel prices. The price of fuel at Costco’s was about 15 percent cheaper than the average gas prices in Iceland at the time this article was published. In the first few days months of operation, Costco had claimed 32 percent of the gasoline market share, which was higher than the country’s Bonus that had 28 percent of the market share. The second topic primarily discussed was Costco's effect on other Icelandic prices. Icelanders were so impressed with Costco's low prices that there was a personal rebellion occurring within Iceland. Many individuals went out of their way (e.g., out of their towns) to travel to Costco to get better deals on items. The third topic was Costco's effect on the Icelandic market. Many individuals and media articles mentioned that Costco's low prices would force Icelandic retailers to stop their extreme markups and end the corruption in the market. It seems that Costco changed many of Icelander's views of foreign businesses for the better with their low-cost leader strategy, as discussed in the book's case study. It was stated in the article that three months after the grand opening, Costco had given out 90,000 membership cards, which was reported to be about 35 percent of the total Icelandic population in 2017.

• Baek, J. Y. & Wang, S. (2018). The localization strategies and success of Costco: Focusing on a Japanese mature retail market. International Journal of Industrial Distribution & Business

Japan has the second-largest consumer market in the world, but it was also a relatively closed market. It has been difficult for foreign businesses to establish themselves in Japan. Japanese retailers are relatively more sophisticated with technology and for their knowledge of handling perishable foods (e.g., fish, fruits/vegetables, and meat) when compared to Western retailers. The Japanese have a high priority towards freshness, and foreign retailers have not met the Japanese standard, till Costco. This article examined how Costco became the first major foreign company to enter successfully into Japan. Costco was able to successfully navigate its entry into Japan by sticking to their business model of offering its members low prices on their products. The Japanese found shopping at Costco a family event where they spend a long time in the store shopping and enjoying their leisure time. This was different from the norm as most Japanese go to the local grocery store a few times a week and spend a short amount of time there. This reinforces the concepts – cultural environment (e.g., collectivism) and economic environment (e.g., developed country) as learned in International Business. It would have been vital for Costco to research Japan and diagnosis its environments before launching new stores. It was also reported that Costco was adaptive and listened to its members' suggestions. In the Japanese culture, family and friends share their food.

To accommodate this, Costco changed some of its packaging types to allow better their members to share among themselves. Costco also had to be aggressive with its in-store advertisements to inform its Japanese members that it is acceptable to try a product (e.g., taste tests) without feeling obligated to buy the product. They heavily advertised a free two-bite service to members with a Korean grilled beef Costco was selling at the time. Costco's entry into Japan has amazed many as they have not changed their core business model or strategy like some of the other foreign retailers have (e.g., Dairy Farm, Walmart, and Carrefour). The article mentioned that their Japanese members prefer Costco over local supermarkets for the following reasons: a variety of goods, in-store promotions and amenities, large packaging, price, the spaciousness of store, and customer services. Costco had successfully opened 26 stores across Japan as of November 2017. That is more than 260,000 memberships. Costco's low-cost leader strategy was successful yet again.

• Bhattarai, A. (January 19, 2018). Could millennials kill Costco, Sam's Club? The Washington Post.

Bhattarai proposes that millennials could be the downfall of the wholesales area. The average club customer is older (e.g., baby boomer). Costco, while making advancements to target the younger generations (e.g., Generation X, Generation Y, and Generation Z) are losing to new wholesale companies taking advantage of their slow progress. The company Boxed, started in 2013, is an online wholesaler that requires no membership fee, offers bulk items, delivery within two days, and most importantly, offers its customers convenience. The company has conducted their market research and found popular market trends (e.g., Internet trend), as discussed in both Marketing Management and Entrepreneur Management. Boxed found a niche market with the younger generations.

The younger generations have started a strong push towards online shopping as they lack time to go into a Costco and spend a whole morning or afternoon getting lost in hunting for the treasured good low-price deals. As we learned in chapter one of this course, Boxed is using a focused low-cost strategy as opposed to Costco’s low-cost provider strategy. Moreover, it seems that Boxed’s strategy is paying off well as the company's annuals sales went from $8 million in 2014 to exceed $100 million in 2018. Boxed's average shopper age ranges from 25 to 44 and does not have to rely strongly on a physical location to reach customers like Costco. It is believed important to mention that Costco has made efforts to reach and market to the younger generations by offering online ordering and grocery delivery services. Even with these efforts, it has failed at an important aspect of their business model. As mentioned in the case study, Costco keeps its pricing ultra-low to keep other companies from coming in and taking current or potential customers away from them. Unfortunately, this has occurred.

• Wiener-Bronner, D. (August 15, 2017). Costco owes Tiffany more than $19 million for selling counterfeit rings. CNN.

Costco was ruled guilty of infringing on Tiffany & Co’s trademarked name. In 2013, a lawsuit was filed against Costco for selling rings advertised in-store as “Tiffany” rings, to customers for multiple years. Based on the case study, Costco would not sell a Tiffany & Co ring as it is not a product at a low price, so it would be unlike Costco to sell a Tiffany & Co ring. Costco argued that Tiffany was a generic term in describing a ring setting and that the rings they were selling were not sold in the distinct blue Tiffany boxes or labeled as a Tiffany & Co ring. As learned in Business Law and Ethics, a generic term is a commonly used name (e.g., Aspirin). Costco should not have advertised the ring as "Tiffany" as it led to customer confusion. Costco should have advertised the rings as a Tiffany setting, which would not have been as misleading the customers. So, against all of Costco's efforts to make a case against Tiffany & Co, the judge finally made a verdict. Costco was ruled to be guilty of infringing on Tiffany & Co's trademark and ordered to pay Tiffany & Co a total of $19.3 million in punitive damages. Punitive damages, also learned in Business Law and Ethics, are to compensate the plaintiff for their losses and to punish the defendant.

References

• Baek, J. Y. & Wang, S. (2018). The localization strategies and success of Costco: Focusing on a Japanese mature retail market. International Journal of Industrial Distribution & Business, 9(2). doi: http://dx.doi.org/10.13106/ijidb.2018.vol9.no2.7
• Bhattarai, A. (January 19, 2018). Could millennials kill Costco, Sam's Club? The Washington Post. Retrieved from https://www.sfgate.com/business/article/Will-millennials-kill-Costco-and-Sam-s-Club-12511119.php
• IMP. (February 12, 2018). Vision statement – your compass to future practice success. Retrieved from https://integratedmp.com/vision-statement-compass-future-practice-success/
• Loftsdottir, K., & Wolfgana Mixa, M. (2017). The opening of Costco in Iceland: Unexpected meanings of globalized phenomenon. Stjournal. 13(2). Retrieved from https://opinvisindi.is/bitstream/handle/20.500.11815/664/2665-3718-1-PB.pdf?sequence=1&isAllowed=y
• Thompson, A. A., Peteraf, M. A., Gamble, J. E., & Strickland, A. J. III. (21st ed). (2018). Crafting & executing strategy: The quest for competitive advantage. New York: NY: McGraw-Hill Education.
• Vault. (2019). Costco wholesale corporation. Retrieved from https://www.vault.com/company-profiles/retail/costco-wholesale-corporation
• Wiener-Bronner, D. (August 15, 2017). Costco owes Tiffany more than $19 million for selling counterfeit rings. CNN. Retrieved from https://money.cnn.com/2017/08/14/news/tiffany-costco-lawsuit/index.html