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Company Perspectives:
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.
Are you in the market for a summer-camp-sized tub of peanut butter? Or perhaps a lifetime supply of panty liners? Maybe you are tantalized by one of the shiny new wheelbarrows stacked high to the ceiling or can't resist the outrageously cheap DVD player? But more than likely, you, like many of the other Costco customers, will at least buy an industrial-sized package of toilet paper, the consistently number-one selling item at Costco Wholesale Corporation's hugely popular discount-shopping warehouses.
Costco Wholesale Corporation operates a chain of membership warehouses that sell a wide variety of name-brand products, as well as the company's own Kirkland Signature brand of products, at discount prices to businesses and individuals who are members of selected employee groups. The membership warehouse-club concept emerged in the early 1980s and has become a huge industry, crossing into international markets. With 360 warehouses, located in the United States, Canada, Mexico, Japan, Taiwan, Korea, and the United Kingdom, Costco Wholesale Corporation is the largest and most profitable chain of its kind.
1980s Beginnings
In September 1983 Costco's first warehouse opened in Seattle, Washington. At this time, warehouse outlets had long existed, but the concept of a wholesale club was relatively new and promising. Dubbed "buyers' clubs" and begun in 1976, these warehouses were wholesalers that required shoppers to become members and pay an annual membership fee. The membership fee helped reduce already-low overhead, so that items could be sold at an average of 9 percent over cost from the manufacturer. At the time Costco was formed, membership warehouses were primarily a West Coast phenomenon. However since then, their popularity has spread throughout the United States, across the borders to Canada and Mexico, and beyond to many other countries.
From the company's inception, Jeffrey H. Brotman has served as chairman of Costco, and James D. Sinegal has been president. While Sinegal had a background in membership warehouses and retail chains (having been mentored by Sol Price, the founder of Fed Mart and Price Club), Brotman was an executive of an oil exploration company and cofounder of a group that operated a chain of apparel stores. In 1985 Costco became a publicly owned company, and in 1993, Costco merged with Price Club to become Price/Costco, Inc. In August 1999, the company reincorporated and changed its name to Costco Wholesale Corporation.
Increased Sales and New Marketing Concepts
Since 1984 Costco has had to increase the size of their shopping carts four times. Their customers spend an average of $95 a visit, a rate that has been steady over the years. But with some savvy stocking practices, including being the first membership warehouse to offer an expanding fresh-food section (featuring a bakery, refrigerated produce area, fresh meats, and seafood), people are visiting Costco more often. In 1995 customers visited an average of once every three weeks, but by 1999, they were returning every ten days. With more and more frequently returning customers, as well as the company's constant expansion into new markets with warehouses opening every year, Costco saw its sales earnings grow by a rate of 6 percent a year from 1995 to 2000.
Costco has three membership levels, ranging in price from $35 to $100 a year (in the U.S.): Business, Gold Star (individual), and Executive. Any business or store with a retail sales license is qualified for a Business membership ($45 a year), allowing these customers to shop for resale or business use. Business members (numbering 4.1 million in 2000) can also buy goods for private use, and the membership includes a spouse card. The member also has the option of buying up to six additional membership cards ($35 each) for associates or partners in the business (with a transferable company card being another option).
Gold Card memberships ($45 annual fee) are available to individuals in selected occupations or groups, and is also open to those who do not own a business. These memberships include the same wholesale prices offered to business members. Annual fees are fully refunded if members are not satisfied.
The third membership level, Executive ($100 annual fee), has all the perks of the other memberships, and other benefits. Members can purchase additional services such as auto and homeowner insurance, long-distance services, and mortgage services, as well as discounted business services such as health insurance and merchant credit card processing at vastly reduced rates. Executive members also get a 2 percent annual reward on most of their purchases. An additional perk for Executive and Business members is special opening hours, beyond the regular member shopping hours.
Discount-Shopping Warehouse Strategy Changes and Expands
Costco's strategy is to offer high-quality, brand-name merchandise at prices below those of traditional wholesalers, discount retailers, and supermarkets. To achieve this, Costco buys nearly all of its merchandise at volume discounts from manufacturers, rather than distributors, and stock is usually shipped directly to selling warehouses to minimize freight costs. Warehouses are often on industrial sites or in other areas where property costs are at a minimum, and stocked items are placed directly onto the selling floor or are still stacked on their pallets, reducing handling and stocking labor. The number of sales and service employees is also minimal, with a large percentage of the employees holding part-time status. Warehouses are almost entirely self-service, from finding and buying items, to loading them into a customer's vehicle.
Despite having warehouses that span three acres, and piles of merchandise stacked to the ceiling, Costco only carries 4,000 carefully chosen products at a time. Compared to a grocery store, that has an average of 40,000 products, or a Wal-Mart Supercenter, that has as many as 125,000 items, Costco's stock selection may seem relatively spare. However, the fewer products makes for easier inventory and tracking of prices. Three-quarters of the items are "basic" products like batteries, laundry detergent, or instant noodles. But then there are the "high-end" name-brand products, from exclusive trendsetters such as Ralph Lauren, or Nike, or Waterford, which may be stocked at Costco one day, and then gone the next day. With the complete lack of advertising (with expenditures reserved only for new warehouse openings), the sudden and seemingly random appearance of ultra-cheap name-brand products keeps the customers returning for fear of missing a good deal. Word of mouth and savings do the rest. The company manages to keep its sale prices at 14 percent above the product's cost or less. Striving for high volume, not high margins keeps profits high. In 1999, Costco's individual warehouses were pulling in an average of $91 million per year.
The company also has its own line of products, released under the Costco label of Kirkland Signature. In the constant quest to better prices, the company decided to start making products themselves. "We sell a six-pack of Kodak 200-speed film for $21.99," CEO Sinegal told Fortune magazine in 1999, "Then we have our own [private-label brand] for $6.99. How can you not provide that value for your customers? That doesn't mean we want to get rid of Kodak. But at some point, a vendor's going to realize that option is open. And it does create leverage for us." The company also taps factories around the world to produce items that are dead-ringers in look and quality of name-brand products (such as popular clothing brands), and sells them at even lower cut-rate prices than the name brands. In 1999, roughly 12 percent of Costco's products were released marked with the Kirkland name.
Costco has an extremely generous return policy on its products sold, garnering trust and loyalty in its customers. Costco is so confident in their products, they have a "return-anything-at-anytime" guarantee. Fortune magazine, profiling the "cult of Costco" in 1999, highlighted the "diamond guarantee," where Costco promised to pay a member $100 if a stone was appraised for less than double the Costco price. Buying diamonds at Costco? You bet. At times, they often experienced waiting lists for Costco's $20,000 engagement rings. Having such upscale items on sale in a warehouse next to stacks of printer paper or a year's supply of cat food may seem odd, but Costco tends to attract middle- and upper-middle-class customers, those who are "noticeably more bourgeois, ... some of the most overeducated, overemployed hoarders," according to Fortune.
Over the years, Costco has added departments, expanding beyond just the traditional discount warehouse offerings. Extremely successful is the fresh-food department, which includes meat, bakery, deli, and produce. A large majority of the stores also feature a pharmacy, an optical-dispensing center, one-hour photo services, a food court, and the ever-popular and cheap hot-dog stands.
By the year 2001, 125 of the U.S. Costco stores also featured gas stations with cut-rate prices. The trend of selling gas at discount superstores was repeated by chains such as Wal-Mart and Sam's Club, competing with traditional gas stations, and cutting into the market. According to Reuters, these so-called "hypermarkets" (including Costco) contributed to an at least one-cent decline in U.S. retail gasoline profits from 1997 to 2001, from 13.6 to 12.4 cents a gallon. "Gasoline wars are becoming more frequent as a result of the growing share of these big competitors," Holly Tuminello, Vice-President of the Petroleum Marketers Association of American (PMAA) told Reuters in July 2001. "That's because they are willing to use gasoline as a loss-leader to attract people to their other products." In 2001 the "hypermarket" gasoline sales accounted for roughly 3.5 percent of U.S. gasoline sales (or more than 12.6 million gallons a day), but that amount was expected to grow to 16 percent by 2005 as the various superstore chains continued to expand their services to meet the demand.
Surviving 21st-Century Challenges
With a bull run of over six years straight of profit-earning increases, Costco experienced an unexpected decline in earnings in the first half of 2001. Much of this was beyond the company's control, as the West Coast of the U.S. suffered from an energy crisis that sent energy prices skyrocketing. The state of California, where fully one-fourth of Costco's warehouses were located, experienced some of the worst of the crisis, as rolling blackouts became a concern. "Energy prices in California will certainly impact Costco more than another national retailer," David Schick, an analyst at Robinson-Humphrey, told the New York Times in June 2001, "It costs more to operate in California, and they have an awful lot of operations in California." The company responded to the crisis by equipping California stores with backup generators to keep refrigeration units running in case of blackouts, turning down air-conditioning, and designing new warehouses with as many skylights as building codes permit to allow the company to turn off lights during the day.
Though the energy crisis was much to blame for the slide in profits, there were several other factors that contributed. The economy was in a slowdown, decreasing overall retail sales. Plus the company was dramatically expanding, having already opened 27 new warehouses that fiscal year (a 90 percent spending jump), bringing the total to 360 warehouses in the U.S., Canada, Mexico, the United Kingdom, Korea, Taiwan, and Japan. Also, the profits couldn't match the year-earlier profits that were driven much by Y2K-related buying.
Despite the slowdown, Costco sales (in stores open at least a year) rose 5 percent in 2001, a crucial statistic in the industry. Revenue from membership fees (which had been increased the previous year) increased 23 percent, and Costco continued to maintain an impressive 86 percent renewal rate in memberships, the highest in the industry. The company had about 16 million active members and over 35 million cardholders.
In addition to its already existing e-commerce Web site for members, Costco.com (that had been launched in 1998), Costco officially launched the "B2B" (Business to Business) portion of their online shopping Web site in April 2001. This new feature allowed businesses in the U.S. to order products online for delivery, with some areas (Seattle, Los Angeles, and San Francisco) having the option of next-business-day local delivery from the Costco fleet. By further branching into e-commerce, and with plans to continue the company's expansion at the rate of 40 new warehouses a year, Costco continued its rapid growth with no slowdown in sight.
Principal Competitors:BJs Wholesale Club; Kmart; Wal-Mart; Target.