Costco Wholesale Corporation: Mission, Business Model and Strategy

COMPANY BACKGROUND

Costco was founded by Jim Sinegal and Seattle entrepreneur Jeff Brotman (now chairman of
the board of directors). The first Costco store began operations in Seattle in 1983, the same
year that Wal-Mart launched its warehouse membership format, Sam’s Club. By the end of
1984, there were nine Costco stores in five states serving over 200,000 members. In
December 1985, Costco became a public company, selling shares to the public and raising
additional capital for expansion. Costco became the first ever U.S. company to reach $1
billion in sales in less than six years. In October 1993, Costco merged with Price Club. Jim
Sinegal became CEO of the merged company, presiding over 206 PriceCostco locations,
which in total generated $16 billion in annual sales. Jeff Brotman, who had functioned as
Costco’s chairman since the company’s founding, became vice chairman of PriceCostco in
1993 and was elevated to chairman in December 1994. Brotman kept abreast of company
operations but stayed in the background and concentrated on managing the company’s $9
billion investment in real estate operations—in 2006, Costco owned the land and buildings
for almost 80 percent of its stores.

In January 1997, after the spin-off of most of its non-warehouse assets to Price Enterprises
Inc., PriceCostco changed its name to Costco Companies Inc. When the company
reincorporated from Delaware to Washington in August 1999, the name was changed to
Costco Wholesale Corporation. The company’s headquarters was in Issaquah, Washington,
not far from Seattle. Exhibit 1 contains a financial and operating summary for Costco for
fiscal years 2000–2006.

COSTCO’S MISSION,

Mission: - Costco’s mission in the membership warehouse business read: “To continually
provide our members with quality goods and services at the lowest possible prices.”

This mission statement has the following main points: Quality goods and services, so if we

talk about the quality so basically is

 Products and Services that meet or exceed customer expectations result in customer
satisfaction. Quality is the expected product/service being realized. What happens Before a
customer makes a purchase (exchanges money for a product/service) he or she does a
mental calculation:  “Is the worth of the product/service (as I perceive and expect) equal to
the money that I am about to exchange?” now talking about the full mission statement that
is “To continually provide our members with quality goods and services at Lowest
possible prices” Continual offers Costco’s mission statement shows that the business uses

quality as a selling point. This factor is important because there are many other firms that

compete against Costco on the basis of low prices. The company’s mission statement also

indicates low prices as a major selling point. Customers are drawn to the discounts and low

prices available at Costco. Moreover, the mission statement shows that these offers are

always available at Costco warehouses/stores to members. A strategic objective linked to this

mission statement is to develop a supply chain that supports cost minimization and high

quality.

Costco’s Strategy

The cornerstones of Costco’s strategy were low prices, limited selection, and a
treasurehunt shopping environment.

Pricing: Costco was known for selling top-quality national and regional brands at prices
consistently below traditional wholesale or retail outlets. The company stocked only those
items that could be priced at bargain levels and thus provide members with significant cost
savings; this was true even if an item was often requested by customers. A key element of
Costco’s pricing strategy was to cap its markup on brand-name merchandise at 14 percent
(Compared to 20 to 50 percent markups at other discounters and many supermarkets).
Markups on Costco’s 400 private-label (Kirkland Signature) items could be no higher than
15 percent, but the sometimes fractionally higher markups still resulted in Kirkland
Signature items being priced about 20 percent below comparable name-brand items.
Kirkland Signature products—which included juice, cookies, coffee, tires, house wares,
luggage, appliances, clothing, and detergent—were designed to be of equal or better quality
than national brands. Costco’s philosophy was to keep customers coming in to shop by
wowing them with low prices. Indeed, Costco’s markups and prices were so low that Wall
Street analysts had criticized Costco management for going all out to please customers at
the expense of increasing profits for shareholders. One retailing analyst said, “They could
probably get more money for a lot of the items they sell.” Sinegal was unimpressed with
Wall Street calls for Costco to abandon its ultra-low pricing strategy, commenting:

“Those people are in the business of making money between now and next Tuesday. We’re
trying to build an organization that’s going to be here 50 years from now.”

Treasure-Hunt Merchandising: While Costco’s product line consisted of approximately

4,000 items, about one-fourth of its product offerings were constantly changing. Costco’s
merchandise buyers remained on the lookout to make one-time purchases of items that
would appeal to the company’s clientele and that would sell out quickly. A sizable number
of these items were high-end or name-brand products that carried big price tags—like
$2,000–$3,500 big screen HDTVs or $800 leather sofas. The idea was to entice shoppers to
spend more than they might otherwise by offering irresistible deals on luxury items.
According to Jim Sinegal, “Of that 4,000, about 3,000 can be found on the floor all the time.
The other 1,000 are the treasure-hunt stuff that’s always changing. It’s the type of item a
customer knows they better buy because it will not be there next time, like Waterford
crystal. In many cases, Costco did not obtain its luxury offerings directly from high-end
manufacturers like Calvin Klein or Waterford (who were unlikely to want their
merchandise marketed at deep discounts at places like Costco); rather, Costco buyers
searched for opportunities to source such items legally on the gray market from other
wholesalers or distressed retailers looking to get rid of excess or slow-selling inventory.
Examples of treasure-hunt specials included $800 espresso machines, diamond rings and
other jewelry items with price tags of anywhere from $5,000 to $250,000, Italian-made
Hathaway shirts priced at $29.99, Movado watches, exotic cheeses, Coach bags, cashmere
sports coats, $1,500 digital pianos, and Dom Perignon champagne.

Marketing and Advertising: Costco’s low prices and its reputation for treasure-hunt
shopping made it unnecessary for the company to engage in extensive advertising or sales
campaigns. Marketing and promotional activities were generally limited to direct mail
programs promoting selected merchandise to existing members, occasional direct mail
marketing to prospective new members, and special campaigns for new warehouse
openings. For new warehouse openings, marketing teams personally contacted businesses
in the area that were potential wholesale members; these contacts were supplemented
with direct mailings during the period immediately prior to opening. Management believed
that its emphasis on direct mail advertising kept its marketing expenses low relative to
those at typical retailers, discounter, and supermarkets.

Growth Strategy: In recent years, Costco had opened an average 20–25 locations annually;
most were in the United States, but expansion was under way internationally as well. The
company opened 68 new warehouses in the United States in fiscal years 2002–2006; 16
new warehouses opened in the first four months of fiscal 2007 (between September 1 and
December 31, 2006), and management planned to open another 20–24 by the end of fiscal
2007. Five new warehouses were opened outside the United States in fiscal 2005, five more
were opened in fiscal 2006, and four were opened in the first four months of fiscal 2007.
Going into 2007, Costco had a total of 102 wholly-owned warehouses in operation outside
the United States, including 70 in Canada, 18 in the United Kingdom, 5 in Korea, 5 in Japan,
and 4 in Taiwan. Costco was a 50–50 partner in a venture to operate 30 Costco warehouses
in Mexico. Exhibit 2 shows a breakdown of Costco’s geographic operations for fiscal years
2003–2006. (The data for the 30 warehouses in Mexico are not included in the exhibit
because the 50–50 venture in Mexico was accounted for using the equity method.)

Web Site Sales: Costco operated two Web sites— www.costco.com in the United States and
www.costco.ca in Canada—both to provide another shopping alternative for members and
to provide members with a way to purchase products and services that might not be
available at the warehouse where they customarily shopped, especially such services as
digital photo processing, prescription fulfillment, and travel and other membership
services.

Warehouse Operations: Costco warehouses averaged 140,000 square feet and were
constructed inexpensively with concrete floors. Because shoppers were attracted
principally by Costco’s low prices, its warehouses were rarely located on prime commercial
real estate sites. Merchandise was generally stored on racks above the sales floor and
displayed on pallets containing large quantities of each item, thereby reducing labor
required for handling and stocking. In effect, warehouse managers functioned as
entrepreneurs running their own retail operation. They were responsible for coming up
with new ideas about what items would sell in their stores, effectively merchandising the
ever-changing lineup of treasure-hunt products, and orchestrating in-store product
locations and displays to maximize sales and quick turnover. Costco had direct buying
relationships with many producers of national brand-name merchandise (including Canon,
Casio, Coca-Cola, Colgate-Palmolive, Dell, Fuji, Hewlett-Packard, Kimberly-Clark, Kodak,
Levi Strauss, Michelin, Nestlé, Panasonic, Procter & Gamble, Samsung, Sony, Kitchen Aid,
and Jones of New York) and with manufacturers that supplied its Kirkland Signature
products. No one manufacturer supplied a signify cant percentage of the merchandise that
Costco stocked. Costco had not experienced any difficulty in obtaining sufficient quantities
of merchandise, and management believed that if one or more of its current sources of
supply became unavailable, the company could switch its purchases to alternative
manufacturers without experiencing a substantial disruption of its business. Costco
warehouses accepted cash, checks, most debit cards, American Express, and a private label
Costco credit card. Costco accepted merchandise returns when members were dissatisfied
with their purchases. Losses associated with dishonored checks were minimal because any
member whose check had been dishonored was prevented from paying by check or cashing
a check at the point of sale until restitution was made.

Business Model: - The Company’s business model was to generate high sales volumes and
rapid inventory turnover by offering members low prices on a limited selection of
nationally branded and selected private label products in a wide range of merchandise
categories. Management believed that rapid inventory turnover—when combined with the
operating efficiencies achieved by volume purchasing, efficient distribution, and reduced
handling of merchandise in no-frills, self-service warehouse facilities—enabled Costco to
operate profitably at significantly lower gross margins than traditional wholesalers, mass
merchandisers, supermarkets, and supercenters.

Financial Perspective: *** given data from case study

 Financial Measure 2006 2005 2004
gross profit margin 10.5% 10.6% 10.7%
return on stockholder equity 5.6% 11.1% 11.4%
current ratio 1.05 1.22 1.18
debt to equity ratio 0.02 0.09 0.13
inventory turnover 11.42 11.45 11.41
working capital (in millions) 413 1477 1099
The gross profit margin falls into the normal range for this industry. However, it should be
trending upward and as you can see it is actually decreasing slightly. If this trend continues,
steps will need to be taken to correct the problem. Another probability indicator, return on
stockholder equity indicates that the company has a problem. Average returns are around
12%, which Costco was nearing in 2004 and 2005. In 2006, the company experienced a
sharp decline which is cause for concern. Investigate this decline. It could be due to low
profits after taxes. If the pricing is too low, this can happen. Currently, Sinegal, admittedly,
tries to sell products at the lowest price possible for longevity.

However, if the investors in the firm are not making appropriate returns for the risk, they
will invest elsewhere. The current ratio figure is in the average range but on the decline.
The debt to equity shows a strong balance sheet and low levels of debt. It is trending
downward. The inventory turnover rate is slightly higher than average, indicating that
Costco is outperforming competitors in moving product. Also cause for concern is the fact
that the working capital is shrinking. This might indicate the inability to expand without a
loan.

Costco’s Membership Base and Member Demographics

GOALS TOWARDS MEMEBERS: Take Care of our Members

 Provide quality products at the best prices

 100% satisfactions guarantee warranty on every product & membership fee.
 Provide ecologically sensitive products
 Provide the best customer service in the retail industry
 Give back to our community through volunteerism and corporate contributions

COMPENSATION & WORKFORCE:

Compensation and Workforce Practices: “Our employees are our most important asset; they
are the key to executing the strategy successfully.” –Sinegal

Provide Competitive Wages Starting hourly wage: $12; Average hourly wage: $17-18
Generous Benefits
Career Opportunities: Policy that 86% of higher lever openings are hired from within.
In actuality, the figure runs at 98%.
Open Door Policy-that allows ascending levels of management to resolve issues.

Executive compensation: Salary-roughly 12 times of a person working the sales floor plus
Stock Options and Bonuses

Results of Taking Care of Employees:

120,000 employees spreading a positive message about Costco

High employee retention (6% turnover rate)
Higher productivity from workers

Costco’s Business Philosophy, Values, and Code of Ethics

Costco’s corporate culture and the manner in which the company operated values,
principles and operating approaches
are the following excerpts:

Goals:

1. Obey the Law

2. Take Care of Members

3. Take Care of our Employees

4. Respect our Suppliers

5. Reward our Shareholders Competitor Analysis:

Primary Competition:

1. Sam’s Club

2. BJ’s wholesale

Factors of Competition:

Price, merchandise quality, location

& membership services

Secondary Competition:

1. Retail Discounters: Wal-Mart & Dollar General

2. General Merchandise Chains: Target & Kohls

3. Low-Cost Specialty Stores: Lowe’s, Home Depot, Staples, Best Buy, Circuit City, Barnes &
Noble

Competitive Outlook
Costco is beating both Sam’s Club and BJ’s wholesale in net sales and market share.
However, Sam’s Club has launched an aggressive campaign that its product offering is
nearly twice as large. Costco’s overseas performance is mixed. The last four years, the
return on sales remained constant at 3% in the U.S., 4% in Canada, and other foreign
operations show a 1% return in 2003 and an increase to 2% in the last three years. This
ratio shows the profitability of the different geographic locations of the firm, without taking
into account interest or taxes. Since 2004, the return on sales from international endeavors
has been equal to the U.S. return on sales. This indicates that national and international
ventures are equal in profitability of current operations.

SWOT ANALYSIS

It is important that companies experience strengths in order to grow. Costco has several
strengths that allow their company to continue growing, such as:
STRENGTHS:

 Hiring from within the company and lower employee turnover.

 Minimal Advertising is required as the company primarily depends on word-of-mouth
advertising.
 Although Costco’s advertising activities are very minimal, over the past 10 years the
company has seen a steady increase in comparable store sales and, in turn, a strong
steady increase in net profits.
 Rapid Inventory Turnover: Costco’s high sales volume and rapid inventory turnover
present a number of opportunities for the company.

 In addition to buying power, the rapid inventory turnover generally allows Costco to
obtain cash for the inventory before having to pay the vendors, while still being able to
take advantage of early-payment discounts. Both of these strengths allow the company
to stick to their mission of providing “the lowest possible prices” by passing these
savings directly on to consumers.

WEAKNESSES: Though Costco has several strengths and has a well-established brand
image, they have also experienced several setbacks as well. These weaknesses are outlined
here:

Slow growth of private labels

Limited choices for customers
Jim Sinegal is 79!!! Happy Retirement. Then who will be the next CEO & what will
happen?

OPPORTUNITIES: As a company, Costco has several opportunities available to assist with

growth. These opportunities are discussed in detail as follows:

Positive outlook for internet sales

Increases in home improvement expenditures
Expanding electronic equipment
As for concurrent recession, luxury goods will be found cheaper for Costco!
 Costco still have to go to enter Europe, China & India.

THREATS: As a company that is established in the retail industry, there are several threats
that are open to Costco. These threats are explored as follows:

 Decline in housing market

 Increasing retail rates

STRATEGIC FORMULATION

Although Costco is currently a very successful company with a straightforward vision,

focus, and strategy, there are a few things that could be changed or implemented in order
to further increase the company’s success.

Open additional smaller stores in smaller markets

Offer a larger product selection
Provide the tools to allow customers to better serve themselves.

Recommendations

Membership Strategy Adjustments:

1. Non-Member Day: A quarterly event that allows non-members a trial day at the store
allowing raises in probability of a prospect becoming a club member
2. “Household” Plan: $20 for every additional household member purposing the use of
existing relationships to leverage new ones to increase membership rates
3. Membership Rewards Program: Pay $80 for your annual membership and get 2% off
every purchase

Credit Cards:

1. Current payment methods: cash, check, debit, and Costco Credit

2. Recommended: Allow the Use of Credit Cards but charge a 2% fee purchasing by credit.

Advertising:
1. TV Brand Advertising for awareness & reminder ads
2. In the Northeast and West Coast regions where locations are clustered in order to
receive marketing efficiencies
3. Seasonal TV advertising & periodic direct mail promotions of Treasure Hunt items
Expand Ancillary Business Programs:

1. Ancillary businesses services benefit Costco by: Increase the frequency of customer
visits
2. Benefit members by offering multidisciplinary services that are efficient and

costeffective Making Costco a “One-Stop Shop” Growth Opportunities:

We recommend that Costco should plan to enter Brazil, China, and India & Europe. Sam’s
Club has taken the Pioneering Costs of introducing Warehouse Retail into these societies.
China is predicted to have a five-fold increase in urban consumer spending over the next 20
years to $2.3 trillion a year.
REFERENCES

Costco Wholesale. (n.d.). Buckmaster. Retrieved February 27, 2011, from

buck.com/annual_report?nam=DEMO2&pw=DEMO2&co=COST

Farfan, B. (n.d.). Costco Wholesale Warehouse Mission Statement. About.com. Retrieved

February 27, 2011, from

http://retailindustry.about.com/od/retailbestpractices/ig/Company -Mission-
Statements/Costco-Stores-Mission-Statement.htm

Thompson, A., Gamble, J., & III, A. S. (2009). Crafting & Executing Strategy: The Quest for

Competitive Advantage: Concepts and Cases. n.d.: The McGraw-Hill Companies.