Strategic Management Casebook CASE 2 Arthur A. Thompson The University of Alabama Costco Wholesale, was the driving force behind Costco’s 29-year march to become the third largest retailer in the United States, the seventh larg. est retailer in the world, and the clear leader of the discount warehouse and wholesale club segment of the North American retailing industry. Sinegal was far from the stereotypical CEO. Grandfatherly and in his 70s, he dressed casually and unpretentiously, often going to the office or touring Costco stores wearing an open-collared cotton shirt that came from a Costco bargain rack and sporting a stan- dard employee name tag that said, simply, “Jim.” His informal dress, mustache, gray hair, and unimpos ing appearance made it easy for Costco shoppers to mistake him for a store clerk. He answered his own phone, once telling ABC News reporters, “If a cus. tomer’ calling and they havea gripe, don't you think they kind of enjoy the fact that I picked up the phone and talked to them?”! Sinegal spent considerable time touring Costco stores, using the company plane to fly from location to location and sometimes visting & to 10 stores daily (the record for a single day was 12). Treated like a celebrity when he appeared at a store (the news “Jims in the store” spread quickly), Sinegal made a point of ‘greeting store employees, He observed, “The employ- es know that 1 want to say hello to them, because I like them, We have said from the very beginning: ‘Were going to be a company that’s on a first-name basis with everyone””® Employees genuinely seemed to like Sinegal. He talked quietly, in a commonsensi cal manner that suggested what he was saying was no bigdeal He came across as kind yet stern, but he was prone to display irritation when he disagreed sharply ‘with what people were sayingto him. Je Sinegal, co-founder and long-time CEO of Costco Wholesale in 2012: Mission, Business Model, and Strategy In touring a Costcostore with the local store man. ager, Sinegal was very much the person-in-charge. He functioned as producer, director, and knowledge able critic. He cut to the chase quickly, exhibiting intense attention to detail and pricing, wandering through store aisles firing a barrage of questiors at store managers about sales volumes and stock levels of particular items, critiquing merchandising displays cr the position of certain products in the stores, com: ‘menting on any aspect of store operations that caught his eye, and asking managers to do further research and get back to him with more information when- ever he found their answers to his questions less than satisfying. Sinegal had tremendous merchandis. ing savy, demanded much of store managers and employees, and definitely set the tone for how the company operated its discounted retailing business Knowledgeable observers regarded Jim Sinegal’s mer- chandising expertise as being on a par with Walmart’ legendary founder, Sam Walton. In January 2012, Costco had a total of $98 ware. hhouses in 40 states and Puerto Rico (433 locations), nine Canadian provinces (82 locations), the United Kingdom (22 locations), Korea (7 locations), Taiwan (8 locations, through a 55 percent-owned subsid jary), Japan (11 locations), Australia (3 locations), and 32 warehouses in Mexico through a 50 percent-owned. joint venture. Costco’ fiscal 2011 total revenues were a record high of $88.9 billion and net income was a record high of $1.46 billion, About 25 million hoase- holds and 64 million businesses had membership cards entitling them to shop at Costco, generating nearly $1.9 billion in membership fees for the company. ‘Annual sales per store averaged about $146 million, Coppi © 2012 by Act A. Thopen. Al sighs earedCosco Wholesale in 2012: Misio, Business Model, and Strategy Case2 Costco Wholesale in 2012: Mission, Business Model, and Strategy co about 85 percent higher than the $78 million figure for Sams Club, Costco’ chief competitor. In fiscal 211, 93 of Costcas warehouses generated sales exceeding $200 million annually, up from 56 in 2010 and four sores had sales exceeding $300 million, including one that had more than $400 milion in sales. COMPANY BACKGROUND ‘The membership warehouse concept was pionezred by discount. merchandising sage Sol Price, who ‘opened the first Price Club in a converted airplane ‘hangar on Morena Boulevard in San Diego in 1976. Price Club lost $750,000 in its first year of operation, but by 1979 it had two stores, 900 employees, 200,000 ‘members, and a $1 milion profit. Years earlier, Sol Price had experimented with discount retailing at a San Diego store called Fed-Mart. Jim Sinegal got his startin retailing there at the age of 18, loading mat- tresses for $1.25 an hoar while attending San Diego ‘Community College. When Sol Price sold Fed-Mart, Sinegal left with Price to help him start the San Diego Price Club store; within a few years, Sol Price’ Price ‘Club emerged as the unchallenged leader in member ‘warehouse retailing, with stores operating primarily ‘on the West Coast. Although he originally conceived Price Club as a place where small local businesses could obtain needed ‘merchandise at economical prices, Sol Price soon con- cluded that his fledgling operation could achieve far ‘greater sales volumes and gain buying clout with sup- pliers by also granting membership to individuals—a conclusion that launched the deep-discount warehouse club industry on a steep growth curve. When Sinegal was 26, Sol Price made him the ‘manager of the original San Diego store, which had become unprofitable. Price saw that Sinegal had a spe- ial knack for discount retailing and for spotting what 2 store was doing wrong (usually either not being in the right merchandise categories or not selling items at the right price points)—the very things that Sol Price was good at and that were at the root of Price ‘Clubs growing success in the marketplace. Sinegal soon got the San Diego store back into the black. Over the next several years, Sinegal continued to build his, prowess and talents for discount merchandising. He ‘mirrored Sol Price’ attention to detail and absorbed all the nuances and subtleties of his mentor’ sty of ‘operating—constantly improving store operations, keeping operating costs and overhead low, stocking items that moved quickly, and charging ultralow prices that kept customers coming back to shop. Real- ining that he had mastered the tricks of running a successful membership warehouse business from Sol Price, Sinegal decided to leave Price Club and form his, ‘own warehouse club operation. Sinegal and Seattle entrepreneur Jeff Brotman (now chairman ofCostco’ board of directors) founded. Costco, and the first Costco store began operations in Seattle in 1983, the same year that Walmart launched its warehouse membership format, Sams Club. By the end of 1984, there were nine Costco stores infive states, serving over 200000 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 US. 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, with total annual sales of $16 billion. Jeff Brotman, who had functioned as Costco's chairman since the company’s founding, became vice chairman of PriceCostco in 1993 and ‘was elevated to chairman in December 1994. Brotman. kept abreast of operations but stayed in the back- ground and concentrated on managing the company’s extensive real estate investment in land and buildings. In amary 1997, after the spin-off of mostofits non: ‘warehouse assets to Price Enterprises Inc, PriceCostco changed its name to Costco Companies Inc. When the company reincorporated from Delaware to Washington in August 1999, the name was changed to Costco Wholesale Corporation, The company’s headquarters ‘was in Issaquah, Washington, not far from Seattle. In September 2011, Jim Sinegal informed Costco's Board of Directorsofhis intention to step downas Chief Executive Officer of the Company effective January 2012. The Board elected Craig Jelinek, President and. Chief Operating Officer since February 2010, to suc ceed Sinegal and hold the titles of both President and. Chief Executive Officer. Jelinek was a highly experi enced retail executive with 37 years in the industry, 28 of them at Costco, where he started as one of the ‘Company's first warehouse managers in 1984. He had served in every major role elated to Costco’ business operations and merchandising activities during his temure. Sinegal was to remain with Costco through January 2013, serving in an advisory role and assisting Jelinek during the transition; he also remained a mem- ber of the company’s board of directors. Exhibit 1 contains a financial and operating sum- ‘mary for Costco for fiscal years 2000-2011.Strategic Management Casebook ce Pert2 Cases in Crafting and Executing Strategy EXHIBIT 1 Selected Financial and Operating Data for Costco Wholesale Corp., Fiscal Years 2000-2011 ($ in millions, except for per share data) ee er Cee Ee ee 2005-2000 Net sales $87,048 $76,255 $69,889 $70,977 $51,862 $31,621 Nemiersip feos 1867 4,681 14533 _1,508 4.073 Bae Total revenue Bess 7788 71422 7adeS © 52905 O.104 ‘Operating expenses ‘Merchandise costs T178 —-67995 6280565878. Soling, gonoral, and ‘administrative ees. 7.407.252 8.94 5044785 Proopening expenses 46 8 a a7 53 2 Frovision for impaired assets and ‘store closing costs 8 8 47 ° 7 Cperating income 2aso 2077 hr? 1,889 1087 ‘ther income (expense) Intorest expense (16) (411) (108) (1a) =) Interest income and other 0 28 45 408 * Income betore income taxes. 2983 «20547141089 1052 Frovision for income taxes ai Bi 628 76 421 Net income Saaz Sims Sto |S 1209 = oat Diluted net income per share 330 $292 S247 8288 $135 Dividends per share $089 $077, $0880. $0.00 Nitions of shares used in per share calculations 443144604805 4a 4757 ‘Cash and cash equivalents ‘$4009 $3214 $3,187 $2,619 $505 Nerchandise inventories 668 5638 54055009 2.40 Curent assets 13708 11,708 «108878462 3470 Current tiabiitos 12050 © 10083 9281.84 3.408 Net property and equipment 124s2 11,814 = 10.900 10,355, 40% Total assets 26,761 23815 21.979 20.682 ood ‘Short-term porrowings 0 8 16 194 10 Long-o1m debt 2183 atst 22082206 790 Stockholders’ equity 1257310829 10018 9.190 420 Net cash provided by operating actvitos $3198 $2,780 $2,002 $2,206 $1,773 1,070 Warehouse Operations Viarehouses at boginning of year 72 2 512 486 a7 282 ‘New warehouses opened (inciuding relocations) 24 4 19 u at B Existing warehouses closed (inctuing relocations) @ a ® () @ ® Warehouses at end of year 582 540 sar 52 433 313 [Net sales per warehouse open at yearend (in miions}* sia71 Siva sigs siage Stiga st010 ‘Average annual growth at warehouses open more than a yoar 10% % 4% % ™% 11%Cosco Wholesale in 2012: Misio, Business Model, and Strategy Case2 Costco Wholesale in 2012: Mission, Business Model, and Strategy co EXHIBIT 1 (Concluded) Businesses (000s) 6300 5.800 ©5700 5.600 © 0004200, ‘Gold Star members (000s) 25.000 22,500 21,500 20200-16200 10,500 ‘Add-on cardholders (employoes ‘of businass members, spouses ‘of mambers) 2,700 29,700 28,800 27,700 na. na. ‘otal carcholders 64,000 58,000 56,000 48,460. = - * Excludes, for years 2008-2010, those warehouses operated in Mec through a $0 percert-ouned joint venture Mxico opened 20 of ‘hese warshoutes m 2007, ee in 2008, and one 2000, Hower, de man accouriing change that became efecive atthe begining of {ical 2011, he 22 Mexico wachouses were consoidatd andreporied as part of Casio's totaloperatons atthe bapinning ofthe fcal year © This number is "biased downward’ because new warehouses opened during the year hadnt sales fo oss than 12 full months. Membership numbers do nt include Casto Maxicecardhoters of approximately 2 0001 2010 and 2.500 00 in 2000 ‘Naf: Some tals may not add due to rounding and the fact hat sore ine toms in the comary'ssatorent of income were ratincluded in tis summary, for reasons of simpy. ‘Sources: Company 10- reports fr fiscal years 2000, 2008, 2008, 2010, and 20. COSTCO'S MISSION, BUSINESS MODEL, AND STRATEGY Numerous company documents stated that Cosico's iission in the membership warehouse business was: “To continually provide our members with qual- ity goods and services atthe lowest possible prices”* However, in their “Letter to Shareholders” in the company’s 2011 Annual Report, Costco three top ‘executives—Jeff Brotman, Jim Sinegal, and Craig Jelinek—provided a more expansive view of Costco ‘mission, stating? “The company will coatinue to pursue ite mission of binging the highest quality goods and services to mar: ketal the lowest possible prices while providing excel- lent customer service and adhering to a strict code of ‘ethics that includes taking caze of our employees and ‘members, respecting our suppliers, rewarding our shareholders, and seeking to be responsible corporate citizens and environmental stewards in our operations around the world ‘The centerpiece of Costco business model entailed generating high sales volumes and rapid inventory turnover by offering fee-paying members attractively low prices on a limited selection of nation- ally branded and selected private-label products in a ‘wide range of merchandise categories. Rapid inven- tory turnover—when combined with the low oper ating costs 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 mer- chandisers, supermarkets, and supercenters. Member- ship fees were a critical element of Costco’ business ‘model because they provided sufficient supplemental revenues to boost the company’s overall profitability to acceptable leves, ‘A second important business model element was that Costco’ high sales volume and rapid inventory turnover generally allowed it to sell and receive cash for inventory before it had to pay many of its merchandise ‘vendors, even when vendor payments were made in timeto take advantage of early payment discounts. Thus, Costco was able to finance a big percentage of its mer- chandise inventory through the payment terms provided by vendors rather than by having to maintain sizable ‘working capital (defined as current assets minus current liabilities) to facilitate timely payment of suppliers, Costco's Strategy ‘The key elements of Costco’ strategy weee ultra-low prices, a limited selection of nationally branded and. private-label products, a “treasure hunt” shopping environment, strong emphasis on low operating costs, and geographic expansion, Pricing Costess philosophy was to keep custom- ers coming in to shop by wowing them with low prices. "The company stocked only those items that could be priced at bargain eves and thus provide members with significant cost savings; this was true even if an itemStrategic Management Casebook cu Pert2 Cases in Crafting and Executing Strategy ‘was often requested by customers, For many years, a key element of Costco’ pricing strategy had been 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’ private-label Kirkland Signature items were a marimum of 15 percent, but the sometimes fraction ally higher markups still resulted in Kirkland Signature items being priced about 20 percent below comparable ‘name-brand items. Kirkland Signature products— which included vitamins, juice, bottled water, coffee, spies, olive oi, canned salmon and tana, nuts, laundry detergent, baby products, dog food, luggage, cookware, ‘trash bags, batteries, wines and spirits, paper towels and ‘wilet paper, and clothing —were designed to be of equal or better quality than national brands. ‘Asa result of these low markups, Costco prices were just fractionally above breakeven levels, producing net ‘sales revenues (not counting membership fees) that barely ‘covered all operating expenses and generated only amod- ‘est contribution to operating profits, As can be verified from Exhibit 1, in 2005 and every year during 2008-2011, ‘over 70 percent of Costco’ operating profits were attrib ‘table to membership fees and, in fact, membership fees ‘were larger than Costco's net income in every year shown. in Exhibit 1 (or to put it another way, without the rev- ‘emues from membership fees, Costco net income after ‘anes would be miniscule because of its ultra-low pricing strategy and practice of capping the margins on branded ‘goods at 14 percent and private label goodsat 15 percent). Jim Sinegal explained the company’s approach to pricing: We always look to see how much of gulf we can cre ste between ourselves and the competition. So that the ‘competitors eventualy say, “These guys are crazy. Wel compete somewhere else” Some years ago, we were selling a hot brand of jeans for $28.99, They were $50 ina department store. We go a great deal on them and «ould have sold them for a higher price but we went down to $29.99, Why? We kaew it would create a riot ® ‘At another time, he said: ‘Were very good merchants, and we offer value. The traditional retailer will say: “Tm selling this for $10. wonder whether we can get $10.50 or $11.” We say: “Wee selling this for $9. How do we get it down to 8?" We understand that our members don't come and shop with us because of the window displays or the Santa Claus or the piano player. They come and shop with us because we offer great values. Indeed, Costco’s markups and prices were so frac tionally above the level needed to cover companywide ‘operating costs and interest expenses that Wall Street analysts had criticized Costco management for going all out to please customers at the expense of increas- ing profits for shareholders. One retailing analyst said, “They could probably get more money for a lot of the items they sell”* Sinegel was unimpressed with Wall, Street calls for Costco to abandon its ultra-low pricing strategy, commenting: "Those people are in the busi- ness of making money between now and next Tuesday. Were trying to build an organization that’s going to be here 50 years from now”? He went on to explain why Costecs approach to pricing would remain unaltered during his tenure: ‘When I started, Sears, Roebuck was the Costeo of the country, but they allowed someone else to come in under them. We donit want to be one of the casualties. ‘We don't want to turn sround and say, “We got so fancy ‘we've raised our prices and all ofa sudden a new com. petitor comes in and beats our prices!” Product Selection Whereas typical supermar- kets stocked about 40,000 items and a Walmart Super- center or a SuperTarget might have 125,000 to 150,000 items for shoppers to choose from, Costco’s merchan- dlising strategy was to provide members with a selection of approximately 3,600 active items, Of these, about 85 percent were quality brand-name products and 15 percent carried the company’s private-label Kirkland Signature brand—however, Kirkland Signature items accounted for 20 percent of sales in fiscal 2011. Manage- ‘ment believed that there were opportunities to increase the number of Kirkland Signature selections and build sales penetration of Kirkland Signature products to 30 percent of total sales over the next several years Costeos product range covered a broad spectrim— rotisserie chicken, all types of fresh meats, seafood, fresh and canned fruits and vegetables, paper prod- ucts, cereals, coffee, dairy products, cheeses, frozen foods, flat-screen televisions, iPods, digital cameras, fresh flowers, fine wines, caskets, baby strollers, toys and games, musical instruments, ceiling fans, vacuum, cleaners, books, apparel, cleaning supplies, DVDs, light bulbs, batteries, cookware, electric toothbrushes, vitamins, and washers and dryers—but the selection in each product category was deliberately limited to ‘ast- selling models, sizes, and colors. Many consumable products like detergents, canned goods, office supplies, and soft drinks were sold only in big-container, case, carton, or multiple-pack quantities only. ‘But the selection within each prochict category was restricted, in some casesto a single offering. For exam ple, Costco stocked onlya 325-count bottle of Advil—aCosco Wholesale in 2012: Misio, Business Model, and Strategy Case2 Costco Wholesale in 2012: Mission, Business Model, and Strategy EXHIBIT 2 Costeo's Sales by Major Product Category, 2003-201 eee 2011 2010 2009 2007 2005 2003 Food ({resh produce, meats and fish. bakery and del products. and dry ‘and institutionally packaged foods) 39% 93% 39% 31% 30% 30% ‘Sundries (candy, snacs foods, tobacco, alcoholic and nonalcoholic ‘beverages, and clearing and institutional supplies) 22% 28% 20% 20% 25% 26% Hardlnes (major appliances, electronics, health and beauty aids, hardware, office supplies, garden and patio, poring goods, furniture, cameras, and automotive supplies) 17% 18% 19% 21% 20% 20% ‘Softlines (including apparel, domestics, jewelry, housewares, books, movie DVDs, video games and music, home furnishings, and small appliances) 10% 10% 10% 11% 12% 14% Ancillary and Other (gasoline, pharmacy, food court, optical, one-hour Phot, heating aids and travel) 18% 16% 18% 14% 19% 10% ‘Source: Company 10-K reports, 2005, 2007, 2008, and 2011. size many shoppers might find too large for their needs. ‘Sinogal explained why selections were limited: If you had ten customers come in to buy Advil, how ‘many are not going to buy any because you just have ‘one size? Maybe one or two. We refer to that as the intelligent los of sales We are prepared to give up that ‘one customer. But if we had four or five sizes of Advil as most grocery stores do, it would make our business ‘more dificult to manage. Our business can only sue- ‘eed if we are efficien. You cant go on selling at these ‘margins if you are not ‘The approximate percentage of net sales accounted for by each major category of items stocked by Costco is shown in Exhibit 2. ‘As a means of giving members reasons to shop at Costco more frequertly and make Costco more of 4 one-stop shopping destination, the company had ‘opened ancillary departments within or next to most ‘Costco warehouses, as shown just below: Ea “Total number of warehouses 592. Warehouses having stcres with Food Court 586 ‘One-Hour photo centars 581 ‘Optica! dispensing centers 574 Pharmacies 529 Gas stations 268 Hearing aid centers 427 Print shops and copy centers, 40 Car washes 7 Sales in Costco’ ancillary businesses increased by 24 percent in 2011. Gasoline sales alone totaled nearly $9 billion, an increase of 40 percent over fiscal 2010. Only members were eligible to buy gasoline at Cost- o's discounted gasoline prices. Costco management believed that the availability of attractively priced gaso line at Costco warehouses acted to boost the frequency with which members shopped at Costco and made in-store purchases, Costcos pharmacies were highly regarded by members because ofthe low prices. A fac- tor contributing to Costcos low prescription prices, ‘was its three central fil facilites that cut the cost of filling a prescription by about 50 percent; these three facilities serviced most of Costco's West Coast ware- houses. Both prescription and over-the-counter drugs hhad strong sales and profit increases in fiscal 2011, ‘Treasure Hunt Merchandising While Costcos product line consisted of approximately 3,600 active 2010 2008 rd a 540. 527 512 488 534 521 508 482 530 518 504 400 523 509 498 472 480 464 451 429 349 23 307 279 357 303 274 237 10 10 a a 7 2 = = Note: Tha numbers for 2009 and 2011 exclude the $2 warehouses operated in Maxica,Strategic Management Casebook cn Pert2 Cases in Crafting and Executing Strategy items, some 20 to 25 percent of its product offerings ‘were constantly changing. Costco's merchandise buy- cers were continuously making 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 $1,000-$2,500 big-screen HDTVs, $800 espresso machines, expensive jewel: lery and diamond rings (priced from $50,000 to as high as $250,000), Movado watches, exotic cheeses, Coach bags, $5,000 neckhces, cashmere sports coats, $1,500 digital pianos, and Dom Perignon champagne. Dozens of featured specials came and ‘went quickly, sometimes in several days or a week— like Itlian-made Hathaway shirts priced at $29.99 ‘and $800 leather sectional sofas. The strategy was to entice shoppers to spend more than they might by offering irresistible deals on big-ticket items or name-brand specials and, further, to keep the mix of featured and treasure-huntitems constantly chang- ing so that bargain-hunting shoppers would go to Costco more frequently than for periodic “stock ‘up trips. Costco members quicily learned that they needed to go ahead and buy treasure-hunt specials that interested them because the items would very likely not be available on their next shopping trip. In ‘many cases, Costco did not obtain its upscale treasure hhunt items directly fom 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 inventor Management believed that these practices kept its marketing expenses low relative to those at typical retailers, discounter, and supermarkets Low-Cost Emphasis Keeping operating costs at a bare minimum was a major element of Costco's strategy and a key to its low pricing, As Jim Sinegal cexplained:!* Costco is able to offer lower prices and better values by ‘liminating virtually all the ills and costs historically sssociated with conventional wholesalers and retailers, including salespeople, fancy buildings, delivery, billing, sind accounts receivable. Werun a tight operation with ‘exemely low overhead which enables us «© pass on dramatic savings to our members While Costco management made a point of locating warehouses on high-traffic routes in or near upscale suburbs that were easily accessible by small businesses and residents with above-average incomes, it avoided prime real estate sites in order 10 contain land costs, Because shoppers were attracted. principally by Costco’ low prices and merchandise selection, most warehouses were of a metal pre- engineered design, with concrete floors and minimal interior décor. Floor plans were designed for econ: omy and efficiency in use of selling space, the han- dling of merchandise, and the control of inventory. Merchandise was generally stored on racks above the sales floor and displayed on pallets contin- ing large quantities of each item, thereby reducing labor required for handling and stocking. In-store signage was done mostly on laser printers; there ‘were no shopping bags at the checkout counter— merchandise was put directly into the shopping cart or sometimes loaded into empty boxes. Costco ware- houses ranged in size from 70,000 to 205,000 square feet; the average size was 143,000 square feet. Newer units were usually in the 150,000- to 205,000-square- foot range. Images of Castco’s warehouses are shown, in Exhibit 3. ‘Warehouses generally operated on a seven-day, 69-hour week, typicallybeingapen between 10:00a.m. and 8:30 p.m, weekdays, with earlier closing hours fon the weekend; the gasoline operations ouside ‘many stores usually had extended hours, The shorter hours of operation as compared to those of tradi- tional retailers, discount retailers, and supermarkets, resulted in lower labor costs relative to the volume of sales, Growth Strategy Costco's growth strategy ‘was to increase sales at existing stores by 5 percent or ‘more annually and to open additional warehouses, both domestically and. internationally. In fiscal 2011, sales at Costco’s existing warehouses grew by an average of 10 percent, chiefly because members, shopped Costco warehouses an average of four per- cent more often and spent about five percent more per visit than they did in fiscal 2010 (see Exhibit 1 for recent average annual sales increases at existing stores). In recent years, Costco had opened between, 14 and 34 new locations annually (Exhibit 1); ‘most were in the United States, but expansion was under way internationally as well. In fiscal 2011, Costco spent nearly $1.3 billion to open 20 new loca tions, two newiy relocated warehouses, and severalCosco Wholesale in 2012: Misio, Business Model, and Strategy Case2 Costco Wholesale in 2012: Mission, Business Model, and Strategy cn EXHIBIT 3 Images of Costco's Warehouses ‘Source: Cosice managerant presentation, May 29,2008 ana March 201. distribution depots. Average annualized sales for these newly opened warehouses was $103 million per warehouse, the highest-ever number in the company’s history. Costco opened 4 new warehouses in the United States and 2 new warehouses in Japan in fist four months ‘of fiscal 2012 (between August 28 and December 31, 2011), and management planned to open an additonal 12 new warehouses (including reopening the Tamasakat, Japan, warehouse damaged by the tsunami in early 2011, and relocating one Canadian warehouse) by the end ofits fiscal year on September 2, 2012. Exhibit 4 shows a breakdown of Costcds geo- ‘graphic operations for fiscal years 2005-2011, Marketing and Advertising Costco’ low prices and its reputation for making shopping at Costco something of a treasure-hunt ‘made it unnecessary to engage in extensive advertis- ing or sales campaigns. Marketing and promotionalStrategic Management Casebook cu Pert2 Cases in Crafting and Executing Strategy EXHIBIT 4 Selected Geographic Operating Data, Costco Wholesale Corporation, Fiscal Years 2005-20n1 ($ in millions) United States Canadian Other Intemational Ce Co on Year Ended August 28, 2011 ‘Total revenue (including membership fees) $84,904 $14,000 $9,991 09,915 ‘Oparating income 1,905, 2 423 2.499 Capital expencitures 878 144 270 1,200 ‘Number of warehouses 429 ee 81 592 Year Ended August 28, 2010 “Total revenue (including membership fees) «$59,624 s12601 se271 S77 48 ‘Operating income 1,310 547 220 2077 Capital expencitures 804 162 89 1,665, ‘Number of warehouses 416 73 45 540 ‘Year Ended August 30, 2008 ‘Total venue (including membership fees) $56,548 8 9797 35.197 $71,402 ‘Operating income 1,279 364 180 477 Capital expenditures ‘08 198 ait 1,280 ‘Number of warehouses 408 7” 44 27 ‘Year Ended September 2, 2007 ‘Total revenue (including membership fees) $51,532 8 e724 saiae $64,400 ‘Operating income 4207 287 105 1,€09 Capital expenditures 4,104 207 ™ 1.308 ‘Number of warehouses 983 n 34 488 Year Ended August 28, 2005 ‘Total revenue (including membership fees) $43,084 8 6702 $3,158 $52,952 ‘Operating income 41,188 242 65 4.474 Capital expenditures 734 140 122 25 ‘Number of warehouses 238 65 30 493 ‘Not: Tho detar numbers shown fer‘Other countries represent only Castco's onmarsip share sinc al fosign operations ware joint ‘entues(athough Costoo was the majority ower of these ventures the warehouses operated ey Coston Mexico in which Cosice was a [Sorpercent jt vertareparner were nt ncuded in the dala or he Other counties unt Fiscal Year 2011. ‘Source: Company 10-K reports, 20,2010, 2008, and 2007 activities were generally limited to monthly coupon ‘mailers to members, weekly e-mails to members from Costco.com, occasional direct mail to prospective ‘new members, and regular direct marketing programs (such as The Costco Connection, a magazine pub- lished for members), in-store product sampling, 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. Potential Gold Star (individual) members were contacted by direct mail ‘or by promotions at local employee associations and businesses with large numbers of employees. After a membership base was established in an area, most ‘ew memberships came from word of mouth (erist- ing members telling friends and acquaintances about their shopping experiences at Costco), follow-up mes- sages distributed through regular payroll or other ‘organizational communications to employee groups, and ongoing direct solicitations to prospective busi- ness and Gold Star members. Website Sales Costco operated two websites—www.costee.com in the United States and www.costeo.ca in Canada— both to enable members to shop for many in-storeCosco Wholesale in 2012: Misio, Business Model, and Strategy Case2 Costco Wholesale in 2012: Mission, Business Model, and Strategy products online and to provide members with a ‘means of obtaining a much wider variety of value priced products and services that were not practical to stock at the company’s warehouses, Examples of items that members could buy online at low Costco prices included sofas, beds, entertainment centers and TV lift cabinets, outdoor furniture, office furni ture, kitchen appliances, billiard tables, and hot tubs. ‘Members could also use the company’s websites for such services as digital photo processing, prescrip- tion fulfillment, travel, the Costco auto program (for purchasing selected new vehicles with discount prices through participating dealerships), and other mem- bership services, At Costeos online photo center, cus tomers could upload images and pick up the prines at their local warehouse in litte over an hou. Supply Chain and Distribution Costes bought the majerty ofits merchandise directly from manufacturers, routing it either directly to its warehouse stores or to one of the company’s cross locking depots that served as distribution points for nearby stores. Depots received container-bised shipments fom manuficturers and reallocated these goods for combined shipment to individual ware- houses, generally in less than 24 hours. This maxi mized freight volume and handling efficiencies. Going into 2012, Costco had 12 regional cros-docking depos in the United Sites, 4 such depots in Canada, nd 4 depots at various other international locations, which had a combined space of 8.3 milion square feet. When merchandise arrived at warehouse, twas ‘moved straight to the sles floor; very lite was stored in locations off the sales oor in order to minimize receiving and handling cost. Costco had direc buying relationships with any producers of national brand-name merchandise (including Canon Casio,Coca-Cola, Copate-Palmolv, Del, Fuji Hewlett-Packard, Kimberly-Clark, Kodak, Levi Strauss, Michelin, Nese, Panasonic, Procter & Gamble, Samsung, Sony, KitchenAid, and Jones of New York) and with manufactures that supple is Kirkland Signature products. No one manufactrer supplied a significant percentage of the merchandise that Costco stocked. Costco had not experienced diff culty in obtaining sufcent quantities of merchandise, ‘and management believed that if one or more of itscur- rent sources of supply beame unavalable, the company Seale nrtch Ie abuoes alesis mamstie es without experiencing a substantial disruption ofits busines. cas Costcas merchandise buyers were always alert for ‘opportunities to add products of top quality manu. facturers and vendors. In fiscal 2011, the company established new relationships with Precor (a maker of premium fitness equipment), Cannon Gun Safes, Stanley Tools, Craftsman, Asics, Hartmana, Hurley (a popular maker of youth apparel and a Nike sub. sidiary), and Spanx (a well-known maker of body- slimming undergerments). Additionally the company introduced a co-branded product with both the Kirkland Signature and the Cinnabon names on the package of cinnamon rolls sold in Costco bakeries; a co-branded turkey breast with Foster Farms; 2 new ready-to-drink green tea in partnership with Ito En, a leading Japanese food company; and finally, an assort- ‘ment of canned soups that were co-branded with the ‘Campbell Soup Company. Costco's Membership Base and Member Demographics Costco attracted the most afflint customers in ds count retalingthe average income of individual ‘members was about $75,000 with over 30 percent of sembers having nual incomes of $100,000 or mor. Many members were affluent urbanites, ling in nice neighborhoods not far from Costco warehouses. One loyal Executive member, a criminal defense lawyer, sald, “I think I spend over $20,000-$25,000 a year buying all my products here from food to dothing— encept my sts. | have to buy them at the Armani stores” Another Costco loyalist said, "This is the best place in the world. Is like going to church on Sunday. You canttget anything beter than this. This is iaaeenen Costco had tvo primary types of memberships: Business and Gold Star (individual). Gold Star mem- berships were for individuals who did not qualify for a Business membership. Businesses—incuding ind- Viduals with a business lense, retail sales license, or other evidence of business exstence—qualified as Business members, Beginning in Novenber 2011, business members in the United States and Canada paid an annual membership fe of $55 forthe primary Iembership card, which also included a household membership card. These members could also pur- chase add-on membership cards for an annual fee of 855 each for partners or associates in the busines. A significant number of business members aso shopped 2 Costzo far their personal needs Individuals in the United States and Canada who did not qualify for business membership couldStrategic Management Casebook cas Pert2 Cases in Crafting and Executing Strategy purchase a Gold Star membership for an annual fee of $55, which included a household card for another family member. In addition, both business and indi- vidual (Gold Star) members could upgrade to an Executive membership for an annual fee of $110. Executive members were entitled to an additional 2 percent savings on qualified purchases at Costco (redeemable at Costco warehouses), up to a maximum rebate of $750 per year. Executive members also were cligible for savings and benefits on various business ‘and consumer services offered by Costco, including merchant creditcard processing, small-business loans, auto and home insurance, long-distance telephone service, check printing, and real estate and mortgage services; these services were mostly offered by third party providers and varied by state. In fiscal 2011, ‘Executive members represented 38 percent of Costco's primary membership base and generally spent more than other members, Recent trends in membership are shown at the bottom of Exhibit 1. Members could shop at any Costco warehouse, Member renewal rates ‘were about 89 percent in the US. and Canada, and approximately 86 percent on a worldwide basis. 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 atthe point of sale until restitution ‘was made, The membership format facilitated stricly controlling the entrances and exits of warehouses, resulting in limited inventory losses of less than two: temths of 1 percent of net sales—well below those of ‘typical discount retail operations. Warehouse Management Costco warehouse managers were delegated consider able authority over store operations. In effect, ware hhouse managers functioned as entrepreneurs running ther own retail operation, They were responsible for coming up with new ideas cbout what items would sell in their stores, effectively merchandising. the ever-changing lineup of tresure-hunt products, and orchestrating in-store product locations and displays to maximize sales and quick turnover. In experi menting with what items to stock and what in-store merchandising. techniques to employ, warehouse Inanagers had to know the dlentele who patronized ther locations —for instance, big-ticket damonds sold well at some warehouses but not at others. Costco’ best managers kept their finger on the pulse of the members who shoppeé their warehouse location to stay in syne with what would sell well, and they had a flair for creating certain element of excitement, hum, and buzz in their warehouses, Such managers spurred. above-average sales volumes—sales at Costco top. volume warehouses ran about $4 million to $7 milion ‘a week, with sales exceeding $1 million on many cays Successful managers also thrived on the rat race of running a high-traffic core and solving the inevitable ctises of the moment Compensation and Workforce Practices InSeptember2011,Costcohad92,000full-timeemploy- ees and 72,000 part-time employees, including approx- imately 9,000 people employed by Costco Mexico, whose operations were not consolidated in Costco’ financial and operating results. Approximately 13.600 hourly employees at locations in California, Maryland, New Jersey, and New York, as well as atone warehouse in Virginia, were represented by the International Brotherhood of Teamsters. All remaining employees Starting wages for new Costco employees were in ‘the $10-$12 range in 2011; hourly pay scales for ware house jobs ranged from $12 to $23, depending on the type of job. Salaried employees in Costco warehouses, could earn anywhere from $30,000 to $125,000 annu- ally. For example, salaries for merchandise manag- ers were in the $58,000 to $68,000 range; salaries for supervisors ranged from $45,000 to $73,000; and sala- ries for general managers of warehouses were in the {$90,000 to $125,000 range. Employees enjoyed the full, spectrum of benefits. Sclaried employees were eligible for benefits on the first of the month after the date of hire. Full-time hourly employees were eligible for benefits starting the first of the month after working a probationary 90 days part-time hourly employees became benefit-eligible on the first of the month after ‘working 180 days, The beneftt package included the following: + Health and dental care plans. Full-time employ. e2s could choose from two different health care plans (a freedom-of choice health care plan and a choice-plus plan) and two dental plans (a core den- tal plan and a premium dental plan) A choice-plus health cate and a core dental plan were available for part-time employeesCosco Wholesale in 2012: Misio, Business Model, and Strategy Case2 Costco Wholesale in 2012: Mission, Business Model, and Strategy + Convenient prescription pickup at Costco’s phar: ‘macies, with co-payments of $3 for generic drugs and 15 percent for brand-name drugs, subject toa ‘minimum co-pay of $10 for brand-name drugsand ‘2 maximum co-pay of $50. +A vision program that paid up to $60 for a refrac tion eye exam (the amount charged at Cosco’ optical centers) and had $150 annual allowances for the purchase of glasses and contact lenses at ‘Costco Optical departments or $100 annual allow. ances if purchased elewhere. + A 401(&) plan in which Costco matched hourly ‘employee contributions by 50 cents on the dollar for the first $1,000 annually to a maximum com pany match of $500 per year. Eligible employees qualified for additional company contributions ‘based on the employees years of service and eligible ‘earnings. The company’s union employees on the West Coast qualified for matching contributions of 50 cents on the dolar to a maximum company ‘match of $250 a year, eligible union employees qualified for additional company contributions based on straight-time hours worked. Company contributions to employee 410(k) plans were $287 million in fiscel 2009, $313 million in fiscal 2010, and $345 million in fiscal 2011. + A dependent care reimbursement plan in which ‘Costco employees whose families qualified could pay for day care for children under 13 or adult day care with pretax dollars and realize savings of any- ‘where from $750 to §2,000 per year. + Confidential professional counseling services. + Company-paid long term disability coverage equal to 60 percent of earnings if out for more than 180 days on a non-worker’s compensation leave of absence. + All employees who passed their 90-day probation period and were working at least 10 hours per ‘week were automatically enrolled in a short-term disability plan covering non-work-related injuries for illnesses for up 10 26 weeks. Weekly short-term disability payments equaled 60 percent of average ‘weekly wages up to a maximum of $1,000. + Generous life insurance and accidental death and dismemberment coverage, with benefits based on years of service and whether the employee worked full-time or parttime. Employees could elect to purchase supplemental coverage for themselves, their spouses, or ther children. cu + An employee stock purchase plan allowing all ‘employees to buy Costco stock via payroll deduc- tion so as to avoid commissions and fees. + A-health care reimbursement plan in which benefit cligible employees could arrange to have pretax ‘money automatically deducted from their paychecks ‘and deposited ina health care reimbursement account that could be used to pay medical and dental bills. + A long-term care insurance plan for employees ‘with 10 or more years of service. Eligible employees could purchase a basic or supplemental policy for ‘nursing home care for themselves, their spouses, or their parents (including in-laws) or grandparents (including in-laws). ‘Although admitting that paying good wages and good. benefits was contrary to conventional wisdom in dis count retailing, Jim Sinegal was convinced that having a well-compensated workforce was very important to executing Costco’ strategy successfully, He sald, “Imag. ine that you have 120,000 loyal ambassadors out there ‘who are constantly saying good things about Costco. It has to be a significant advantage for you. ... Paying ‘good wages and keeping your people working with you is very good business”"* When a reporter asked him about why Costco treated its workers so well compared to other retailers (particularly Walmart, which paid lower wages and had a skimpier benefits package), Sin egal replied: “Why shouldnt employees have the right to good wages and good careers... It absolutely makes, good business serse. Most people agree that were the lowest-cost producer. Yet we pay the highest wages. So it must mean we get better productivity. Its axiomatic in our business—you get what you pay for””” Good wages and benefits were said to be why employee turnover at Costco typically ran under 6 to7 percent afer the first year of employment. Some Costco employees had been with the company since its founding in 1983. Many others had started work- ing part-time at Costco while in high school or col- lege and opted to make a career at the company. One Costco employee told an ABC 20/20 reporter, “Its a good place to work; they take good care of us?” A Costco vice president and head baker said working for Costco was a family affair: “My whole family works for Costco, my husband does, my daughter does, my new son-in-law does”!® Another employee, a receiv ing clerk who made about $40,000 a year, sid, “I want to retire here. I love it here” An employee with over two years of service could not be fired without the approval ofa senior company officerStrategic Management Casebook cu Selecting People for Open Positions Costco’ top management wanted employees to feel that they could have a long career at Costco. It was ‘company policy to fill the vast majority ofits higher level openings by promotions from within; at one recent point, the percentage ran close to 98 percent, ‘which meant that the majority of Costco's manage- ‘ment team members (including warehouse, mer- chandise, administrative, membership, front end, and receiving managers) had come up through the ranks. ‘Many of the company’s vice presidents had started in entry-level jobs. According to Jim Sinegal, "We have ‘guys who started pushing shopping carts out on the parking lot for us who are now vice presidents of our ‘company? Costco made a point of recruiting at local universities; Sinegal explained why: “These people are smarter than the average person, hardworking, ‘and they haven't made a career choice”? On another ‘occasion, he said, “If someone came to us and said he just got a master’ in busines at Harvard, we would say fine, would you like to start pushing carts” ‘Those employees who demonstrated smarts and strong people management skills moved up through theranks. But without an aptitude for the details of discount retailing, even up-and-coming employees stood no chance of being promoted toa position of warehouse ‘manager. Sinegal and other top Costco executives who ‘oversaw warehouse operations insisted that candi- dates for warehouse managers be top-flight merchan isers with a gift for the details of making items fly off the shelves. Sinegal said, “People who have a feel fort just start to get it. Others, you look at them and its lke staring at a blank canvas. I'm not trying to bbe unduly harsh, but thats the way it works"** Most nevily appointed warehouse managers at Costco came from the ranks of assistant warehouse managers who hada track record of being shrewd merchandisers and ‘tuned into what new or different products might sell ‘well given the clientele that patronized their particular ‘warehouse. Just having the requisite skills in people management. crisis management, and cost-effective ‘warehouse operations was not enough. Executive Compensation Executives at Costco did not earn the outlandish salaries that had. become customary over the past decade at most large corporations. In fiscal 2011, both Jeff Brotman. ‘and Jim Sinegal each received a salary of $350,000 ‘and a bonus of $198,400 (as compared to salaries of $350,000 and bonuses of $190,400 in fiscal 2010). Pert2 Cases in Crafting und Executing Strategy As of late 2011, Brotman owned or had exercisable ‘options for about 550,000 shares of Costco stock; Sin- egal owned or had exercisable options for 2.35 million shares of Costco stock. Craig Jelinek’s salary as Presi- dent and Chief Operating Officer in fiscal 2011 was 649,999, and he received a bonus of $99,200, Other high-paid officers at Costco received salaries in the '$575,000-$645,000 range and bonuses of $79,000- '$89,000, Sinegal explained why executive compen- sation at Costco was only a fraction of the amounts typically paid to top-level executives at other corpora. tions with annual sales of $75 billion to $90 billion: “I figured that if I was making something like 12 times ‘more than the typical person working on the floor, that that was a fair salary’”* To another reporter, he said: “Listen, I'm one of the founders of this business. ve been very well rewarded. I don't require a salary that’s 100 times more than the people who work on the sales floor” Sinegal’s employment contract was, only a page long and provided that he could be termi. nated for cause. Costco’s Business Philosophy, Values, and Code of Ethics Jim Sinegal, who was the son of a steelworker, had Igaiel the Gaple aod demsctrcarth badecs principles into Coste corporate culture and the Tmunner in which the company operated. ‘The fl Towing are excerpts ofthese principles and operating approaches 1. Obey the law—The lw is irrefutable! Absent @ ‘mol perio urchalegea ny We ist cr doctor Furic total eerie ri ts of every community wire we do business: We pledge to: Comply with “all laws eee > Respect ll publi ofica and th poco Comply with sty and security aandards for al products sold «Hevea ecological dents Gaal is wy oomity whess we do bao, + Comply with all applicable wage and hour ws. Comply with all applicable antitrust laws, + Ceuta i and with feign ei ‘tries in a manner that is legal and proper under United Sates and foreign laws and other legalCosco Wholesale in 2012: Misio, Business Model, and Strategy Case2 Costco Wholesale in 2012: Mission, Business Model, and Strategy ce + Not offer, give, ask for, or receive any form of bribe or Kickback to or from any person or pay to expedite government action or otherwise act in violation of the Foreign Corrupt Practices ‘Actor the laws of other countries. + Promote fair, accurate, timely, and understand- able disclosure ia reports filed with the Secu: rities and Exchange Commission and in other public communications by the Company. 2, Take care of our members—Costco membership is open to business owners, as well as individuals. ‘Our members are our reason for being—the key to ‘our success, If we dorit keep our members happy, little else that we do will make a difference. There are plenty of shopping alternatives for our mem: bers, and if they fal to show up, we cannot survive. ‘Our members have extended a trust to Costco by vvirtue of paying a fee to shop with us. We will suc- ceed only if we do not violate the trust they have ‘extended to us, and that trust extends to everyarea ‘of our business. We pledge to: + Provide top-quality products at the best prices in the market. + Provide high-quality safe, and wholesome food products by requiring that both vendors and employees be in compliance with the highest food safety standards in the industry. + Provide our members with a 100 percent satisfac tion guaranteed warranty on every product and service we sell, inciuding their membership fee. + Assure our members that every product we sell is authentic in make and in representation of performance. + Make our shopping environment a pleasant experience by making our members feel wel- come as our guess + Provide products to our members that will be ecologically sensitive. + Provide our members with the best customer service in the retail industry. + Give back to our communities through employee volunteerism and employee and cor porate contributions to United Way and Chil- drenis Hospitals. 3. Take care of our employees—Our employees are ‘our most important asset. We believe we have the very best employees in the warehouse club indus ‘try, and we are committed to providing them with rewarding challenges and ample opportunities for personal and career growth, We pledge to provide ‘our employees with: + Competitive wages. + Great benefits + Assafe and healthy work environment, + Challenging and fun work. + Career opportunities. + An atmosphere free from harassment or discrimination, + An Open Door Policy that allows access to ascending levels of management to resolve issues. + Opportunities to give back to their communi- ties through volunteerism and fundraising . Respect our suppliers—Our suppliers are our partners in business and for us to prosperas a com: any, they must prosper with us. To that end, we strive to; + Treat all suppliers and their representatives as. ‘we would expect to be treated if visiting their places of business, + Honor all commitments. + Protect all suppliers’ property assigned to Costco as though it were our own. + Not accept gratuities of any kind from a supplier, + Avoid actual or apparent conflicts of interest, including creating a business in competition with the Company or working for or on behalf of another employer in competition with the ‘Company. 1+ Ifin doubts to what courte of actionto take on 1a business matter that is open to varying ethi- cal interpretations, TAKE THE HIGH ROAD AND DO WHAT IS RIGHT. If we do these four things throughout our orga- nization, then we will achieve our ultimate goal, which is to: . Reward our sharcholders—As a company with stock that is traded publicly on the NASDAQ stock ‘exchange, our shareholders are our business part: ners. We can only be successful so long as we are providing them with a good return on the money they invest in our company. ... We pledge to oper: ate our company in such a way that our present and future stockholders, as well as our employees, will be rewarded for our effortsStrategic Management Casebook ca Pert2 Cases in Crafting and Executing Strategy Environmental Sustainability In recent years, Costco management had undertaken several initiatives to reduce the company’s carbon foot print by investing in various environmental and energy saving systems. Going into 2012, Costco had rooftop solar photovoliaic systems in operation at 60 of its faclites, which were projected to generate 55 million kWh of electricity per year. Costco’ metal warehouse design, one of several warehouse desig styles the com: pany had utilized over the pat several years, was con sistent with the requirements of the Silver Level LEED Standard—the certification standards ofthe organiza tion Leadership in Energy and Environmental Design (LEED) were nationally accepted as a benchmark green building design and corstruction, Costeas metal building envelopes were all insulated to meet or exceed ccurent energy code requirements, and the main building structure used 100 percent recycled steel material. The roof materials teed on Cotten metal pre-engineered warehouses were 100 percent recycled standing seam metal panels, designed to maximize eff ciency for spanning the structare;and the exterior skin oftie building was also 100 percent recycled metal, Costco was continuing to expand the use of non- chemical water treatment sysems used in warehouse codling towers to reduce the amount of chemicals going into sewer systems In addition, the tons of trash that, ‘warehouses generated each week, much of which was ‘once sent to landfills, was being recycled into usable products. Grease recovery systems bad been installed in 257 warehouses, resulting in the recovery of more than four million pounds of grease from the waste stream. Costco had been an activemember of the Environ- mental Protection Agency’s Energy Star and Climate Protection Partnerships since 2002 and was @ major retailer of Energy Star qualified compact florescent lamp (CFL) bulbs. Costco sold more than 35 million energy-saving CFL bulbs ard 9 million LED light bulbs in the US. during 2011; since 2005, Costco had sold over 204 million energy-saving light bulbs. COMPETITION ‘Thewholesale club and warehouse segment of retailing in North America was a $155 billion business in 2011, and it was growing 15-20 percent faster than retail ing as a whole, There were three main competitors— Costco Wholesale, Sams Club, and BJs Wholesale ‘Club. In early 2012, there were about 1,400 warehouse locations across the United States and Canada; most, every major metropolitan area had one, if not several, warehouse clubs. Costeo had just over a $7 percent share of warehouse club sales across the United States and Canada, with Sams Club (a division of Walmart) having roughly a 35 percent share and BY’s Wholesale Club and several small warehouse club competitors about an 8 percent share, Competition among the warehouse clubs was based on such factors as price, merchandise quality and selection, location, and member service. How- ever, warehouse clubs also competed with a wide range of other types of retailers, including retail dis counters like Walmart and Dollar General, supermar- kets, general merchandise chains, specialty chains, gasoline stations, and Internet retailers. Not only did ‘Walmart, the world’s lagest retailer, compete directly with Costco via its Sams Club subsidiary, but its ‘Walmart Supercenters sold many of the same types of ‘merchandise at attractirely low prices as wel. Target, Kohl’, and Amazon.com had emerged as significant retail Competitors in certain general merchandise cat egories. Low-cost operaiors selling a single category or narrow range of merchandise—such as ‘Trader Joe, Lowes, Home Depot, Office Depot, Staples, Best Buy, Circuit City, PetSmart, and Barnes & Noble—had sig- nificant market share in their respective product cat- cegories. Notwithstanding the competition from other retailers and discounters, the low prices and merchan- dise selection found at Costco, Sams Club, and BY’ Wholesale were attractive to small business owners, individual households (particularly bargain-hunters, and those with large families), churches and non profit organizations, caterers, and small restaurants. ‘The internationally located warehouses faced similar types of competitors Brief profiles of Costco's two primary compett- tors in North America are presented in the following sections, Sam's Club ‘The first Sams Club opened in 1984, and Walmart ‘management in the ensuing years proceeded to grow the warchouse membership club concept into a sig: nificant business and major Walmart division. The concept of the Samis Club format was to sell merchan- dise at very low profit margins, resulting in low prices to members, The mission of Samis Club was "to make savings simple for members by providing them with exciting, quality merchandise and a superior shopping experience, all at a great value?™* In early 2012, there were 611 Samis Club locations in the United States with 49 million members andCosco Wholesale in 2012: Misio, Business Model, and Strategy Case2 Costco Wholesale in 2012: Mission, Business Model, and Strategy ca record-high fiscal 2012 sales of $53.8 billion; many Sams Club locations in the United States were adja~ cent to Walmart Supercenters. There were an addi- tional 140 San’s Club locations in Mexico, Brazil, and ‘China, and plans called for Sams Club to open 10 to 15 additional locations by January 2013. Samis Clubs ranged between 70,000 and 190,000 square feet, with the average being about 133,000 square feet. ‘All Sams Club warehouses had concrete floors, sparse décor, and goods displayed on pallets, simple ‘wooden shelves, or racksin the case of apparel. In 2009 2010, Samis Club began 2 long-term warehouse remod- cling program; 52 remodels were completed in 2009 ‘and about 70 more remodels were completed in 2010. ‘Additional remodels were undertaken in fiscal years 2011 and 2012, with more scheduled for fiscal year 2013. Exhibit 5 provides financial and operating high- lights for selected years during 2001-2012. Merchandise Offerings Sams Club warehouses stocked about 4,000 items, big fraction of which were standard and a small fraction, ‘of which represented special buys and one-time offer- ‘ngs. The treasure-hunt items at Sam's Club tended to be less upscale and carry lower price tags than those at Costco, The merchandise selection included brand-name merchandise in a variety of categocies: ‘canned goods, cereals, spices, packaged foods, paper products, detergents and cleaning supplies, health and wellness, apparel, electronics, software, small appliances, DVDs, books and games, jewelry, sport- ing goods, toys, tires and batteries, office supplies, res- ‘aurant supplies, institutional foods, and a selection of private-label items sold under the “Member's Mark” “Bakers & Chefs'and “Samis Club” brands. Most club locations had fresh-foods departments that incinded bakery, meat, produce, floral products, and a Sams Café. A significant number of clubs had a one-hour photo processing department, a pharmacy that filled prescriptions, an optical department, and self-service gasoline pumps. Sams Club guaranteed it would beat any price for branded prescriptions. In 2010, Sams Club pharmacies received the highest score inthe Pre- scription Ordering and Pickup Process factor in a J.D. Power and Associates study. Members could shop fora, ‘wider assortment of merchandise and services on at www.samsclub.com. The percentage composition of sales across major merchandise categories is shown. in the table at the bottom of this page. In February 2012, there were media reports that ‘Apple and Samis Club were exploring the expansion of Apples presence at as many as 50 Sams Club loca- tions. It was as yet unclear whether the expansion ‘would take the form of a mini-Apple store in the electronics section of a Sam’s Club warehouse or whether the partnership would just entail expand- ing the lineup of iPhones, Pods, and iPads that Sams Club already had to include selected Mac computer ‘models. In December 2010, Apple and Costco agreed that Apple products would no longer be sold at Costco, due (in part) to a restriction that kept Costco from being able to sell Apple's products online. Membership and Hours of Operation ‘The annual fee for Sam's Club business members was $35 for the primary membership card, with a spouse card availble at no additional cost. Business ‘members could add up to eight business associates for $35 each. The annual membership fee for an individual ey a Ee Grocery and consumable (dairy, meat, bakery del, roduc, dry, child or ozon ‘ackagod ode, aleoolo and nonalochole Boveragos, feral, snack food, ancy, ether grocery roms, health and beauty aids, papor goods laundry and home cao, baby caro pot supplies, and ether consumable toms ane grocery tons) Fuel and othr categories (cbacco, snac foods, tools and power equipment, sales ‘of gasoline, and tre and battery centers) Technology, ofice and entertainment (electronics, wireless, software, video games, movies, books, musi, toys, offce supplies, ofce furniture and photo processing} Home and apparel (home improvement, outdoor ving, grils, gardening, furniture, ‘apparel, jewelry, house wares, seasonal items, mattresses, and small appliancos) Health and weliness (otarmacy and optical services, and overthe-counter drugs)