Author: Zachary Crockett
Source: The Hustle (https://thehustle.co/costco-membership-economics)
CEOs and management teams of companies are typically expected to focus on maximising shareholder value. Here’s a company whose investors have always complained for putting its customers and employees ahead of its shareholders and yet achieved greatness and delivered shareholder value – Costco, the American brick & mortar retail company. Today when most brick & mortar retail companies are struggling due to the onslaught unleashed by e-commerce companies, Costco is witnessing steady growth. This piece in The Hustle summarises how Costco built its empire by flying in the face of traditional wisdom:
“On first impression, Costco makes no sense. It is a place where you can buy, in the course of one trip, a 27-pound bucket of mac and cheese, a patio table, a wedding dress, a casket, a handle of gin, a tank of gas, a passport photo, a sheepskin rug, a chicken coop, prescription medications, life insurance, a $1.50 hotdog, and a $250,000 diamond ring. Items sit on wooden pallets in dark, unmarked aisles. Brand selection is limited. And you pay a $60 annual membership fee just to get in the door.
The end goal: To cut the “fat” out of traditional retail and pass on the savings to loyal customers and employees. This philosophy often anguishes Costco’s shareholders — but it has also earned the company a cult following around the world. At a time when brick-and-mortar retail is crumbling at the feet of e-commerce, Costco has experienced steady growth. How did this nondescript chain of warehouses find success?
1. It refuses to boost markups: “If [saving the customer money] doesn’t turn you on,” Sinegal, who retired as CEO in 2012, once said, “then you’re in the wrong business.” Surely enough, Costco’s immense buying power allows it to finagle deep discount deals with vendors, and the savings are always passed down to its shoppers. Costco has stated in the past that it caps its markups at 14% for brand-name items, and 15% for its in-house Kirkland brands — even wine, which is notorious for its 200% to 300% markups elsewhere. But according to the company’s 2018 annual report, the average item in the store is only marked up 11%, compared to the 25%-50% often seen in retail. That means that if Costco pays $100 wholesale for, say, a pound of Wagyu beef, it sells it to you for a mere $111. Because Costco buys in such large volumes, its purchase price is often lower than other retailers to begin with; add in the company’s reduced markups, and you’ve got yourself a much cheaper piece of meat. In fact, Costco’s prices are so low that it barely breaks even on its merchandise sales. So, how does Costco make its money?
2. It charges people to enter its stores: Costco’s members gladly pay annual fees ($60 for “Gold Star” and $120 for “Executive”) because they believe that having access to the chain’s economies of scale and bulk quantities justifies the upfront cost. As of 2018, 51,600,000 people pay Costco membership fees, good for $3.14B in annual revenue. More impressively, the renewal rate is a whopping 90%….
3. It stocks massive volumes of few products: Prevailing retail wisdom tells us that excess choice is good — that shoppers want to walk down the chip aisle and be able to pick from 100 varieties and brands. Costco, on the other hand, acts as a bulk curator for its customers. The average warehouse stocks just 3,700 SKUs at any given time, less than 1/10th of most supermarkets’ 40,000 to 50,000 items, and not much more than the average corner store. Often, Costco provides only one or two brands in a given category……
4. It reengineers products to be cheaper: Because Costco stocks limited inventory in massive amounts, it is extremely fickle about the vendors it chooses to work with. When Costco comes across a product it likes, it often spends months working closely with the vendor and its factories to both reduce the price of an item and amp up its quality…
5. It realizes the economic incentive for treating employees well: Retail workers are among America’s lowest-paid employees, earning an average of around $10 per hour. They rarely get full benefits, and their employers view them as expendable (turnover rates are as high as 65%). But Costco realizes that it is more cost effective to retain happy employees and — brace yourself — actually pay them a livable wage, than it is to churn and burn. The average pay among its 245,000 workers (143,000 full-time, 102,000 part-time) works out to $21 per hour, double the national retail average and nearly 2x Walmart’s going rate. Moreover, 88% of Costco workers receive company-sponsored health insurance…..[leading to higher retention which reduces hiring and training costs and increases worker productivity].
6. It values its customers over its shareholders: CEOs of public companies often blame unpopular decisions — price hikes, layoffs, cutting corners — on their “responsibility to maximize shareholder value.” In the last 30 years, the percentage of corporate profits going to stockholders has increased from 50% to 86%, resulting in fewer deals for customers and less money for employees. This investor-first mentality has, in many ways, harmed American industry. Since the day Costco went public in December of 1985, investors have complained that the company has been “too generous” with its customers and employees. They’ve called for higher markups on goods, steeper prices, and reduced benefits for workers.
But Costco has always insisted that their policies aren’t just altruistic — they’re good for business: By sticking to their principles, stock has gone up 387% since 2000. “On Wall Street, they’re in the business of making money between now and next Thursday,” Sinegal told the New York Times in 2005. “We can’t take that view. We want to build a company that will still be here 50 years from now.” In other words, about twice as long as the shelf life on its 27-pound tubs of mac and cheese.
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