Assignment 2: Costco Wholesale

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Case Study Assignment 2: Costco Wholesale

1. What is Costco’s business model? Is the company’s model appealing? Why or why not. Costco’s business model is to generate high sales volume and rapid inventory turnover by offering members very low prices on a limited selection of nationally branded and select private-label products in a wide range of merchandise categories.
The company’s business model is appealing from an operational standpoint; in the pursuit of its goal of selling a high volume of product at low prices it necessitates operating efficiencies to be sustainable. These operating efficiencies create core competitive advantages/strengths to Costco. The following are additional reasons why I find Costco’s business model appealing.

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Rapid inventory turnover
enabled Costco to receive cash before inventory payment due date. Cash on hand enabled Costco not only to achieve additional finance saving by paying within terms but importantly within discount terms and use those savings to finance additional purchases.
Consider the following; using FYE 2008 merchandise cost of $63.5 billion
Costco could realize non-operating income of $1.3 billion by paying within discounted terms assuming 2% discount term.

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An important criterion for a business model is whether or not the company is capable of generating positive income.
The financial data in Case 2 shows the following FYE results ($ in millions) which further demonstrates the appeal of the business model.

Operating Income
Net Income
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2008
1,969
1,283

2007
1,609
1,083

2006
1,626
1,103

2005
1,474
1,063

In addition an article by Timothy M. Otte dated February 13, 2008 states
“while the rest of the retail world is trying to figure out how to make money in a flat to down comp-sales environment Costco is running an 8% comp growth through its first 22 weeks of this fiscal year”. Its important to note that in reviewing Costco’s 2009 annual report, financial highlights, comparable sales growth for YE 2008 was 8% in comparison to 6% YE 2007.

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As of 3:30 pm EST January 21, 2010 stock price for Costco and its principal competitors were as follow. Given the economic downturn investor confidence in Costco is still high as shown by the premium stock price in comparison to its competitors. Stakeholder should be please with their value positions. Costco
Target Corporation
Wal-Mart
BJ’s Whole Sale Club

57.45 (COST)
50.30 (TGT)
52.90 (WMT)
34.14
(BJ)

2. What are the chief elements of Costco’s strategy? How good is the strategy?
The chief elements of Costco’s strategy can be broken down into the following.
• Low prices.
• Limited product line and limited selection
• A treasure hunt shopping environment.
• Business expansion.
Low prices: Costco is known for selling premium quality products at prices consistently below that of other wholesale and retail outlets. This was achieved through the implementation of a strategy to cap the margin on name brand merchandise at 14 percent; compared to industry margins of 20 to 50 percent. Private label merchandise such as
Kirkland signature items were caped at 15 percent which still afforded them a cost advantage of 20 percent. The strategy is good for Costco as it allows it to maintain its lead in this segment of the retail market and cements its long term sustainability. As Jim
Sinegal stated “we’re trying to build and organization that’s going to be here fifty years from now”. The strategy keeps shoppers returning to avail themselves to the cost savings.
Product selection: Costco has a slimed down product selection menu of 4000 items many which are sold only in big container or multi-pack quantities. This has allowed Costco’s managers to recognize and offer faster selling products to its customers; consider the product selection offered by its competitors i.e. BJ’s 7300 items. This allowed for a faster turnover of inventory and gave Costco an enviable cash position, note the financial ratio below. An important part of Costco product offering is its ancillary business which covered such items as, gasoline, pharmacy, food court, hearing aid and travel. These offerings allowed for a more relaxed shopping experience with members spending more time within the warehouse which translates into higher purchases. Ancillary product accounted per 2009 annual report accounted for 15 percent of net sales.
FYE 2008 ($ in millions)
Current Assets
Current Liabilities
Working Capital

9,462
8,874
588

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Treasure-Hunt Merchandising: Of the 4000 items Costco offered approximately 1000 of these fell under the category of treasure hunt items. These items many of which are high end products are constantly changing and are priced to ensure quick turnover of inventory. The key idea being a bargain you will not see again. This strategy component is enabled by the demographic make up of Costco’s members; with annual average of individual income of $75 K and 30 percent of members with incomes of $100 K.
Business expansion: The environment in which Costco competes necessitates company growth; external growth .i.e. warehouses and product line growth to capture profitable market segment. Companies such as Costco which compete on price need purchasing clout or symbiotically beneficial upstream arrangements. Costco has approached this by entering new markets nationally and globally, see warehouses in operation numbers below as noted in Costco’s annual report 2009 financial highlights. By being astute merchandisers and recognizing opportunities Costco opened Costco Home in 2004; case study 2 by Thompson Arthur A., states sales increased 132% in 2005 over 2004 levels.
FYE
Number of Warehouses

2005
433

2006
458

2007
488

2008
512

2009
527

This strategy has evidently been good for Costco, store opening has increased year on year through 2009 which has been facilitated by a strong financial position, P& L and balance sheet. Net income has remained positive as shown below, also Costco’s long – term debt to capital ratios show its balance sheet strength for same period.
FYE ($ in the millions)
Net Income
Long term debt to capital ratio

2005
1,283
7.4%

2006
1,083
2.3%

2007
2008
1,103 1,063
19.6% 19.4%

3. Do you think Jim Sinegal is an effective CEO? What grade would you give him in crafting and executing Costco’s strategy? What support can you offer for these grades?
Refer to figure 2.1 in chap 2 in developing your answer.
Yes, I do believe Jim Sinegal is an effective CEO. I would give him an A in crafting and executing Costco’s strategy. Jim Sinegal had a vision for Costco which is to be the leader in providing quality product at the lowest price and he has achieved this. He has been able to communicate his vision not only to stockholders and employees which garnered financing and a team to implement his vision but critically to the audience he serves;
Costco’s members have rewarded Costco’s through their pockets, by making Costco a financially viable and sustainable entity and their loyalty by having an 87% renewal rate.
Jim Sinegal by his easy but shrewd demeanor, ongoing evaluation and oversight of warehouse activity has ensured Costco’s industry leadership.

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4. How well is Costco performing from a financial perspective? Do some numbercrunching using the data in case exhibit 1 to support your answer. Use the financial ratios presented in "A Guide to Case Analysis" and in table 4.1 of the text to help you diagnose
Costco 's financial performance. How does the company compare to Sam 's Club and BJ 's
Wholesale?
Costco for the period in review is performing consistently year to year. The following key financial ratios outline my reason.
Profitability Ratios:
• Operating profit margins which shows profitability of current operations remained flat; this is to be expected when Costco’s price strategy is considered. A continued disciplined approach in cost centers and efficient purchasing techniques to achieve best possible product price is required maintain the positive but low margins. • Return on stockholders equity shows a company that is stable consistent company it shows incremental increase for the period in question and importantly is within the range of 12-15% which is considered average; the trend however is positive.
This reflects a company for the long haul.
Liquidity Ratios:
• The current ratio is higher that 1.0 which reflects Costco’s ability to pay current liabilities using assets which can be converted to cash in the short term. This is important as ongoing operations can be financed internally.
• The quick ratio gives reason for pause as it shows that for every dollar of current liabilities there is less than one dollar of easily convertible current asset to pay for it. The questions is does this fall within industry standard.
Leverage ratios:
• Long term debt to capital ratio is a measure of the credit worthiness and balance sheet strength of a company as it indicates percentage of capital investment which has been financed by creditors and bondholders and should be below 25%. For the period in question Costco has rates well below 25%, however this ratio has been growing. This debt is not required to finance ongoing operation in any significant way when one factors in the financial ratios previously considered thus must be used to finance business expansion, this may be a prudent move considering the low finance cost rates currently available. See ratio results below.
Costco is certainly a stable and sustainable company and for the potential investor it is a long term buy.

FYE

2005

2006

2007

2008

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Operating Profit Margin
Return on Stockholder Equity
Current Ratio
Quick Ratio
Long term debt to capital ratio

2.8%
11.9%
1.2%
.62
7.4%

2.7% 2.5% 2.7%
12% 12.5% 13.9%
1.05% 1.05% 1.06%
.47
.50
.50
2.3% 19.6% 19.4%

The limited data available leads me to believe that Costco’s compares favorably in relation to BJ’s and Sam’s Club. All three entities compete on price; Costco’s has the most consistent low operation profit margin, and is able Costco to pass on to its member’s additional savings. BJ’s whose numbers are more aligned with Costco’s has not achieved for the period in question a sustainable competency as evidenced by its year on year percentage point changes. The ability to achieve the above stated by Costco is reflected in average sales per location within the continental USA. Overall Costco has garnered greater market support than its rival by passing on to its members achieved sustainable competitive advantage as reflected in its operating profit margin. Costco’s product line and merchandising strategy needs to be noted, price competiveness is not solely responsible; through such strategies and treasure hunting and supplying quality products enjoys greater customer loyalty which translates into repeat business.

FYE
Operating Profit Margin (Costco)
Operating Profit Margin (Sam’s)
Operating Profit Margin (BJ’s)
Average Sales ($ in million):
Costco’s
Sam’s Club
BJ’s

2005
2.8%
3.5%
2.8%
127.4
70.2
47.2

2006
2007
2.7% 2.5%
3.6% 3.6%
1.7% 2.2%
135.4 134.5
71.8
75.1
48.3
49.8

5. Does the data in case exhibit 2 indicate that Costco 's expansion outside the United
States is financially successful? Why or why not?
The data does not overtly state the financial success of Costco’s over sea expansion.
However the data does contain information to imply that it is. The first thing to note is that revenues earned outside the U.S.A. is converted and stated in U.S. dollars; taking that in consideration average earning per store has increased year on year and in 2008 is more evenly aliened with U.S. results. Of note is the in reviewing calendar year 2009 financial specifically the Five Year Operating & Financial Highlights year on year compsales national vs. international; international was greater. Currency valuation is important as shown below; Costco as it expands globally will have to pay greater attention to this area.

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FYE (Comp Sales)
United States
International
International (local currency)
Average Sales ($ in million):
United States
Canada
Other

2005
6%
11%
4%
127.4
103
105

2006
7%
11%
7%

2007
5%
9%
5%

135.4 134.5
149
122
111
121

2008
6%
15%
6%

2009
(2%)
(8%)
7%

142
140
129

6. Perform a SWOT analysis and complete a strategic group map for Costco. What do these tell you about the company 's strategy and performance? How well is Costco performing from a strategic perspective? Does Costco enjoy a competitive advantage over Sam 's Club? Over BJ 's Wholesale?
Costco SWOT Analysis
Strengths:
Limited product line
High quality product
Rapid inventory turnover
Bulk sales
Good return policy
Affluent member base
High annual member retainage
Dedicated productive employees
Efficient and effective management
Effective cost containment
National & International presence
Name brand goodwill
Opportunities:
National expansion
International expansion
Expand e-commerce opportunities
Select product line increase
Diversify and increase marketing/adv channels
Expand business member base

Weakness:
Limited marketing/advertising
Lack of carrying option
Lack of emphasis on business member
Limited non-bulk product selection
Small e-commerce revenue stream

Threats:
Global economic slowdown
Rapid e-commerce expansion
Wal-Mart acquires BJ’s
Wal-Mart competes aggressively on operating margins

(SEE ATTACHEMENT FOR STRATEGIC GROUP MAP)

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The industry that Costco competes in can be classified as a member warehouse retail industry. The industry competes primarily on price point; as such Costco is performing well from a strategic standpoint. It has been able to be the industry leader in offering low price to its members whiles giving added value through product quality and service; this been accomplished whiles offering the best salaries and employee package, all this has made the Costco brand the industry standard.
Yes Costco has competitive advantage over both Sam’s Club and BJ’s, from the above stated it has a (1) cost advantage being the low price seller (2) employee loyalty and productivity advantage (3) brand name advantage.

7. Does Costco pay its employees too much? Does it make sense for Costco to compensate its employees so much better than the employees at Wal-Mart or Sam 's
Club? Why or why not?
From a strictly industry standpoint Costco does pay its employees too much. Costco competitors pay significantly less and offer less benefits, so it stands that Costco could offer less. Yes, it makes sense absolute sense for Costco to compensate its employees as it does for the following reasons.
• Employee retention: employees who feel satisfied with rewards are more inclined to remain with a company; financial benefits come through repeat training and learning curve effect.
• Productivity levels: employees reward employers who they perceive to have their interest in mind by not only their loyalty but by grater productivity. To summarize a statement Jim Sinegal made Costco is the lowest cost producer and highest wage payer this could only be sustained through grater productivity “It’s axiomatic in business; you get what you pay for”
• Strategy implementation: The front of the house in any business can make or break it. The employees are the foot soldiers and it is their attention to protocol and entrepreneurial drive that enables the strategy to succeed. A dissatisfied and unhappy employee cannot and will not deliver such benefits; cash/reward is king.

8. What recommendations would you make to Jim Sinegal regarding the actions that
Costco management needs to take to sustain the company 's growth and improve its financial performance?
Costco strategy is a success, however in reviewing the 2009 financial report specific areas of concern stood out such as the net decrease in comp-sales and significant increase in selling, general and administrative expenses which rose YOY 2008, 2009 from 9.8% to
10.38%. The following are suggestion I would make to Mr. Sinegal.

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Expansion should continue but gauged carefully. The decrease in comp-sales nationally may indicate market cannibalization. A review off all store openings should take place to determine areas of market saturation and take corrective action. Keeping the same tone of expansion, exchange rates and their impact on combined financial data should be reviewed. Foreign exchange hedging and other techniques should be analyzed for possible benefits.
Costco should continue to expand particular in the international market as that is the area of greatest potential growth, however population demographics in terms of income and density should be a guiding force.
Cost/Expense containment. Costco has maintained its industry leadership through cost competiveness. The spike in SG&AE should be reviewed to determine cause and corrective action taken.
The major concern I have regarding Costco is the maintenance of management philosophy. Jim Sinegal is the driving force behind Costco’s success and as such efforts should be implemented to groom potential candidates who may succeed him. As evidenced by the case study your normal pool of candidates will not be a good match, from compensation, oversight and merchandising ability. Costco is well advised to start the grooming process now.

Works Cited:
Thompson, A., Strickland, A., Gamble, J, (2009) Crafting and Executing Strategy: The
Quest for Competitive Advantage
New York: McGraw-Hill Irwin
Business Model Generates Winning Investments
By Timothy M. Otte February 13, 2008

http://www.fool.com/investing/general/2008/02/13/business-models-generate-winninginvestments.aspx http://www.jetro.go.jp/en/invest/success_stories/pdf/a25_Costco.pdf How Costco Became the Anti-Wal-Mart
By Steven Greenhouse
First published by the New York Times, July, 17, 2005

http://www.reclaimdemocracy.org/walmart/costco_vs_sams.php
Annual Report 2009 Costco Wholesale http://phx.corporate-ir.net/phoenix.zhtml?c=83830&p=irol-irhome Shopping Centers Today: Costco Taking Anchor Spots, By Debra Hazel http://www.icsc.org/srch/sct/sct0703/page1b.php http://www.wikinvest.com/stock/Costco_Wholesale_(COST)