Costco wholesale value chain analysis

Sustainable Solutions Paper: Several Strategic Analyses of Costco Wholesale Corporation

Sustainable Solutions Paper: Several Strategic Analyses of Costco Wholesale Corporation

by

J. A. Spencer-McDaniel, Sr.

Doctoral degree in Business Administration (DBA): Business Strategy & Innovation

(Senior Level Program Course: DDBA-8160-11)

School of Management, Walden University

Professor Peter Anthony, Ph.D.

November 19, 2012

The purpose of this paper is to identify a competitive firm in a competitive industry, and

proposition for a sustainable solutions paper. The sustainable solutions paper (SSP) focuses to

cover (a) corporate strategic thinking, (b) systems thinking, (c) a complexity analysis, and (d) a

sustainability analysis (Walden, 2012a). The problem to be addressed in this SSP is the gap

between Costco’s ability to create and implement sustainable value creation strategies for

increasing profitability and maximizing shareholder value.

Costco is one of four leading global retailers providing customers a variety of merchandise,

ranging from private label to well known brands (Corona, 2012). Costco began operations in

1983, operates as a low cost leader, and offers a no frills warehouse business model (Costco,

2012). Today, Costco competes intensely for customers and profits with Target Corporation’s

department store model, and Wal-Mart’s Sam’s Club warehouse model. Applying the tools of

the sustainable solutions paper provides Costco detailed analyses for transforming business

activities relative to industry rivals, in order to create profits and maximize shareholder

value.

I. Executive Summary

This paper includes (a) Part I & II: Applying Traditional Strategic Thinking, (b) Applying

Complexity Analyses, and (c) Applying Systems and Sustainability Analyses. These tools capture

the bigger picture of challenges surrounding Costco’s future operations and profitability.

Applying these tools provides Costco detailed analyses for creating long-term viability and

future success.

Applying Traditional Strategic Thinking Part I includes conducting (a) Stakeholder

Identification and Value Analysis, (b) General Force Analysis, (c) Porter’s Five Force

Analysis, (d) Detailed Value Chain Analysis, (e) Detailed SWOT/ SCOT Analysis, and (f) Key

Success Factor Matrix. The results from the Stakeholder Identification and Value

Analysis suggest Costco exemplifies a utilitarian strategy by maximizing benefits for all

stakeholders, but Costco willingly neglects stockholders for other stakeholder groups. According

to the classification framework by Meznar, Chrisman, and Carroll, 1990), Costco’s mission,

values, strategies, and competences suggests Costco employs a broad enterprise strategy.

Costco’s value proposition fits feasibly within the currently accepted societal framework, and

operates at Level 3 maximizing good.

The results from the General Force Analysis reveal the top threats include (a) increasing labor

and healthcare costs, stems from the General Force Analysis (GFA) subsection Government/

military/legal. The second top threat (b) fluctuations in foreign exchange rate, stems from GFA

subsection Economic. The third top threat (c) low growth in mature markets and heavy reliance

on US operations, stems from GFA subsection Economic. The top three threats pose the most

harm to future profitability. The top three opportunities in online sales, growing demand for

private label brands, and strong growth in Asian markets stems from GFA subsection Economic.

The top three opportunities align with Costco’s competences, skills, and capabilities to increase

potential profitability.

The results from Porter’s Five Forces identify threats to global barriers to entry are low and the

threat of new entrants is high with a negative impact on profitability. Buyer power, rivalry, and

substitutes present the most potential for strong negative impacts to profitability. The

opportunities include domestic barriers to entry are high and the threat of new entrants is low

positively impacting potential profitability. Supplier power presents opportunities positively

impacting potential profitability.

The results from the Detailed Value Chain Analysis reveal Costco’s value chain is successful at

exploiting strengths, skills, and capabilities to leverage against weaknesses. Costco’s top three

strengths include firm infrastructure, HRM, and Support Services. Costco’s major weakness is

consistently low operating profit margins. Costco maintains operational effectiveness and better

positioning than industry averages. Costco receives cost advantages from business (value adding)

activities, and focuses to differentiate core competencies (skills) successfully outperforming

competitor’s capabilities and achieving higher than industry averages across business activities.

Costco lacks significant strategic innovations, and continues to follow down the inevitable path

of coping and competing with Wal-Mart and Target, whom do not require a membership fee to

shop for great deals, and offer the shopper enhanced experiences.

The results from the Detailed SWOT/ SCOT Analysis reveal possible strategies and action plans

that position Costco’s strengths, skills, and capabilities to leverage opportunities, mitigate

weaknesses and guard against threats. The results from the Key Success Factor Matrix reveal 10

key success factors are critical for Costco because of their affect on future profitability. (1) Value

propositions must be high and prices low, (2) sufficient management support, (3) hiring and

training excellent employees, (4) keeping current customers happy, (5) opening new stores, (6)

supplier partnerships, (7) extending customer base, (8) enhance brand image and loyalty, (9)

manage financial ratios, and (10) reducing energy costs and wastage.

Applying Traditional Strategic Thinking Part II includes analyzing (a) the Company Strategy

Type, (b) Strategy Moves, (c) Alignment & Goals Analysis, and (d) Action Plan Analysis.

Costco’s current Strategy Types emerge from the original company mission and early

foundations. Costco pursues elements of three of the four generic strategy types (a) low cost

leadership, (b) differentiation and (c) customer relationship strategy, which exposes their

strategic intent thinking to attain global leadership. Costco must revamp strategic efforts for

business activities competing in the global marketplace, and closely align planning and strategic

intent for future success. Costco’s current Strategic Moves embody the six additional methods

amongst the generic strategies to globally compete. Costco’s strategy to create and dominate new

markets seems stagnate to ineffective, other large retailers such as Target, Wal-Mart, Sears, or

Home Depot usually operate nearby. The results from the Alignment and Goals Analysis reveal

the employees at Costco have the necessary skills to make the strategy work, support the

strategy, maintain attitudes that align with the strategy, and have the resources needed to achieve

success. The results from the Action Plan Analysis have financial implications that can increase

gross profit margin to 18.4%, and operating profit margin to 9.42% by year-end 2017 (see

Appendix 1).

Applying Complexity Analysis includes conducting (a) Fitness Landscape Translation Analysis,

(b) Boid Analysis, and (c) Industry Evolution Modeling. The results from the Fitness Landscape

Translation Analysis reveal the current shape of the retail industry, for the scope of this analysis

includes “Big box” retailers comprising a different strategic category. Costco is climbing out of a

recessionary valley toward a promising peak in the fitness landscape for the Discount, Variety

stores industry. Wal-Mart seems to also heavily shape the patterns of the fitness landscape for the

entire Retail stores industry, but not as much in the Discount, Variety stores industry. Some

retailers reported expanding operations, but others reported downsizing and closures. Closures

were due to shifts in consumer spending and shopping trends. Approximately, 33 companies

comprise the majority of this industry, but Costco, Wal-Mart, and Target comprise 97.3% of the

total industry market capitalization, which totaled $5.31 trillion in 2012 (Yahoo.com, 2012a).

The current peaks and valleys provide profound uncertainty due to a changing technological

environment, cultural shifts, and resource depletion. Large retailers are dynamic, automated, can

create different promotions and pricing hourly, no longer require the traditional sales

representatives to showcase products, and can provide more information at purchasing touch

points (Goel, 2011). During the 1990s, firm’s employing brick-n-mortar models began closures

because of online shopping retailers, this trend continues because of the recession in 2009, but

those remaining have an opportunity to enhance shopping experiences beyond convenience.

The Boid Analysis results identify the three simple rules governing the retail industry and

Costco’s behaviors. The first rule is to maintain customer driven focus by adding value to the

merchandise mix. The second rule is to match pricing or promotion by creating flexible pricing

and promotion structures. The third rule is to move towards adopting global cultural changes by

shaping and adapting to customer preference changes, specific and according to each culture or

country that has operating units.

The Industry Evolution Modeling results reveal Costco’s efforts to continuously evolve to match

and shape the industry, simultaneously. Costco can improve on industry association positioning

and strive for RILA’s Premier membership. Costco seems to forego short-term profit

maximization for long-term viability and shareholder satisfaction. Costco seems slow to adopt

new technologies that capture customers attention and can improve on research and development

initiatives.

Applying Systems and Sustainability Analyses includes conducting (a) Life Cycle

Assessment, (b) Compliance to Innovation Analysis, and (c) Sustainable Value Framework

Analysis. The Life Cycle Assessment results reveal Costco understands the bigger picture and

works to minimize downstream and upstream risks and environmental impacts caused by

warehouse operations. The measures governing Costco’s processes for sales and services do not

take the traditional approach, and Costco seems to strive for continual improvements that provide

methods that reach the goal to go beyond. Costco monitors and reports on four greenhouse gases,

(a) carbon dioxide, (b) methane, (c) nitrous oxide, and (d) hydro fluorocarbons (Costco, 2009).

The Compliance to Innovation Analysis results reveal Costco goes above and beyond the average

large retailer by operating at Stage 5, and integrates measures strategically. Costco is compliant

with all laws, but also abides by strict ethical codes for suppliers and partners at the business

strategy level. Costco and partners work together to enhance overall product safety for

consumers.

The Sustainable Value Framework Analysis results reveal Costco’s overall basic corporate social

responsibility (CSR) rating ranks higher than the global average (CSRHub, 2012). Costco’s

approach to organizational behavior, CSR and Total Quality Management when comparing to

industry peers is mostly measureable for employees and partners, and through corporate

governance. Costco finds pride in providing a friendly work environment with highly motivated

and knowledgeable employees.

Summary Focus

Applying Traditional Strategic Thinking Part I suggests Costco’s value adding activities provide

high quality products and services in a low cost business model, and qualifies Costco’s use of a

broad accommodative enterprise strategy. Threats and weaknesses can be overcome with current

skills, strengths, and capabilities. Applying Traditional Strategic Thinking Part II suggests

Costco employs generic strategies, moves according to multiple principles, and achieves

successful alignment for effective strategy implementation. Applying Complexity

Analysis suggests Costco operates according to industry behavioral rules, and maintains fitness

strong enough to survive and change the changing landscape. Applying Systems and

Sustainability Analyses suggests Costco understands Life Cycle Assessments, the need for

innovation, and currently employs methods to promote sustainability and future profitability.

Key Takeaways

The Key Takeaways from the results of each analysis suggest Costco’s current strategic efforts

align with the theories and frameworks discussed in this paper. The level of success ranges from

low to high. Costco has a high level of success aligning strategy, except for medium levels of

success for the General Force Analysis, Porter’s Five Forces Industry Analysis, and the Key

Success Factors: Integrating the Analysis (see Table 1). Improving in these areas can

dramatically improve short-term profitability and future viability.

Table 1

Key Takeaway Matrix

Name of Analysis or Assessment Costco’s results indicate current strategy

aligns with theory (YES or NO)? How

successful is alignment (Low, Medium,

or High level)

Stakeholder Identification and Value

Analysis

YES. High level of success.

General Force Analysis YES. Medium level of success.

Porter’s Five Forces Industry Analysis YES. Medium level of success.

Detailed Value Chain Analysis YES. High level of success.

Key Success Factors: Integrating the

Analysis

YES. Medium level of success.

Analyzing the Company Strategy Type YES. High level of success.

Analyzing the Company Strategy Moves YES. High level of success.

Alignment & Goals Analysis YES. High level of success.

Fitness Landscape Translation Analysis YES. High level of success.

Boid Analysis YES. High level of success.

Industry Evolution Modeling YES. High level of success.

Life- Cycle Assessment (LCA) YES. High level of success.

Compliance to Innovation Analysis YES. High level of success.

Sustainable Value Framework Synthesis:

Detailed Driver Analysis

YES. High level of success.

Integration of Concepts

The theoretical concepts in this and the next paragraphs provide support for Part I: Applying

Traditional Strategic Thinking. Strategic planning is a corporate mechanism striving to

understand and cope with the many problematic competitive forces impacting the future (Porter,

2008). The goal of strategic planning is to create competitive advantages aligning a firm’s

existing business activities and resources, and seeks to identify the internal and external structure

of the firm based on the firm’s goals to achieve the mission. According to Mintzberg and

Hunsicker (1988), “ a superior strategy is much more than a simple step beyond an accurate

description of the problem” (p. 71). A strategy is a senior management tool and framework to

isolate existing resources (financial, human, and technical) and search for the most critical

strengths and opportunities, in order to mitigate internal weaknesses and guard against outside

threats, also known as conducting a SWOT analysis. From the SWOT analysis, the next

challenge is creating alternative action plans and implementing measures for success. The final

step evaluation and feedback determine results of performance. From performance results the

process of creating a strategy starts over.

Conventional strategy focuses on creating sustainable competitive advantages by managing the

level of fit between a firm’s existing resources and business activities, in order to leverage

capabilities for capitalizing on opportunities and increasing shareholder value (Hamal and

Prahalad, 2005). Strategic fit aims for consistency, reinforcement or optimization of business

activities. Firms heavily rely on strategic management tools, such as operational effectiveness

(OE) for managing business activities, but adversely confuse the tool’s purpose with strategy. To

enhance strategic positioning, OE is necessary, but in today’s global competitive environment

OE will not sustain competitive advantage overtime. Therefore, management must aim to choose

“to perform [well and integrated] activities differently or to perform different [well and

integrated] activities than rivals” (Porter, 1996). Maintaining a sustainable strategic position

requires trade-offs between business activities, which creates barriers to imitators and straddlers.

Leadership plays a vital role in developing, communicating, and helping to implement a clear

strategy, which includes explaining to subordinates the differences in achieving both the strategy

and OE. According to Kaplan and Norton (2008), there are 5 steps to close the loop between

strategic and operational planning; (step 1) develop the strategy, (step 2) translate the strategy,

(step 3) plan operations, (step 4) monitor and learn, and (step 5) test and adapt the strategy (p.

65).

Traditional strategic models attempt to achieve the firm’s goal for an optimal sustainable

competitive advantage in order to, increase shareholder value and maximize profits (Porter,

2008). Strategic choice theories encompass the various tools and methods management employs

to formulate and implement traditional strategic models (Harvard Business Review, 2005).

Management’s goal is to employ strategies that exploit internal strengths while mitigating

weaknesses, searching for external opportunities, and guarding against threats (Porter, 2008).

Strategic choice theory identifies human self-regulation or human ability to control as cybernetic

systems capable of autonomy, independence, and able to achieve harmonious equilibrium

(Stacey, 2011). A typical strategic choice is to develop a well thought out long-term strategic

plan for a firm’s human, technical, and financial resources; formulated by top management and

implemented by all employees at the business and enterprise levels (Harvard Business Review,

2005). Unfortunately, when strategies fail, management is to blame, and usually for

incompetence.

The theoretical concepts in this and the next paragraphs provide support for Part II: Applying

Traditional Strategic Thinking. Strategic intent seeks long-term innovative methods for a firm to

reach audacious goals of global leadership. Hamal and Prahalad (2005) argue innovation is

necessary to enable sustainable growth, global leadership, competitive revitalization, and avoid

imitating competitors. The authors argue that withering competitiveness is brought on by

management’s overuse of (a) broad strategic concepts, (b) three generic strategies, and (c) the

strategy process (Hamal and Prahalad, 2005). Strategic intent focuses to win by thinking outside

the box, remains stable over time, and requires a personal effort and commitment to achieve

results. Examples of strategic intent include four techniques exhibited in Japanese companies; (a)

reducing risks by deepening advantages, such as pursuing multiple generic strategies; (b)

searching for uncontested market share peripheral to the industry leader; (c) changing industry

boundaries and redefining customer segments; and (d) increase organizational learning via

collaborations with competitors (Hamal and Prahalad, 2005).

Strategic choice theories strive to maintain strategic positioning and represent management’s

attempt to adapt to the ongoing changes occurring in the firm’s internal and external

environments by analyzing quantitative data relative to industry rivals (Stacey, 2011). The

limitations of strategic choice theory include (a) assumptions about the given reality or the

fitness landscape, (b) the accuracy of management’s predictions, (c) the failure for cybernetic

systems to account for human spontaneity or innovation, and (d) decision-making by other

organizations (Stacey, 2011). Strategic choice theory makes contradictory assumptions about

individuals (cybernetic systems) existing within an organizational cybernetic system; the paradox

occurs when organizations exhibit control while individuals remain autonomous. Strategic

choice theories define the dominant practical and literary perspectives in strategic management

despite criticism and limitations. To minimize limitations, theorists suggest firms become

learning organizations and shift to dynamic systems thinking to create competitive advantages

(Stacey, 2011). Some theorists argue hyper competition amongst industry rivals inhibits the

possibility of a sustainable competitive advantage; instead firms must utilize temporary

competitive advantages and take aggressive competitive actions (Stacey, 2011).

The theoretical concepts in this and the next paragraphs provide support for Applying Complexity

Analyses. Organizations are instruments of order and change, but one person cannot control an

organization, and one organization cannot predictably change an industry. Crafting sustainable

strategies, adapting to unpredictable change, and lack of control requires an understanding of

how complexity sciences can determine patterns resulting in organizations and within an

industry. Traditional strategic management tools rely on predictability and control to manage

uncertainty and achieve long-term stability. Long-term predictability remains difficult, if not

impossible, and control is problematic. The systemic thinking involved in long-term strategic

planning, in the scope of complexity analysis or sciences, includes Mathematical

Chaos theory, Dissipative Structure theory and complex adaptive systems. Chaotic patterns are

not random, but exhibit paradoxical states of predictability and unpredictability, simultaneously,

which makes short term planning feasible and long-term predictability impossible (Stacey,

2011). In a dissipative system, the structure is hard to maintain and easy to change. Dissipative

patterns are problematic for future decision-making and emerge as intrinsic uncertainty and

regular irregularities (Stacey, 2011). These forecasting limitations render control impossible. An

organization is commonly referred to as the whole and is a sum of its various parts. Complex

adaptive systems examine behavioral patterns of the interacting parts (Stacey, 2011). The simple