How costco became the anti wal mart

C-2

Case 1 Costco Wholesale Corporation: Mission, Business Model, and Strategy

J im Sinegal, cofounder and CEO of Costco Wholesale, was the driving force behind Costco’s 23-year march to become the fourth largest re- tailer in the United States and the seventh larg-

est in the world. He was far from the stereotypical CEO. A grandfatherly 70-year-old, Sinegal dressed casually and unpretentiously, often going to the offi ce or touring Costco stores wearing an open- collared cotton shirt that came from a Costco bargain rack and sporting a standard employee name tag that said, simply, “Jim.” His informal dress, mustache, gray hair, and unimposing 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 customer’s calling and they have a gripe, don’t you think they kind of enjoy the fact that I picked up the phone and talked to them?”1

Sinegal spent much of his time touring Costco stores, using the company plane to fl y from location to location and sometimes visiting 8 to 10 stores daily (the record for a single day was 12). Treated like a celebrity when he appeared at a store (the news “Jim’s in the store” spread quickly), Sinegal made a point of greeting store employees. He observed, “The employ- ees know that I want to say hello to them, because I like them. We have said from the very beginning: ‘We’re going to be a company that’s on a fi rst-name basis with everyone.’ ”2 Employees genuinely seemed to like Sinegal. He talked quietly, in a commonsensi- cal manner that suggested what he was saying was no big deal.3 He came across as kind yet stern, but

he was prone to display irritation when he disagreed sharply with what people were saying to him.

In touring a Costco store with the local store man- ager, Sinegal was very much the person-in-charge. He functioned as producer, director, and knowledgeable critic. He cut to the chase quickly, exhibiting intense attention to detail and pricing, wandering through store aisles fi ring a barrage of questions at store man- agers about sales volumes and stock levels of partic- ular items, critiquing merchandising displays or the position of certain products in the stores, comment- ing 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 whenever he found their answers to his questions less than satisfy- ing. It was readily apparent that Sinegal had tremen- dous merchandising savvy, that he demanded much of store managers and employees, and that his views about discount retailing set the tone for how the com- pany operated. Knowledgeable observers regarded Jim Sinegal’s merchandising expertise as being on a par with that of the legendary Sam Walton.

In 2006, Costco’s sales totaled almost $59 bil- lion at 496 stores in 37 states, Puerto Rico, Canada, the United Kingdom, Taiwan, Japan, Korea, and Mexico. About 26 million households and 5.2 mil- lion businesses had membership cards entitling them to shop at Costco, generating nearly $1.2 billion in membership fees for the company. Annual sales per store averaged about $128 million, nearly dou- ble the $67 million fi gure for Sam’s Club, Costco’s chief competitor in the membership warehouse re- tail segment.

Arthur A. Thompson Jr. The University of Alabama

Copyright © 2007 by Arthur A. Thompson. All rights reserved.

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Strategia aziendale - Formulazione ed esecuzione Arthur A. Thompson, A. J. Strickland III, John E. Gamble

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Case 1 Costco Wholesale Corporation: Mission, Business Model, and Strategy C-3

COMPANY BACKGROUND The membership warehouse concept was pioneered by discount merchandising sage Sol Price, who opened the fi rst Price Club in a converted airplane hangar on Morena Boulevard in San Diego in 1976. Price Club lost $750,000 in its fi rst year of opera- tion, but by 1979 it had two stores, 900 employees, 200,000 members, and a $1 million profi t. Years earlier, Sol Price had experimented with discount retailing at a San Diego store called Fed-Mart. Jim Sinegal got his start in retailing there at the age of 18, loading mattresses for $1.25 an hour while at- tending 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’s Price Club emerged as the un- challenged 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 concluded that his fl edgling operation could achieve far greater sales volumes and gain buying clout with suppliers 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 unprofi table. Price saw that Sinegal had a special knack for discount retailing and for spotting what a store was doing wrong (usually either not being in the right merchandise categories or not sell- ing items at the right price points)—the very things that Sol Price was good at and that were at the root of the Price Club’s 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 merchan- dising. He mirrored Sol Price’s attention to detail and absorbed all the nuances and subtleties of his men- tor’s style of operating—constantly improving store operations, keeping operating costs and overhead low, stocking items that moved quickly, and charg- ing ultra-low prices that kept customers coming back to shop. Realizing that he had mastered the tricks of running a successful membership warehouse busi- ness from Sol Price, Sinegal decided to leave Price Club and form his own warehouse club operation.

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

In January 1997, after the spin-off of most of its nonwarehouse assets to Price Enterprises Inc., PriceCostco changed its name to Costco Companies Inc. When the company reincorporated from Delaware to Washington in August 1999, the name was changed to Costco Wholesale Corporation. The company’s headquarters was in Issaquah, Washington, not far from Seattle.

Exhibit 1 contains a fi nancial and operating summary for Costco for fi scal years 2000–2006.

COSTCO’S MISSION, BUSINESS MODEL, AND STRATEGY Costco’s mission in the membership warehouse busi- ness read: “To continually provide our members with quality goods and services at the lowest pos- sible prices.” The company’s business model was to generate high sales volumes and rapid inventory turnover by offering members low prices on a limited selection of nationally branded and selected private- label products in a wide range of merchandise cat- egories. Management believed that rapid inventory

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C-4 Part 2 Cases in Crafting and Executing Strategy

Exhibit 1 Financial and Operating Summary, Costco Wholesale Corporation, Fiscal Years 2000–2006 ($ in millions, except for per share data)

Fiscal Years Ending on Sunday Closest to August 31

2006 2005 2004 2002 2000

Income Statement Data Net sales $58,963 $51,862 $47,146 $37,993 $31,621 Membership fees 1,188 1,073 961 769 544

Total revenue 60,151 52,935 48,107 38,762 32,164 Operating expenses Merchandise costs 52,745 46,347 42,092 33,983 28,322 Selling, general, and administrative 5,732 5,044 4,598 3,576 2,755 Preopening expenses 43 53 30 51 42 Provision for impaired assets and store closing costs 5 16 1 21 7

Operating income 1,626 1,474 1,386 1,132 1,037 Other income (expense) Interest expense (13) (34) (37) (29) (39) Interest income and other 138 109 52 36 54

Income before income taxes 1,751 1,549 1,401 1,138 1,052 Provision for income taxes 648 486 518 438 421

Net income $ 1,103 $ 1,063 $ 882 $ 700 $ 631 Diluted net income per share $ 2.30 $ 2.18 $ 1.85 $ 1.48 $ 1.35 Dividends per share $ 0.49 $ 0.43 $ 0.20 $ 0.00 $ 0.00 Millions of shares used in per share calculations 480.3 492.0 482.5 479.3 475.7

Balance Sheet Data Cash and cash equivalents $ 1,511 $ 2,063 $ 2,823 $ 806 $ 525 Merchandise inventories 4,569 4,015 3,644 3,127 2,490 Current assets 8,232 8,238 7,269 4,631 3,470 Current liabilities 7,819 6,761 6,170 4,450 3,404 Working capital 413 1,477 1,099 181 66 Net property and equipment 8,564 7,790 7,219 6,523 4,834 Total assets 17,495 16,514 15,093 11,620 8,634 Short-term borrowings 41 54 22 104 10 Long-term debt 215 711 994 1,211 790 Stockholders’ equity 9,143 8,881 7,625 5,694 4,240

Cash Flow Data Net cash provided by operating activities $ 1,827 $ 1,776 $ 2,096 $ 1,018 $ 1,070

Warehouses in Operation Beginning of year 433 417 397 345 292 Opened 28 21 20 35 25 Closed (3) (5) — (6) (4) End of year 458 433 417 374 313

Primary members at year-end Businesses (000s) 5,214 5,050 4,810 4,476 4,358 Gold Star members (000s) 17,338 16,233 15,018 14,597 12,737

Sources: Company 10-K reports 2006, 2005, 2002, and 2000.

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Strategia aziendale - Formulazione ed esecuzione Arthur A. Thompson, A. J. Strickland III, John E. Gamble

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Case 1 Costco Wholesale Corporation: Mission, Business Model, and Strategy C-5

turnover—when combined with the operating ef- fi ciencies achieved by volume purchasing, effi cient distribution, and reduced handling of merchandise in no-frills, self-service warehouse facilities—enabled Costco to operate profi tably at signifi cantly lower gross margins than traditional wholesalers, mass merchandisers, supermarkets, and supercenters.

Examples of Costco’s incredible annual sales volumes included 96,000 carats of diamonds (2006), 1.5 million televisions, $300 million worth of dig- ital cameras, 28 million rotisserie chickens (over 500,000 weekly), 40 percent of the Tuscan olive oil bought in the United States, $16 million worth of pumpkin pies during the fall holiday season, $3 bil- lion worth of gasoline, 21 million prescriptions, and 52 million $1.50 hot dog/soda pop combinations. Costco was also the world’s largest seller of fi ne wines ($385 million out of total 2006 fi ne wine sales of $805 million).4 At one of Costco’s largest volume stores, which had annual sales of $285 million and 232,000 members, annual sales volume ran 283,000 rotisserie chickens, 375,000 gallons of milk, and 8.4 million rolls of toilet paper—this store had an aver- age customer bill per trip of $150.5

Furthermore, Costco’s 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 time to take advantage of early payment discounts. Thus, Costco was able to fi nance a big percentage of its merchandise inven- tory through the payment terms provided by vendors rather than by having to maintain sizable working capital (defi ned as current assets minus current li- abilities) to facilitate timely payment of suppliers.

Costco’s Strategy The cornerstones of Costco’s strategy were low prices, limited selection, and a treasure-hunt shop- ping environment.

Pricing. Costco was known for selling top-quality national and regional brands at prices consistently below traditional wholesale or retail outlets. The company stocked only those items that could be priced at bargain levels and thus provide members with signifi cant cost savings; this was true even if an item was often requested by customers. A key element of Costco’s pricing strategy was to cap its markup on brand-name merchandise at 14 percent (compared to 20 to 50 percent markups at other

discounters and many supermarkets). Markups on Costco’s 400 private-label (Kirkland Signature) items could be no higher than 15 percent, but the sometimes fractionally higher markups still resulted in Kirkland Signature items being priced about 20 percent below comparable name-brand items. Kirkland Signature products—which included juice, cookies, coffee, tires, housewares, luggage, appliances, clothing, and detergent—were designed to be of equal or better quality than national brands.

Costco’s philosophy was to keep customers com- ing in to shop by wowing them with low prices. Jim Sinegal explained the company’s approach to pricing as follows:

We always look to see how much of a gulf we can create between ourselves and the competi- tion. So that the competitors eventually say, “These guys are crazy. We’ll compete somewhere else.” Some years ago, we were selling a hot brand of jeans for $29.99. They were $50 in a department store. We got a great deal on them and could have sold them for a higher price but we went down to $29.99. Why? We knew it would create a riot.6

At another time he said:

We’re very good merchants, and we offer value. The traditional retailer will say: “I’m selling this for $10. I wonder whether we can get $10.50 or $11.” We say: “We 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.7

Indeed, Costco’s markups and prices were so low that Wall Street analysts had criticized Costco man- agement for going all out to please customers at the expense of increasing profi ts for shareholders. One retailing analyst said, “They could probably get more money for a lot of the items they sell.”8 Sinegal was unimpressed with Wall Street calls for Costco to abandon its ultra-low pricing strategy, commenting: “Those people are in the business of making money between now and next Tuesday. We’re trying to build an organization that’s going to be here 50 years from now.”9 He went on to explain why Costco’s approach to pricing would remain unaltered during his tenure:

When I started, Sears, Roebuck was the Costco of the country, but they allowed someone else to come in under them. We don’t want to be one of the casual- ties. We don’t want to turn around and say, “We got so fancy we’ve raised our prices, and all of a sudden a new competitor comes in and beats our prices.”10

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C-6 Part 2 Cases in Crafting and Executing Strategy

Product Selection. Whereas typical supermar- kets stocked about 40,000 items and a Wal-Mart Supercenter or a SuperTarget might have as many as 150,000 items for shoppers to choose from, Cost- co’s merchandising strategy was to provide members with a selection of only about 4,000 items.

Costco’s product range did cover a broad spectrum—rotisserie chicken, prime steaks, caviar, fl at-screen televisions, digital cameras, fresh fl ow- ers, fi ne wines, caskets, baby strollers, toys and games, musical instruments, ceiling fans, vacuum cleaners, books, DVDs, chandeliers, stainless-steel cookware, seat-cover kits for autos, prescription drugs, gasoline, and one-hour photo fi nishing—but the company deliberately limited the selection in each product category to fast-selling models, sizes, and colors. Many consumable products like detergents, canned goods, offi ce supplies, and soft drinks were sold only in big-container, case, carton, or multiple-pack quantities. For example, Costco stocked only a 325- count bottle of Advil—a size many shoppers might fi nd too large for their needs. Sinegal explained the reason for the deliberately limited selection as follows:

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 loss of sales. We are prepared to give up that one customer. But if we had four or fi ve sizes of Advil, as most grocery stores do, it would make our business more diffi cult to manage. Our business can only succeed if we are effi cient. You can’t go on selling at these margins if you are not.11

Costco’s selections of appliances, equipment, and tools often included commercial and professional models because so many of its members were small businesses. The approximate percentage of net sales accounted for by each major category of items stocked by Costco is shown in the following table:

To encourage members to shop at Costco more frequently, the company operated ancillary busi- nesses within or next to most Costco warehouses; the number of ancillary businesses at Costco ware- houses is shown in the following table:

2006 2005 2004

Total number of warehouses 458 433 417

Warehouses having stores with Food court and hot dog stands 452 427 412 One-hour photo centers 450 423 408 Optical dispensing centers 442 414 397 Pharmacies 401 374 359 Gas stations 250 225 211 Hearing aid centers 196 168 143 Print shops and copy centers 9 10 10

Treasure-Hunt Merchandising. While Costco’s product line consisted of approximately 4,000 items, about one-fourth of its product offerings were con- stantly changing. Costco’s merchandise buyers re- mained on the lookout to make one-time purchases of items that would appeal to the company’s clientele and that would sell out quickly. A sizable number of these items were high-end or name-brand products that carried big price tags—like $2,000–$3,500 big- screen HDTVs or $800 leather sofas. The idea was to entice shoppers to spend more than they might otherwise by offering irresistible deals on luxury items. According to Jim Sinegal, “Of that 4,000, about 3,000 can be found on the fl oor all the time. The other 1,000 are the treasure-hunt stuff that’s always changing. It’s the type of item a customer knows they better buy because it will not be there next time, like Waterford crystal. We try to get that sense of urgency in our customers.”12

2006 2005 2004 2003

Food (fresh produce, meats and fi sh, bakery and deli products, and dry and institutionally packaged foods)

30% 30% 31% 30%

Sundries (candy, snack foods, tobacco, alcoholic and nonalcoholic beverages, and cleaning and institutional supplies)

24 25 25 26

Hard lines (major appliances, electronics, health and beauty aids, hardware, offi ce supplies, garden and patio, sporting goods, furniture, cameras and automotive supplies)

20 20 20 20

Soft lines (apparel, domestics, jewelry, housewares, media, home furnishings, and small appliances)

12 12 13 14

Ancillary and other (gasoline, pharmacy, food court, optical, one-hour photo, hearing aids, and travel)

14 13 11 10

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Case 1 Costco Wholesale Corporation: Mission, Business Model, and Strategy C-7

In many cases, Costco did not obtain its luxury offerings directly from high-end manufacturers like Calvin Klein or Waterford (who were unlikely to want their merchandise marketed at deep discounts at places like Costco); rather, Costco buyers searched for opportunities to source such items legally on the gray market from other wholesalers or distressed re- tailers looking to get rid of excess or slow-selling inventory. Examples of treasure-hunt specials in- cluded $800 espresso machines, diamond rings and other jewelry items with price tags of anywhere from $5,000 to $250,000, Italian-made Hathaway shirts priced at $29.99, Movado watches, exotic cheeses, Coach bags, cashmere sports coats, $1,500 digital pianos, and Dom Perignon champagne.

Marketing and Advertising. Costco’s low prices and its reputation for treasure-hunt shopping made it unnecessary for the company to engage in extensive advertising or sales campaigns. Marketing and pro- motional activities were generally limited to direct mail programs promoting selected merchandise to existing members, occasional direct mail marketing to prospective new members, and special campaigns for new warehouse openings. For new warehouse openings, marketing teams personally contacted businesses in the area that were potential wholesale members; these contacts were supplemented with di- rect 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 new member- ships came from word of mouth (existing members telling friends and acquaintances about their shop- ping experiences at Costco), follow-up messages distributed through regular payroll or other organi- zational communications to employee groups, and ongoing direct solicitations to prospective business and Gold Star members. Management believed that its emphasis on direct mail advertising kept its mar- keting expenses low relative to those at typical retail- ers, discounter, and supermarkets.

Growth Strategy. In recent years, Costco had opened an average 20–25 locations annually; most were in the United States, but expansion was under way internationally as well. The company opened 68 new warehouses in the United States in fi scal years 2002–2006; 16 new warehouses opened in the fi rst four months of fi scal 2007 (between September 1

and December 31, 2006), and management planned to open another 20–24 by the end of fi scal 2007. Five new warehouses were opened outside the United States in fi scal 2005, fi ve more were opened in fi scal 2006, and four were opened in the fi rst four months of fi scal 2007. Going into 2007, Costco had a total of 102 wholly-owned warehouses in operation outside the United States, including 70 in Canada, 18 in the United Kingdom, 5 in Korea, 5 in Japan, and 4 in Taiwan. Costco was a 50–50 partner in a venture to operate 30 Costco warehouses in Mexico. Exhibit 2 shows a breakdown of Costco’s geographic opera- tions for fi scal years 2003–2006. (The data for the 30 warehouses in Mexico are not included in the exhibit because the 50–50 venture in Mexico was accounted for using the equity method.)

Costco had recently opened two freestand- ing high-end furniture warehouse businesses called Costco Home. Sales in 2005 at these two locations increased by 132 percent over 2004 levels, and prof- its were up signifi cantly. So far, however, rather than opening additional Costco Home stores, management had opted to experiment with adding about 45,000 square feet to the size of selected new Costco stores and using the extra space to stock a much bigger selection of furniture—furniture was one of the top three best-selling categories at Costco’s Web site.

A third growth initiative was to expand the company’s offerings of Kirkland Signature items. Management believed there were opportunities to expand its private-label offerings from the present level of 400 items to as many as 600 items over the next fi ve years.

Web Site Sales. Costco operated two Web sites— www.costco.com in the United States and www. costco.ca in Canada—both to provide another shop- ping alternative for members and to provide mem- bers with a way to purchase products and services that might not be available at the warehouse where they customarily shopped, especially such services as digital photo processing, prescription fulfi llment, and travel and other membership services. At Cost- co’s online photo center, customers could upload im- ages and pick up the prints at their local warehouse in little over an hour; one-hour photo sales were up 10 percent in fi scal 2005, a year in which the in- dustry overall had negative sales growth. Costco’s e-commerce sales totaled $534 million in fi scal 2005 and $376 million in fi scal 2004. (Data for fi scal 2006 e-commerce sales were not available.)

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Strategia aziendale - Formulazione ed esecuzione Arthur A. Thompson, A. J. Strickland III, John E. Gamble

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Warehouse Operations In Costco’s 2005 annual report, Jim Sinegal summed up the company’s approach to operations as follows:

Costco is able to offer lower prices and better values by eliminating virtually all the frills and costs histori- cally associated with conventional wholesalers and

retailers, including salespeople, fancy buildings, de- livery, billing, and accounts receivable. We run a tight operation with extremely low overhead which ena- bles us to pass on dramatic savings to our members.

Costco warehouses averaged 140,000 square feet and were constructed inexpensively with concrete fl oors. Because shoppers were attracted principally

Exhibit 2 Geographic Operating Data, Costco Wholesale Corporation, Fiscal Years 2003–2006 ($ in millions)

United States Operations

Canadian Operations

Other International Operations Total

Year Ended September 3, 2006 Total revenue (including membership fees) $48,465 $8,122 $3,564 $60,151 Operating income 1,246 293 87 1,626 Depreciation and amortization 413 61 41 515 Capital expenditures 934 188 90 1,213 Property and equipment 6,676 1,032 855 8,564 Total assets 14,009 1,914 1,572 17,495 Net assets 7,190 1,043 910 9,143 Number of warehouses 358 68 32 458

Year Ended August 28, 2005 Total revenue (including membership fees) $43,064 $6,732 $3,155 $52,952 Operating income 1,168 242 65 1,474 Depreciation and amortization 389 51 42 482 Capital expenditures 734 140 122 995 Property and equipment 6,171 834 786 7,790 Total assets 13,203 2,034 1,428 16,665 Net assets 6,769 1,285 827 8,881 Number of warehouses 338 65 30 433

Year Ended August 29, 2004 Total revenue (including membership fees) $39,430 $6,043 $2,637 $48,110 Operating income 1,121 215 50 1,386 Depreciation and amortization 364 40 36 441 Capital expenditures 560 90 55 706 Property and equipment 5,853 676 691 7,220 Total assets 12,108 1,718 1,267 15,093 Net assets 5,871 1,012 742 7,625 Number of Warehouses 327 63 27 417

Year Ended August 31, 2003 Total revenue (including membership fees) $35,119 $5,237 $2,189 $42,546 Operating income 928 199 30 1,157 Depreciation and amortization 324 34 34 391 Capital expenditures 699 69 44 811 Long lived assets 5,706 613 642 6,960 Total assets 10,522 1,580 1,089 13,192 Net assets 5,141 784 630 6,555 Number of warehouses 309 61 27 397

Source: Company 10-K reports, 2004 and 2006.

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Case 1 Costco Wholesale Corporation: Mission, Business Model, and Strategy C-9

by Costco’s low prices, its warehouses were rare- ly located on prime commercial real estate sites. Merchandise was generally stored on racks above the sales fl oor and displayed on pallets containing large quantities of each item, thereby reducing labor required for handling and stocking. In-store signage was done mostly on laser printers, and there were no shopping bags at the checkout counter—merchandise was put directly into the shopping cart or sometimes loaded into empty boxes. Warehouses generally op- erated on a seven-day, 69-hour week, typically being open between 10:00 a.m. and 8:30 p.m. weekdays, with earlier closing hours on the weekend; the gaso- line operations outside many stores generally had extended hours. The shorter hours of operation—as compared to those of traditional retailers, discount retailers, and supermarkets—resulted in lower labor costs relative to the volume of sales.

Costco warehouse managers were delegated considerable authority over store operations. In effect, warehouse managers functioned as entrepre- neurs running their own retail operation. They were responsible for coming up with new ideas about what items would sell in their stores, effectively merchandising the ever-changing lineup of treasure- hunt products, and orchestrating in-store prod- uct locations and displays to maximize sales and quick turnover. In experimenting with what items to stock and what in-store merchandising techniques to employ, warehouse managers had to know the clientele who patronized their locations—for in- stance, big-ticket diamonds sold well at some ware- houses but not at others. Costco’s best managers kept their fi nger on the pulse of the members who shopped their warehouse location to stay in sync with what would sell well, and they had a fl air for creat- ing a certain element of excitement, hum, and buzz in their warehouses. Such managers spurred above- average sales volumes—sales at Costco’s top-volume warehouses often exceeded $5 million a week, with sales exceeding $1 million on many days. Successful managers also thrived on the rat race of running a high-traffi c store and solving the inevitable crises of the moment.

Costco bought the majority of its merchandise directly from manufacturers, routing it either direct- ly to its warehouse stores or to one of nine cross- docking depots that served as distribution points for nearby stores. Depots received container-based shipments from manufacturers and reallocated these goods for combined shipment to individual

warehouses, generally in less than 24 hours. This maximized freight volume and handling effi cien- cies. When merchandise arrived at a warehouse, it was moved straight to the sales fl oor; very little was stored in locations off the sales fl oor, thereby lower- ing receiving costs by eliminating many of the costs associated with multiple-step distribution channels, which include purchasing from distributors as op- posed to manufacturers; using central receiving, storage, and distribution warehouses; and storing merchandise in locations off the sales fl oor.

Costco had direct buying relationships with many producers of national brand-name mer- chandise (including Canon, Casio, Coca-Cola, Colgate-Palmolive, Dell, Fuji, Hewlett-Packard, Kimberly-Clark, Kodak, Levi Strauss, Michelin, Nestlé, Panasonic, Procter & Gamble, Samsung, Sony, KitchenAid, and Jones of New York) and with manufacturers that supplied its Kirkland Signature products. No one manufacturer supplied a sig- nifi cant percentage of the merchandise that Costco stocked. Costco had not experienced any diffi culty in obtaining suffi cient quantities of merchandise, and management believed that if one or more of its current sources of supply became unavailable, the company could switch its purchases to alternative manufacturers without experiencing a substantial disruption of its business.

Costco warehouses accepted cash, checks, most debit cards, American Express, and a private- label Costco credit card. Costco accepted merchan- dise returns when members were dissatisfi ed with their purchases. Losses associated with dishonored checks were minimal because any member whose check had been dishonored was prevented from paying by check or cashing a check at the point of sale until restitution was made. The membership format facilitated strictly controlling the entrances and exits of warehouses, resulting in limited inven- tory losses of less than two-tenths of 1 percent of net sales—well below those of typical discount re- tail operations.

Costco’s Membership Base and Member Demographics Costco attracted the most affl uent customers in dis- count retailing—the average income of individual members was about $75,000, with over 30 percent of members having annual incomes of $100,000 or more. Many members were affl uent urbanites,

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Strategia aziendale - Formulazione ed esecuzione Arthur A. Thompson, A. J. Strickland III, John E. Gamble

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C-10 Part 2 Cases in Crafting and Executing Strategy

living in nice neighborhoods not far from Costco warehouses. One loyal Executive member, a crimi- nal defense lawyer, said, “I think I spend over $20,000–$25,000 a year buying all my products here from food to clothing—except my suits. I have to buy them at the Armani stores.”13 Another Costco loyalist said, “This is the best place in the world. It’s like going to church on Sunday. You can’t get anything better than this. This is a reli- gious experience.”14

Costco had two primary types of member- ships: Business and Gold Star (individual). Gold Star memberships were for individuals who did not qualify for a Business membership. Businesses— including individuals with a business license, retail sales license, or other evidence of business exist- ence—qualifi ed as Business members. Business members generally paid an annual membership fee of $50 for the primary membership card, which also included a spouse membership card, and could purchase up to six additional membership cards for an annual fee of $40 each for partners or as- sociates in the business; they could also purchase a transferable company card. A signifi cant number of business members also shopped at Costco for their personal needs.

Gold Star members generally paid an annual membership fee of $50, which included a spouse card. In addition, members could upgrade to an Executive membership for an annual fee of $100; Executive members were entitled an additional 2 percent savings on qualifi ed purchases at Costco (redeemable at Costco warehouses), up to a maxi- mum rebate of $500 per year. Executive members also were eligible for savings and benefi ts on vari- ous business and consumer services offered by Costco, including merchant credit card 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 provid- ers and varied by state. In 2006, Executive mem- bers represented 23 percent of Costco’s primary membership base and generated approximately 45 percent of consolidated net sales. Effective May 1, 2006, Costco increased annual membership fees by $5 for U.S. and Canadian Gold Star, Business, and Business Add-on members; the $5 increase, the fi rst in nearly six years, impacted approximately 15 mil- lion members.

At the end of fi scal 2006, Costco had almost 48 million cardholders:

Recent trends in membership are shown at bottom of Exhibit 1. Members could shop at any Costco ware- house; member renewal rates were about 86.5 percent.

Compensation and Workforce Practices In September 2006, Costco had 71,000 full-time employees and 56,000 part-time employees, includ- ing approximately 8,000 people employed by Costco Mexico, whose operations were not consolidated in Costco’s fi nancial and operating results. Approxi- mately 13,800 hourly employees at locations in California, Maryland, New Jersey, and New York, as well as at one warehouse in Virginia, were rep- resented by the International Brotherhood of Team- sters. All remaining employees were non-union.

Starting wages for new Costco employees were in the $10–$12 range in 2006; on average, Costco employees earned $17–$18 per hour, plus biannual bonuses. Employees enjoyed the full spectrum of benefi ts. Salaried employees were eligible for ben- efi ts on the fi rst of the month after the date of hire. Full-time hourly employees were eligible for benefi ts of the fi rst of the month after working a probationary 90 days; part-time hourly employees became benefi t- eligible on the fi rst of the month after working 180 days. The benefi t package included the following:

Health and dental care plans. Full-time em- ployees could choose from among a freedom- of-choice health care plan, a managed-choice health care plan, and three dental plans. A managed-choice health care and a core dental plan were available for part-time employees. The company paid about 90 percent of an employee’s premiums for health care (far above the more normal 50 percent contributions at many other

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Gold Star members (including Executive members) 17,338,000 Business members 5,214,000 Total primary cardholders 22,552,000 Add-on cardholders 25,127,000 Total cardholders 47,679,000

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Strategia aziendale - Formulazione ed esecuzione Arthur A. Thompson, A. J. Strickland III, John E. Gamble

Copyright © 2009 - The McGraw-Hill Companies srl

Case 1 Costco Wholesale Corporation: Mission, Business Model, and Strategy C-11

retailers), but employees did have to pick up the premiums for coverage for family members. Convenient prescription pickup at Costco’s pharmacies, with co-payments as low as $5 for generic drugs. Generally, employees paid no more than 15 percent of the cost for the most expensive branded drugs. A vision program that paid $45 for an optical exam (the amount charged at Costco’s optical centers) and had generous allowances for the purchase of glasses and contact lenses. A 401(k) plan in which Costco matched hourly employee contributions by 50 cents on the dollar for the fi rst $1,000 annually to a maximum com- pany match of $500 per year. Eligible employees qualifi ed for additional company contributions based on the employee’s years of service and eli- gible earnings. The company’s union employees on the West Coast qualifi ed for matching contri- butions of 50 cents on the dollar to a maximum company match of $250 a year; eligible union employees qualifi ed for additional company con- tributions based on straight-time hours worked. Company contributions for salaried workers ran about 3 percent of salary during the second year of employment and could be as high as 9 percent of salary after 25 years. Company contributions to employee 410 (k) plans were $233.6 million in fi scal 2006, $191.6 million in fi scal 2005, and $169.7 million in fi scal 2004. A dependent care reimbursement plan in which Costco employees whose families qualifi ed could pay for day care for children under 13 or adult day care with pretax dollars and realize savings of anywhere from $750 to $2,000 per year. Confi dential 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 proba- tion period and were working at least 10 hours per week were automatically enrolled in a short- term disability plan covering non-work-related injuries or illnesses for up to 26 weeks. Weekly short-term disability payments equaled 60 per- cent of average weekly wages up to a maximum of $1,000 and were tax free. Generous life insurance and accidental death and dismemberment coverage, with benefi ts based

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on years or service and whether the employee worked full-time or part-time. Employees could elect to purchase supplemental coverage for themselves, their spouses, or their children. An employee stock purchase plan allowing all employees to buy Costco stock via payroll de- duction and avoid commissions and fees. A health care reimbursement plan in which ben- efi t eligible employees could arrange to have pretax money automatically deducted from their paychecks and deposited in a 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 em- ployees 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 benefi ts was contrary to conventional wisdom in dis- count retailing, Jim Sinegal was convinced that hav- ing a well-compensated workforce was very impor- tant to executing Costco’s strategy successfully. He said, “Imagine that you have 120,000 loyal ambassa- dors out there who are constantly saying good things about Costco. It has to be a signifi cant advan tage for you. . . . Paying good wages and keeping your people working with you is very good business.”15 When a reporter asked him about why Costco treated its workers so well compared to other retailers (par- ticularly Wal-Mart, which paid lower wages and had a skimpier benefi ts package), Sinegal replied: “Why shouldn’t employees have the right to good wages and good careers. . . . It absolutely makes good busi- ness sense. Most people agree that we’re 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.”16