Executive Summary

Costco is at a prime point in its maturity, as main competitors like Walmart and Target

suffer from an ailing brand image. Costco does well by selling a limited number of products at

deep discounts.

Costco depends heavily on warehouse operations for sales revenue and growth: Costco

receives 100% of its sales revenue from warehouse operations. However, Costco is faced with a

problem: as the company overtakes its competitors and expands its overall market share,

Costco will inevitably hit a ceiling that will limit and could halt warehouse expansion.

Should Costco increase orders to its existing stores, or should Costco aggressively go

after online sales and integrate its online and retail operations? Both propositions would solve

the problem of dependence of warehouse expansion driving sales, but due to the compliance

with their standard operating procedures and the benefits available and fostering membership

loyalty and interaction, Solution 1 would be the more cost-effective.

Costco could implement some very definitive methods of evaluating results. An increase

in sales could be measured by daily or weekly revenue reports made to the corporate office. A

report that shows daily transactions, revenues, and transaction values would be excellent

indicators of increased store sales. This would allow Costco to calculate average order values,

return on investment on new memberships, revenue incurred on specific days of events or

sales, and it would help Costco optimize their marketing and advertising costs.
 Costco Problem Statement

Costco depends heavily on warehouse operations for sales revenue and growth: Costco

receives 100% of its sales revenue from warehouse operations, according to a Marketline

report (2015). However, Costco is faced with a problem: as the company overtakes Walmart in

overall market share, Costco will inevitably hit a ceiling that will limit and could halt warehouse

expansion.

Background

Costco’s 10-K discusses the tight integration of Costco’s sales growth by expanding

warehouses. The 10-K clarifies its relationship by saying, “As our warehouse base grows

however, available and desirable potential sites become more difficult and potentially more

expensive to secure, and square footage growth may become a comparatively less substantial

component of sales growth” (Costco 2014 10-K, p. 17). As favorable warehouse sites decrease,

sales growth will undoubtedly slow. Environmental factors and community resistance will surely

hamper growth as Costco continues its quest for expansion and sales growth. Costco is at a

prime point in its maturity, as main competitors like Walmart and Target suffer from an ailing

brand image. Ashley Lutz’s article summarizes the brand crisis of Walmart and Target: “Huge

Wal-Mart and Target stores lack the convenience of smaller dollar chains and drugstores. They

also can't offer the deep discounting of warehouse clubs like Costco” (Business Insider, 2014).

Costco does well by selling a limited number of products at deep discounts. Lutz also

postulates, “Selling fewer items increases sales volume and helps drive discounts” (Business

Insider, 2014). Costco is at a point that is ripe to capitalize on competitors’ ailing brands by

increasing sales further to their stores. Costco doesn’t necessarily have a large penetration
overseas, nor do they have subsidiaries overseas like most other public companies. Valueline’s

SWOT analysis states that “Sales in the U.S. and Canada represented 87% of the total for 2014”

(Dalavagas, para. 7). Approximately 70% of Costco’s store base is located in the United States,

and 30% of its stores are located across eight other countries. Since international expansion

appears to be a secondary priority for Costco—even though there is much room for growth—a

different solution is needed to mitigate the problem of limited warehouse sites. Costco does

well to offset high operating costs and costs of expansion by selling memberships that allow for

purchasing, but there is still a risk, as Costco is heavily dependent on warehouse expansion for

sales growth.

Solution 1: Increase sales to existing warehouse locations

Costco should encourage new and returning customers to shop at their warehouses

more and put less priority on warehouse expansion, especially as they approach the ceiling of

oversaturation to help mitigate the risk of overexpansion. Costco already drives loyalty by

requiring that shoppers purchase a membership in order to shop in-store, which drives

discounts on products and services (Lutz, 2014). However, offering members-only events and

other extended, time-sensitive incentives would increase sales to stores without warehouse

expansion. This would require a fundamental change in operating procedures by including

increased advertising and marketing to current and prospective customers, since their 10-K

never once mentions the word “advertising”. The word “marketing” appears only once in their

2014 10-K:

Marketing activities generally include community outreach programs to local businesses

in new and existing markets and direct mail to prospective new members. Ongoing
 promotional programs primarily relate to coupon mailers, The Costco Connection (a

magazine we publish for our members), and e-mails to members promoting selected

merchandise (p. 4).

Much of Costco’s business deals directly with labor optimization. For example, Costco is

not open during traditional supermarket hours. Generally, according to their 10-K (p. 4), they

are open from 10:00AM–8:30PM, and close earlier on the weekends. They do not have

additional warehouse storage for overstock of products, and many of the products are sold by

the case, so workers do not have to spend time dismantling manufacturers’ packaging

materials.

Costco Solution 1 Cost-Benefit Analysis

Costco does little advertising, and relies on membership fees and competitive pricing to

foster customer loyalty. This has been effective in keeping prices low, but it would help Costco

in the long run for Costco to market their stores to increase sales in their existing locations by

attracting new customers, and reward their current customers with greater incentives like

members-only events and offers—not just discounts. The cost of increased advertising and

marketing would be the biggest chunk of costs for this solution. Another cost would include

increased labor and training costs—depending on the event or incentive offered. Offering

additional discounts on products could eat into profits, but this depends on the product or

service offered.

The benefits would be increased memberships and increased brand loyalty to Costco,

and would come at the expense of an initial advertising budget and the costs to acquire their

customers. Some of these costs are tangible, like a marketing budget and the costs to the
company to make up for events, and the events themselves, but the benefits would help drive

sales. Some other costs are intangible, like the reception of the solution by the marketplace,

and the effects this solution would have on competitors like Walmart, Target, and BJ’s. Costco

could explore the option of selling bundled products or offering buy one get one—BOGO—sales

or deals on frequently purchased item groups. For example, Costco could offer an additional

discount on jars of pasta sauce if a customer bought a certain amount of pasta.

Solution 2: Aggressively Market Costco Online to Drive More Sales

There may be another way to achieve increased sales and become less dependent on

warehouse expansion. According to Costco’s 10-K, “Net sales for [Costco’s] online business

were approximately 3% of our consolidated net sales (2015, p. 5). Euromonitor’s Passport

Industry Overview summarizes retailing in the United States market as one that is in decline

where bricks-and-mortar stores are concerned (2015). In order to attract more customers,

grocers have had to make changes in order to combat increased online sales. This solution

would include increasing online sales or driving online sales with the intent on visiting existing

warehouses. Currently, Costco does not offer an in-store pickup option; rather, products that

Costco customers order online are shipped to the customer’s home or business directly from

the manufacturer (Customer Service, 2015). Costco mentions that this is to keep shipping and

logistics efficient, but it might behoove them to offer an option to pick up the items in store,

encouraging more shopping. A customer might reason that since they are picking up items from

a previous online purchase that they could do more shopping since they are already at Costco.

Solution 2 Cost-Benefit Analysis

 In order to make this solution relevant, warehouses would need to have space devoted

to customer purchases, which could cause a fundamental shift in operating procedures. There

would need to be labor to stock and maintain the product received for in-store pickup. There

would be marketing and advertising costs incurred in order to drive customers to utilize the

service, and there would be time involved in developing the option on the company’s website.

Manufacturers and vendors would also need to be notified. Some manufacturers and vendors

might not agree to these terms if it violates their logistics procedures, meaning that their

relationship with Costco could end or be altered in a way not favorable to Costco.

While it is important for a retailer to drive sales online, this particular solution focuses

on one part of a larger picture. The benefits of increasing a sales channel need not be discussed

here, but an in-store pickup solution would prove beneficial in that it would encourage

customers to shop more while they are already in the store. Costco would receive more

customer traffic to their stores if there were a pickup in-store option, driving sales online and

in-store without warehouse expansion.

Analysis & Recommendation

There are more initial startup costs to the second solution, since the author sees a more

complicated rollout due to startup costs. The first solution would be easier to roll out, since

there would less startup costs, and it lends itself more to the existing operating procedures of

the company.

Both propositions would solve the problem of dependence of warehouse expansion

driving sales, but due to the compliance with their standard operating procedures and the
benefits available and fostering membership loyalty and interaction, Solution 1 would be the

more cost-effective.

Evaluation

Costco could implement some very definitive methods of evaluating results. An increase

in sales could be measured by daily or weekly revenue reports made to the corporate office. A

report that shows daily transactions, revenues, and average transaction values would be

excellent indicators of increased store sales. This would allow Costco to calculate average order

values, return on investment on new memberships, revenue incurred on specific days of events

or sales, and it would help Costco optimize their marketing and advertising costs. The fruits of

advertising could be measured by calculating return on investment (ROI) by using the following

formula:

New memberships - Cost of advertising

Cost of advertising

A negative ROI would indicate that the current marketing strategy is not viable and

should be optimized aggressively, while a positive ROI would indicate just the opposite: the

strategy is viable and does not require as much optimization.

Costco could also measure an increase or decrease in their average order value (AOV).

For example, when customers purchase an average of $50 per sale one year, then see an

increase to $65 per sale the next year due to increased advertising, Costco could conclude that

their advertising is effective, as long as the cost of advertising does not exceed an average of

$15 per customer.

Conclusion
 Costco is at a prime for growth thanks to highly optimized operating procedures and

competitors’ suffering brand images, but they will hit a major wall if they do not implement a

solution to combat warehouse overexpansion. One effective and feasible solution would be

increasing customer sales by holding special events and offers at existing warehouses and

putting warehouse expansion at a lower priority. Costco needs to solve this problem before it’s

too late. Since they are already heavily dependent on warehouse expansion, putting emphasis

on increased sales would be a natural step in the right direction.

 References

Costco. (2015). Form 10-K 2014. Retrieved from SEC EDGAR website

http://www.sec.gov/edgar.shtm

Costco.com product shipment to Costco location. (n.d.). Retrieved from http://bit.ly/1LuYh9Q

Dalavagas, I. (2015, February 9). SWOT analysis: Costco wholesale corporation. Retrieved from

http://www.valueline.com/Stocks/Highlights/SWOT_Analysis__Costco_Wholesale_Corp

oration.aspx

Euromonitor International. (2015, June 2). Costco wholesale corp in retailing (USA) [Local

Company Profile]. Retrieved from http://go.euromonitor.com/Passport-Home

Euromonitor International. (2015, June 2). Mixed retailers in the US [Category Briefing].

Retrieved from http://go.euromonitor.com/Passport-Home

Euromonitor International. (2015, June 2). Retailing in the US [Industry Overview]. Retrieved

from ​
http://go.euromonitor.com/Passport-Home

Lutz, A. (2014). Costco's simple strategy for outperforming Wal-Mart and Target. Retrieved

from http://www.businessinsider.com/costcos-simple-strategy-2014-9

MarketLine. (2015, August 14). Costco Wholesale Corporation. [company profile]. Retrieved

from MarketLine Advantage database.

Mohr, J. (2015, October 24). Jim Cramer discusses why Costco is superior to Walmart, other

retailers. Retrieved from

http://www.thestreet.com/story/13336536/1/jim-cramer-discusses-why-costco-is-supe

rior-to-walmart-other-retailers.html