Payton Markowski and Auna Allen

Professor Kallback

Bus 350: Managerial Finance

21 October 2021

Porter’s 5 Forces Paper: Costco

Porter claims that there are five forces that drive a company’s competitiveness:

Competition, the threat of new entrants, power of suppliers, power of consumers, and the threat

of substitute products. Costco has many brand competitors competing for the general

merchandise retail market. Such companies include Sam’s Club, Wal-Mart, BJ’s wholesale club,

Target, Kroger, and retail giant Amazon.com (Maverick, 2021).

Competition itself is defined as a company's underlying economics, and competitive

forces that exist beyond the established combatants in the industry (Porter, 1979). When looking

at Costco’s financial data we see a higher rate of inventory turnover followed by Wal-Mart, then

Target (Maverick, 2021). For retail stores, inventory turnover is an important metric by which it

indicates how much inventory is sold in a period. Those that highlight a higher turnover are

higher on the completive scale. Competitive forces go beyond the financial data and other brand

competitors in the market. In Costco’s case, the five-force model indicates external factors that

influence their standing in the retail industry. Such forces include customers, suppliers, potential

entrants, and substitute products. The strength of these forces all determines the profitability of

an industry. Retail itself can be described as a mild industry where there is room for high returns

(Porter, 1979). Thus, Costco has potential for growth, and better performance if they

accommodate and adapt to the needs of the market.

 When it comes to the threat of new entrants, Costco and its main warehouse rival

Walmart’s Sam’s Club have grown so large that the possibility of a new entrant outperforming

either of the two is hard to consider. On the other hand, low switching costs between Costco to

Sam’s Club means it is easier for consumers to switch to new retailers (Young, 2017). Costco

operates on a minuscule margin making most of its net income from the sale of memberships

with extraordinarily little coming from the sale of its products (Logan, 2012). There is such a

cost disadvantage to them and outcompeting Costco as a startup because the capital costs would

be extremely high, and one’s ability to have costs as little as Costco would be particularly

challenging. Furthermore, Costco started a vast international supply chain that has been

developing since the 1970s. Both factors contribute to the claim that the threat of a new entrant is

exceptionally low for Costco.

The threat of substitute products, on the other hand, is much higher. Porter talked about

substitutes limiting profits in normal times, as well as in unprecedented times. For example, with

the evolving technology of today, we see significant competitors in the retail market making

moves online. Companies such as Amazon.com are expanding their services into food, which

makes it highly likely that Costco is going to start competing with the online market very soon.

Even though Costco has a strong position in the market they will earn low returns if they face a

superior lower-cost product. The growing trend of buying online, which has increased

significantly due to Covid-19, will contribute to this threat of substitute products. Costco’s whole

strategy is that people come to their stores to spend a lot of time there, usually over an hour,

which is in stark contrast to the growing convenience culture of online shopping (Logan, 2012).

However, despite Covid-19 and the growing presence of online shopping, Costco has continued

to grow and saw its best year ever this past year. Substitute products that improve their
price-performance trade-off and are produced by industries with higher earning profits will grow

substantially (Porter, 1979). Therefore, it is vital Costco develops substitutes that cause price

reduction or performance improvement like that of the online retail space. Other substitutions

that threaten Costco are the many substitutes to most of their goods found in other retail stores.

These goods are especially related to food products and commodities (Young, 2017). Since there

is an easy transfer or replacement of goods the strong threat of substitution is one of Costco’s

greatest challenges.

When it comes to the power of suppliers in a company in general, suppliers have

considerable say over their prices and have more bargaining power if their product is unique or

general enough for a vast number of customers. Suppliers affect Costco’s wholesale business in

the retail environment (Young, 2017). However, Costco has set itself up so that there is limited

power in the hands of suppliers. Costco only carries one (or rarely two) types of brands of each

product with a grand total of around 4,000 unique products meaning that suppliers must compete

to get into their stores and on the shelves (Logan, 2012). Costco also buys these products in high

quantities furthering the buying power of Costco and weakening the suppliers’ position (Porter,

1979). There is a large population of suppliers in the retail industry environment. Having a large

population of suppliers causes the distributors to meet the demands of Costco (Young, 2017).

Furthermore, if a supplier’s price is too high, then Costco’s brand Kirkland Signature will carry it

instead of their general items like clothes, milk, and toilet paper. Costco pulled an Uno reverse

card on their suppliers and took the power of suppliers away from them. If a supplier wants to be

on Costco’s shelves it must cater to Costco’s wants and price point. Thus, highlighting suppliers

can have significant power over participants in an industry. They do this in many ways but, the
most common is raising or reducing the quality of purchased goods and services. Conversely,

there is also the bargaining power of consumers that Costco also needs to keep in mind.

A buyer group is powerful if they purchase substantial amounts of product. Likewise,

consumers can contribute to the industry by buying their products. Consumers tend to focus on

prices that are relative to their income. This sensitivity allows the buyer of the product to

accommodate the needs of the consumer, thus quality is not particularly important (Porter, 1979).

To remain competitive, Costco must satisfy the needs of consumers (Young, 2017). Since Costco

consumers have many other companies to choose from like Walmart’s Sam’s Club, they must

offer prices that lower their substitution rate. Costco has a net income of $4 billion (about $12

per person in the US) by the end of the 52-week fiscal year which ended August 30, 2020

(Maverick, 2021). This highlights Costco’s ability to sell products tailored to the needs of the

population. Costco also displays its consumer buying power by its inventory turnover ratio. By

the end of their fiscal year, their inventory ratio was 11.84, which means they sold or turned over

their entire month's inventory (Maverick, 2021). This highlights Costco’s ability to sell to

powerful buyers and still come above average profitability even on lower-cost products. On the

contrary, if the company lacks low-cost positions or unique items, selling to everyone may make

them more vulnerable. This is where buyer selection is extremely important. Costco’s initial

buyer membership fee is $60 annually per household. This buyer selection differentiates, and

minimizes the threat of backward integration, thus granting power to their customers (Porter,

1979).

Overall, Costco has medium to low risk for competition regarding Porter’s five forces.

This medium to low risk was evaluated due to the dominance Costco has in the retail market

where they outshine their main competitors, Wal-Mart’s Sam’s Club, and target. Since this
market is large the threat of new entrants is low. Costco also has power over suppliers by which

they meet the demands of the market almost always. This power over suppliers is due to the

distributor's reliance on Costco buying their products. Statistics even provide proof Costco is

efficient in selling goods. This is represented by a high inventory turnover. Substitution products

pose some threat for the industry, but not significant enough to threaten the company. We see

substitute products like food, and commodities being mostly replaced. Power of buyers also

poses some competition due to the ease of transfer to other retail businesses. Although Costco

has a monthly membership fee, consumers can always buy out, and cancel to buy from other

places.