Costco Wholesale Corporation: Mission, Business Model and Strategy COMPANY BACKGROUND Costco was founded by Jim Sinegal

and Seattle entrepreneur Jeff Brotman (now chairman of the board of directors). The first Costco store began operations in Seattle in 1983, the same year that Wal-Mart launched its warehouse membership format, Sams Club. By the end of 1984, there were nine Costco stores in five states serving over 200,000 members. In December 1985, Costco became a public company, selling shares to the public and raising additional capital for expansion. Costco became the first 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 Costcos chairman since the companys 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 companys $9 billion investment in real estate operationsin 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 non-warehouse 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 companys headquarters was in Issaquah, Washington, not far from Seattle. Exhibit 1 contains a financial and operating summary for Costco for fiscal years 20002006.

COSTCOS MISSION, BUSINESS MODEL, AND STRATEGY Mission: - Costcos mission in the membership warehouse business read: To continually provide our members with quality goods and services at the lowest possible prices. Costcos Strategy The cornerstones of Costcos strategy were low prices, limited selection, and a treasurehunt shopping 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 significant cost savings; this was true even if an item was often requested by customers. A key element of Costcos 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 Costcos 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 productswhich included juice, cookies, coffee, tires, house wares, luggage, appliances, clothing, and detergentwere designed to be of equal or better quality than national brands. Costcos philosophy was to keep customers coming in to shop by wowing them with low prices. Indeed, Costcos markups and prices were so low that Wall Street analysts had criticized Costco management for going all out to please customers at the expense of increasing profits for shareholders. One retailing analyst said, They could probably get more money for a lot of the items they sell. 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. Were trying to build an organization thats going to be here 50 years from now. Treasure-Hunt Merchandising: While Costcos product line consisted of approximately 4,000 items, about one-fourth of its product offerings were constantly changing. Costcos merchandise buyers remained on the lookout to make one-time purchases of items that

would appeal to the companys clientele and that would sell out quickly. A sizable number of these items were high-end or name-brand products that carried big price tagslike $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 floor all the time. The other 1,000 are the treasure-hunt stuff thats always changing. Its the type of item a customer knows they better buy because it will not be there next time, like Waterford crystal. 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 retailers looking to get rid of excess or slow-selling inventory. Examples of treasure-hunt specials included $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: Costcos 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 promotional 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 direct mailings during the period immediately prior to opening. Management believed that its emphasis on direct mail advertising kept its marketing expenses low relative to those at typical retailers, discounter, and supermarkets. Growth Strategy: In recent years, Costco had opened an average 2025 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 fiscal years 20022006; 16 new warehouses opened in the first four months of fiscal 2007 (between September 1 and

December 31, 2006), and management planned to open another 2024 by the end of fiscal 2007. Five new warehouses were opened outside the United States in fiscal 2005, five more were opened in fiscal 2006, and four were opened in the first four months of fiscal 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 5050 partner in a venture to operate 30 Costco warehouses in Mexico. Exhibit 2 shows a breakdown of Costcos geographic operations for fiscal years 20032006. (The data for the 30 warehouses in Mexico are not included in the exhibit because the 5050 venture in Mexico was accounted for using the equity method.) Web Site Sales: Costco operated two Web sites www.costco.com in the United States and www.costco.ca in Canadaboth to provide another shopping alternative for members and to provide members 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 fulfillment, and travel and other membership services. Warehouse Operations: Costco warehouses averaged 140,000 square feet and were constructed inexpensively with concrete floors. Because shoppers were attracted principally by Costcos low prices, its warehouses were rarely located on prime commercial real estate sites. Merchandise was generally stored on racks above the sales floor and displayed on pallets containing large quantities of each item, thereby reducing labor required for handling and stocking. In effect, warehouse managers functioned as entrepreneurs 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 product locations and displays to maximize sales and quick turnover. Costco had direct buying relationships with many producers of national brand-name merchandise (including Canon, Casio, Coca-Cola, Colgate-Palmolive, Dell, Fuji, Hewlett-Packard, Kimberly-Clark, Kodak, Levi Strauss, Michelin, Nestl, Panasonic, Procter & Gamble, Samsung, Sony, Kitchen Aid, and Jones of New York) and with manufacturers that supplied its Kirkland Signature products. No one manufacturer supplied a signify cant percentage of the merchandise that

Costco stocked. Costco had not experienced any difficulty in obtaining sufficient 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 merchandise returns when members were dissatisfied 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. Business Model: - The Companys 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 categories. Management believed that rapid inventory turnoverwhen combined with the operating efficiencies achieved by volume purchasing, efficient distribution, and reduced handling of merchandise in no-frills, self-service warehouse facilitiesenabled Costco to operate profitably at significantly lower gross margins than traditional wholesalers, mass merchandisers, supermarkets, and supercenters. Financial Perspective: Financial Measure gross profit margin 2006
*** given data from case study

2005

2004

10.5% 10.6% 10.7% 11.1% 11.4% 1.22 0.09 11.45 1477 1.18 0.13 11.41 1099

return on stockholder equity 5.6% current ratio debt to equity ratio inventory turnover working capital (in millions) 1.05 0.02 11.42 413

The gross profit margin falls into the normal range for this industry. However, it should be trending upward and as you can see it is actually decreasing slightly. If this trend continues, steps will need to be taken to correct the problem. Another probability indicator, return on stockholder equity indicates that the company has a problem. Average returns are around

12%, which Costco was nearing in 2004 and 2005. In 2006, the company experienced a sharp decline which is cause for concern. Investigate this decline. It could be due to low profits after taxes. If the pricing is too low, this can happen. Currently, Sinegal, admittedly, tries to sell products at the lowest price possible for longevity. However, if the investors in the firm are not making appropriate returns for the risk, they will invest elsewhere. The current ratio figure is in the average range but on the decline. The debt to equity shows a strong balance sheet and low levels of debt. It is trending downward. The inventory turnover rate is slightly higher than average, indicating that Costco is outperforming competitors in moving product. Also cause for concern is the fact that the working capital is shrinking. This might indicate the inability to expand without a loan. Costcos Membership Base and Member Demographics GOALS TOWARDS MEMEBERS: Take Care of our Members Provide quality products at the best prices 100% satisfactions guarantee warranty on every product & membership fee. Provide ecologically sensitive products Provide the best customer service in the retail industry Give back to our community through volunteerism and corporate contributions COMPENSATION & WORKFORCE: Compensation and Workforce Practices: Our employees are our most important asset; they are the key to executing the strategy successfully. Sinegal Provide Competitive Wages Starting hourly wage: $12; Average hourly wage: $17-18 Generous Benefits Career Opportunities: Policy that 86% of higher lever openings are hired from within. In actuality, the figure runs at 98%. Open Door Policy-that allows ascending levels of management to resolve issues.

Executive compensation: Salary-roughly 12 times of a person working the sales floor plus Stock Options and Bonuses Results of Taking Care of Employees: 120,000 employees spreading a positive message about Costco High employee retention (6% turnover rate) Higher productivity from workers Costcos Business Philosophy, Values, and Code of Ethics Costcos corporate culture and the manner in which the company operated values, principles and operating approaches are the following excerpts: Goals: 1. Obey the Law 2. Take Care of Members 3. Take Care of our Employees 4. Respect our Suppliers 5. Reward our Shareholders Competitor Analysis: Primary Competition: 1. Sams Club 2. BJs wholesale Factors of Competition: Price, merchandise quality, location & membership services

Secondary Competition: 1. Retail Discounters: Wal-Mart & Dollar General 2. General Merchandise Chains: Target & Kohls 3. Low-Cost Specialty Stores: Lowes, Home Depot, Staples, Best Buy, Circuit City, Barnes & Noble

Competitive Outlook
Costco is beating both Sams Club and BJs wholesale in net sales and market share. However, Sams Club has launched an aggressive campaign that its product offering is nearly twice as large. Costcos overseas performance is mixed. The last four years, the return on sales remained constant at 3% in the U.S., 4% in Canada, and other foreign operations show a 1% return in 2003 and an increase to 2% in the last three years. This ratio shows the profitability of the different geographic locations of the firm, without taking into account interest or taxes. Since 2004, the return on sales from international endeavors has been equal to the U.S. return on sales. This indicates that national and international ventures are equal in profitability of current operations. SWOT ANALYSIS It is important that companies experience strengths in order to grow. Costco has several strengths that allow their company to continue growing, such as: STRENGTHS: Hiring from within the company and lower employee turnover. Minimal Advertising is required as the company primarily depends on word-of-mouth advertising. Although Costcos advertising activities are very minimal, over the past 10 years the company has seen a steady increase in comparable store sales and, in turn, a strong steady increase in net profits. Rapid Inventory Turnover: Costcos high sales volume and rapid inventory turnover present a number of opportunities for the company.

 In addition to buying power, the rapid inventory turnover generally allows Costco to obtain cash for the inventory before having to pay the vendors, while still being able to take advantage of early-payment discounts. Both of these strengths allow the company to stick to their mission of providing the lowest possible prices by passing these savings directly on to consumers. WEAKNESSES: Though Costco has several strengths and has a well-established brand image, they have also experienced several setbacks as well. These weaknesses are outlined here: Slow growth of private labels Limited choices for customers Jim Sinegal is 79!!! Happy Retirement. Then who will be the next CEO & what will happen? OPPORTUNITIES: As a company, Costco has several opportunities available to assist with growth. These opportunities are discussed in detail as follows: Positive outlook for internet sales Increases in home improvement expenditures Expanding electronic equipment As for concurrent recession, luxury goods will be found cheaper for Costco! Costco still have to go to enter Europe, China & India. THREATS: As a company that is established in the retail industry, there are several threats that are open to Costco. These threats are explored as follows: Decline in housing market Increasing retail rates

STRATEGIC FORMULATION Although Costco is currently a very successful company with a straightforward vision, focus, and strategy, there are a few things that could be changed or implemented in order to further increase the companys success. Open additional smaller stores in smaller markets Offer a larger product selection Provide the tools to allow customers to better serve themselves. Recommendations Membership Strategy Adjustments: 1. Non-Member Day: A quarterly event that allows non-members a trial day at the store allowing raises in probability of a prospect becoming a club member 2. Household Plan: $20 for every additional household member purposing the use of existing relationships to leverage new ones to increase membership rates 3. Membership Rewards Program: Pay $80 for your annual membership and get 2% off every purchase Credit Cards: 1. Current payment methods: cash, check, debit, and Costco Credit 2. Recommended: Allow the Use of Credit Cards but charge a 2% fee purchasing by credit. Advertising: 1. TV Brand Advertising for awareness & reminder ads 2. In the Northeast and West Coast regions where locations are clustered in order to receive marketing efficiencies 3. Seasonal TV advertising & periodic direct mail promotions of Treasure Hunt items

Expand Ancillary Business Programs: 1. Ancillary businesses services benefit Costco by: Increase the frequency of customer visits 2. Benefit members by offering multidisciplinary services that are efficient and costeffective Making Costco a One-Stop Shop Growth Opportunities: We recommend that Costco should plan to enter Brazil, China, and India & Europe. Sams Club has taken the Pioneering Costs of introducing Warehouse Retail into these societies. China is predicted to have a five-fold increase in urban consumer spending over the next 20 years to $2.3 trillion a year.

REFERENCES Costco Wholesale. (n.d.). Buckmaster. Retrieved February 27, 2011, from buck.com/annual_report?nam=DEMO2&pw=DEMO2&co=COST Farfan, B. (n.d.). Costco Wholesale Warehouse Mission Statement. About.com. Retrieved February 27, 2011, from http://retailindustry.about.com/od/retailbestpractices/ig/Company-MissionStatements/Costco-Stores-Mission-Statement.htm Thompson, A., Gamble, J., & III, A. S. (2009). Crafting & Executing Strategy: The Quest for Competitive Advantage: Concepts and Cases. n.d.: The McGraw-Hill Companies.