Costco is a retailer that has figured out how to get its customers to
pay for the privilege of shopping there, and its members decide the
privilege is worth the cost year after year after year.
The now global chain of warehouse stores counts more than 55 million
members around the world, and around 90% of them renew their
memberships each year.
If you want a 25-pound bag of beans, a bucket of soy sauce or a crate
full of bananas, Costco is the place to go.
While you are there, you can buy a flatscreen TV, a pair of
eyeglasses, some gourmet cheese and a few pairs of sweat socks.
You might be astonished at how little each item costs, and yet you
might end up spending much more than you planned to.
Costco developed a retail recipe that might have sounded crazy when
the company was founded, charging people a fee to allow them to spend
money in the store.
But it works, in part because Costco is a company that is run very
much for the pleasure of its members, and its members are fiercely
loyal. But the question is,
how long can it hold onto that?
Younger generations of consumers have grown up shopping online and
companies such as Amazon have taken some of Costco's secrets and
applied them to e-commerce, all while making shopping online a matter
of clicking a single button.
Add that to the downstream effects of the coronavirus.
Sales fell in April for the first time in a decade, largely due to
lockdowns and safety measures.
They bounced back in May, June and July.
But the company, meanwhile, had to spend $283 million in
Covid-related safety and sanitation costs during the third quarter of
2020, which ended in May.
Furthermore, Costco wants or even arguably needs shoppers to
physically visit its stores.
That is a big part of the experience.
Long lockdown periods around the country and general anxiety about
contracting the coronavirus led many shoppers to stay home and buy
more of what they needed online.
The company is highly dependent on membership fees for its profits,
meaning it needs to keep giving customers reasons to pay a minimum of
$60 per year to shop at the store.
Costco also raises membership fees every few years.
Subscriptions and memberships are often some of the household
expenses first to go when budgets tighten and consumers, faced with a
wide array of subscription services for gyms, streaming services,
meal delivery and other things, may be deciding what they ought to
cut if the economy goes into a downturn.
Costco's membership numbers held steady and even increased during the
recession that began around 2008.
But it remains to be seen just how resilient its business is this
time around. Costco declined to participate in this story.
What is today called Costco actually grew out of a merger of two
retailers with similar business models.
The first was called Price Club, and it was started in 1976 in a
converted airplane hangar in San Diego, California.
The store took its name from founder Sol Price, a Bronx-born attorney
who, in many ways, pioneered the club warehouse retail model more
than two decades before starting Price Club.
Price had learned a great deal about the world of business through
his legal work, helping clients with bankruptcies, real estate deals
and partnerships. But he had never run a store before.
He entered the retail business as a way to find a use for a
warehouse he helped his mother-in-law acquire as an investment in
1953. While searching around for a purpose for this property, Price
heard about a company called FedCo, a large warehouse store in Los
Angeles that sold a variety of goods at very low prices.
It was open only to members, run in a manner similar to a
co-operative and had been primarily created to serve U.S.
Postal Service workers and their families.
After trying unsuccessfully to partner with FedCo in his San Diego
warehouse, Price opened FedMart.
At FedMart, Price developed the idea of selling goods at very low
margins while charging a membership fee.
The company became tremendously successful and inspired other large,
low-priced retailers.
Sam Walton said many of his ideas for Walmart came from Price's
store. FedMart went public in 1959 on the American Stock Exchange.
The company was bought by a German retailer in 1975, but the new
owners failed to maintain Price's success, and FedMart closed its
doors by 1983.
Price then founded the Price Company in 1975 and opened Price Club in
1976.
The chain of stores had much the same model as Price's previous
venture. A few years later, two men named Jeff Brotman and Jim
Sinegal founded Costco in the Seattle, Washington area in 1983.
Like Price, Brotman was a lawyer with commercial ambitions, who
ventured into the club warehouse business at the urging of his
father, who had noticed Price's success.
The other Costco founder, Jim Sinegal, had spent years working
closely with Price at both FedMart and Price Club.
Costco grew rapidly from nothing to $3 billion in sales in under
six years.
Price Club and Costco merged in 1993 and were initially named
PriceCostco. The company became just Costco in 1997.
Since that merger, Costco has attained explosive growth.
In 1993, the company reported $15.5 billion in sales.
In 2019, its sales totaled $152.7 billion.
The company went public on December 5th, 1985.
Since then, shares have risen more than 19,000% from an IPO price
before stock splits of $10 per share to $344 per share
on August 26th, 2020.
A basic Costco membership costs $60 per year.
There is also a gold star executive membership that costs twice that.
That comes with some special perks, such as 2% cash back rewards up to
$1000 per year, savings on trips booked through Costco Travel, and on
a variety of other services Costco provides, such as identity
protection, auto and home insurance and bottled water delivery.
The value of these services would vary per customer, but someone who
opted out of them and only collected the 2% cash back reward would
have to spend $6000 per year to recoup the $120 executive membership
fee. The thing is that Costco doesn't make most of its money from the
actual sale of goods.
Its margins on the products on its shelves are extremely thin, much
thinner than those of grocery stores, for example.
Instead, Costco's profits come from its memberships.
"You know, most of their net income comes from membership fee revenue.
So last year, 92% of their total net income came in the
form of membership fee revenue.
So that membership fee revenue essentially drops straight down to the
bottom line because there's basically no cost associated with it."
It could be said that the store actually exists for the purpose of
getting its members to renew their memberships year after year after
year. And so, Costco is extremely focused on keeping its members
happy. In fact, the company has been known to refuse to raise prices
on goods in order to improve margins on sales, just to keep its
customers coming in the door.
It is also known for treating its workers well.
Costco store employees make better wages than those at many other
retailers. The company justifies the better pay and benefits for
workers on the grounds that happier employees will be more helpful to
members and improve the shopping experience
"In this world of, you know, what is what is stakeholder capitalism
versus shareholder capitalism, I think Costco's already have the
right approach to it, look it, you care about your associates, and
you care about your customers because if your associates aren't happy
and working hard and excited to be where they are, then your
customers are going to see that, your members and service levels they
get. And so the virtuous circle and the best thing for shareholders
is ultimately to have happy customers, and the way you get happy
customers is to have generally happy employees.
So to me, they've sort of gotten it the right way.
You know, at the end of the day, it is shareholder capitalism.
But the best way to benefit shareholders longer term is to take care
of your customers. And a key way to do that is take care of your
associates." Costco also offers some perks to all members that are
designed to make the experience of shopping more pleasant and easy.
The store is famous for having various stations set up throughout,
handing out free samples of different products, often food.
Costco had to briefly shut down this practice during the coronavirus
pandemic, no doubt disappointing many members.
In addition to free samples, there are also frequently in-store demos
of other products, such as electronics.
Costco also offers a concierge service for members, essentially a
technical support line where people can call for help with products
purchased in the store.
While some members might be relieved to discover they are able to get
help with products once they have bought them, part of what Costco
offers is extremely careful attention to what it even chooses to
stock in its stores in the first place.
Many customers might not notice as they stroll past the pallets of
sodas, stacks of egg crates and towers of paper towels that despite
the appearance of a vast warehouse stuffed with goods, inventory is
tightly controlled.
Items are packaged in large quantities, but there is a relatively
small number of products, often called stock keeping units or SKU's,
for the unique barcode attached to any unique item.
A single Costco carries only about 4,000 SKU's, whereas a Walmart
Supercenter can carry nearly 150,000.
But those products are very carefully chosen.
In many ways, Costco was a pioneer in the now common practice of
collecting and analyzing customer data.
When a member makes a purchase at Costco, the first thing they do is
swipe their Costco card.
Evercore ISI estimates that Costco has a team of more than 100 buyers.
Those buyers can access shopping data when determining what sorts of
products they ought to fill a store's shelves with.
"Those buyers are able to use that information to really seek out
items that their members might really appreciate, that wouldn't
wouldn't be obvious.
But that could be anything from leather coats, unique jewelry items,
a newly packaged way or innovative way to put together a camera and
the lenses that maybe isn't sold anywhere else.
So really finding what it is that their members might like.
And that's what creates a treasure hunt."
The company uses its massive number of members as leverage when
negotiating with suppliers.
Though Costco's prices are typically low, getting the absolute lowest
price in a category is not always the point.
The point, say analysts who follow the company, is delivering good
value. Products also rotate in and out of the store's inventory.
There's a pretty good chance that many of the items a shopper sees on
Costco shelves might not be there in a month or two.
The rotating stock encourages impulse buying.
Each visit to the store can yield the surprise for a member, maybe a
blender or a pair of running shoes.
Seeing something unexpected and knowing it might not be there in the
future can lead shoppers to jump at the opportunity to make an
unplanned purchase.
The store has also found other ways beyond the shelves to keep people
coming back, including cheap gasoline, optical services and low-cost
medical devices such as hearing aids.
There's a travel service, a credit card and a car buying service.
"The big picture is once you have, in the U.S., we think they have
well over 30 million households that are signed up as Costco members,
you're trying to find a way to add value to those members outside of
the club, outside of those four enclosed walls.
And I think ancillary businesses are a way to take the power of the
membership outside the club.
So, for example, travel, they can get package discounts, everything
from hotels to cruises.
But that's been one area of value add.
One another one's car buying.
So sort of cutting out the middleman and saying, 'Hey, we will bring
our group of members to a pre-negotiated price so that none of us
have to go through the hassle of the whole haggle with the dealer.'
Credit card's another one where there's a cashback program where you
can get 4% back on gasoline, 3% on restaurant spend, on travel spend,
even takeout or curbside pick-up restaurant spend, I've noticed
during this year of Covid.
So that's a pretty good value to the member on top of the normal
extra 2% or 1% you might get elsewhere at a Costco."
And there is, of course, the food court that sells $1.5 hot dogs and
other low-priced fare.
Its efforts to provide value to its members have also led to the
creation of its own house brand: Kirkland Signature, which has become
a considerable and growing portion of its business.
The sheer range of products is astonishing.
There are Kirkland diapers and Kirkland bottled waters, of course,
but there are also Kirkland wines and liquors.
Importantly, Kirkland products are not simply cheaper versions of
name brand goods.
When Costco brings the Kirkland line into a category, the company
takes care to ensure the product it's selling is high quality and
sometimes unique. The retailer is not just trying to sell something
cheaper; it's trying to add unique value, inspiring brand loyalty.
Some members report that they prefer Kirkland paper towels to those
offered by other brands, for example.
Kirkland Signature products accounted for roughly 30% of Costco sales
in 2019. The Kirkland Signature brand is arguably what has helped the
company fend off competition from other clubs such as Walmart's Sam's
Club, other bricks and mortar retailers, and the ever-growing world
of e-commerce, where all kinds of items can be ordered cheaply and in
all kinds of quantities, and often delivered right to a customer's
door. One much talked about segment is Kirkland's wines and liquors,
which have gained a reputation for being cheap, and at least to some
buyers, tastier than more high end brands.
Rumors have even circulated that Kirkland's liquors are just bottled
brand name liquors such as Grey Goose for vodka and Macallan for
whiskey. Grey Goose makers have denied this in the past, and Costco
has refused to comment.
The rumor might in part depend on the fact that Kirkland vodka sourc
es water from the same region in France Grey Goose draws from, and
some taste testers have given Costco's French vodka higher scores
than Grey Goose.
That said, the company does face some threats.
Its e-commerce presence is growing, but it lags behind others.
One very obvious threat comes from another Washington-based company
that has probably done more to upset retail in America and around the
world than any other: Amazon.
Jeff Bezos's mostly online empire has taken pages right out of
Costco's playbook.
You don't need a membership to shop on Amazon, but having one does
come with perks, such as fast shipping on many purchases, as well as
access to other services like online video and music.
Through services like it, consumers have become accustomed to the
lightning-fast and seamless experience of one-click buying.
If there is a place where Costco lags, it is in e-commerce.
There are often minimum order requirements, and products can be more
expensive online than they are in the club.
"But the way that they keep costs in line to make sure they keep that
promise that that I'm not paying more for my paper towels because you
want yours delivered, they do have minimum order thresholds.
Two-day delivery: $75.
They do charge more for products that are sold through Instacart or
on their two-day delivery. So, they're addressing e-commerce, I
think, in a very Costco kind of manner.
They're not going at it just to get more e-commerce sales, but
they're doing it to take care of their members."
In fact, Costco wants customers to go to the store.
The store is where Costco shines, and members locate those unexpected
finds that fill their carts and help drive up sales.
That may be a problem for them in the long-term.
Analysts who follow the company say e-commerce sales are growing, if
slowly, and Costco is, if also slowly, beefing up its online
presence. "Like all hypermarkets and supercenters, such as Walmart,
Target, a lot of their competitors, they've had a huge surge in
e-commerce sales from Covid-19.
If you look, their e-commerce sales year to date through July, were up
about 45%.
In more recent months, like June and July, their growth rates have
been much higher than that.
So, you know, they've really benefited from this shift."
In March 2020, Costco acquired a transportation company called Inovel
Solutions that specializes in last-mile delivery, especially for
larger goods like major appliances, furniture, mattresses, television
grills, patio, fitness equipment and wine cellars.
But the retailer is also calibrating its in-store inventory to suit
changing tastes, say investors.
Younger shoppers may be willing to pony up the $60 minimum membership
fee if they find goods on Costco shelves which they cannot find
anywhere else, even on the largest online marketplaces.
"From our survey work, we think the median or
typical Costco member in the U.S.
is around approaching 50-years-old per head of household.
And I think, ideally, you'd want that to be more like 40, 45.
You usually want your demographic to be younger to have that customer
for longer. So just things they've done over the years to really move
and get millennials to join have been adding organics in a pretty
major way, you know, emphasizing sustainability in more areas."
There is also the question of subscription fatigue.
Customers often have many more subscriptions today than in the past,
for streaming services, fitness centers, news outlets and in some
cases even cars.
There are worries that customers will cut some of these out of
budgets when they become overwhelmed or when economic times are
tight. But Costco memberships may prove more resilient than other
such services. "We think subscription fatigue is a real thing, but we
don't really see it for Costco, because they sell essentials.
I mean, this is a retailer of consumer staples.
So, yeah, they're more defensive play.
Therefore, we think their renewal rates will stay very high through
the pandemic. Now, we don't see them raising their subscription fees
for the foreseeable future, but we think Costco has a place as kind
of an essential subscription for families."
There is evidence that Costco's model might be rather resilient and
quite exportable, Costco has expanded into countries around the world
and in many markets it has proven a hit.
"You know, this is a company who, you know, 87% of their stores are
located in North America, 70% of their total stores are located in
the U.S. Costco is having a huge growth opportunity internationally,
especially in China.
But they've really done a good job growing out their North American
store base over the last three decades or so."
In fact, analysts say Costco is more profitable outside the U.S.
than inside of it.
Part of that just might be domestic competition.
In some countries, Costco is the only club retailer around.
It even works in some unlikely markets.
"It's funny, I'll admit, I was wrong when they first went in Japan.
And I went to go see it 15 years ago, I'm like, 'This is not going to
work.' Selling large packaged cube bulk items in a place where the
average household is less than half the size of an American home.
Just doesn't make sense.
But what I think they found there, and I think they're up close to
now 50 clubs, or on their path to be there, is people like shocking
value and quality.
And even in Japan, they've been able to develop some really highly
productive stores with a very strong membership model, including a
magazine that's in print that's very popular about the Costco
lifestyle." When a Costco opened in Shanghai, China, where there is
no shortage of competition online and offline in retail, shoppers
mobbed the store.
On its first day open, Costco had to cap the number of customers
allowed inside.
A number of international grocery chains and other retailers have
struggled in China. But Costco's opening day in China produced
traffic jams, reported three-hour waits for parking spaces and even
scenes of customers tussling over cuts at the meat counter.
If that kind of enthusiasm persists, Costco may soon find it has
created a whole new crop of fanatical members, this time in the
world's most populous country.