Have you ever wondered what makes Costco such an enigma in the retail landscape?
I’m Jenny Rae Le Roux, the Managing Director of Management Consulted. And today on Strategy
Simplified, I’m going to walk through why Costco is how it is, how its business model operates,
and some of the secrets to Costco's success. What kind of business is Costco in? We always
start Strategy Simplified by talking about whether it's a fixed or a variable cost business. Second,
when they're measuring to those metrics, what key metrics do they use to define their success.
And third, what does the future hold for Costco. Costco is one of the world's most
unusual organizations from a retail perspective. Not only do members have to pay a subscription
to get in the door, but also there are long lines un-sexy warehouses, and you can't buy toilet paper
in anything less than a three month supply. So for me personally, I’ve never been a member of Costco
and I’ve always wondered what those weird lines are. However, I’ve recently gained
some understanding after looking at Costco's financials and some of their business model,
to try to figure out what they do to make their strategy so powerful. Now if you’ve followed
Strategy Simplified before, you'll know that one of the things that we tease out first and foremost
is whether this business is a fixed cost or a variable cost business, because that drives most
of its decisions going forward. And Costco may seem like a fixed cost business. They have big,
fixed cost footprints in their stores, they hold inventory, they have fixed cost staffing - they
have staff members that are generally there and it doesn't really seem like they flex them too much
positively or negatively. They've got overhead, they've got mailers, they've got marketing. And so
Costco does seem to be a pretty fixed cost based business. But if you’ve followed us for any length
of time, you'll recognize that most retail stores are actually variable cost business, just with one
big fixed cost line item. Either their mortgage or their rent. And Costco is absolutely the same.
So why then does Costco have this model where you have to pay a membership to come in the
door in order to save money? Well, Costco has a blended model of revenues. They are a variable
cost business that makes primarily their amount of money on per unit margins for each of their
products. But one thing that having a membership does for Costco is it incentivizes you to return
because they don't just have a model where if you buy one product once that's sufficient.
Their ultimate goal is acquiring a customer and maximizing the lifetime value of the
customer through repeated purchases. And one way to ensure that you do that is to make sure
that you're paying for the privilege of going in, so you're activated, psychologically reminded to
use the service to buy more of your goods and more of your services through Costco. Costco over time
has added additional functions, such as photo, pharmacy, and even a big deli with big birthday
cakes. Everything is big at Costco. So in general, Costco, when they think about the development of
their stores, they manage to two main things. One is the repeat value of a customer. Their lifetime
value. And they really work on making sure that each customer is increasing their purchases,
and increasing the volume of visits that they make to the store so that their maximum revenue per
customer adopts to a good bottom line. That helps them leverage what they do have in fixed costs
most effectively. In addition, Costco works on building scale across its entire organization. And
scale in many businesses is there for fixed cost businesses to drive down costs so that they can
drive overall margins. But in a retail business, scale like with Walmart, is there to drive down
the per unit cost. So every time that Costco is buying something, whether it's wallpaper,
or whether it's widgets, then they are able to get a lower price for it from their suppliers so
that they're able to get more margin on the other side. So if they manage those two things: driving
repeat purchases and maximum revenue on a per customer basis so that their margins are healthy,
but overall lifetime margins are also super strong, and then if they're able to manage
costs down on the cost side through having a larger network of Costcos, and therefore
a larger demand on suppliers and more leverage for those suppliers, they're able to play
both sides of the variable cost per. Overall, Costco does think about how to manage other things
like their staffing costs and their overheads, but ultimately this margin business is the big
one that they're in. Pay attention to how Costco is facing certain crises around the world. Pay
attention to their store opening announcements, or the limited store openings that they have. And pay
attention to some of the metrics that they use to build their business. We hope that you've enjoyed
this readout in Strategy Simplified on what makes Costco, Costco. Please join us for more Strategy
Simplified podcasts and videos, both on your favorite podcast platform and here on YouTube.