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.
man i remember my family went to fedco and price club waaay back in the day.
price club had those frozen lemonades, so good
Used to go to the FedCo in Costa Mesa, back in the day