Main elements of Costco’s strategy
Costco stco Corporation is the biggest wholesale club in the United States. Part of its success lies with early entry into the industry, but more still is the company’s ability to provide a wide variety of products to its members at the lowest cost possible. Costco’s operating model involves buying products in bulk, which in turn minimizes costs, and the company is subsequently able to pass on the discounts to its members.
Members, in turn, buy these products in bulk to experience these benefits and are also required to pay membership fees, which constitute another revenue stream for the company. As the company increases in worth, the membership fees increase to reflect value to customers, hence raising the company’s revenues (Berman, Knight & Case 2008).
Costco has a policy of not marking up the products by more than 14 percent. This portrays consistency, which goes on well with its members. Costco also differentiates its customers by it targeting small business owners and the middle class. This strategy is quite advantageous since these customers have more income at their disposal and hence can buy Costco’s products regularly. Even though selling products in mass allows for several operating efficiencies, Costco ensures that it offers the lowest possible cost per unit through bulk packaging.
The low cost per unit for the items translates into value to the customer. Item package sizes are limited in size so as to encourage repeat sales. Costco is a powerful purchaser, which puts it in a better position to negotiate prices from its suppliers. Suppliers are able to save on production processes since Costco only purchases a handful of SKUs (stock-keeping units). Cost savings incurred by the producers are negotiated for by Costco so that they can be passed on to the end-user.
Furthermore, Costco increases the value to members by providing a wider range of brand-name products and product augmentation. Costco’s house brand, Kirkland, aims at providing quality products at discounted prices. Due to the company’s low gross margin, Costco has had to focus on operating efficiency so as to minimize costs. Cost-cutting programs are meant to reduce capital expenditure, whereby the company strives to reduce transportation, storage and utility costs.
Costco’s comparison with its competitors
Costco’s differentiation strategy is much more profitable than Wal-Mart’s SAM’S club, as the latter targets lower-income earners. Low-income earners don’t offer as much volume sales as Costco’s middle class and small businesses, explaining Costco’s higher revenue and operating income per store. SAM’S club experienced more top management turnover in the 1990s while Costco’s had been in control since the inception of the company. Frequent top management changes imply that the company lacks a clear consensus on the way forward, which in turn decreases effectiveness (Bernstein & Wild 2000).
BJ’s Wholesale Club also uses the 14 percent limit on common products, but the club exceeds the 14 percent limit on select items, which puts BJ’s in a better position to claim more revenue and profit on those items. BJ’s also targets the same customer group as Costco, but BJ’s has smaller stores and offers more SKUs than Costco. As a result, BJ’s club members have more freedom in selection of product brands. BJ’s also invested more money in its facilities to create a shopping experience; hence these three strategies indicate possible reasons as to why BJ’s achieved more revenue growth.
Common size financial statements
Costco increased the number of stores from 1997’s 274 to year 2001’s 365 stores (exhibit 5), while the number of club members has increased modestly in that same period. Costco’s operating expenses are consistent through the period in focus, averaging to almost 90 percent of total revenue, which proves that the company is still implementing its bulk sale strategy.
Owner’s equity has been increasing at a slow pace, from 45.07 to 48.39 percent (exhibit 9), meaning the company is gaining in financial strength (Brigham & Ehrhardt 2008). The retained earnings have increased at a steady rate, from 33 percent in 1997 to 38.94 percent in 2001 (exhibit 9), signifying that the company is becoming more efficient.
Sustainable growth modeling
Costco’s return on equity (ROE) is equal to 14.2 percent, whereby the highest contributor is asset turnover, at 4.03 percent (exhibit 10). The company’s earnings retention ratio is 100 percent, indicating that Costco can sustain its growth rate by itself without sourcing for more equity or use of leverage (Fridson & Álvarez 2002). As a result, Costco’s sustainable growth rate (=ROE*[1-dividend retention ratio]) for 2001 is 14.2 percent (exhibit 10), which means that the company makes a 14.2 percent profit per every dollar in equity.
Benchmark ratios
Costco, SAM’S, BJ’s and Sears all have low net profit margins, meaning that they all rely on high sales for profitability. Across the board, Costco has the highest inventory turnover at 11.7 percent (exhibit 11), thus higher sales per store mean its more efficient and profitable than the other entities.
The current ratio of 0.94 percent is the least in the competition group, but its closeness to 1 percent indicates that the company is fairly liquid and has better utilization of resources than its competitors, who all have ratios of above 1 percent, and more than 2 percent in the case of Wal-Mart and Sears. High current ratios may be as a result of slow-moving inventory or non-recoverable debtors; hence it does not always portray an appropriate liquidity position. Costco is in a strong position to continue growing.
References:
Berman, K., Knight, J. & Case, J. (2008). Financial Intelligence for entrepreneurs: What you really need to know about the numbers. New York, NY: Harvard Business Press.
Bernstein, L. A. & Wild, J., (2000). Analysis of financial statements. Sturgis, KY: McGraw-Hill.
Brigham, E. F. & Ehrhardt, M. C. (2008). Financial management: theory and practice. 12th ed. Stamford, PI: Cengage Learning.
Fridson, M. S. & Álvarez, F. (2002). Financial statement analysis: a practitioner’s guide. Hoboken, NJ: John Wiley and Sons.