Costco Wholesale Corporate Logo

Costco Wholesale Corporate Logo (Photo credit: Wikipedia)

I love shopping at Costco! Ever since I was a little girl, the thought of going to Costco was always so exciting.  Every time you step into the store it is like going on a treasure hunt, you never know exactly what you are going to find.  Sure they always have the same standard products, but with a bit of luck they could have anything from UGG boots and designer jeans to diamond bracelets and pro golf clubs.  Not to mention all the food samples they have scattered among the aisles.  My love for the store and company use to be purely based on the shopping experience.  Now having learned about their business model and strategies I am truly infatuated!

If you had asked me about Costco and Wal-Mart before I read “Decency Means More Than “Always Low Prices” by Wayne Cascio, I would have guessed that the two companies were pretty similar.  I thought that they operated with similar business models and that Wal-Mart was more successful.  However I was grossly mistaken and ill-informed.  Not only was Costco a more successful company when the article was written in 2006, but today Costco continues to be just as, if not more successful than they were in 2006.   Thanks to a fantastic business model that takes into account the interests of all stakeholders and attempts to maximize utility for all.  Not only is Costco the “Anti-Wal-Mart”, they are also the perfect example of a company that correctly applies stakeholder theory and whose actions follow utilitarianism by maximizing benefit for as many parties as possible.  Costco truly proves that companies can be successful and generous at the same time, while still creating high profits that are not at the expense of employees or customers.

Costco was the brain child of Jeff Brotman and Jim Sinegal. It was founded in 1982 in Issaquah, Washington and the very first store opened a year later in Seattle.  Costco continued to increase their store count over the next few years and went public in December of 1985.  By their tenth anniversary, Costco had over 100 stores in the US and Canada.  Costco had also merged with Price Club, a similar warehouse retailer that was run by Mr. Sinegal’s former boss Sol Price.  Now fast forward to the end of 2011, the company is the 3rd largest retailer in the USA with 598 warehouses in the US, Canada, UK, Korea, Taiwan, Japan, Australia and Mexico (Costco Annual Report, 2011).  For 2011 the company posted net sales of $87 million and net income of $1.5 billion, improving on 2010 numbers by 14 percent and 12 percent respectively. (See fig. 1)  Costco’s performance is even more impressive when compared to their competitors Sam’s Club, owned by Wal-Mart, and Target.  According to Deutsche Bank Securities Inc. analyst Charles Grom, “the company [Costco] produced $1,079 worth of sales per square foot in 2011 – 65% more than Sam’s Club and more than triple Target’s numbers” (Milstead, 2012).  Costco posted revenues of almost $89 million in 2011 compared to only $50 million for Sam’s Club.  Equally as impressive is the fact that Costco has managed to beat out its competitors while operating on a very different business model.

Costco is one of my favourite places to shop when I am looking for anything besides clothing.  Perhaps some of the allure is the fact that Costco stores are unlike any other.  The moment you walk through the doors you notice a few striking differences.  First when customers or “members” enter the store they must show their membership card.  The cost of a Business or Gold (standard level) membership is $55 and an Executive membership, which offers more perks including a 2 percent reward on most purchases, is $110.  The membership fees generated by their approximately 32 million members earned Costco $1.9 billion in 2011 and accounted for close to 77 percent of their earnings before interest and tax (The Australian, 2011).  Although membership fees increased in November 2011, Costco typically has a 90 percent renewal rate among existing members.  This shows how loyal their members truly are and how receptive they have been to Costco’s business strategies.

Once inside the store you are essentially in a bare boned warehouse with none of the fancier amenities found in typical supermarkets or department stores.  All of the products are kept on the original pallets used for transportation and instead of standard shelves there is massive scaffolding to hold the excess pallets.  Unlike Wal-Mart that stocks nearly 100,000 items, Costco only stocks around 4,000 of the most popular items in bulk sized packages (Bick, 2007).  They also carry fewer brands as well as selling their own Kirkland brand products.  Although the selection might be lacking, all the products Costco sells are top quality and very affordable.  On top of a liberal return policy, Jim Sinegal made it very clear that Costco would never sell any branded item for more than a 14 percent mark up and no more than 15 percent for a private label (Greenhouse, 2005).  In comparison most supermarkets generally mark up products by as much as 25 percent and for department stores it is closer to 50 percent (Greenhouse, 2005).   All these strategies including bare warehouses, higher sales volumes from larger packages and fewer brands allow them to reduce their costs and increase their revenue.   Additionally Costco spends little money on advertising and marketing, except to promote a new store, occasional direct mailings to prospective customers and direct marketing campaign to current customers with coupons, a magazine and weekly emails (Costco Annual Report 2011).  The additional savings from Costco’s numerous strategies are then passed on to employees and customers.  According to the University of Michigan’s American Consumer Satisfaction Index, Costco is number one among all US retailers for customer satisfaction.

Another factor in Costco’s success is their employees, who are an integral part of their strategy and as such are treated very well. Costco has one of the lowest employee turnover rates in the industry hovering at around 12 percent (Ruggeri, 2009).  Costco also provides healthcare and benefits for about 86 percent of its total 164,000 employees many of whom are only part-time (Ruggeri, 2009).  Even during the recession Costco did not have to make any layoffs while other companies made major cuts to reduce costs (Ruggeri, 2009).  Costco’s minimal spending on marketing and advertising is also tied to their employees, who play an integral part in customers’ impressions and perceptions of Costco.  Therefore it is critical that employees are treated well and enjoy working for Costco as they are ambassadors of the Costco brand and company.   As Sinegal states:

“It’s really pretty simple. It’s good business. When you hire good people, and you provide good jobs and good wages and a career, good things are going to happen. We try to give a message of quality in everything that we do, and we think that starts with the people. It doesn’t do much good to have a quality image, whether it’s with the facility or whether it’s with the merchandise, if you don’t have real quality people taking care of your customers” (Ruggeri, 2009)

As a CEO Jim Sinegal is also an anomaly.  In 2010 Jim’s salary was $350,000; in addition to stock options and other compensation his total take-home pay is around $3.5 million, a far cry from the median of $9.3 million (McGregor, 2011).   Costco is living proof that companies need to be generous to their employees and customers before they are successful and that “generosity helps companies become and stay successful” (Berry, 2007).  By investing in employees Jim Sinegal is creating an environment where employees want to stay long-term and will work as hard as they can for the company.  In essence employees at any company are volunteers; they can put in the minimum effort to get by or they can “volunteer” and choose to do more (Berry, 2007).  Costco employees typically choose to do more resulting in higher productivity, higher customer satisfaction and ultimately higher revenue.  Instead of trying to cut costs by reducing employee pay and benefits, Costco would rather make changes in various items on their income statement including lowering gross margin and selling, general and administrative expenses (SG&A) (Costco Annual Report, 2011).  In fact, in 2011 Costco posted a 3 year low for total SG&A costs which accounted for only 9.5 percent of their total sales.

Although employees and customers admire Costco and enjoy shopping and working there, not everyone is as approving.  Many on Wall Street are not fans of their business strategy.  Analysts have argued that Costco is too generous to their customer and employees instead of focusing on their shareholders. “At Costco, it’s better to be an employee or a customer than a shareholder” laments one analyst (Cascio, 2006).  One article even asked if Costco would be more profitable if it was more like Wal-Mart (Shaw, 2009).  But are profits what it is really all about?  Even if shareholders only based their investment decisions on profitability, Costco would still be a good company to invest in.  Based on a 5 year comparison of a $100 investment in Costco, the S&P 500 and a Peer Group Index, the investment in Costco resulted in a value of $175 by 2011 in comparison to the S&P and Peer Group which barely increased in value (Costco Annual Report, 2011). (See fig. 2). Costco’s net sales and net income have also been steadily increasing over the past few years. (See fig. 1).    Net sales increased most recently from 2010 to 2011 due to 20 new warehouse openings, the strength of foreign currencies and gasoline sales (Costco Annual Report, 2011).  Costco’s earnings per share were also up by 13 percent bringing it to $3.30.

Looking at a variety of factors, Costco today can still be deemed successful but there are many ways to be successful.   Assessing success can be a difficult thing to quantify; “we can say of a strategy that it has been shown to be profitable and that the firm that followed it is doing well, but we are rarely  justified in saying that it chose the optimal or profit-maximizing course” (Shaw, 2009).  Both Costco and Wal-Mart are profitable, but based on utilitarianism and stakeholder theory which business strategy is best? Should Costco stay true to its current strategies and policies or would implementing Wal-Mart style strategies bring more success?  Additionally, what specifically can be classified as success and for what parties?  With the retirement of Jim Sinegal, these questions are now up to Craig Jelinek.  Since January 2012 Craig Jelinek has been the one calling the shots and now could be a perfect time to potentially try something different.

Let us s Costco’s current business strategy as well as an altered more Wal-Mart style strategy based on stakeholder theory and utilitarianism.  Stakeholder theory and utilitarianism align together well as they both seek to create value or maximize benefit to a majority of people with vested interests or stakes in a company.   Utilitarianism is a consequentialist ethical theory that deems an act to be right based purely on the consequences of the action, regardless of what the action was.  The act is considered morally right if it maximizes utility and creates the greatest balance of benefit to harm (Snoeybos and Humber, 2007). Stakeholder theory proposed by Edward Freeman states that stakeholders, including suppliers, customer, employees, stockholders and the local community, all have a stake in or claim on the firm (Freeman, 1993).  He believes that “each of these groups has a right not to be treated as a means to some end,” therefore the interests of all these groups must be taken into account and meshed together when firms are determining their future course of action.

So what would happen if Costco focused solely on profits and altered their strategies to be more like Wal-Mart? Many critics believe that shareholders are best serviced by companies like Wal-Mart, who keep costs low in order to maximize profits.  In society today everyone, individuals and companies alike, are all striving to for the next level of success.  But the definition of success varies for different stakeholders.  Customers may deem success as buying products at a low price while employees might feel successful if they earn a good salary or are involved in meaningful work.  Success for businesses, as determined by analysts and shareholders, is usually based on profits and the numbers reported in annual reports.  However businesses could also be successful if they have low employee turnover and high customer satisfaction.  Depending on the viewpoint used to assess a company’s successfulness, different factors will be analyzed to determine how successful a company truly is.  Based on Stakeholder Theory companies must balances various interests in addition to maximizing “success” for each party involved.   Costco is currently successful from the viewpoint of employees and customers.  However could Costco be more successful for shareholders if they made changes to be more like Wal-Mart?

Costco could make the following changes to become more like Wal-Mart.  First instead of capping the mark up on products at 15 percent, Costco could increase it.  Supermarkets currently mark up to almost 25 percent, so Costco could increase profits by marking up products somewhere between 15 and 25 percent.   Costco could also raise membership fees and pay their employees less to reduce costs further and increase revenues.  Based on information from BusinessWeek, Costco could drop almost $4 off of their current wages to be on par with Wal-Mart’s Sam’s Club.   By reducing the number of employees who receive health insurance and increasing the fees employees have to pay for it, Costco would save a considerable amount of money.  Currently Sam’s Club covers about half as many employees as Costco.  Employees at Sam’s Club also have to be employed longer before they are covered and fewer part-time employees have coverage.  If Costco were to make changes to be more like Wal-Mart, they could potentially improve their revenues and profits.  This would make shareholders pleased and the company more “successful” if success is based on profits. However Costco would not want to completely change and become exactly like Wal-Mart as they would lose their competitive advantages that have made them successful thus far.  They would need to strike a balance between what they currently do and the strategies that Wal-Mart employs to potentially become more successful.   However the success, in terms of profits, would not be felt by all and the consequences felt by employees and customers would potentially outweigh the benefit realized by shareholders.

Based on the numbers available we can assess the impact of Costco’s current strategy versus the hypothetical Wal-Mart style strategies to determine which course of action truly maximizes utility. Costco has 164,000 employees and approximately 32 million members.  On the other hand they only have around 8,200 shareholders, many of whom might also be Costco members or employees (MergentOnline).  Without even adding in the stakes of the community and suppliers, it is evident that for Costco to maximize utility for the greatest number of people, they should focus on their employees and customers instead pleasing their shareholders and Wall Street analysts. Utilitarianism would point to Costco keeping with its original business model and not trying to be like Wal-Mart.  Although many of Costco’s strategies may not maximize profits for shareholders, their actions create the greatest benefit for the largest amount of people.  Sure shareholders could potentially receive more utility if Costco was more like Wal-Mart, but then they would not be complying with stakeholder theory.  The interests of shareholders are not the only concerns that a company should focus on.  All the interests of all the stakeholders must be taken into consideration with each action or endeavour a firm undertakes.  Additionally turning into Wal-Mart would go against many of the values that Costco and its former CEO believed in.  So to the author who proposed the question “would Costco be more successful (in terms of profits) if they were more like Wal-Mart”, I say “would Wal-Mart be more successful (in terms of all their stakeholders) if they were more like Costco”.

Overall Costco has managed to strike a perfect balance between stakeholder theory and utilitarianism, a feat which not all companies can master.  Although some say Costco is not as successful as they could be, in terms of profits, their 32 million plus customers and employees would disagree.  Costco truly shows that businesses today do not have to focus on minimizing costs to maximize profits; companies can be generous and successful.   The “Costco Way” means assessing the interests of all stakeholders and trying to maximize utility by giving employees decent wages and health coverage and allowing customers to spend their hard-earned income on quality products that are not excessively marked up.  Perhaps in this day and age everyone would be better off if more companies were like

Works Cited

Berry, L. “The Best Companies Are Generous Companies.” Business Horizons 50.4 (2007): 263-69. Google Scholar. Web. 8 Apr. 2012.

Bick, Julie. “24 Rolls of Toilet Paper, a Tub of Salsa and a Plasma TV.” NYTimes. NYTimes, 28 Jan. 2007. Web. 2 Apr. 2012..

Costco Annual Report 2011. Rep. Costco Corporation, 19 Dec. 2011. Web. 9 Apr. 2012. http://phx.corporate-ir.net/phoenix.zhtml?c=83830&p=irol-reportsannual.

Freeman, R. Edward. “Stakeholder Theory of the Modern Corporation.” 1993. 38-48. Web

Greenhouse, Steven. “How Costco Became the Anti-Wal-Mart.” NYTimes. NYTimes, 17 July 2005. Web. 9 Apr. 2012..

Humber, James and Snoeyenbos, Milton. “Utilitarianism and Business Ethics.” Wiley-Blackwell (2002): 17-29. Print

Milstead, David. “Costco shares: No bargain to be had here; Slim profit margins leave U.S. retailer’s stock with little potential upside unless the new CEO takes a different pricing tack.” The Globe and Mail. January 10, 2012. LexisNexis Academic. Web. 8 Apr. 2012.

Ruggeri, Amanda. “Jim Sinegal: Costco CEO Focuses on Employees.” USNews. USNews, 22 Oct. 2009. Web. 5 Apr. 2012..

Shaw, William H. “Marxism, Business Ethics, And Corporate Social Responsibility.” Journal Of Business Ethics 84.4 (2009): 565-576. Education Full Text (H.W. Wilson). Web. 9 Apr. 2012.

“Costco hikes membership fee; Up $5 for most; Ten-per-cent boost pleases analysts.” The Gazette. October 6, 2011. LexisNexis Academic. Web.  8 Apr. 2012.

“Costco revenue soars, but fee hike not yet in store.” The Australian. October 7, 2011. LexisNexis Academic. Web. 8 Apr. 2012.

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