Introduction
Costco was ranked one of the best employers in America and around the world in 2020 [1] and 2021 [2]. Its apparent strong financial numbers[4] and high brand equity[3] perceived by customers, employees, and investors have led Costco to a phenomenal run in the stock market since 2016. In fact, if one bought Costco’s shares in March 2016 and sold them in November 2020[5], the returns would more than doubled and outperformed Gold’s returns in the same period.[6]
While analyses and financial numbers crunched undoubtedly proved that Costco is still a good stock for Value Investors to keep[27], Warren Buffett dumped 4.3 million shares of Costco in November 2020 [7][28], just before Costco released their strong annual report in December. The Peter Lynch chart suggests the stock was overvalued. On 8 March 2021 after nearly 3 months of decline, the share price started to rebound slightly from the support level previously seen on 6 July 2020.
The Key Strategic Question
The key question which this paper aims to address is whether the current successful business model and strategies, adopted by Costco since 2012 when Craig Jelinek became the CEO, will likely be able to continue delivering the same investors’ confidence, value propositions, and financial results beyond 2021. In order for the assessment to be contextual, the subsequent discussion and recommendation will reference from the following analyses done, which can be found in the Appendices:
- Analysis of Costco’s business model, based on Business Model Canvas.
- Types and magnitude of market forces facing Costco, based on Porter’s Five Forces.
- Competitive strategies adopted by Costco, based on Porter’s Generic Strategies.
- SWOT analysis.
- Results of Costco’s strategies, based on Ratio Analysis and Share Prices.
- Costco’s Brand Equity Over the Years
- Customers’ Demographics: Costco vs Other Major Competitors
The Overarching Competitive Advantage of Costco
Customer Experience and Relationships are perhaps the focal points in everything that Costco does and this is what sets them apart from their major competitors like BJ’s Wholesale Club and Sam’s Club. Based on the analyses and assessments done, these two are apparently the top underpinning priority of almost all the strategies adopted in the way how the business operates. Costco’s people-centric focus can be seen in the way how the company rewards and compensates its employees, how Costco’s suppliers are respected in terms of payment, property rights, and commitment to fair business practices.[8] In their Relationship Management with members (ie. registered customers), Costco provides top-quality products at very low prices with a no-questions-asked refund policy. In terms of online sales, Costco emphasizes customer experience when they shop online for Costco products. Towards the government, Costco spared no effort in obeying the law and comply with all relevant regulations. Within the communities, Costco encouraged employee volunteerism and corporate contributions to charities. These “human touch” centric strategies created a very positive atmosphere in Costco’s warehouses and overall customer experience that brought in as many as 90 million loyal members by 2019. [9]
The treasure hunt experience at Costco’s warehouse is one of the key reasons why their customers keep going back. Many of the products are on flash sale and there are almost no labels along the aisles to show customers where various items are. All in all, the apparent results could be described as an iterative valuable domino effect between happy customers, motivated employees, satisfied shareholders, and profitable business. [10][11]
Successful Hybrid Of Generic Strategies
Limiting the variety of brands within a product category but having a wide variety of products means that Costco has economies of scale in procuring inventory and at the same time be able to offer product ranges that permeate into more different areas of needs in customers’ daily lives.[12] The economies of scale achieved through limited brands allow Costco to maintain its Cost Leadership position with a Focus approach, on top of an intangible strong differentiation crafted through a combination of selling high-quality products, providing excellent customer service, and creating a uniquely positive customer experience for their members.
The strong intangible differentiation that translated to tangible revenue numbers would not have been possible without their long-term commitment to taking care of their employees. This strong employer-employee relationship directly affects whether Costco’s commitment to taking care of their members on the other hand would pan out well, especially since employees are the front liners interfacing with customers. In the recent Retail Customer Satisfaction Study done by Businesswire around the end of 2020, Costco emerged as the top winner with the highest score related to trust. [13]
Effects of COVID-19 on Costco’s business.
Many retail and F&B businesses got hit globally by the COVID-19 pandemic in early 2020 due to the lockdowns and situations got worse when the economy entered into a recession with no sign of recovery in sight for the next six months at least. Costco’s value proposition of providing unique customer shopping experiences faced an unprecedented challenge. Shopping activities at physical locations were significantly reduced in terms of the no of shoppers allowed but each shopper bought more due to panic buying. During the same period, Costco still maintained its principle of paying their employees competitive wages and incur additional costs on financial aids as well as heightened sanitization measures.
Surprisingly, despite a drop in sales numbers around April 2020 which missed analysts’ estimates [14], Costco’s overall profit for that year hit a record high of above USD 4 billion with online sales rose by 90%.[15] At the same time, USD 281 million more was spent on taking care of their employees during the crisis[16]. This unprecedented period might well have been the best litmus test to prove that Costco’s value proposition has already transcended from the traditional physical shopping experience to online shopping[17].
Costco’s financial numbers in the midst of COVID-19 outperformed their own pre-COVID 19 levels. As at end of August 2020, Earnings Per Share rose by more than 27%, the Current Ratio was up by about 10%, Net Profit went up by 0.2% all within 2 years, despite having to spend more on their employees during the pandemic. The customer base also hit a 3-year high of 105,500,000 members according to their annual report, contributing to membership revenue of $3.54 billion. According to the Income Statement published in their 2020 annual report, each dollar increase in merchandising costs correlates with a USD 17 increase in Operating Income. [4]
The Key Issue Now
Market analysts consider the recent move to raise their minimum wages a Costco’s key issue in the mid-term and how significant that impact will be [18] on their financial numbers is a major concern[31]. However, the key performance numbers gathered for the writing of this report show that spending more on their employees did not jeopardize Costco’s profitability up to the year 2020, even in the midst of what Singapore’s Prime Minister called “CRISIS OF A GENERATION”. [21]
One fundamental issue stood out though. The only target segments, in terms of age, that Costco has more market share compared to other competitors are Boomers and the Matures (57 to 75 years old). Their market share in the Millenials and GenXers (18 to 47 years old) is the lowest compared to Amazon, Walmart, Target, and Kroger. That is to say, Costco will eventually lose its Market Leader position in about 10 years’ time if this trend continues.
Coincidentally, Warren Buffett once said that “if you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes.” [19] Could this seemingly one of the least talked about issues of Costco in the news be the real reason why Warren Buffet dumped all of his Costco shares in November 2020?[29] Whether the answer is a yes or not, does not change the fact that it is an issue that Costco has to manage, in order to sustain the same profitability with the same value proposition in the post-COVID era.[30]
Apparently, Costco is likely well aware of that and therefore introduced a digital cardless membership in 2019 in an attempt to lure millennials over. [20]
Recommendation
Since Costco’s financial performances have been exceptionally phenomenal, any recommendation for improvement made should not be a trade-off with any areas of the business model that have proven their contribution to Costco’s profitability. Able to create the greatest impact with the relatively lowest effort and cost should be prioritized as the guiding principle underpinning any recommendation.
In the same annual report, Costco highlighted that changing consumer preferences and demographics would be a risk if the business is unable to adapt or predict those trends. These risks would directly impact the speed of inventory turnover and sales of their selected products, especially when Costco made their move to lure the millennials, of which many are tech-savvy, quick to try, or even subscribe to new services, products, unique customer experiences in the market[21]. Touchpoints to reach millennials are likely very different from the Boomers and Matures, so much so that even Search Engine Optimised online stores and websites would probably not come close to addressing their consumer behavior trends.
Therefore, it is recommended to adopt a data-driven approach to analyze, predict and pinpoint where the next marketing dollar should be spent in order to bring in millennials’ memberships and sales for revenue and market share. Machine learning algorithms like Clustering, Factorization Machines, DeepAR, Latent Dirichlet Allocation (LDA) are readily available for deployment. This approach could provide powerful insights through Sentiment Analysis and Topic Modeling of social media posts using LDA, a grouping of customers to cross-sell products they might like using Clustering as well as forecasting sales volume by product types and seasons using DeepAR. This is literally turning data into gold.[22]
One latest major competitor of Costco would most likely have no issue implementing such a data-driven approach of understanding their customers: Amazon. In fact, Amazon’s AWS cloud-based Artificial Intelligence capabilities are ranked No. 1 by Gartner. Perhaps, Amazon’s apparent ability to capture more of millennials’ market share than Costco might have been due to their own AWS cloud technology capabilities designed for such e-commerce’s purposes.
As Costco has already chosen Microsoft Azure to be their cloud infrastructure provider in 2017, it is recommended that they should leverage more on Azure Artificial Intelligence capabilities[23] to carry out the above recommendation that will help Costco make better-informed decisions in their future inventory procurement or promotion campaign; using data insights which traditional ratio analysis or human judgment may most likely not be able to provide.
Appendix A
SWOT Analysis on COSTCO
| Strength | Weakness |
| 1. Low Prices 2. Membership Business Model 3. Loyal Customer Base 4. Low Marketing and Advertising Cost 5. Transfer savings to customers 6. High-quality products 7. Competitive Wages, Compensation and Benefits to Employees 8. Low employee turnover rate 9. A large number of warehouses globally | 1. Limited Product Selection Per Category 2. Cost of Transportation 3. Cater to a less diverse customer base 4. Lacks appeal to younger generations |
| Opportunities | Threats |
| 1. Enhance online presence 2. Increase digital marketing efforts | 1. Brand Reputation due to product recall in Nov 2015. 2. Security issues with 3rd party Cloud Service Provider. 3. May be vulnerable to each countries’ political uncertainties. 4. Rise of e-commerce 5. Constant price competition exchange rates risk in global operations. 6. Intense competition from Walmart and Amazon. |
Appendix B
Costco’s deployment of Porter’s Generic Strategies
Appendix C
Costco’s Key Financial Ratios from 2012, 2018 and 2020
| As of 31 August 2012 | As of 31 August 2018 | As of 31 August 2020 | |
| Current Ratio = Current Assets / Current Liabilities | 1.10 | 1.02 | 1.13 |
| Debt-To-Capital Ratio = Debt / (Debt + Shareholders’ Equity) | 0.099 | 0.33 | 0.29 |
| Operating Margin Ratio = Operating Income / Net Sales | 2.78% | 3.16% | 3.26% |
| Net Profit Margin Ratio = Net Income / Net Sales | 1.72% | 2.21% | 2.4% |
| Gross Margin = (Revenue – COGS) / Revenue | 12.42% | 13.01% | 13.09% |
| Earnings Per Share | $3.89 | $7.09 | $9.02 |
| PE Ratio = Share Price / Earnings Per Share | 19.48 | 31.34 | 37.43 |
Source: https://www.macrotrends.net/stocks/charts/COST/costco/financial-ratios
Appendix D
Costco’s Brand Equity from 2017 to 2021
Appendix E
Customer demographics of Costco vs other major competitors
Appendix F
Costco’s Business Model Canvas
Appendix G
Porter’s Five Forces facing Costco
References
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[32]news, Full Bio Follow Linkedin Follow Twitter Matthew Johnston has more than 5 years writing content for Investopedia He is an expert on company, Market News, Political News, Trading News, investing, the economy He received his bachelor’s degree in interdisciplinary studies from St Stephen’s University, and his master’s degree in economics at The New School for Social Research He teaches macroeconomics at St Stephen’s University Learn about our editorial policies Matthew Johnston. n.d. “Costco Earnings: What Happened.” Investopedia. Accessed March 24, 2021. https://www.investopedia.com/costco-q2-2021-earnings-5114831.