Team 1 -Costco Wholesale Corporation Cas PDF

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William Shonk, Danny Anders, Brytnie Miller Miñiel April 2016 Danny Anders Brytnie Miller Miñiel William Shonk

Team 1 - Costco Wholesale Corporation Case Analysis Costco Wholesale Corporation is an American membership only warehouse club that provides a wide selection of merchandise. They are currently the largest membership only warehouse club in the United States, and as of 2014, Costco was the third largest retailer in the U.S. and the second largest in the world behind Walmart. Costco was founded in 1983 and its headquarters are in Issaquah, Washington. Costco operates an international chain of membership warehouses, mainly under the "Costco Wholesale" name, that carry quality, brand name merchandise at substantially lower prices than what are typically found at conventional wholesale or retail sources. Costco offers three types of memberships: Business, Gold Star (individual), and the Executive membership. Business members qualify by owning or operating a business and pay an annual fee of $55 in the U.S. to shop for resale, business, and personal use. The Gold Star membership is for individuals who do not own a business and is available for a $55 annual fee in the U.S. This fee includes a free household membership. The Company also has a third membership level, called the Executive Membership. _____________________________________________________________________________________________

Costco’s Mission: “To continually provide our members with quality goods and services at the lowest possible prices.” Costco’s mission statement shows that the business focuses on quality as a selling point. Quality is integral because there are many other firms that compete against Costco on the basis of low prices. The company’s mission statement also indicates low prices as a major selling point. Customers are drawn to the discounts and low prices available at Costco. Moreover, the mission statement shows that these offers are always available at Costco warehouses to members. One key strategic objective linked to this mission statement is to develop a supply chain that supports cost minimization and high quality. The strategic objective of the company’s intent is to sustain and improve the company’s competitive strength and long-term market position through customer value. While financial objectives focus on achieving acceptable profitability in a company’s pursuit of its mission and survival in revenues. Costco’s mission will help to achieve our vision.

Costco’s Vision: “A place where efficient buying and operating practices give members access to unmatched savings.” The vision statement shows Costco’s need to ensure efficiency in its operations. Efficiency is critical because it minimizes the costs that effect pricing. Cost minimization leads to the next point of the vision statement: unmatched savings. Costco’s customers can expect such savings

William Shonk, Danny Anders, Brytnie Miller Miñiel April 2016

through discounts based on membership status or by using Costco Cash Cards. Access through membership is the component of the vision statement that indicates Costco Wholesale’s membership only warehouse club model. Cost minimization is central to the company’s competitive low pricing strategy. It is this low pricing strategy that ensures the discounts necessary to attract customers to Costco’s warehouses. _____________________________________________________________________________________________

What is Costco’s business model? Is the company’s business model appealing? Why or why not? Costco’s business model is called a subscription business model and entails generating high sales volumes and rapid inventory turnover by offering fee paying members attractively low prices on a limited selection of nationally branded and selected private label products in a wide range of merchandise categories. Rapid inventory turnover when combined with the low operating cost achieved by volume purchasing, efficient distribution, and reduced handling of merchandise in nor frills, self-service warehouse facilities enable Costco to operate profitably at significantly lower gross margins than other wholesalers. Costco is measured by its performance variable Return on Net Operating Assets (RNOA). In this case Costco’s RNOA, is calculated by: Net Operating Profit after Taxes (NOPAT)/Average Net Operating Assets (NOA), which for 2015 was 2,454/10,571 = 23.21%. Compared to Walmart’s RNOA, which was 1124/9329=12.01%. Costco’s RNOA is greater than Walmart’s due to the company’s high sales volume and rapid inventory turnover. This also allows the company to sell and receive cash for inventory before it must pay many of its merchandise vendors. Costco's warehouses present one of the largest and most exclusive product category selections to be found under a single roof. Costco’s provides its members with a selection of approximately 3,600 active items. Of these, about 85% are quality brand name products and 15% carry the company’s private label, Kirkland Signature, which is designed to be of equal or better quality than national brands. A typical retailer carries about 125,000 to 150,000 items for shoppers to choose from. Costco operates self-service gasoline stations at a number of its locations in the U.S., Canada, Australia, Japan, Spain, and United Kingdom. Costco is known for carrying top quality national and regional brands, with 100% satisfaction guaranteed, at prices consistently below traditional wholesale or retail outlets. Additionally, Costco Wholesale Industries, a division of Costco, operates manufacturing businesses such as: special food packaging, optical laboratories, meat processing, and jewelry distribution. These businesses share the common goal of providing members with high quality products at substantially lower prices. Costco makes most of its profit from membership fees, not margins on product sales. This means the company can sell its products at cost, or sometimes even at loss, which allows it to charge amazingly low prices and provide a crucial source of competitive advantage in the discount retail industry. Costco continues to grow in size. It gains purchasing power with suppliers, which allows it to negotiate better prices and more flexible financial conditions for its products.

William Shonk, Danny Anders, Brytnie Miller Miñiel April 2016

A company is said to enjoy economies of scale whenever it gains operating efficiency and is able to reduce the total cost of making successive goods. In addition to the operating efficiency needed for economies of scale, the supply chain efficiencies generate additional cost savings as sales volume expands. Costco’s large warehouses and large sales volume of bulk items are due in part to economies of scale. In essence, the more products the company sells, the bigger the scale and cost advantages. Therefore, it is logical to infer that Costco becomes better and more competitive as it grows in size over time. Costco is also well known for paying its employees high wages, about $21 per hour, health benefits, ample vacation time and a 401K. Costco’s high employee wages are part of its cost savings plan. That is, when employees earn a decent wage they are more productive and less likely to quit. Employee turnover can be a huge cost to any business. Costco has a policy of carrying less product selection than other retailers with the purpose of cataloging fewer SKUs. Having fewer products to order, track, and display means cost savings and in turn increases its purchasing power. Costco induces cost savings and while increasing its purchasing power. ______________________________________________________________________________

What are the chief elements of Costco’s strategy? How good is the strategy? The Five P’s for Strategy: Plan, Ploy, Pattern, Position, and Perspective: Costco accomplishes its business model with a low-cost leader strategy that strives to be the overall low-cost provider of a product or service that appeals to a broad range of customers. Costco’s plan has been to offer ultra-low prices, a limited selection of nationally branded and private label products, a “treasure hunt” shopping environment, strong emphasis on low operating costs, and geographic expansion. Costco’s ploy is its philosophy to keep customers coming in to shop by wowing them with low prices. Costco has disrupted their competitors by only stocking those items that could be priced at bargains levels and thus provide members with significant cost savings. Costco emphasis low cost by offering lower prices and better values by eliminating virtually all the frills and costs historically associated with conventional wholesalers and retailers, including salespeople, fancy buildings, delivery, billing and accounts receivable. This ploy has become a pattern within their business strategy. Costco caps their margins at a steady 10.6%. This means that for every $100 that Costco spends to buy its products, it’s selling them, on average, for $110.60. Costco has decided to position itself in the market place through product selection. Costco’s supply chain efficiency is the cross dock distribution (depot) facility. Costco purchases the majority of its merchandise directly from manufacturers and routes it through a network of cross-docking facilities which act as vendor consolidation points to move goods in full truckload volumes to the stores. Costco’s merchandising strategy is to provide members with a selection of approximately 3,600 active items. As mentioned previously, about 85% are quality brand name products and 15% carry the company’s private label Kirkland Signature. A typical retailer carries about 125,000 to 150,000 items for shoppers to choose from. The choices an organization makes about its strategy rely heavily on its culture – just as patterns of behavior can emerge as strategy, patterns of

William Shonk, Danny Anders, Brytnie Miller Miñiel April 2016

thinking will shape an organization's perspective, and the things that it is able to do well. The CEO is quoted with an example of Costco’s culture perspective: “If you had ten customers come in to buy Advil how many are not going to buy any because you just have one size. Maybe one or two. We refer to that as the intelligent loss of sales. We are prepared to give up that one customer. But if we had four or five sizes of Advil, as most grocery stores do, it would make our business more difficult to manage. Our business can only succeed if we are efficient. You can’t go on selling at these margins if you are not.” Costco runs a tight operation with extremely low overhead which enables the company to pass on dramatic savings to its members. Costco can only succeed if they are efficient. Costco growth strategy has been to increase sales at existing stores by 5% or more annually and to open additional warehouses both domestically and internationally. Their marketing objective has been strictly by word of mouth only and has never use a public relations department.

Strategic Fit: Strategic fit aims for consistency, reinforcement or optimization of business activities. We are starting to see the 7-S framework for strategic fit that supports Costco’s operation. Costco’s business strategy succeeds because there is a close fit between its competitive strategies and business model as we see below they are all moving in one direction:

Old 7s Breakdown: Strategy. Costco offers ultra-low prices, a limited selection of nationally branded and private label products, a “treasure hunt” shopping environment, strong emphasis on low operating costs, and geographic expansion. Structure. The main advantage of Costco’s business structure is that the functional grouping characteristic supports organization-wide control. The company can easily implement new policies and strategies to take effect in all geographic divisions. Also, the geographic divisions are a characteristic of Costco’s organizational structure that presents the advantage of flexibility to adjust to regional market conditions. Systems. Costco runs a tight operation with extremely low overhead which enables them to pass on dramatic savings to their members. Costco Wholesale’s strategy involves service quality control through HR training and development, as well as co-branding using the Kirkland Signature brand to indicate high quality. Shared values. Costco’s culture is rich and successful because it is supported by four values 1. Obey the law 2. Take care of your customers 3. Take care of your employees 4. Practice the intelligent loss of sales Skills. Costco runs top notch training and development programs that enable the company to attract and retain knowledgeable and friendly employees. It is the employees that implement the Costco experience.

William Shonk, Danny Anders, Brytnie Miller Miñiel April 2016

Style. Innovation and flexibility creates the style of the organization. Management style is more of an inspirational management. The workforce can be effectively motivated for higher performances with less financial resources. Staff. Benefits packages and comprehensive training help retain highly qualified employees. This helps minimize turnover. Only capable and promising candidates are employed by Costco.

New 7s Breakdown: Superior stakeholder satisfaction. This is the key to winning with competitors. Costco has loyal customers and they are the ones that create value. Costco has one of the lowest profit margins among major U.S. corporations. In its 2013 fiscal year, Costco posted a pretax margin of 3% and an after-tax margin of 1.9%. However, Costco has a very efficient business model that allows it to consistently generate a strong return on invested capital. Consumers continue to flock to its stores to take advantage of its industry-leading prices, and the company has significant global growth opportunities. As a result, Costco shares have more than tripled in the last 10 years. Strategic soothsaying. Costco mastered this by learning what the customers wanted through research and development. Costco goes after a certain type of customer: the small business owners who is status conscious and who has money to spend on bargain-priced premium items. The reason why Costco decided to focus on small business owners is that they realized that these people are often some of the wealthiest people in their communities. Positioning for speed. Costco plans to continue to expand, both domestically and internationally. Its current store base is around 670, but management hopes to reach 1,200 warehouses in the long term. It will likely continue to open about 30-35 stores a year over the next few years. Over the next 10 years, we think roughly 60% of these stores will be opened outside the United States. Positioning for Surprise. Costco out preforms their competitors by building a leading brand. Costco makes most of its profit from membership fees, as opposed to profit margins on product sales. This means Costco can sell its products at cost, or sometimes even at a loss, which allows the company to charge amazingly low prices, a key competitive advantage in the discount retail sector, where price competitiveness is a central factor for success. Their brand is about social class. Shifting the rules of competition. Costco, apart from offering slightly lower price points on certain key products, is trying to improve its customer experience by implementing consumer friendly return policies, accepting several payment methods, and adding gift prizes. More importantly, Costco is always changing its brands and introducing new products in order to provide customers with a pleasant "treasure hunt" experience. Signaling strategic intent. Costco’s aggressive international expansion announcements, establishing a strong online presence and ensuring that the strong membership renewal rate continues is part of their strategic intent.

William Shonk, Danny Anders, Brytnie Miller Miñiel April 2016

Simultaneous and sequential strategic thrusts. Costco has used several moves over the years to try and get one up on its competitors. Costco has a worldwide niche market that focuses on small business owners because they realized that these people are often some of the wealthiest people in their communities. ______________________________________________________________________________

Use the information in chapter 3 to do a complete five-forces analysis of competition in the North American wholesale club industry. Which of the five competitive forces is strongest and why? A five forces analysis is a strategic model that identifies and analyzes the five fundamental forces that shape every industry and determine its attractiveness. These five industry shaping forces are as follows: 1. 2. 3. 4. 5.

Rivalry/competition in the industry Potential of new entrants into the industry Power of suppliers Power of customers Threat of substitutes

The attractiveness of an industry is directly related to its profitability. Perfect competition eventually drives profits to zero, therefore, the least amount of competition, the more attractive the industry. However, perfect competition is not experienced in the real world. This allows the companies to utilize the five forces model to analyze the internal and external influences to define and modify their company’s strategy to gain a competitive advantage. In the end, the main goal is to increase stakeholder value, which is primarily to increase company profitability. Below we will explore the individual five forces Costco faces in the American wholesale club industry.

Rivalry/Competition in the Industry: The wholesale club industry attracts consumers through discounted prices on a wide variety of retail products at large warehouse locations. Nevertheless, in order for consumers to gain access to these discounted warehouse locations, consumers are charged yearly membership fees. The industry business model is based on discounted warehouse pricing which makes competition extremely high. The top three major players in the American wholesale club industry, according to total U.S sales are: (1) Costco, (2) Sam’s Club, and (3) BJ’s Wholesale Club. Due to low profit margin and competitive pricing, the power of rivalry is extremely high. Consumers are exceedingly price elastic in this industry. This creates hyper pricing competition among the top three competitors. Competitors offer the lowest prices to attract consumers.  The industry is maturing as market saturation increases and efforts to increase foot traffic in new and existing stores intensifies.  Competitors offer little differentiation as they offer similar products and services at comparable prices. 

William Shonk, Danny Anders, Brytnie Miller Miñiel April 2016

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Rivalry differentiation is low due to similar product offerings and pricing. Consumers can take their business from one competitor to another with ease due to the weak switching costs and weak differentiation.

Potential of New Entrants into Industry: Barriers of entry are high in the industry due to the large economies of scale needed to drive down costs to sufficiently competitive yet profitable prices. The likelihood of new threatening entrants is minimal. Competitor mergers and acquisitions could play an effective means for rivalry to expand and steal market share from competitors. Companies must build an adequate membership base that supports sustained large volume sales for competitively discounted and low profit margin products. As a consequence, entrants will be met with aggressive incumbent competitors and low profit margins that would make entry very costly and unappealing.  Sam’s Club, Costco and BJ’s Wholesale are already consumer known brands that command high sales volumes that would be difficult and costly to replicate to new unknown and unexperienced entrants.  The current incumbents, especially Costco and Sam’s Club are already established nationwide and to compete on a nationwide level, It would require extensive capital expenditure to create an at par image.

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Power of Suppliers: Suppliers a...