Ode to Costco

ode to
Costco
Acquired
Author

Lawrence Wu

Published

February 28, 2024

Modified

February 28, 2024

I’ve been a fan of Costco for many years. Charlie Munger famously loved Costco too. I still remember growing up and going to Price Club with my mom or dad and seeing them write checks because they didn’t accept credit cards yet. There are many reasons to love Costco. It’s honestly one of my favorite places to shop. Some of my favorite things are in no particular order:

I recently learned about the Acquired podcast from Cal Newport’s post, How the Acquired Podcast Became a Sensation. They do long deep dives into business. One of their recent episodes was a 3-hour dive into all things Costco, the history of the company ad how it traces it’s roots into the people behind Fedmart and Price Club. After listening to the episode, I now appreciate Costco as a business even more. One of the biggest learnings was Costco capping their gross margins at 14%! This means they are intentionally leaving profits on the table to provide more value to their members! From the episode:

And because of Costco’s gross margins always being targeted at 11% capped at 14%, this means that for every dollar that Costco gets a supplier to reduce the price on something—again, tough but fair—the customer actually sees most 89% of the benefit. Costco really does just get to pass whenever they get a benefit, 89% of that benefit goes to the member.

The way I look at this is some companies always look for ways to make more margin. Costco specifically does the opposite. They look for ways to provide more value to members, retain them for members as longer, and get them to get their friends to be members. They try hard across the board to get lower overhead costs through cleverness and efficiency, not through squeezing, underpaying, or anything like that.

Based on the episode, here are 33 reasons why Costco is considered an extraordinary business:

  1. Bulk Sales Model: “What if I told you that there was one place where you could get all these things under one roof? A 2½ pound container of cashews, prescription eyeglasses, a tank of gas, new tires for your car, 96 rolls of toilet paper, a new refrigerator, an outdoor shed, a 10 carat diamond ring, some freshly prepared sushi, fine wine at a great price.” - Ben illustrates the diverse and bulk offerings of Costco, underscoring the convenience and variety it provides to members.
  2. Consistent Low Prices: “And you could even grab a hot dog with a soda and a free refill on your way out for just $1.50. Hey, it has been the same price for 40 years now.” - Highlighting Costco’s commitment to maintaining low prices for its food court items, which enhances the shopping experience and customer loyalty.
  3. Innovative Operations: “But what really makes it work are the 50 clever innovations that they’ve refined over the years, that all work together like an orchestra that’s been rehearsing for decades.” - David acknowledges Costco’s operational ingenuity and continuous improvement mindset.
  4. Quality Products: “If your goal is to offer extremely great value to your customers on high-quality products at the lowest possible prices, there are a lot of ways that you could go about doing that.” - Ben emphasizes the company’s dedication to quality alongside its value proposition.
  5. Customer Value Focus: “Today, we will walk through the very specific path of decisions and trade-offs that Costco has chosen to accomplish just this.” - Introducing the strategic decisions Costco makes to uphold its value proposition.
  6. Revenue Growth: “Costco has grown revenue right about 10% for over 30 years in a row.” - Showcasing Costco’s remarkable consistency in revenue growth.
  7. Efficient Space Utilization: “Their revenue per square foot of their warehouses belongs more in a conversation with Tiffany than Walmart.” - Highlighting how efficiently Costco utilizes its warehouse space to generate high revenue.
  8. Kirkland Signature Brand: “Their store brand, Kirkland Signature, does more revenue alone, not including anything else in the store, than all of Nike.” - Demonstrating the success and scale of Costco’s private label brand.
  9. International Expansion Potential: “They seem to have incredible running room ahead of them to expand internationally and here in North America.” - Noting Costco’s significant potential for further global expansion.
  10. Customer Loyalty: “Most of you are very familiar with this Disneyland of consumer value that I’m referring to.” - Ben alludes to the strong customer loyalty and fondness for Costco.
  11. Supply Chain Mastery: “Jim Sinegal, of course, co-founder and CEO of Costco, tells the story that a reporter once asked him if he learned a lot from Sol. Jim replied, no, that’s inaccurate. I didn’t learn a lot, I learned everything.” - Reflecting on the foundational knowledge and principles Costco inherited from its predecessors.
  12. Legal Compliance and Ethics: “Obey the law” - The primary code of ethics at Costco, ensuring that the company operates within legal boundaries and ethical standards.
  13. Employee Care: “Take care of our employees” - Costco’s commitment to employee welfare, indicating the company’s recognition of its workforce as a key stakeholder.
  14. Supplier Respect: “Respect our suppliers” - Highlighting Costco’s ethical approach to dealing with suppliers, fostering mutual respect and long-term relationships.
  15. Membership Model Efficiency: “The economics of membership…selects for wealthy customers.” - Discussing how the membership model not only generates revenue but also curates a specific customer demographic.
  16. Low Shrinkage Rates: “Membership further decreases shrinkage.” - The impact of the membership model on reducing theft and loss within Costco warehouses.
  17. High-Quality Member Demographic: “The typical Costco consumer makes about $125,000 a year in household income.” - Indicating the affluent demographic of Costco’s membership base.
  18. Stringent Product Markups: “Strict cap on the margin…only markup anything a maximum of 14% above what the suppliers sell it to them for.” - Explaining Costco’s policy on limiting product markups to ensure low prices for members.
  19. Global Expansion Success: “First, they go to the UK, then they go to Korea, to Taiwan, to Japan…” - Detailing Costco’s strategic and successful international expansion efforts.
  20. Sustainable Growth Strategy: “Amazon is a company that works hard to charge its customers less, and that is directly from Jim Sinegal.” - Highlighting Costco’s influence on other major retailers regarding pricing strategy.
  21. Member Trust and Transparency: “Members have to trust that they are going to get the absolute best price on everything…” - The importance of maintaining member trust through transparent pricing and consistent value.
  22. Efficient Inventory Management: “Costco actually turns their inventory 12.4 times per year…” - Showcasing Costco’s exceptional efficiency in inventory management and the benefits of a negative cash conversion cycle.
  23. Selective Product Offering: “Each buyer is only really adding 3, 5, 10, maybe 15 new SKUs a year…” - Reflecting on the curated and limited product selection strategy that ensures quality and value.
  24. Ethical Supplier Negotiations: “Costco buyers always ask why when a supplier tries to increase the price…” - Demonstrating Costco’s fair and informed approach to supplier negotiations.
  25. Commitment to Social Responsibility: “Sol and Robert are great at creative ideas in retail. They’re not so great at scale execution.” - Acknowledging the founders’ innovative contributions to retail, balanced with an awareness of their limitations in executing at scale, leading to strategic decisions that shaped Costco’s trajectory.
  26. Limited SKU Strategy: “Costco makes the opposite bet. They bet that you don’t need selection, as long as you ensure that everything you can buy is high quality…Consumers, because they do all that work ahead of time, are basically just okay, sacrificing selection entirely and saying, yeah, as long as you give us good value on great stuff, we’re totally okay with that.”
  27. Trust and Quality Over Selection: “That’s an important unlock. You can’t just have low selection and be like, well, it’s all cheap stuff. It has to be high quality in its category and the best deal on the market in order for people to be okay with low selection, which drives low SKU count, which drives all the amazing things we’ve talked about so far.”
  28. The Intelligent Loss of Sales Principle: “Sol uses the example in the book of household lubricating oil, like WD-40 type stuff. He’s like, we only carried the eight ounce can, even though there was a three ounce can out there…But it was worth it to us to forgo that, because by only having the eight ounce can, we could reduce the number of SKUs that we had and get all these benefits that you’re talking about, Ben.”
  29. Simplifying Logistics Through Limited SKUs:: “They only have so many suppliers who are bringing goods to Costco. The fact that they sell in bulk means that they can bring a whole pallet into a warehouse and consumers just come and pluck it off the pallet…This is so much simpler, and it really plays into that cash flow dynamic, where things can be available for sale so fast.”
  30. Employee Compensation and Efficiency: “This also plays into this labor thing. You can totally pay your employees more when you need less people to generate the same amount of sales. You don’t have wasted manpower unwrapping items from pallets, no one turning the labels out to look pretty. The customers do all of this. It legitimately means they just need less people.”
  31. The Membership Model as a Profit Center: “A lot of people like to make a lot of hay about the idea that Costco generates all their profit on memberships and that retail is just a break-even business. This has been popular to say because they run the retail business at such thin margins. Memberships are nearly a 100% margin business.”
  32. High Renewal Rates and Customer Loyalty: “Executive members, as you would guess, also renew at a higher rate. It helps with retention…Ninety-three percent of members in the US renew every single year.”
  33. Innovative Crossdocking:

Exactly, but here’s how the distribution centers work. Trucks pull up on one side and unload pallets, that’s where the suppliers trucks are. On the other side of the warehouse, there are Costco trucks.

What happens is, since they move stuff entirely by the pallet, no partial pallets, these few things go to this store, these few things go to that store, the supplier trucks unload the pallets. They just get scooted across the dock to go directly to a Costco warehouse. Within minutes to hours, that truck leaves, and there’s no unwrapping of individual boxes. There’s nothing sitting overnight in the facility.

This is so much simpler, and it really plays into that cash flow dynamic, where things can be available for sale so fast. Just to underscore how differentiated the system is, 92% of Costco’s merchandise is crossdocked. Only 10% of Walmart has crossdocked merchandise on a pallet system like this.