The Economics of Costco

Stitched Panorama

From my experience working at Costco last summer, I was able see Costco’s brilliant business model from an employee’s perspective. Costco’s business model enables it to make massive profits, sell products at rock bottom prices and treat its employees well. Costco marks up its merchandise about 11% above its average total costs. Most other retailers mark up their products anywhere from 20% to over 100% of their average total costs. This means that Costco’s per unit profit is typically only a few cents. However, since Costco sells billions of items, the seemingly tiny per-unit profits equate to billions of dollars. In 2014, Costco made $112.4 billion in revenue. Its cost of goods sold added up to $98.46 billion, which means Costco made a gross income of $14.18 billion.

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Costco sells exactly what consumers want. It has a wide variety of name brand products including groceries, electronics, appliances, clothing, office products and so much more in bulk sizes. Consumers love the bulk sizes because they are proportionately much cheaper than competitors and they love getting a lot of what they want. Especially because of America’s super-sized culture, the bulk sizes are extremely popular. There is so much demand for Costco’s low prices, that people will pay the $55 annual membership fee in order to take advantage of Costco’s discounts.

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Costco is able to sell its products at the lowest prices for a variety of reasons. First Costco has great relationships with manufacturers. Companies want to sell their products to Costco because of the massive number of units that will sell if their product is sold at Costco. However, at the same time, if a product is not selling at the rate that Costco expects, it will discontinue it after 9-12 months. While they have great relationships with producers, Costco also negotiates down to the penny. In 2010, Costco halted its relationship with Apple because Apple would not let Costco sell its products online. Because of its negotiating power, Costco is able to get its inventory for the lowest price of any firm in the market. In addition, Costco is extremely frugal when it comes to costs that it deems unnecessary. All Costco locations are warehouses with cement floors. The warehouse setup has much lower fixed costs than its competitor’s retail spaces. Extra inventory is stored on huge orange platforms that are certainly not the most appealing sight. However, visual appearance is not a concern for Costco. They are in the market to provide the best prices on the high quality products that all consumers use. The warehouse break rooms and offices are very simple. There are only a few computers in the warehouse offices. In addition, the cash registers are quite outdated, but they still get the job done. Since Visa, Mastercard and Discover were unwilling to accept the deal that Costco wanted, Costco decided that it would make American Express its exclusive credit card provider. In sum, Visa, Mastercard and Discover were going to charge Costco a fee on all credit transactions that was more than Costco was willing to pay, so Costco decided not to do business with them. Costco figured that since the credit card companies wouldn’t accept the deal that Costco wanted, the credit card companies would miss out on providing credit for billions of dollars’ worth of transactions. Even though most members’ savings accumulate to many times the membership fee, the $55 paid by each member helps Costco cover some of its operating costs. When walking around a Costco, one may notice that there are not many employees to answer questions around the warehouse. This is because all employees have specific jobs that command all of their energy and attention. Costco does not want to pay employees to stand around and answer questions because it is an inefficient use of their time and an inefficient use of Costco’s money. All of the shelves are stocked during the night because it is most efficient when customers are not in the aisles.  Costco is also environmentally efficient in that instead of using bags, it reuses boxes at the check-out line. Lastly, Costco cuts out huge costs by not advertising on TV. Costco relies on word of mouth to attract new customers, while its competitors have enormous advertising budgets.

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Because of Costco’s brilliant for lowering costs without affecting its popularity, it is able to compensate its employees like no other retail company. Employee treatment is a key part of Costco’s successful business model. Costco strongly believes that happy workers are more efficient, provide better customer service and overall make Costco a more successful company. Costco’s hourly workers make an average hourly salary of $20.89 and 88% of its employees have company sponsored health insurance. I was paid $11.50 per hour, which is Costco’s starting wage. For each additional 200 hours of accumulated work, hourly wages increase by $0.25, until they reach the cap of $25.00 an hour. If there is one thing that the general public does not know about Costco, it is just how much Costco expects out of its employees in exchange for its above average wages. Costco expects all of its employees to go 100%, 100% of the time. I worked 6 hour shifts retrieving carts on hundred degree days or worked in the checkout lines loading heavy items into carts. Supervisors monitored how many transactions each checkout line completed each hour, which meant I was always pushed to go faster. There was never any down time because Costco was always packed with shoppers and there was always work to be done. Overall, working at Costco was hard and laborious, but at the same time I was able to gain valuable insight into the day to day operations of one of the most well run companies in the world.

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Sources:

http://www.marketwatch.com/investing/stock/cost/financials

http://www.consumerreports.org/cro/magazine/2014/12/q-a-with-costco-s-ceo-w-craig-jelinek/index.htm

http://www.businessweek.com/printer/articles/123492-costco-ceo-craig-jelinek-leads-the-cheapest-happiest-company-in-the-world

http://www.photoprintprices.com/wp-content/uploads/2014/04/Costco-PhotoPrintPrices.jpg

http://static01.nyt.com/images/2012/10/06/arts/design/06costco-1/06costco-1-articleLarge.jpg

http://g.foolcdn.com/editorial/images/76394/img_1597-xl1_large.jpg

http://dg6qn11ynnp6a.cloudfront.net/wp-content/uploads/Costco.jpg

http://s1.ibtimes.com/sites/www.ibtimes.com/files/styles/v2_article_large/public/2010/09/02/19405-an-exterior-view-showing-a-costco-warehouse-store-in-chicago.jpg?itok=wa21sp9R

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One thought on “The Economics of Costco

  1. This is an awesome perspective to have gained! I always wondered how Costco got away with such low prices. I assumed that since they bought in bulk this was the entire reason they offered lower prices. But the fact that they only mark up their merchandise 11% above their average total costs is incredible, especially when compared to the competition. Costco still pulls in billions just because they are SMART. I never thought much about the concrete floors and really simple shelves. They are not fancy, they are efficient and that all saves money. I think it would be really interesting to see their average total costs line up with say a Sam’s Club or other bulk retailer like Costco. I want to know how much they spend compared to Costco in a year and how much they make. I believe they have a similar foundation and business model. Costco is just superior? That would be a cool investigation.

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