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

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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

The Economics of the NCAA Tournament

Over spring break, I attended the second and third rounds of the NCAA Tournament in Seattle. Thousands of people from all over the country travelled to Seattle to cheer on their favorite teams. This made me wonder what kind of impact hosting the NCAA Tournament had on a city’s economy. Over the course of the 3 week NCAA Tournament, billions of dollars are spent. It all starts with the television and media rights deal. In 2010, CBS Sports and Turner Broadcasting Group signed a $10.8 billion deal to broadcast every NCAA Tournament game for the next 14 years. This means that the NCAA is paid more than $770 million for the broadcasting rights of the NCAA Tournament each year.

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There are a number of factors that determine whether a city gets a massive economic boost or a possible loss from hosting the NCAA Tournament. The most significant factor is the location of the participating schools. This is the reason I attended the NCAA Tournament in Seattle. I am a huge Gonzaga basketball fan, so I travelled from Spokane to Seattle to watch them play. Gonzaga fans were all over Seattle. There was a big alumni reception at Safeco field and a big ballroom at the Washington Athletic Club turned into the Gonzaga fan headquarters. All of these fans occupy hotel rooms and fill up restaurants which has a positive effect on Seattle’s economy. The second factor is brand appeal. Some teams have bigger fan bases or simply travel in bigger masses than others. It helps when fans are excited about a schools current team and they are optimistic about potential success in the tournament. For example, the Northern Iowa fan base travelled really well because they had one of their best seasons in program history and were anticipating a deep tournament run. On the other hand, their third round opponent who beat them, Louisville, is a perennial power. This prompted their fans to figure it was not worth the travel expense to go all the way to Seattle because they make the tournament every year. Another factor is the intrigue of matchups. Rivalries bring in the most appeal, which prompts more people to travel and spend money supporting their team.

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Based on the masses of people visiting Seattle for the NCAA Tournament, I assumed that all of the full hotel rooms and restaurants would produce a surefire economic boost for every host city. However, it is not always the case. When New Orleans hosted the Final Four in 2012, they only expected a small economic benefit. Allen Sanderson, a sports economist at the University of Chicago stated, “A lot of the activity is just substitution of one thing for another. The tournament may affect where people drink beer, but not how much beer they drink.” Sanderson raises an intriguing correlation between increased economic activity in one part of the city and decreased economic activity in other parts. For example, there is probably less economic activity at malls and movie theaters during this time, which reduces the economic benefit of hosting the Final Four. Also people who would otherwise visit the city and spend money will steer clear because they do not want to deal with the masses of people. The recipe for maximizing a host cities economic profit is to attract lots of visitors, who will spend money that would not have otherwise been spent.

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Another significant economic aspect of the NCAA Tournament is the tendency of employees to either take sick days to watch the games at home or to watch the games at work. Considering how many people do this, it can have a huge economic impact on the national scale. According to a 2009 Microsoft survey, 50 million Americans plan to watch games at work during the NCAA Tournament. On top of that, a 2013 msn.com survey found that 86% of workers will check scores intermittingly throughout the day. If you calculate the economic loss based on the 50 million workers not doing their job and an average hourly wage of $24.31 according to the Bureau of Labor Statistics, $1.2 billion would be lost every hour. Since workers are likely to check scores regardless of management intervention, it is best for managers to let employees take short breaks to catch glimpses of the games that they are most interested in. Letting employees watch March Madness in the workplace builds camaraderie and morale, which could increase productivity in the following weeks.

Sources:

http://www.forbes.com/sites/leighsteinberg/2013/03/20/march-madness-packs-economic-whallop/

http://www.newrepublic.com/article/117045/economic-costs-and-benefits-college-basketball-ncaa-tournament

http://www.nationaljournal.com/daily/the-economics-of-march-madness-20120311

http://www.forbes.com/sites/prishe/2015/03/19/march-madness-economic-impact-on-host-cities-rests-on-luck-of-the-draw/3/

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The Financial Struggles for Retired Professional Athletes

It is reasonable to look at professional athletes salaries and become outraged by how much money they are making for simply playing a game. This past November, Giancarlo Stanton, an outfielder for the Florida Marlins signed the biggest contract in the history of Major League Baseball for a whopping $325 million over the course of 13 years. That is $31.14 million per season. If he were to average 539 plate appearances (2014 total) for the length of his contract, he would be getting paid $57,773.65 every time he stepped up to the plate. Whether he struck out on three pitches or hit a grandslam, he would still get $57,773.65 each time. Not all professional athletes make this much money, but they still have exorbitant  salaries. The average salaries for professional athletes are displayed in the diagram below. The immediate question is how can athletes get paid so much money to swing a bat, shoot a ball or even make a tackle? Athlete’s salaries are not going to decrease as long there is such a competitive market for their services. For teams in big markets such as the Red Sox or the Yankees, it makes sense to sign the best players and put together winning teams because they will produce more revenue from TV deals and higher ticket prices. The increased revenue will outweigh the excessively large player contracts.

pro athlete salary diagram

While we may be jealous or even disgusted by the size of professional athlete’s contracts, we should be confused how so many of them become financially insecure shortly after they retire. According to a 2009 Sports Illustrated article, 78% of NFL players are broke or under financial stress within two years of retirement. This same article estimates that 60% of NBA players are broke within five years of retirement. These statistics are hard to fathom considering the average career earnings in the diagram above. How do these individuals blow so much money in such a short period of time?

Boston Celtics v Indiana Pacers

Just ask Antoine Walker. He is one of the saddest examples of an athlete losing all of his career earnings. I was a big fan of Antoine during his days with the Celtics and I sensed from his post-game interviews that he was caught up in the celebrity lifestyle, but I can’t believe what that actually turned out to mean. Over the course of his NBA career, Antoine made $110 million in player salary, which does not include endorsements. However, in 2010, he filed for bankruptcy. Antoine’s present economic struggles are the result of years of not being able to say “No.” Antoine made countless poor investments in houses, cars, watches, and suits on top of being an avid gambler. During the 2002 NBA Playoffs, Antoine had a new custom made suit for each postgame news conference. Throughout his NBA career, Antoine would support his extremely large entourage, which included over seventy friends and family members. He was such a nice guy that he wanted those closest to him to also live the celebrity lifestyle. By being so willing to spend money on himself and on others, it was only a matter of time until Antoine’s money ran out.

While Antoine is a great example of how to blow over $110 million, there are a variety of factors that explain why so many retired athletes face similar situations. The most significant factor is that many athletes were poor growing up and they are not equipped with money management skills when they get paychecks with six zeroes. The combination of not knowing how to handle money and not thinking to hire qualified accountants proves to be costly for far too many professional athletes. On top of that, most athletes have huge egos, which makes them believe they can make sound financial decisions without guidance.  Yes, they may be extremely talented on the court or field but that doesn’t mean they also know everything about finance. Another issue is that far too many professional athletes delegate full management of their finances to the wrong people. These people are sometimes so-called friends or friends of friends and athletes let them manage their money as a favor not because they are experienced investors. These unqualified investors get all the bills sent to them and gain complete control of the athlete’s finances. They typically make risky investments and sometimes even take extra money for themselves. In addition, research has shown that athletes are more focused on the present and less focused on the future than their non-athlete counterparts. This is why they have so much trouble saving money and avoid making safer, long term investments. In order to avoid becoming the next Antoine Walker, young professional athletes should hire experienced accountants to create long term financial plans. With the right investments and refraining from excessively lavish behavior, there is no reason professional athletes can’t live comfortably for the rest of their lives.

Sources:

http://www.bloomberg.com/news/articles/2014-10-23/basketball-star-who-went-bankrupt-wishes-he-d-gotten-an-mba

http://www.si.com/vault/2009/03/23/105789480/how-and-why-athletes-go-broke

http://www.cbsnews.com/news/why-athletes-go-broke-the-myth-of-the-dumb-jock/

http://ftw.usatoday.com/2013/10/average-career-earnings-nfl-nba-mlb-nhl-mls

http://espn.go.com/mlb/story/_/id/11897600/giancarlo-stanton-325m-miami-marlins-heavily-backloaded

http://www.boston.com/sports/basketball/celtics/articles/2009/10/25/former_celtics_star_antoine_walker_pursued_by_creditors_as_wealth_vanishes/?page=2