Business model of Costco

Business Model of Costco:

Costco is a membership-only warehouse, unlike either Walmart or Target. It adopted a very different business model than other retailers. The focus was always on providing the customers seamless shopping experience and developing an organizational culture that fostered employee motivation and placed a heavy focus on customer service. Apart from other things, Costco is known for its unique organizational culture. In this way, the company has built an outstanding image and achieved a place among the leading and most popular employers of the United States. However, Costco has also been successful at expanding its presence to various other geographical markets lying outside the United States.

How Costco makes money?

Costco generates a substantial part of its revenue from retail sales. However, apart from that, it generates a small portion of its net revenue from memberships. During 2019, the company generated $149.4 billion from retail sales and $3.4 billion from memberships. (Revenue from membership fees increased 7% in 2019 compared to the last fiscal.) Compared to that Costco’s revenue from retail sales was $138.4 billion in 2018 and $3.14 billion from memberships.

Business Segments of Costco:

Costco operates its business mainly on a geographical basis. It has divided its business into three main geographical segments that include the United States, Canada, and other international markets.

United States:

It is the largest market of Costco based on revenue and the number of warehouses. As of December 2019, 546 of Costco warehouses were operational in the United States and Puerto Rico while Canada had 100. The remaining of the total 785 warehouses were operational in the other international markets. Costco also runs e-commerce platforms in the United States. As of fiscal 2019, the company generated a total of $111.8 billion in net sales from the US operations compared to $102.3 billion in 2018. Its operating income from the United States market was a total of $3.1 billion compared to $2.8 billion in 2018.

Canada:

Canada is the second-largest geographical market of Costco based on the number of stores and net revenue. In December 2019, the number of Costco warehouses operational in Canada was 100. The company generated $21.4 billion in net revenue from the Canadian market. Apart from that, the operating income of Costco from its Canada operations was $924 million compared to $939 million in 2018.

Other International Operations:

The operations of Costco in the markets excluding the US and Canada are included in one segment called ‘Other international markets’. These markets include Mexico, U.K., Japan, Korea, Australia, Spain, Iceland, France, and China as well as Taiwan where Costco operates its business through a majority-owned subsidiary. The other international operations of Costco generated $19.6 billion in net revenue in 2019 compared to $18.6 billion in 2018. The operating income of Costco from other international operations remained nearly flat at around $750 million for the last two fiscals.

Costco Merchandising:

Like Walmart, Costco also relies on direct sourcing to keep prices low for its customers. In this way, it has eliminated the middlemen and been able to reduce the prices of merchandise for its customers. This has helped the company gain cost efficiency which is further bolstered through the use of efficient inventory management techniques. The company sources from manufacturers directly and sends the merchandise to cross-docking units which helps it reduce the costs related to warehousing and inventory management. Apart from quality merchandise, the company also maintains consistently lower prices to attract customers. The strategy of the retail brand is to provide its customers with high-quality merchandise at prices consistently lower than its competitors. Costco offers its customers merchandise in the following five main categories:

Food and Sundries:

This merchandise category includes dry foods, packaged foods, groceries, snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies. This is the largest segment of merchandise based on net revenue. During 2019, the company generated $59.7 billion in net sales from food and sundries compared to $56.1 billion in 2018.

Hardlines:

This merchandise category includes major appliances, electronics, health and beauty aids, hardware, and garden and patio. This is the third-largest merchandise segment based on net sales. Hardlines generated $24.6 billion in net sales in 2019 compared to $22.6 billion in 2018.

Fresh Foods:

This merchandise category includes meat, produce, deli, and bakery. Fresh foods generated $19.95 billion in net sales in 2019 for Costco compared to $18.9 billion in 2018.

Softlines:

This merchandise category includes apparel and small appliances. Softlines is the smallest category of merchandise based on net yearly sales. In 2019, this segment generated $16.6 billion in net sales compared to $15.4 billion in 2018.

Ancillary:

This merchandise segment includes the gasoline and pharmacy businesses of Costco. As of 2019, the company operated 593 gas stations and gasoline sales accounted for 11% of the net sales of Costco. The ancillary businesses of Costco operate inside or next to its warehouses. They offer expanded products or services to encourage customers to shop from Costco more frequently. The ancillary businesses of Costco include gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers.

Costco E-commerce operations:

Apart from being the disruptor, digital technology is also generating new opportunities for retail brands in the United States. The challenge from Amazon is growing and therefore leading retailers in the United States including Walmart, Costco and Target are investing more in technology to grow their sales and competitive position in e-commerce.

Costco’s Competitive advantage:

Costco is a leading retail brand based in the United States. The company has enjoyed impressive growth in net sales and revenue over the past several years. The business model of Costco has several strong sources of competitive advantage. In terms of retail sales, despite a limited presence compared to the leading retailer Walmart, it enjoys a strong presence in the US and is one of Walmart’s most powerful competitors. Just like Walmart’s Sam’s Club, Costco also owns a private label brand Kirkland signature which is one of the primary drivers of demand and sales as well as popularity for Costco. However, the company is now eyeing a bigger pie of the US e-commerce market and therefore continues to grow its investment in digital technology. The leading pillars upon which the success of Costco rests and that are the primary drivers of competitive advantage are discussed below:

Lower pricing:

One of the leading sources of competitive advantage for Costco is its large merchandise range that the company offers at consistently lower prices compared to most rivals in the US and international markets. One of the core values of Costco is to provide great quality goods and services at lower prices and the company has remained committed to its core value in its history. While the product range offered by Costco is limited compared to Walmart, its gross margin is also much lower than Walmart and Target. The company has designed its business model in a manner to generate most of its profits from membership fees. By keeping prices very low and using efficient inventory management techniques, the brand has managed to attract a large customer base. Most of its customers like to make repeat purchases from the warehouse retail giant which is the primary driver of sales and revenue for the company. A limited selection of nationally branded and private label products in a wide range of categories has continued to drive higher sales volume and rapid inventory turnover for Costco.

Organizational culture and HRM:

Costco is also known for its organizational culture and excellent HR management strategy. In terms of HR management and organizational culture, it has earned the reputation of a leader which is also a source of competitive advantage for the brand. Costco clearly acknowledges that its employees are an asset for the organization and the leading drivers of competitive advantage for the brand in the physical retail industry. Apart from providing them great wages and health benefits, the company also promotes inclusion and diversity. It also focuses on employee training including leadership training and creates growth opportunities for the workers like promoting from within. The number of employees working for Costco increased to 254,000 in 2019 compared to 245,000 in 2018. Its organizational culture and focus on human resource management have also helped the company gain popularity and build a strong social image.

Private label brand:

Private label brands are also major drivers of demand and growth for both Costco and Target. Kirkland Signature is a private label brand owned by Costco. The company has remained committed to the growth of its private-label brand Kirkland Signature and continues to develop new items and build stronger relationships with premium brands. During 2019, the company added products from Apple, Columbia Sportswear, Sony, and Weber brands to its Kirkland Signature range. The company offers a very large collection of products from Kirkland Signature. Product quality and lower pricing is key to maintaining customer loyalty for Kirkland Signature.

Product Quality:

Another important area where Costco has maintained a consistent focus is product quality and which has continued to drive demand and customer loyalty for the business is product quality. The company sources directly from the manufacturers and also places heavy focus upon quality to attract and retain customers. A large range of good quality products is one of the main attractions of Costco and its private label brand Kirkland Signature.

Strong customer loyalty:

As a physical retail brand, the company enjoys a very high level of customer loyalty which is clearly reflected in its membership renewal rates. Its customer retention rate over the past several years has remained impressive. In 2019, the membership renewal rate of Costco was 91% in the United States and Canada. Overall worldwide, the company had a membership renewal rate of 88%. The company also continues to attract new customers worldwide through strong branding. In Shanghai (China, when the company opened its first store in 2019, it had 139,000 membership signups by the day of opening its first warehouses. The company remains committed to customer experience in order to maintain strong customer loyalty.

Supply chain and inventory management:

Supply chain and inventory management practices also decide the competitive edge of the brand in the physical retail industry. Costco sources products directly from the manufacturers in order to keep prices of the merchandise low. Like Walmart, it has also adopted innovative supply chain management practices that drive higher efficiency and help maintain consistently lower prices. It also utilizes cross-docking to keep inventory low and reduce the costs related to warehousing and inventory management.

Financial Performance of Costco over the last two years

Costco’s financial performance has grown consistently over the past several years. The net revenue of the company grew by around 8% in 2019 compared to the previous fiscal year. Net sales of the company during 2018 was $138.4 billion. Apart from that Costco generated $3.1 billion from memberships. The net revenue of the company in 2018 was $141.6 billion. It climbed to $152.7 billion in 2019 of which $149.4 billion came from retail sales and $3.4 billion from membership fees. Net sales of the company experienced an 8% growth from 2018 to 2019.

Five Operational Performance Objectives

To run an organization, a well-defined set of operations performance objectives is essential. There are five basic performance objectives applicable to all types of business operations. These five basic operations objectives include cost, dependability, flexibility, quality, and speed. There are both internal and external implications of these five performance objectives. Moreover, the internal effects of these performance objectives have a definite impact on cost.

Quality:

This is the first leading operational performance objective. It refers to consistent performance according to your customer’s expectations. Quality also affects customer satisfaction to a significant extent. However, the meaning of quality can vary across industries and businesses. Suppose there is an automobile business and there is another technology business. The same quality standards would not apply to each of the two businesses. Quality can acquire different meanings in different settings or industry environments. While in some industries, the level of staff friendliness is a leading parameter on which to measure quality, product efficiency is the main indicator of quality for another. However, no matter whatever industry a business belongs to, customers appreciate quality cannot be denied. Quality can, therefore, bear a direct and major influence on customer satisfaction as well as organizational performance. Nevertheless, quality is also related to a company’s image and apart from making certain things easier for the business like customer acquisition, it can also increase an organization’s profitability. When looked at in the context of the retail industry, quality denotes many things including product and service quality, staff friendliness, store environment, as well as more things like the image of the business as well as organizational culture.

Speed:

As the industry has evolved with the growth of digital technology, speed has become more and more integral to business performance and growth. In fact, you cannot imagine good operational performance without speed. Now in nearly every industry speed matters just as much as quality or prices. Customers want that products are delivered to their doorsteps faster. In this era, where a large range of services are delivered and consumed online including a large range of technology and entertainment services, speed matters a lot and sometimes it can be a leading differentiating factor for a company. A company that brings ideas to the table and products to the shelves faster than its competitors usually finds itself ahead of the others in the market. In some industries where services have to be consumed instantly, speed matters more than ever. Apart from that, in some industries, businesses need to keep the shelf filled with the latest items in order to engage their customers and it is also a reason that speed is so important. For the retail industry, speed has also acquired distinct importance since it also has a direct impact on the competitive position of a brand. However, speed is important not just in terms of delivery but in other operational areas too.

Analysis of Costco’s Operations based on the 4Vs model:

Operations and operational processes are like the fundamental building blocks of organizations that have a significant influence on the productivity of the organization and the quality of the organizational output as well. Focusing on operational efficiency has helped businesses find faster market growth as well as maximize output. Many times, if the efficiency of processes is low then it is mainly because the organization has adopted a poor operational design. Processes across business organizations and industries can differ significantly and that is why all processes must be managed differently. Some of the leading differences between various processes are due to the technologies and the level of know-how involved. Different processes require different production equipment as well as different skills and know-how. However, apart from these things, the difference also lies in the nature of the demand for the products and services these processes produce. There are four particular characteristics of demand that have a significant impact on process management and which are as follows:

  • The volume of the products and services produced
  • Variety of products and services produced
  • Variation in the demand for products and services.
  • Degree of visibility that customers have of the production of products and services

The volume of products and services:

Does the business being discussed produce a large amount of the same products and services or various items in small volumes? For example, a car company will produce thousands of pieces of the same model. On the other hand, a fashion brand will produce limited pieces of various designs. If the volume of output is high, it indicates repeatability or high-level familiarity of the processes. Many times since a large business produces more and more of the same thing, it gains significant expertise in producing that product. It also helps the business gain a significant competitive advantage compared to the smaller ones.

Variety of processes (products and services produced):

Variety is related to the various types of activities that are being performed by the company and how well it manages the various processes. The level of operational complexity is very high when it comes to a mixed model manufacturer that is engaged in lots of changeovers between processes. It means apart from having to choose from a very wide range of inputs, the company has to handle the additional complexity of matching specific customer requirements in terms of products and services. Generally, the high variety processes are more costly as compared to the lower variety processes.

Variation in demand of products and services:

In fact, demand variation is among the most challenging aspects of business operations. It is easier for businesses to manage the processes when the level of demand is predictably constant. However, when demand can fluctuate significantly, then managing processes becomes somewhat complex. If demand is predictably constant, it is easier to gear resources to efficiently cater to the existing demand, Moreover, businesses can plan operational activities including marketing and sales or after-sales services in advance.

Visibility of processes:

This is also a rather complex aspect of business operations to grasp. It denotes that aspect of business operations that is easily visible to the customers. The businesses that work with consumers directly may have more visible processes. For example, the healthcare and retail industry have more visible processes. However, the same is not true about an automobile business. Customers generally do not have a very clear view of the production and distribution processes of automobile brands. They cannot peep into everything that goes on before the finalized cars reach the showrooms. This is the only aspect of automobile operations that they are generally familiar with. It is also true about businesses like Apple inc. However, when it comes to businesses like Amazon or even Facebook, these are highly customer-facing businesses or customers have very high visibility into their operations. These are also some businesses for which transparency and accountability matters a lot. However, even in the physical retail industry, accountability and transparency have become of paramount importance because of the growing focus on the brand image as well as customer trust and customer experience.

A Few Last Words about Costco’s Business Model:

Costco has established an outstanding and string business model whose core strengths include a competitive pricing strategy and product quality. The company has found impressive growth in recent years driven by strong sales, e-commerce growth as well as higher customer loyalty. Its private label brand Kirkland signature is also an important driver of growth and competitive advantage for the brand. Moreover, Costco’s strength lies in its strong reputation and organizational culture.

--

--

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store