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Marketing Excellence: >> Costco

Costco’s mission is “to continually provide our members with quality goods and services at the lowest possible prices.” With more than 75 million card-carrying members and $110 billion in sales, it is the largest warehouse club chain in the United States and the third-largest retailer in the United States after Walmart and Kroger. The company’s success comes from years of building consumer loyalty through its dedicated merchandising and pricing strategy, combined with no-frills, cost-cutting policies.

Costco’s merchandising strategy focuses on offering a broad range of brand-name and private-label merchandise at extremely low prices. But unlike a grocery store that carries 40,000 SKUs or a Walmart that can carry up to 150,000, the company offers about 3,750 SKUs—only the fastest-selling flavors, sizes, models, and colors from a single vendor in each category. For example, it sells four brands of toothpaste compared with Walmart’s 60. This efficient product sourcing results in several outcomes: high volume of sales, rapid inventory turnover, extremely low prices, and better product manageability.

Costco buys its merchandise directly from the manufacturer. Products are shipped directly to the company’s warehouses or to a depot, which reallocates the shipments to warehouses within 24 hours. This process eliminates several steps such as using a distributor and other intermediaries, which avoids costs associated with storage, additional freight, and handling. At the warehouse, shipments are often taken directly to the floor, unwrapped, and left on the pallet, ready to sell.

Over the years, Costco has expanded its products and services from simple boxed items such as cereal and paper products to fresh produce and flowers, which must be displayed attractively and managed more closely. Today, the company sells dairy, baked goods, seafood, clothing, books, computer software, vacuums, home appliances, electronics, jewelry, tires, art, wine, liquor, hot tubs, and furniture. Its service departments include pharmacies, optometrists, photo processors, food courts, and gas stations. Costco’s private label, Kirkland Signature, offers high-quality products at lower prices than the comparable branded item, ranging from diapers and bed sheets to coffee and makeup.

Of the 4,000 products sold, 3,000 are staples found at Costco week after week, while the remaining 1,000 rotate as part of the company’s “treasure hunt.” These special items are offered only temporarily and can be as exotic as Coach bags, Waterford crystal, and expensive jewelry. Costco believes its treasure hunt offerings create excitement and increase consumer loyalty, bringing bargain hunters back again and again.

The company’s pricing strategy is transparent: It limits the markup of any branded item to 14 percent and any private-label item to 15 percent. (In comparison, supermarkets and department stores mark up anywhere from 25 percent to 50 percent.) If a manufacturer’s price is too high, Costco will not restock the item. Founder and former CEO Jim Sinegal explained, “The traditional retailer will say: ‘I’m selling this for $10. I wonder whether I can get $10.50 or $11.’ We say: ‘We’re selling it for $9. How do we get it down to $8?’” One staple is the $1.50 hotdog and fountain drink combo, priced the same since 1985. In 2013, Costco sold about $168 million worth of the combo in the United States alone.

Costco’s cost-saving tactics extend to the interiors its 634 warehouse-style stores around the world. Most average 143,000 square feet, with floor plans designed to optimize selling space, the handling of merchandise, and the control of inventory. Decor is simple: concrete floors, bare-bones signage, and product displays that consist of pallets right off the truck. Central skylights and day-lighting controls hold down energy usage, and the company also saves by not supplying shopping bags. Instead, consumers use their own bags or leftover boxes and crates stacked near cash registers. Costco spends little on marketing and promotions, except for the occasional direct mail to prospective new members and coupons to regular members.

The one area Costco does not cut costs is in its workforce. Employees earn an average of $17 per hour, 42 percent higher than Sam’s Club salaries. In addition, 85 percent have health insurance, more than twice the percentage at Target or Walmart. As a result, employee turnover and employee theft are extremely low, and employees are better trained and dedicated to the company. Costco’s loyal consumer base appreciates the fact that its deep discounts come from strategic business planning and are not at the workers’ expense.

Costco’s customers are not only loyal; many are affluent. Their average household income is $74,000; 31 percent earn more than $100,000 per year. Membership starts at $55 a year and can be upgraded to Executive levels that provide additional benefits. Costco accepts only debit cards, cash, checks, and American Express. While consumers need membership to shop at the warehouse locations, nonmembers can shop online without it and pay an additional 5 percent fee for any purchase.

Costco’s success has come from focusing on a handful of business practices: sell a limited number of items, keep costs down, rely on high volume, pay workers well, require consumers to buy memberships, and target upscale consumers and business owners. This vision has led to many achievements, including ranking number 22 in the Fortune 500 and number 23 on Fortune’s Most Admired list. Costco also was the first company to grow from zero to $3 billion in sales in less than six years.

Questions

1. What is unique about Costco’s channel management process? Which of its channel practices can other retailers borrow or implement?