The main economic trend that currently bears an affect on this industry is the low level of U.S. unemployment. It is our belief that the current economic situation will have a positive effect on this industry in a couple of ways. First, the low unemployment rate suggests that consumers have more money in their pockets to spend. However, the economy is not so stable where the average person is no longer price-price-sensitive at all. Thus, the discount retailers in this industry should continue to see high demand for their products. Typically in such a tight market, demand for workers is high and firms may have to pay higher wages in order to attract employees.
Bargaining power of suppliers. Most warehouse clubs in this industry rely on a large number of suppliers and are not reliant on any one supplier. In fact, often times suppliers have to compete against each other in order to secure an agreement for a warehouse club to sell their product. This lowers the bargaining power of suppliers. In addition, many warehouse clubs have signature private-label brands which are designed to be lower than the price of name-brand products. This can put further pressure on suppliers to lower the wholesale prices they offer to warehouse clubs.
Rivalry among established companies. Costco not only competes with its direct competitors in the discount warehouse club segment, but they also compete with general retail superstores like Target and Walmart and online retailers like Amazon. This industry is saturated with competitors, but in general, Costco competes with a handful of main competitors. Rivalry among established companies poses a high threat to Costco because there are only a few main competitors and there are many substitutes that customers can choose from. For instance,
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Sam’s Club – caters to small businesses, whereas Costco focuses more on individual customers. Since Sam’s Club does not market as much to individual customers, they are not as greatly affected by changing demographics or individual buying patterns and preferences.
Extended hours for business members at Sam’s Club. Also has Walmart distribution centers.
Sam’s Club – parent company is Walmart, capital. Strong brand name. Larger product offerings. Better e-commerce platform.
BJ’s – much larger product offering than Sam’s Club and Costco. More similar to a supermarket. Offer wider variety of package sizes. Focused on better customer experience (express and self-checkout lanes, longer store hours, same day delivery and pick-up options, accepts manufacturer’s coupons unlike Sam’s and Costco). More diversified product selection.
Sam’s club – serves U.S., Mexico, Brazil, and China. But has not penetrated the global market as aggressively as Costco. Much smaller customer base than Csotco.
As the leader in its industry, Costco has proved its ability to utilize its core competencies to help achieve and maintain a competitive advantage. What sets Costco aside from many other competitors is their ability to maintain a low-cost/high-volume strategy. A cost leadership strategy, like what Costco employs, can present financial challenges to a business. Costco maintains very low profit margins, and yet is able to remain a strong force in the industry due to its distinctive competencies and competitive advantages.
Financial metrics show Costco’s continuing growth over the past two decades. Costco has increased its total revenue from $32.16 billion in 2000 to $118.71 billion in 2016, which amounts to an increase of roughly 269%. Costco’s net income also grew from $631 million to $2.35 billion during the same time period. In terms of solvency, Costco has maintained a current ratio of 0.98 in 2016, which is slightly higher than those of Target and Walmart. Costco’s debt-equity ratio of 1.69 has remained somewhat constant over the past several years. In 2016, about 63% of Costco’s operations were funded with debt and about 37% from equity. Costco is slightly more leveraged than Walmart, but is considerably less leveraged than Target. Over the past decade, Costco’s gross profit margin has remained at about 3%, while EPS has increased from $1.33 in 2000 to $5.33 in 2016.
Costco’s business model is predicated on selling high quality products at the lowest possible price. Costco is able to maintain this strategy by means of several distinctive competencies, all of which revolve around efficiency. Having low operating costs, large economies of scale, a concise supply chain, healthy cash flow, rapid inventory turnover, and making smart merchandising decisions has helped Costco remain profitable while maintaining its cost-leadership strategy.
Lean operating costs. Each Costco location doubles as both a sales floor and warehouse to store inventory. Costco takes a “no-frills” approach to the design of each location, favoring efficiency over aesthetics. Minimizing receiving and handling costs that are often associated with retailers allows Costco to reduce operating expenses.
Economies of scale. Costco generally purchases in large quantities which allows them to benefit from quantity discounts from suppliers. Costco is then able to pass these savings along to the customer. Additionally, Costco’s focus on expanding the number of warehouses both domestically and abroad will contribute to their ability to capitalize on economies of scale.
Working capital. High sales volume and rapid inventory turnover generates a strong cash flow, which enables Costco to use cash received from sales as working capital and minimizes the need for loans.
Selective merchandising. Unlike typical large chain supermarkets that carry inventories of around 125,000 to 150,000 items, Costco carries less than 4,000 items at any given time. Costco only carries products that are fast selling, profitable, and that encourage high inventory turn. By limiting their selection of products, Costco is able to avoid the common pitfall of trying to cater to every possible need. By limiting product selection, Costco may lose on some sales, but it also reduces the risk of having dead inventory. Costco also compensates for their limited selection by utilizing what is known as “treasure hunt merchandising”. This strategy involves offering products that are often upscale and in limited supply in an attempt to lure customers into shopping more frequently.
Supply chain. The majority of Costco’s inventory is purchased directly from manufacturers, which reduces the additional costs that would be incurred if purchasing from a middle-man or re-seller. Having direct buying relationships and a large supplier base reduces costs and minimizes potential supply chain problems. Also, because Costco only allows a limited selection of products to be carried in their store, suppliers must compete with and outbid each other in order to get their products sold by Costco. This increases Costco’s purchasing power and lowers their merchandise costs.
Rapid inventory turnover. One of Costco’s core competencies can be seen in its inventory turnover ratio. The average product sits in inventory for only 27.6 days before being sold, which is the lowest amount among Costco’s competitors. Costco’s ability to quickly turn inventory translates into higher revenue.
Costco’s success and sustained competitive advantage is partially due to the firm’s ability to leverage its strengths and opportunities. However, in order to sustain its competitive advantage and its status as an industry leader, Costco will need to continue to mitigate inherent weaknesses and threats.
Costco’s main strength is its ability to provide high quality products at low prices. This ability is fueled by their determination to keep operating costs low.
One of Costco’s weaknesses is actually predicated on one of its biggest competencies. As mentioned before, Costco’s limited product selection allows them to lower costs and increase profitability, however, it naturally leads to a measure of sales loss. Even though Costco does sell a variety of products, there are minimal options for brand selection and product sizes. Many items are only sold in bulk quantities. This may deter some customers from shopping from Costco if they don’t find it practical to purchase items in such large quantities.
Another notable weakness is that their products are exclusively sold to members which limits the size of their customer base. Their membership model is a two-edged sword: on one hand, the revenue generated from membership fees allows Costco to remain profitable, however, their membership program may result in loss of potential revenue from people who would purchase from Costco if there were no membership requirements.
Costco’s biggest threat is their competition. They not only compete with other membership warehouse stores like Sam’s Club and BJ’s Wholesale, but also with large conglomerates like Target, Walmart, and Amazon.
