Case 2 - Costco Analysis

1. What is Costco’s business model? Is the company’s business model appealing? Why or why not? Business Model is used to exemplify the methods and ways which we used to generate planned revenue. The Costco’s business model is to generate high sales volume and rapid inventory turnover by offering low prices on limited selection of national branded and select private-label products in wide range of merchandise categories. Costco’s offers these products to their members who are of two types’ business members and gold star members. This business model is tempting because it gives a test to Costco’s management to continue to devise strategies and methods through which they can keep hold of existing members and catch the attention of new members. Otherwise they will suffer failure because there will be a risk that discontented members will not renew their membership. This business model takes company towards total quality management. 2. What are the chief elements of Costco’s strategy? How good is the strategy? Strategy is the organization’s pre selected means or approach to gaining its goals or objectives, while keeping in view current and future external conditions. Costco’s strategy’s elements are: • Low prices • Limited product lines and selection • Treasure hunt shopping environment By keeping low prices Costco’s is following cost leadership strategy which is good because on this base they can compete with their competitors. By limited product lines and limited selection they are offering limited 4000 items which are less as compared to its competitors. Costco’s is adopted market development strategy by capturing new markets for existing products. By treasure hunt shopping environment they provides such product at low prices to its members which they believe will not be available in next visit. This works as an incentive and members try to take maximum advantage and therefore Costco’s sales volume increases. At Costco’s warehouse products are not offered in every size. The strategy they followed is that by offering every size their efficiency will decrease therefore it is said intelligent loss of sales. 3. Do you think Jim Sinegal is an effective CEO? What grades would you give him in leading the process of crafting and executing Costco’s strategy? What support can you offer for these grades? Yes, I think Jim Sinegal is an effective CEO. He has a vision and proper plans that where Costco’s is and where it will be in long term time period. He plays an active role in overall strategy formulation, implementation and execution. He acts as producer, director and knowledgeable critic. He cut to the chase quickly, exhibiting passionate intent to detail and pricing. He used to firing a stream of questions at store managers about sales volumes and stock levels of particular items. He used to regularly analyze position of certain products in stores and give his comments on any aspect of store operations that caught his eyes. Jim Sinegal lead its team by front and the position where Costco’s wholesale stand is proof that he is and effective CEO. 4. What core values or business principles is Jim Sinegal stressing at Costco?

There were two core values or business principles appear to place out at Costco. The main business principle activity of Costco is to provide high value to users by offering global and local tag products at low prices. It is observed that the human resource management of the Costco was coordinating and integrating its employees very nicely. It can be seen from the case that comments of Jim Sinegal’s made it very apparent that he was very committed to capture these values as division of Costco’s organization culture. Jim Sinegal wanted to say that these two principal activities reflected in working environment of Costco which makes them profitable throughout the world as compared to other conventional wholesalers and merchandisers. 5. Taking picture 6. How well is Costco performing from a financial perspective? Do some number crunching using the data in case Exhibit 1 to support your answer? Use the financial ratios presented in Table 4.1 of Chapter 4 (pages 104-105) to help you diagnose Costco’s financial performance. It is observed that according to Exhibit 1 in case study which indicates that the financial performance of Costco has been excellent from fiscal year 2000 to 2008. It is analyzed that net sales had increased from $31.6 billion to $71.0 billion throughout the year 2000 to 2008 and indicates CAGR of approximately 12.3% from 2000.With net sales total revenues of the company had also increased from $32.2 billion to $72.5 billion throughout the year 200 to 2008 with CAGR of approximately 12.3%. It can be seen that EPS had also increased from $1.35 to $2.30 throughout the year 2000 to 2006 with CAGR of approximately 9.3%.

2008

2007

2006

2005

2000

89.5%

89.5%

89.5%

89.4%

89.6%

9.6%

9.7%

9.5%

9.5%

8.6%

2.7%

2.5%

2.7%

2.8%

3.2%

total revenues

1.8%

1.7%

1.8%

2.0%

2.0%

ROE

14.0%

12.6%

12.1%

12.0%

14.9%

ROA

6.2%

5.5%

6.3%

6.4%

7.3%

Current Ratio

1.07

1.09

1.05

1.22

1.02

Days of Inventory

29.0

31.5

31.6

31.6

32.1

Merchandise cost as % of sales Selling & administrative expense as % of total revenues Operating income as % of total revenues Net income as % of

After done the calculations of Costco expense and profitability ratios it has been observed that selling and administrative expenses had increased throughout year 2000.It can be seen that both operating margin and net profit margin ratios had decrease slightly from 2000 but the figures of both operating margin and net profit margin had improved in 2008 as compared to year 2007. Return on equity had decreased in 2005 from 14.9% to 12.0%and then again this ratio had increased in 2007 from 12.1% to 12.6% and in 2008 from 12.6% to 14%.The same trend can be seen in the case of ROA, in 2005 ROA was 7.3% and it dropped down to 5.5% in 2007 and then again increased in year 2008 from 5.5% to 6.2%. The days of inventory at Costco had enhanced since year 2000 which reveals that the management of Costco had done fantastic job of inventory management. After doing the analysis of last five years it has been observed that net income profit of Costco had improved throughout the year 2000to 2008 but the financial condition of the company in 2008 was not good as compared to year 2000.However, in year 2008, the company had shown

great profitability as compared to last financial year 2007.The net cash flow from operating activities had increased from 1.78 to 2.08 billion during the last four years which indicates that the company had generated sufficient cash out of its operations and gave an idea to investors that the company had managed its business activities very efficiently and effectively. 7. Is Costco's financial performance superior to that at Sam and BJ? Financial performance of Costco’s wholesale can be measured with the help of financial ratio analysis. Financial ratio analysis is the calculation & comparison of ratios which are derived from the company's financial statements. According to given data current ratio of Costco’s wholesale is 1.07 which shows that it can meet it current liabilities on time. Profitability ratios shows return on sales, as it is 1.8% in 2008 it shows low profit margin on sales which is result of company’s policies of offering low prices. Return on Assets in 6% which shows that company is utilizing its assets in good way. Asset turnover ratio is 3% which shows company’s is efficient in utilizing its assets. This shows that overall financial position of Costco’s is strong. The Costco’s hold major share of 53% of wholesale club sales across the USA and Canada, Sam’s club having roughly 37% and BJ’s wholesale and several small competitors have 10% shares. Asset turnover ratio of Sam’s club and BJ’s wholesale is better in 2007 as compared to Costco’s club because of low prices offered by Costco’s club. Costco’s has low profit margin as compared to its competitors but its sales volume and membership base in strong. 8. How well is Costco performing a strategic perspective? How abt the competitive advantage? Costco has been playing very successful in the wholesaling industry as it can be seen from its business strategies. First of all, for the purpose of supporting the Costco’s business model of generating high sales volumes and rapid inventory turnover, Costco members are given a limited selection of nationally branded and select private label products in a wide range of merchandise categories. Then Costco combine its rapid inventory turnover with the operating efficiencies to run the business profitably at significant lower gross margins than traditional wholesales, mass merchandisers, supermarkets and supercenters. As a result, Costco takes advantages of its high sales volume and rapid inventory turnover to obtain the benefits of early payment discounts from merchandise vendors due to the high sales volume and rapid inventory turnover allow Costco to generate enough cash in account. Secondly, the pricing strategy of Costco is key factors to support the low price business strategy which is to cap the margins on branded name merchandise at 14 percent so that its members can buy with low price. Thirdly, Costco focus to offer limited selection that is about 4000 items with fast selling models, sizes and colors, and target the small businesses for its commercial and professional models selling. Furthermore, advertising and sales campaigns are not being used frequently by Costco for the marketing strategy and the company only launches campaigns for new warehouse openings. In addition, Costco also use direct mail to prospective new members occasionally and direct mail programs promoting selected merchandise to members regularly. Opening more new warehouses, building an ever larger and fiercely loyal membership base and employing well executed merchandising techniques to encourage members to shopping more frequently with big trip are the main central growth strategy of Costco. Moreover, online shopping is another alternative that Costco offered to members so as to make their shopping more convenient rather than switch to competitors. In addition, Majority of merchandise is owned by Costco, and the company also builds direct buying relationships with many producers of national brand name merchandise and manufacturers and this result in the available of flexible alternatives of suppliers for Costco in anytime to have sufficient of stocked merchandise. Also, Costco’s membership base and member demographics contains powerful buying ability as it mainly target the individual customers with minimum income of $75000 and 30 percent of the targeted customers

earn more than $100000 annually. For the purpose of executing Costco’s strategy successfully, the company offer biannual bonuses and full spectrum of benefits for its employees. More important, the promoting opportunities will consider the insiders first based on the company policy. Other factors that determine the success of Costco also include the business philosophy, values and code of ethics such as obey the law and governmental regulations, take of members, take of employees, respect suppliers and business partners, and reward the shareholders. The company’s current strategy is effective because it is using its strengths for exploring opportunities, minimizing its weaknesses and avoiding threats. Because of its effective strategy its market share is continuously increasing and Costco’s wholesale enjoy a good reputation of providing greater value to its customers. Costco’s has maintained a strong loyal member’s base and it is continuously working for increasing its members. Costco’s enjoys a competitive advantage because of its low prices, greater market share and reputation of proving greater value to its customers over Sam’s Club and Bj’s wholesale. 9. Are Costco's prices too low? Why or why not? Costo’s prices are not too low because one of their business strategy is built on low pricing. In order for Costo to continue to be in the business of wholesale and warehouse club, they need to have a strategy and sustainable competitive advantage. Every business understands that customer’s needs and wants for goods have a cordial relationship to price. In line with Costco’s philosophy, in order to keep members coming in to shop, they need to keep wowing them with low prices. We should not forget that there are other competitions in warehouse club business and in order for Costco to stay above them and remain competitive; they need to import one of the most important element of marketing mix, price, which will ultimately lead to more success in their organization. This low pricing has made the company experience high sales volume and rapid inventory turnover. The advantage of this is that rather than the company maintaining a huge working or operating capital, they could invest the capital in another area to grow the company. Maintaining a large operating capital can tie up a company’s financial resources, which can affect the growth of a company. 10. Does Costco’s pay its employee’s too much? Does it make sense for Costco to compensate its employees so much better than the employees at Wal-Mart or Sam’s Club? Why or Why not? Costco’s compensation packages for its employees are much better that its competitors. It is one of the principals of Costco’s business philosophy and values, to take care of their employees. Due to good compensation packages for employees and low compensation packages for executive Costco’s enjoys a strong image of responsible corporate citizen. It makes sense to offer such packages because due to this the employee’s turnover rate is very low in Costco. And employees and given opportunities where they can make good career by performing well in Costco’s. This gives Costco’s a competitive advantage over its competitors.

11. What recommendations would you make to Jim Sinegal regarding the actions that Costco management needs to take to sustain the company’s growth and improve its financial performance?

Jim Sinegal is an effective CEO, who plays an active role in company’s strategic management. Costco’s management should takes further steps to expand it market share by exploring untapped market in United States and outside the United States. They should maintain their good reputation of providing greater value to its customers. They should also provide online shopping opportunities to their customers who are outside from United States and Canada. And finally they should continue their effective strategies like high compensation to employees, low prices and reliable quality products etc.