Lessons in retail from Costco – Nice guys do come first

Value investors Tanvi Mehta, Ramaswamy Ranganathan and Sudarshan Rajan write about how Costco, a multi-billion dollar global retailer with membership-only warehouse club operations in eight countries, has been going from strength to strength by focusing on the wellbeing of its employees, by being obsessive about serving consumers at lower costs, operating on wafer thin net margins and not spending a dime on advertising.

What if we tell you that there is a company which pays its employees more than its competitors, not only that, it is the best paymaster in the retail industry, it has one of the most comprehensive health care packages for its employees and during times of distress, it has gone on to increase the wages in 2008-09 crisis.

What if we tell you that a meeting between Jeff Bezos and the CEO of the company we are talking above, motivated Jeff and he went on to drop prices and also launched Prime as a learning from the meeting eventually.

What if we tell you that the retailing powerhouse has membership renewal rate of 91% in the United States and 88% in Canada? What if we tell you that this company has relentless focus on costs, focus on employee development and doesn’t spend a dime on advertising?

What if we tell you that the company has very low margins, only enough to cover up costs and is operating on wafer thin net margin of 2% to 2.4% and still the stock is a multi-bagger if invested in 1986?

What if we tell you the company has this as its code of ethics – Obey the Law, take care of our customers, take care of employees, respect our suppliers, and reward our shareholders.

What if we tell you that this company in 2009 wasn’t happy with the prices Coca-Cola was offering, rather than stick customers with higher costs, it simply stopped carrying Coke products. Most would pass on that cost to consumers, forget taking on a brand like Coke. The obsession to serve consumers at lower costs has been deeply ingrained.

What’s the name of the company, you would ask.

Well, to divulge the name of the company, it would be a fitting tribute to relay what the greatest investor and vice-chairman of Berkshire has to say about this company. Asked about his favourite company outside of Berkshire, Munger literally interrupted the questioner and answered, “That’s easy. It’s Costco.”

“It’s one of the most admirable capitalistic institutions in the world. And its CEO, Jim Sinegal, is one of the most admirable retailers to ever live on this planet,” he gushed. “I just can’t say enough about my admiration for Costco. More of you should look at Costco. In fact, every time Donald Trump says something and you get discouraged, you should think about Costco.”

He wasn’t done and Munger has even gone to say Costco does more for civilisation than the Rockefeller foundation.

Now dwelling deeply into the financials of Costco:

The membership sales of Costco and the net income close to matches, signifying the obsession to pass on lower cost to consumers and pay its employees generously and deliver the goods to the shareholder by driving customer loyalty.

The shopping experience at Costco is imperishable. Costco’s tasty $1.50 hot-dog-and-soda combo refillable is a marvel, the prices have remained same for over 3 decades. In fact, it has become a religious duty towards the consumer to serve them with fanatic obsession. 

Nicholas sleep called Costco as a Perpetual Motion Machine, utilising a business model he termed “Scaled Economics Shared”. His 2002 investor letter articulated it brilliantly, “The retail concept is as follows: customers pay an annual membership fee which provides entry to the stores for a year, and in exchange Costco operates an every-day-low-pricing strategy by marking up 14% on branded goods and 15% on private label with the result that prices are very, very low. 

This is a very simple and honest consumer proposition in the sense that the membership fee buys the customer’s loyalty (and is almost all profit). and Costco in exchange sells goods while just covering operating costs. 

In addition, by sticking to a standard mark up, savings achieved through purchasing or scale are returned to the customer in the form of lower prices, which in turn encourages growth and extends scale advantages. This is retail’s version of perpetual motion and has been widely adopted by Walmart among others.” 

Costco thrives on the tenet of Good People, Good Jobs, Good Pay, Good Careers, THEN GOOD THINGS HAPPEN. Nothing could have been more true than this.

Costco was born to serve consumers with the same obsession Michael Jordan was born to play basketball. Low prices, combined with customer obsession and employees’ loyalty, forges a defining partnership.

In this era of Amazon and Jeffisim, Costco still gives you a reason to visit a physical store and shop for pleasurable experiences bringing exhilarating moments to consumers.