Costco operates membership warehouses based on the concept that offering members
very low prices on a limited selection of nationally branded and selected private
label products in a wide range of merchandise categories will produce high sales
volumes and rapid inventory turnover. This rapid inventory turnover, when combined
with the operating efficiencies achieved by volume purchasing, efficient distribution
and reduced handling of merchandise in no-frills, self-service warehouse facilities,
enables Costco to operate profitably at significantly lower gross margins than
traditional wholesalers, discount retailers and supermarkets.
Costco buys nearly all of its merchandise directly from manufacturers for shipment
either directly to Costco’s selling warehouses or to a consolidation point (“depot”)
where various shipments are combined so as to minimize freight and handling
costs. As a result, Costco eliminates many of the costs associated with multiple
step distribution channels, which include purchasing from distributors as opposed
to manufacturers, use of central receiving, storing and distributing warehouses,
and storage of merchandise in locations off the sales floor. By providing this
more cost-effective means of distributing goods, Costco meets the needs of business
customers who otherwise would pay a premium for small purchases and for the
distribution services of traditional wholesalers, and who cannot otherwise obtain
the full range of their product requirements from any single source. In addition,
these business members will often combine personal shopping with their business
purchases. The cost savings on brand name and selected private label merchandise
are the primary motivation for individuals shopping for their personal needs.
Costco’s merchandise selection is designed to appeal to both the business and
consumer requirements of its members by offering a wide range of nationally
branded and selected private label products, often in case, carton or multiple-pack
quantities, at attractively low prices.
Because of its high sales volume and rapid inventory turnover, Costco generally
has the opportunity to receive cash from the sale of a substantial portion of
its inventory at mature warehouse operations before it is required to pay all
its merchandise vendors, even though Costco takes advantage of early payment
terms to obtain payment discounts. As sales in a given warehouse increase and
inventory turnover becomes more rapid, a greater percentage of the inventory
is financed through payment terms provided by vendors rather than by working
capital.
Costco’s typical warehouse format averages approximately 139,000 square feet.
Floor plans are designed for economy and efficiency in the use of selling space,
in the handling of merchandise and in the control of inventory. Because shoppers
are attracted principally by the availability of low prices on brand name and
selected private label goods, Costco’s warehouses need not be located on prime
commercial real estate sites or have elaborate facilities.
By strictly controlling the entrances and exits of its warehouses and using
a membership format, Costco has been able to limit inventory losses to approximately
two-tenths of one percent of net sales—well below those of typical discount
retail operations. Losses associated with dishonored checks have also been minimal
and bank information from business members is verified prior to establishing
a check purchase limit. Members are identified and prevented from cashing checks
at the point of sale when they have presented dishonored checks to Costco.
Costco’s merchandising strategy is to provide the customer with a broad range
of high quality merchandise at prices consistently lower than could be obtained
through traditional wholesalers, discount retailers or supermarkets. An important
element of this strategy is to carry only those products on which Costco can
provide its members significant cost savings.
Competition
The Company operates in the rapidly changing and highly competitive merchandising
industry. When The Price Company pioneered the membership warehouse club concept
in 1976, the dominant companies selling comparable lines of merchandise were
department stores, grocery stores and traditional wholesalers. Since then, new
merchandising concepts and aggressive marketing techniques have led to a more
intense and focused competitive environment. Wal-Mart has become the largest
retailer in the United States (and the world) and has expanded further into
various food merchandising formats. Target has also emerged as a significant
retail competitor. Approximately 1,050 warehouse club locations exist across
the U.S. and Canada, including the 370 warehouses operated by the Company in
North America; and every major metropolitan area has one, if not several, club
operations. Low-cost operators selling a single category or narrow range of
merchandise, such as Home Depot, Office Depot, PetSmart, Toys-R-Us, Circuit
City and Barnes & Noble, have significant market share in their respective
categories. New forms of retailing involving modern technology are boosting
sales in certain stores, while home shopping and electronic commerce over the
Internet is becoming increasingly popular. Likewise, in the institutional food
business, companies such as Smart & Final, which operates predominately
in California, Washington, Oregon, Florida and Arizona, are capturing an increasingly
greater share of the institutional food business from wholesale operators and
others.