Fan Yin Case

Fan Yin
Case: Costco Wholesale in 2016: Mission, Business Model, and Strategy
1. What is Costco’s business model? Is the company’s business model appealing? Why or why not?

Costco’s business model is to offer its members “low prices on a limited selection of nationally branded and selected private-label products in a wide range of merchandise categories” to get “high sales volumes and rapid inventory turnover”. The company’s business is appealing because Costco would deliver qualified goods to customers with relatively low prices; therefore, it can attract customers to purchases its products in the next time, helping to connect the loyalty between the consumers and Costco.
2. What are the chief elements of Costco’s strategy? How good is the strategy?

The chief elements of Costco’s strategy are the low prices, limited products selections, a “treasure hunt shopping environment”, “strong emphasis on low operating costs, and ongoing expansion of its geographic network of store locations”. This strategy makes Costco keep a great performance in the market. The low price helps to attract new customers to buy things at the Costco and retain its existing customers to continue to shop and purchase goods at Costco. This price strategy makes its markup on brand-name merchandise be at 14% and generate more revenues than operating costs. The limited products selection allows Costco to choose nearly 3700 items at bargains. The treasure-hunt merchandise helps to attract customers to shop at Costco for their desired items, which may be unavailable on the rack. The low operation costs emphasis helps Costco save a large amount of money, which can be invested in other areas which can increase Costco’s total revenues. The expansion of its network of store locations contributes to its increased sales. For example, the growth of the warehouses opened from 6% at 2014 to 7% at 2015 helps the net sales increase from $110,212 in 2014 to $113,666 in 2015. Therefore, Costco’s strategy is pretty good.
3. Do you think Jim Sinegal was 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? How well is Craig Jelinek performing as Sinegal’s successor? Refer to Figure 2.1 in Chapter 2 in developing your answers.
Personally, I think that Jim Sinegal was an effective CEO, who drives Costco to the third largest retailer in the United States. I would give him A in leading the process of crafting and executing Costco’s strategy. The reasons are showing below:
-Developing a strategic vision: Jim Sinegal developed a very clear vision that providing Costco’s members and customers qualified products with the lowest prices.
-Setting objectives: He set objectives of Costco to generate “high sales volumes and rapid inventory turnover”, helping to make Costco more profitable.
-Crafting a strategy: He crafted the strategies with the low prices, limited products selections, a “treasure hunt shopping environment”, “strong emphasis on low operating costs, and ongoing expansion of its geographic network of store locations”. All of these strategies make Costco generate high sales volumes and revenues.
-Executing the chosen strategy: Sinegal put a lot of attention on the details and pricing. He effectively and efficiently executes the key strategies, such as low price and limited production selections, through some related activities- for example, effective distributions and warehouse management, promotional events such as weekly e-mails to Costco’s members, and efficient supply chain such as “direct buying relationships with many producers” and manufacturers.
-Monitoring developments, evaluating performance, and initiating corrective adjustments: In this case, it does not show clearly how Sinegal evaluate the performance and make some adjustments. However, the continued growth of its sales volumes and revenues show that the strategy he used is on the track.
Therefore, Jim Sinegal is an effective CEO for leading Costco to be outstanding in the retailer market.
As Sinegal’s successor, Craig Jelinek did have a good performance after stepping into Sinegal’s position. Jelinek continuously makes Costco expand from $89 billion annual revenues and 589 membership warehouses at the end of 2011 to $116 billion annual revenues and 686 membership warehouses at the end of 2015. As is consistent with Costco’s visions and core strategies, Jelinek keeps Costco profitability and helped Costco to be the second largest retailer in the United States and the world.
4. What core values or business principles did Jim Sinegal stress at Costco?

The core values or principals Jim Sinegal stressed at Costco were “obeying the law, taking care of their members, taking care of their employees, respecting their suppliers, and rewarding their shareholders.”
5.(In the event you have covered Chapter 3) What is competition like in the North American wholesale club industry? Which of the five competitive forces is strongest and why? Use the information in Figures 3.4, 3.5, 3.6, 3.7, and 3.8 (and the related discussions in Chapter 3) to do a complete five-forces analysis of competition in the North American wholesale club industry.

The competition in the North American wholesale club industry is increasing among three mainly dominant, Costco, Sam’s Club and BJ’s Wholesale. In the market of United states and Canada, Costco takes up around 59 percent of total shares, Sam’s Club takes up 34 percent of total shares, and BJ’s Wholesales takes up 7 percent of total shares. The competitions among these three companies are based on the determined factors, such as price and member services.
The Five Forces Model of Competition

The substitutes are strong because there are some competing firms, Sam’s Club and BJ’s Wholesale, providing good substitutes that can satisfy customers’ needs. Moreover, buyers have low switching costs to purchase substitutes.
The new entry barriers are also high. First, buyers have already had their brand preference and loyalty when they want to shop for the needs. As we know, Costco has taken up nearly 60 percent of the market share, therefore, it is difficult for new entrants to enter the market. Also, Costco has cost advantages that the potential entrants may not have. According to the case, we know that Costco wants to keep a high inventory turnover, implying that Costco spends less money on storing the unsold inventories. This can lead Costco to decrease its operating expenses, thus, increasing its profits. So, I would say that the entry barrier is high for new entrants.
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 66-68) to help you diagnose Costco’s financial performance.

Costco has a good financial performance. Before stating that why Costco has a good financial performance, first let us calculate some financial ratios.
Ratios/years
Year 2000
Year 2005
Year 2011
Year 2013
Year 2014
Year 2015
Total revenue(deduct membership fee)/net sales
1.0172

1.0207
1.0214
1.0222
1.022
1.0223
Operating profit margin
3.28%
2.84%
2.8%
2.97%
2.92%
3.19%
Net profit margin
2%
2.05%
1.68%
1.98%
1.87%
2.09%
Total return on assets
7.76%
6.63%
5.9%
7.06%
6.57%
7.48%
Net return on total assets(ROA)
7.31%
6.44%
5.46%
6.73%
6.23%
7.11%
Return on stockholders’ equity(ROE)
14.88%
11.97%
11.63%
18.52%
16.44%
21.92%
Return on invested capital (ROIC)
12.54%
11.08%
9.93%
12.74%
11.69%
15.13%
Current ratio
1.02
1.22
1.14
1.19
1.22
1.05
Working capital
$66 million
$1477 million
$1656 million
$2583 million
$3176 million
$759 million
Long-term debt-to-capital ratio
0.1571
0.0741
0.1462
0.3122
0.2892
0.3097
Long-term debt-to-equity ratio
0.1863
0.0801
0.1712
0.4539
0.407
0.4486
Times-interest-earned/coverage ratio
26.59
43.35
21.03
30.84
28.50
29.23

From these financial ratios, we can see that its current ratios are greater than 1, showing that Costco can cover its liabilities; its net return on total assets ratios are around to 6.5 percent, meaning that the stockholders can earn around averaged 6.5 percent on the firm’s total assets, a relative good earning. Also, it ROE ratios are between 14% to 21%, signaling that stockholders can earn a good return on their capital investment in the firm. Its ROIC ratios increase from 12.54% to 15.13%, indicating that Costco has a greater bottom-line effectiveness in the use of long-term capital. The working capitals show that Costco has good cash available for its daily operations and the rise of working capital from $66 million in 2000 to $759 million in 2015 indicates that the firm has more internal funds to pay its current liabilities and finance inventory expansion. The Long-term debt-to-capital ratios and Long-term-debt-to-equity ratios are low, though both ratios raise slightly between 2000 to 2015, implying that Costco has a good capacity to borrow additional funds. Its coverage ratios are higher, indicating its progressively better creditworthiness.
Moreover, from its low margins and net profit margins, we can see that the main revenues of Costco are from its membership fees; though Costco still can generate profits by its sales of products. Therefore, we could say that Costco has a good financial performance.
7. Based on the data in case Exhibits 1 and 4, is Costco’s financial performance superior to that at Sam’s Club and BJ’s Wholesale?

Based on the data in case Exhibits 1 and 4, I think that Costco’s financial performance is superior to that at BJ’s Wholesale; Sam’s Club has a better financial performance than Costco. In 2011, the operating profit margin of Sam’s Club is 3.43%; the operating profit margin of BJ’s Wholesale is 1.96%; the operating profit margin of Costco is 2.8%. Therefore, Sam’s Club has more operating returns on net sale revenues than Costco and BJ’s Wholesale, and BJ’s Wholesale has the lowest operating profit margin. When we see the number of the warehouses opened, BJ’s Wholesale has 189 opened warehouses in 2011; Sam’s club has 609 opened warehouses; Costco has 592 opened houses. The number of opened warehouses can be used to explain that Sam’s Club has the highest operating profit margin because it has the most opened warehouses. However, in 2015, Sam’s club has 647 opened houses, and Costco has 663 opened warehouses. Sam’s Club has 3.4% operating profit margin but Costco has 3.19% operating profit margin. It signals that Sam’s club has less operating expenses. Still, Sam’s Club has a better financial performance than Costco.
8. Does the data in case Exhibit 4 indicate that Costco’s expansion outside the U.S. is financially successful? Why or why not?

Yes, the data shows that Costco’s expansion outside the United States is financially successful. The number of warehouses opened outside the U.S. increased from 95 in the year of 2007 to 210 in the year of 2015. This increased number of the total number of warehouses can imply that Costco has earned enough money that can be used to support it to open more warehouses to expand its business. Also, the total revenue generated outside the U.S. increases from $9,887 million in 2005 to $31,848 million in 2015; the operating income increases from $307 million in 2005 to $1,316 million in 2015; capital expenditures raise from $262 million in 2005 to $819 million in 2015. This increases in the total revenues, operating incomes, and capital expenditures support that Costco has a good financial performance outside the United States.
9. How well is Costco performing from a strategic perspective? Does Costco enjoy a competitive advantage over Sam’s Club? Over BJ’s Wholesale? If so, what is the nature of its competitive advantage? Does Costco have a winning strategy? Why or why not?
Costco has a good strategic perspective performance. For example, we can see the Costco’s revenues continue to increase from $89 billion annual revenues and 589 membership warehouses at the end of 2011 to $116 billion annual revenues and 686 membership warehouses at the end of 2015. Costco can keep its profitability by employing its strategies, including the low prices, limited products selections, a “treasure hunt shopping environment”, “strong emphasis on low operating costs, and ongoing expansion of its geographic network of store locations”.
Personally, I think that Costco enjoys a competitive advantage over Sam’s club on its strong emphasis on the operating costs. As the case says, “all Sam’s Club warehouses had concrete floors, sparse décor, and goods displayed on pallets…”; however, Costco has minimal interior décor and economically designed selling places. The lower operating costs of Costco compared to that of Sam’s Club helps Costco to maintain its low-price strategy to attract more members and earn more profits.
Also, I think that Costco enjoys a competitive advantage over BJ’s Wholesales on its limited selections. As the case claims, Costco has limited products offered, much less than the number of BJ’s Wholesale provided-BJ’s Wholesale offers 7,000 items. However, Costco always changes the items it provides and all the items Costco provides are needed by its customers. Part of the items BJ’s Wholesale provides are not satisfy customers’ needs; therefore, BJ’s Wholesale can have more operating expenses by purchasing more unnecessary items than Costco. Therefore, I would say that Costco enjoys a competitive advantage over BJ’s Wholesales.
I think that Costco has a winning strategy because it passes all three tests:
– The Fit Test: the strategy Costco employs is fit its situations. Costco offers the qualified products with low price to its members. This attracts more and more small businesses join into Costco as its members, boosting Costco’s revenues. Moreover, as the case says, “Costco had about a 59 percent share of warehouse club sales across the United States and Canada”, implying that Costco’s strategy fits the market situations because it takes about more than half of the market share in the U.S. and Canada by implementing its strategy.
– The Competitive Advantage Test: Costco can sustain its competitive advantage. From the case, we know that Costco’s revenues earned from its members can exceed its net income, helping to cover whatever losses due to its low-price strategy. Therefore, Costco can sustain its low-price strategy to attract more members to boost its sales volumes and generate more revenues. Moreover, Costco continues to open its new warehouses to expand its business in the market; therefore, helping it to take over more market shares and make more profits by employing its competitive advantages.
– The Performance Test: From the case, we know that Costco has a good financial performance as we see that the Exhibit 1 shows the increased revenues generated by Costco from 2005 to 2015. Also, the answers to the question 6 by showing its financial ratios give an idea that Costco has a good financial performance. The increased revenues and good financial performance make Costco passes the performance test.
Therefore, Costco has a winning strategy by passing the fit test, the competitive advantage test, and the performance test.
10. Are Costco’s prices too low? Why or why not?
Personally, I think that Costco’s prices are not too low. As this case mentions, the main strategy Costco uses is to provide qualified products with the lowest price. If Costco starts to charge the price higher, it could lead Costco to start to lose some businesses because their clients may want to purchase cheaper things from other firms after Costco’s price increase. Moreover, Costco could generate revenues by collecting membership fees. According to the case, “it was common for Costco’s membership fees to exceed its entire net income”. Therefore, Costco can make its profitability. If Costco increases its price, it can lose some members who are attracted by its low-price strategy; thus, it could lose a lot of membership fees, probably hurting the Costco’s business. However, I think that it is not a good idea for Costco to continue to decrease its price because it needs to improve its profitability. We have calculated that the operating profit margins for these years are relatively low, all of these margins are around 3%. This low operating profit margin could provide an idea that if Costco continues to decrease its price, it could lead to a very low operating profit margin. Even though Costco’s main revenue comes from the membership fees, this declined operating profit margin can bring a negative impact on Costco’s profitability when the membership fees just it entire income with low operating income. Therefore, Costco could get no profit by declining its price.
11. What do you think of Costco’s compensation practices? Does it surprise you that Costco employees apparently are rather well-compensated?

Costco’s compensation practices are pretty good. For instance, it provides “health care plans for full-time and part-time employees”, “stock purchase plan”, and good wages. I am a little surprised for Costco’s employees’ well-compensated. All the benefits its employees enjoy can bring the loyalty of these employees to Costco, increase their productivity, and maintain good working performance. I would say that his well-compensated practice can bring the employees’ cohesiveness, contributing to Costco’s development.
12.What recommendations would you make to Costco top management regarding how best to sustain the company’s growth and improve its financial performance?
I would recommend that Costco can continue to open its new warehouses to expand its business by increasing its sales volumes and revenues. As the exhibit 4 shows, we can say that both numbers of warehouses and revenues increase from 2005 to 2015. Though we cannot say that opening new warehouses definitely cause the revenue growth, opening new warehouses did contribute to the revenue and sales growth by earning more member fees through adding more members in the new areas. Also, I would recommend that Costco could continuously to expand its international business because the international markets can bring more opportunities and potential larger amount of new members to Costco.