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Introduction
With the growing threat of the global food crisis resulting from the war in Eastern Europe, the issue of providing quality and affordable consumer goods has become even more urgent for the average American consumer and all businesses in the country. Within the framework of this topic, it is imperative to examine the success of companies in this market, among which Costco, one of the most successful commercial projects of our time, has enhanced its position even in the conditions of todays recurrent crises out most prominently. Costco was able to take its market share where there was a giant competitor in the form of Walmart, which makes the success of this company even more unique and essential within the study of effective business strategies. Thus, this study examines Costcos most effective and unique financial strategies that have allowed it to keep prices down for many years.
Costco a brand that has been able to keep prices down for 40 years on certain products due to the companys internal system based on club subscription principles. The central hypothesis of this study is that the companys success is primarily due to the inability of other companies to compete with it on price factors. It is necessary to answer several questions to achieve the goal and test the hypothesis. What financial and economic schemes does the company use to maintain low prices in its stores? How does a company, whose success is primarily due to the profitability of its cooperation with local producers, manage to expand its network in other countries while maintaining excellent working conditions for its staff? Finally, what attracts investors to invest so heavily in Costco stock?
Literature Review
The article, written by Courtemanche in 2014 was chosen as the primary theoretical basis for the study, in which the author compares Costco and Sams Club, a subsidiary of Walmart. As part of this comparison, the author focuses on the principles of competition between these companies. Besides, the writer describes the structure of club subscriptions in both organizations. Two firms provide a choice of two levels of club subscriptions but the first level of subscription at Costco is a bit more expensive than at Sams Club, which affects the fact that Costco has slightly lower prices for items (Courtemanche, 2014). On the other hand, the author describes the second subscription level as identical for both companies regarding the benefits subscribers receive. Both businesses offer cashback on their products and several other service club privileges as part of this subscription level.
The writer focuses his attention on how the emergence of these two companies affects the level of demand and, consequently, the price balance in the regions where branches of these organizations open. The author concludes that the appearance of Costco on the market leads to an increase in the cost of goods in other supermarkets, as they have no opportunity to compete on the price parameter Courtemanche (2014). Supermarkets are trying to compete on non-price factors, including convenience and quality, which naturally increases the cost of goods from their range. Separately, the author notes that such behavior in the market increases inflation but states the need for more research on this issue. In general, the author answers the question of how club subscription companies compete with each other and with other supermarkets. Nevertheless, the author does not answer the questions of how exactly Costco manages to keep its prices very low, why the company has no advertising budget, etc. What is, he does not describe how exactly the company has achieved its success but only focuses on how the company continues to compete in the market after its success.
The following article, written by Tozier in 2021 describes four of Costcos innovative strategies, one of which is effective management practices, which refers to the experience of Costco, which has taken somewhat more corporate responsibility for its employees and created better working conditions for them than its competitors. Higher wages, health insurance payments, and other company benefits have resulted in Costco employees being several times more efficient than employees of competing companies (Tozier, 2021). The author attributes the organizations success to effective management to improve the quality of employees, which in turn leads to a more positive experience at Costco and causes many customers to return to the chain. This book describes the effectiveness of the companys hiring strategy, but the author does not focus on the economic factors of the companys management strategy.
Returning to how the company manages to compete in the market, it is worth referring to a study by Bauner, written in 2019. In this work, the author used data on changes in prices of several consumer products to examine changes in supply and demand in regions where Costco warehouses have opened. Now, the emergence of Costco leads to higher prices and lower assortments of long-stored products from competitors and vice versa, lower prices and higher assortments for products that deteriorate quickly for a long (Bauner, 2019). This study somewhat extends the information provided in Courtemanches (2014) study as it explores the impact of product categories on how companies compete with each other. The author explains his arguments with empirical data and the logic that companies need to sell products that deteriorate quickly for a long anyway. Therefore, this product category has a price decrease and an assortment increase. For products that keep for a long time, companies increase prices and decrease assortment to maximize profits by artificially reducing customer choices.
The following article by Minahan in 2017 describes the companys experience entering the Australian market. Within this study, the author describes the pessimistic predictions of economists in Australia about Costcos market entry, which was due to the lack of a club subscription culture in the country and the difficulty in implementing the companys discount and coupon systems under Australian law. The author notes the high level of the companys flexibility, which allowed it to find compromises in the new market while maintaining the basic principles of its own business (Minahan,2017). The company had to start cooperating with many Australian manufacturers, which increased customer demand for goods from these stores. Overall, the work shows the flexibility of the system and its ability to adjust to the cultural and legal peculiarities of other markets, which explains the high rate of expansion in Canada, Australia, and other countries.
In the last article reviewed, the authors evaluate the profitability of each Costco outlet based on how far it is from the bulk of households. As part of this study, the authors conclude that there is an optimal threshold of 21 miles (Lim, 2021, p. 29) that a customer needs to travel to shop at Costco. The authors calculate that increasing this distance makes club subscriptions at Costco less cost-effective for customers because of travel costs and also reduces sales at these company branches. The studys authors argue that the distant location of Costco branches causes club subscription holders to buy more items in advance to return to the store as infrequently as possible (Lim, 2021). Logically, it is impossible to make such a calculation entirely ideally, and therefore goods are consumed unevenly, forcing customers to travel to closer supermarkets to restock certain products.
Thus, the research on Costcos strategies examines how it competes with other firms, its internal policies and operating conditions, and how it expands in other countries. Still, it does not examine how it prices its products, what its advertising budget is, and how it keeps costs low. While previous studies have proclaimed the low cost of products from Costco, this study aims to explore how the company achieves such results, which will add to the theoretical base of knowledge about the financial model of club subscription companies.
Analysis
Costco is part of an oligopoly market where its direct competitors are Walmart, its subsidiary Sams Club and Amazon. Besides, the company competes with every other grocery supermarket in the country. Still, this comparison would not be entirely accurate concerning the understanding that Costco is primarily an online warehouse club. The company draws its revenues from two primary sources: subscription fees from the club and revenue from vendor sales. Courtemanche (2014) notes that the revenue from club membership fees far exceeds merchandise sales, which is essential for understanding Costcos financial model.
The companys strategy for selecting suppliers and product categories
Costco partners with local manufacturers by committing to long-term supply contracts. The company currently cooperates with companies in various spheres, including electronics, cars, etc., which is part of the companys diversification strategy (Courtemanche,2014). Still, it is essential to understand that Costco works with a relatively small number of suppliers, reflected in a much more modest assortment of stores than Walmart. This strategy allows the company to react quickly to market changes, negotiate with partners, and reduce the added value of products by saving money on advertising and logistics.
Strategy to maintain minimum cost
Costcos main competitive advantage is the low cost of products in its warehouse network. The company purchases goods from manufacturers at meager prices, offering supply stability and the ability to plan over a long period. Further, the goods suffer less from added value since the producers of the products are usually close to the points of sale (Tozier, 2021). Therefore, the transportation of products is significantly cheaper. In addition, the company has no advertising budget, which will affect the products final cost.
A strategy for maintaining the customer base
Costcos financial model concentrates on the idea that customers are more likely to buy from a company whose membership they have paid. Of course, such wholesale purchases usually aim at families with incomes between $80,000 and $100,000 a year or at small businesses, and therefore the companys target audience in the U.S. is enormous (Courtemanche, 2014). Thus, the company has a very high customer return rate, simplifying the organizations planning and management (Lim, 2021).
Liquidity assessment
The companys gross margin is 12.5%, almost half that of the rest of the industry (Costco financial ratios, 2022). It indicates a high level of product turnover and low product markup. The company focuses on sales volume, not its margin, which provides this low index. Empirical evidence shows that most of the products provided by the company are highly liquid, demand for which is usually inelastic. Of course, the company also sells goods with elastic demand, but there are virtually no luxury items or expensive furnishings in the store. Nevertheless, it is difficult to judge the income elasticity of demand because it varies greatly depending on the category of goods. The cheaper items are more subject to income elasticity, while the middle budget category alternatives are less subject to income elasticity.
It may seem unreasonable to compete for the price of a product for which demand is inelastic. Still, demand becomes more elastic as the quantity of consumer products increases (Bauner, 2019). In the case of retail buying, the price factor has little effect on consumer demand for consumer goods. However, families most vulnerable to changes in the price of a product see a significant difference in the cost per unit in the case of their bulk purchases at Costco and conventional supermarkets.
Fixed and variable costs of the company
Returning to the analysis of the financial part of the company, it is worth mentioning the main items of the companys expenses. Fixed costs include rental of warehouses, repair, and maintenance of equipment, internet portals, applications, etc. Variable costs include employee salaries, product purchases, etc. Based on this information, the companys variable costs are more than fixed, which is generally typical for representatives of this market segment. To reduce fixed costs, the company refused to conduct advertising because it is too much of a blow to the cost of the final product. It is an important decision by the company that sets it apart from Walmart and other competitors.
Investment attractiveness of the company
In financial reporting, it is worth noting that the company has a high P/E ratio of 41.98 (Costco financial ratios, 2022), one and a half times higher than the industry average. Besides, the company has an excellent P/CF ratio of 19.63 with an industry average of 44.98 (Costco financial ratios, 2022). It suggests that the company is undervalued relative to its cash flow. Thanks to this performance, the company attracts many investors, increasing its funds and allowing it to invest in other firms. The company builds up its long-term assets through investment activities, which begin to take an increasing share of the organizations income.
Conclusion
Thus, Costco employs several strategies in conducting its business. Firstly, the company strives to compete on the price factor, which is done by working with local producers and minimizing advertising costs. Secondly, the company maintains a high level of liquidity in its products due to the specifics of its store assortment and its focus on wholesale sales, which makes it more attractive to investors. Despite its low per-unit margins, the company earns most of its money from club subscription fees, reinforcing its competitive advantage of low-cost items. Thirdly, the company takes care of providing good working conditions for its employees, which increases their efficiency and has a positive effect on the brand image. Besides, the club subscription system has several advantages in the ability to plan the budget because the company has a very high customer return rate. Finally, the companys system has proven versatile enough to be distributed based on contracts with new local suppliers in other countries.
Costco is an excellent example of a successful club subscription company. Based on the data on the under-value of the companys assets, its cash flows, and other economic indicators, there can be several assumptions about the organizations future. It will likely continue to increase the number of its warehouses worldwide while attracting more investment from outside. Supposedly, the company will continue its strategy of increasing its share of investment income and will continue to grow at a relatively rapid pace.
References
Bauner, C., & Wang, E. (2019). The effect of competition on pricing and product positioning: Evidence from wholesale club entry. International Journal of Industrial Organization, 67, 102-525.
Costco (cost) financial ratios (n.d). Investing.com.
Courtemanche, C., & Carden, A. (2014). Competing with Costco and Sams Club: Warehouse club entry and grocery prices. Southern Economic Journal, 80(3), 565-585.
Lim, Rabinovich, E., Park, S., & Hwang, M. (2021). Shopping Activity at Warehouse Club Stores and Its Competitive and Network Density Implications. Production and Operations Management, 30(1), 2846. Web.
Minahan, S. M., Huddleston, P., & Bianchi, C. (2017). Costco and The Aussie Shopper: A case study of the market entry of an international retailer. The International Review of Retail, Distribution and Consumer Research, 22(5), 507527.
Tozier, A. (2021). Costco Innovation Strategy: What Are The Four Types Of Innovation In Entrepreneurship?: The Secret Success Stories Relationships. (n.d).
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