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  • Costco is a retailer that has figured out how to get its customers to

  • pay for the privilege of shopping there, and its members decide the

  • privilege is worth the cost year after year after year.

  • The now global chain of warehouse stores counts more than 55 million

  • members around the world, and around 90% of them renew their

  • memberships each year.

  • If you want a 25-pound bag of beans, a bucket of soy sauce or a crate

  • full of bananas, Costco is the place to go.

  • While you are there, you can buy a flatscreen TV, a pair of

  • eyeglasses, some gourmet cheese and a few pairs of sweat socks.

  • You might be astonished at how little each item costs, and yet you

  • might end up spending much more than you planned to.

  • Costco developed a retail recipe that might have sounded crazy when

  • the company was founded, charging people a fee to allow them to spend

  • money in the store.

  • But it works, in part because Costco is a company that is run very

  • much for the pleasure of its members, and its members are fiercely

  • loyal. But the question is,

  • how long can it hold onto that?

  • Younger generations of consumers have grown up shopping online and

  • companies such as Amazon have taken some of Costco's secrets and

  • applied them to e-commerce, all while making shopping online a matter

  • of clicking a single button.

  • Add that to the downstream effects of the coronavirus.

  • Sales fell in April for the first time in a decade, largely due to

  • lockdowns and safety measures.

  • They bounced back in May, June and July.

  • But the company, meanwhile, had to spend $283 million in

  • Covid-related safety and sanitation costs during the third quarter of

  • 2020, which ended in May.

  • Furthermore, Costco wants or even arguably needs shoppers to

  • physically visit its stores.

  • That is a big part of the experience.

  • Long lockdown periods around the country and general anxiety about

  • contracting the coronavirus led many shoppers to stay home and buy

  • more of what they needed online.

  • The company is highly dependent on membership fees for its profits,

  • meaning it needs to keep giving customers reasons to pay a minimum of

  • $60 per year to shop at the store.

  • Costco also raises membership fees every few years.

  • Subscriptions and memberships are often some of the household

  • expenses first to go when budgets tighten and consumers, faced with a

  • wide array of subscription services for gyms, streaming services,

  • meal delivery and other things, may be deciding what they ought to

  • cut if the economy goes into a downturn.

  • Costco's membership numbers held steady and even increased during the

  • recession that began around 2008.

  • But it remains to be seen just how resilient its business is this

  • time around. Costco declined to participate in this story.

  • What is today called Costco actually grew out of a merger of two

  • retailers with similar business models.

  • The first was called Price Club, and it was started in 1976 in a

  • converted airplane hangar in San Diego, California.

  • The store took its name from founder Sol Price, a Bronx-born attorney

  • who, in many ways, pioneered the club warehouse retail model more

  • than two decades before starting Price Club.

  • Price had learned a great deal about the world of business through

  • his legal work, helping clients with bankruptcies, real estate deals

  • and partnerships. But he had never run a store before.

  • He entered the retail business as a way to find a use for a

  • warehouse he helped his mother-in-law acquire as an investment in

  • 1953. While searching around for a purpose for this property, Price

  • heard about a company called FedCo, a large warehouse store in Los

  • Angeles that sold a variety of goods at very low prices.

  • It was open only to members, run in a manner similar to a

  • co-operative and had been primarily created to serve U.S.

  • Postal Service workers and their families.

  • After trying unsuccessfully to partner with FedCo in his San Diego

  • warehouse, Price opened FedMart.

  • At FedMart, Price developed the idea of selling goods at very low

  • margins while charging a membership fee.

  • The company became tremendously successful and inspired other large,

  • low-priced retailers.

  • Sam Walton said many of his ideas for Walmart came from Price's

  • store. FedMart went public in 1959 on the American Stock Exchange.

  • The company was bought by a German retailer in 1975, but the new

  • owners failed to maintain Price's success, and FedMart closed its

  • doors by 1983.

  • Price then founded the Price Company in 1975 and opened Price Club in

  • 1976.

  • The chain of stores had much the same model as Price's previous

  • venture. A few years later, two men named Jeff Brotman and Jim

  • Sinegal founded Costco in the Seattle, Washington area in 1983.

  • Like Price, Brotman was a lawyer with commercial ambitions, who

  • ventured into the club warehouse business at the urging of his

  • father, who had noticed Price's success.

  • The other Costco founder, Jim Sinegal, had spent years working

  • closely with Price at both FedMart and Price Club.

  • Costco grew rapidly from nothing to $3 billion in sales in under

  • six years.

  • Price Club and Costco merged in 1993 and were initially named

  • PriceCostco. The company became just Costco in 1997.

  • Since that merger, Costco has attained explosive growth.

  • In 1993, the company reported $15.5 billion in sales.

  • In 2019, its sales totaled $152.7 billion.

  • The company went public on December 5th, 1985.

  • Since then, shares have risen more than 19,000% from an IPO price

  • before stock splits of $10 per share to $344 per share

  • on August 26th, 2020.

  • A basic Costco membership costs $60 per year.

  • There is also a gold star executive membership that costs twice that.

  • That comes with some special perks, such as 2% cash back rewards up to

  • $1000 per year, savings on trips booked through Costco Travel, and on

  • a variety of other services Costco provides, such as identity

  • protection, auto and home insurance and bottled water delivery.

  • The value of these services would vary per customer, but someone who

  • opted out of them and only collected the 2% cash back reward would

  • have to spend $6000 per year to recoup the $120 executive membership

  • fee. The thing is that Costco doesn't make most of its money from the

  • actual sale of goods.

  • Its margins on the products on its shelves are extremely thin, much

  • thinner than those of grocery stores, for example.

  • Instead, Costco's profits come from its memberships.

  • "You know, most of their net income comes from membership fee revenue.

  • So last year, 92% of their total net income came in the

  • form of membership fee revenue.

  • So that membership fee revenue essentially drops straight down to the

  • bottom line because there's basically no cost associated with it."

  • It could be said that the store actually exists for the purpose of

  • getting its members to renew their memberships year after year after

  • year. And so, Costco is extremely focused on keeping its members

  • happy. In fact, the company has been known to refuse to raise prices

  • on goods in order to improve margins on sales, just to keep its

  • customers coming in the door.

  • It is also known for treating its workers well.

  • Costco store employees make better wages than those at many other

  • retailers. The company justifies the better pay and benefits for

  • workers on the grounds that happier employees will be more helpful to

  • members and improve the shopping experience

  • "In this world of, you know, what is what is stakeholder capitalism

  • versus shareholder capitalism, I think Costco's already have the

  • right approach to it, look it, you care about your associates, and

  • you care about your customers because if your associates aren't happy

  • and working hard and excited to be where they are, then your

  • customers are going to see that, your members and service levels they

  • get. And so the virtuous circle and the best thing for shareholders

  • is ultimately to have happy customers, and the way you get happy

  • customers is to have generally happy employees.

  • So to me, they've sort of gotten it the right way.

  • You know, at the end of the day, it is shareholder capitalism.

  • But the best way to benefit shareholders longer term is to take care

  • of your customers. And a key way to do that is take care of your

  • associates." Costco also offers some perks to all members that are

  • designed to make the experience of shopping more pleasant and easy.

  • The store is famous for having various stations set up throughout,

  • handing out free samples of different products, often food.

  • Costco had to briefly shut down this practice during the coronavirus

  • pandemic, no doubt disappointing many members.

  • In addition to free samples, there are also frequently in-store demos

  • of other products, such as electronics.

  • Costco also offers a concierge service for members, essentially a

  • technical support line where people can call for help with products

  • purchased in the store.

  • While some members might be relieved to discover they are able to get

  • help with products once they have bought them, part of what Costco

  • offers is extremely careful attention to what it even chooses to

  • stock in its stores in the first place.

  • Many customers might not notice as they stroll past the pallets of

  • sodas, stacks of egg crates and towers of paper towels that despite

  • the appearance of a vast warehouse stuffed with goods, inventory is

  • tightly controlled.

  • Items are packaged in large quantities, but there is a relatively

  • small number of products, often called stock keeping units or SKU's,

  • for the unique barcode attached to any unique item.

  • A single Costco carries only about 4,000 SKU's, whereas a Walmart

  • Supercenter can carry nearly 150,000.

  • But those products are very carefully chosen.

  • In many ways, Costco was a pioneer in the now common practice of

  • collecting and analyzing customer data.

  • When a member makes a purchase at Costco, the first thing they do is

  • swipe their Costco card.

  • Evercore ISI estimates that Costco has a team of more than 100 buyers.

  • Those buyers can access shopping data when determining what sorts of

  • products they ought to fill a store's shelves with.

  • "Those buyers are able to use that information to really seek out

  • items that their members might really appreciate, that wouldn't

  • wouldn't be obvious.

  • But that could be anything from leather coats, unique jewelry items,

  • a newly packaged way or innovative way to put together a camera and

  • the lenses that maybe isn't sold anywhere else.

  • So really finding what it is that their members might like.

  • And that's what creates a treasure hunt."

  • The company uses its massive number of members as leverage when

  • negotiating with suppliers.

  • Though Costco's prices are typically low, getting the absolute lowest

  • price in a category is not always the point.

  • The point, say analysts who follow the company, is delivering good

  • value. Products also rotate in and out of the store's inventory.

  • There's a pretty good chance that many of the items a shopper sees on

  • Costco shelves might not be there in a month or two.

  • The rotating stock encourages impulse buying.

  • Each visit to the store can yield the surprise for a member, maybe a

  • blender or a pair of running shoes.

  • Seeing something unexpected and knowing it might not be there in the

  • future can lead shoppers to jump at the opportunity to make an

  • unplanned purchase.

  • The store has also found other ways beyond the shelves to keep people

  • coming back, including cheap gasoline, optical services and low-cost

  • medical devices such as hearing aids.

  • There's a travel service, a credit card and a car buying service.

  • "The big picture is once you have, in the U.S., we think they have

  • well over 30 million households that are signed up as Costco members,

  • you're trying to find a way to add value to those members outside of

  • the club, outside of those four enclosed walls.

  • And I think ancillary businesses are a way to take the power of the

  • membership outside the club.

  • So, for example, travel, they can get package discounts, everything

  • from hotels to cruises.

  • But that's been one area of value add.

  • One another one's car buying.

  • So sort of cutting out the middleman and saying, 'Hey, we will bring

  • our group of members to a pre-negotiated price so that none of us

  • have to go through the hassle of the whole haggle with the dealer.'

  • Credit card's another one where there's a cashback program where you

  • can get 4% back on gasoline, 3% on restaurant spend, on travel spend,

  • even takeout or curbside pick-up restaurant spend, I've noticed

  • during this year of Covid.

  • So that's a pretty good value to the member on top of the normal

  • extra 2% or 1% you might get elsewhere at a Costco."

  • And there is, of course, the food court that sells $1.5 hot dogs and

  • other low-priced fare.

  • Its efforts to provide value to its members have also led to the

  • creation of its own house brand: Kirkland Signature, which has become

  • a considerable and growing portion of its business.

  • The sheer range of products is astonishing.

  • There are Kirkland diapers and Kirkland bottled waters, of course,

  • but there are also Kirkland wines and liquors.

  • Importantly, Kirkland products are not simply cheaper versions of

  • name brand goods.

  • When Costco brings the Kirkland line into a category, the company

  • takes care to ensure the product it's selling is high quality and

  • sometimes unique. The retailer is not just trying to sell something

  • cheaper; it's trying to add unique value, inspiring brand loyalty.

  • Some members report that they prefer Kirkland paper towels to those

  • offered by other brands, for example.

  • Kirkland Signature products accounted for roughly 30% of Costco sales

  • in 2019. The Kirkland Signature brand is arguably what has helped the

  • company fend off competition from other clubs such as Walmart's Sam's

  • Club, other bricks and mortar retailers, and the ever-growing world

  • of e-commerce, where all kinds of items can be ordered cheaply and in

  • all kinds of quantities, and often delivered right to a customer's

  • door. One much talked about segment is Kirkland's wines and liquors,

  • which have gained a reputation for being cheap, and at least to some

  • buyers, tastier than more high end brands.

  • Rumors have even circulated that Kirkland's liquors are just bottled

  • brand name liquors such as Grey Goose for vodka and Macallan for

  • whiskey. Grey Goose makers have denied this in the past, and Costco