If you want to be Costco, you gotta cut costs …

Excerpted from BusinessWeek, “Costco’s Artful Discounts”, by Jena McGregor, October 20, 2008

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In Costco Wholesale’s New Jersey distribution center, some 2 million rolls of paper towels recently sat stacked in a mountain of green and orange plastic. Nearby, row upon row of jumbo tissue rolls formed a wall of cushiony toilet paper.

A year ago, the space was virtually empty.

Costco’s customers have not, of course, suddenly stopped buying paper products. The 258 truckloads of Bounty and Charmin are the result of a “buy-in,” just one strategy Costco ( has been using to hold prices down amid rising costs. After Procter & Gamble announced a 6% price increase in August, Costco bought as much as it could stuff into its depots at the old rate.  “We’ll have a six-week supply when everyone else is going up in price.”

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At Costco, where more than 29 million households pay $50 to $100 a year to shop, low prices aren’t just a nice-to-have. They’re a way of life.

Not only does Costco’s famously frugal CEO James D. Sinegal cap margins at a sacrosanct 14% on branded goods, he’s constantly pushing his buyers to find creative ways to lower prices and add value while getting his managers to crank up their efficiency efforts. Besides the buy-in strategy, Costco has been redesigning product packaging to squeeze more bulky goods onto trucks and revamping processes for moving goods through its depots. 

 For one, holding prices low is the best way to protect profits: About 75% of Costco’s operating earnings come directly from membership fees, and if prices rose too quickly, some members could flee.  Costco’s reputation for bargain prices and surprise designer goods could inspire a new crop of warehouse chic devotees. 

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What Sinegal isn’t doing is wavering from the basic model that helped him  build Costco into a retail phenomenon. The company’s warehouse model relies on selling core items at rock-bottom prices while scooping up excess inventory from high-end brands. The average store does $137 million in annual sales, a volume so high that Costco turns its inventory 11.9 times a year, meaning it often sells goods before it technically has to pay its suppliers. Combine that with high-income customers—the average Costco household makes upwards of $75,000—and “what they’re doing is really high velocity retailing.”

As consumers cut back, Costco is finding more available inventory and fielding more calls from companies hungry to boost slumping sales. Lately, the loot in that treasure chest is getting even more high end. Over the last year, Versace dinnerware, Waterford crystal, and pastel girls’ Lilly Pulitzer dresses have all made their way into Costco’s stores. “Their ability to sell stuff is staggering.”

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With about 4000 SKUs, compared to 5300 at Sam’s Club and 40,000 at an average grocery store, Costco’s pared-down approach can make vendors more willing to cut them a deal.

The limited SKU count also helps to drive impulse shopping and remind customers that Costco doesn’t stock everything. “In a tough economy, the ability to change your assortment towards products that are selling more is a huge advantage  …If the item isn’t a value anymore, or isn’t generating the sales hurdles, it’ll be deleted.”  This holiday season, for example, almost all of Costco’s Christmas lights will be light-emitting diode because of the demand for energy-efficient bulbs. Regional food buyers also have significant sway to reflect local tastes.

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Costco has even gotten vendors to redesign product packages to fit more items on a pallet, the wooden platforms it uses to ship and display its goods. Putting cashews into square containers instead of round ones will decrease the number of pallets shipped by 24,000 this year, cutting the number of trucks by 600. By reshaping everything from laundry detergent buckets to milk jugs, Costco has needed 200,000 fewer pallets a year overall.

Sinegal acknowledges that he can’t hold back the cost increases forever. “The biggest concern to me is that we lose our way and start thinking it doesn’t matter if you charge another dime or another dollar or another hundred dollars,” he says. “Without those disciplines, we don’t have anything.”

Edit by DAF

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