Costco Case Analysis

Lance Ziegler

Austin Dean

David Hitzhusen

Vince Milo

Irvin Benitez

BA 405: Mercier

17, April 2016

Costco Case Analysis

Beginning with only one location in Seattle nearly three and a half decades ago, Costco Wholesale has grown into a multi-billion dollar company with physical store locations scattered across the world. The tremendous growth Costco has experienced since its inception can be attributed to an array of reasons. However, most influential in Costco’s sheer dominance in its marketplace are the ridiculously low prices and unique membership revenue model. Of course, former CEO Jim Senegal’s personable leadership style and unifying vision played a critical role in the thirty years of growth and expansion. Although successfully solidifying a global footprint and unwavering spots in consumers’ hearts everywhere, Costco’s growth and expansion brought its fair share of challenges. Namely, Costco’s famously low prices are directly correlated to unfavorable low profit margins, which are hurting the profitability of the global business. Secondly, Costco’s financial records show an insufficient amount of revenue stream diversification via an over reliance on membership fees to help push its bottom line. In an effort to assist Costco in achieving an additional three decades of marketplace dominance, these issues need to be analyzed and remedied with a focus on leveraging international and sustainable solutions.

Costco is the dominant force within its industry but its success isn’t without issues. The company’s primary concern is its low profitability. Costco’s competitive advantage comes from its ability to have lower prices than its competition, having a markup that never exceeds 14 percent compared to the 20 to 50 percent standard of its competitors. However, this low price advantage barely lets Costco cover its operating expenses leaving a profit margin, on average, of around 3 percent. For this reason, Costco relies heavily on its revenue gained from annual membership fees.

Costco has had an increase in the number of its memberships every year from 2000 to 2011. From 2005 to 2011, 70 percent of their profit was from membership fees. Despite its success during this period of years, such a heavy reliance on membership is a risk for Costco that may affect Costco’s sustainability. In the recent years the fees were even larger than its net income. To add to the issue, because Costco’s competitive advantage is its ultra low cost, if it raises its prices to offset revenue lost from a decline in memberships it would give up its competitive advantage making a price increase out of the question.

Costco does a great job selling its products but because the prices are so low, and reliance on membership fees is so high, sustainability and profitability are major issues for them. We are recommending several courses of action to help management sustain the company’s growth and improve financial performance. These will require reducing costs in key areas and implementing strategies that will increase revenue.

A large percent of Costco’s annual costs are from its logistics, more specifically its fleet of trucks used to transport products to the hundreds of warehouse locations. Costco owns and operates 527 semi-trucks that are used regularly throughout the year. We feel that this is an area Costco can reduce costs in. In total, Costco’s fleet travels about 34.2 million miles per year. A semi-truck is estimated to have a 6.5 miles per gallon rate when operating at capacity on highway speeds and the price of diesel is currently about $2.90 per gallon. With these estimated figures, Costco spends upwards of $15 million per year on fuel alone. Costco can reduce these expenses by increasing its fuel efficiency through aerodynamic additions to its trucks. Trailer Tail is one name of an aerodynamic part that could be attached to a semi-truck in order to increase fuel efficiency. Trailer Tail provides a savings of eight gallons of fuel for every 1,000 miles. This small increase in fuel efficiency would save Costco almost $800 thousand per year. With a total cost of $2,200 per truck, Costco would need to invest $1.2 million to outfit its entire fleet, seeing a return on its investment in just one and a half years.