Costco Case Analysis

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STRATEGIC MANAGEMENT 15

Costco Case Analysis

Table of contents

1.0 Introduction 4

1.1 General environment analysis 4

1.2 Industry environment analysis 5

71.3 Competitor environment analysis

1.4 Internal environment analysis 9

1.4.1 Resources 9

1.4.2 Core competencies 10

1.4.3 Capabilities 10

1.4.4 Value chain activities 10

1.4.5 Current strategies and objectives 11

111.5 SWOT analysis

1.5.1 Strengths 11

1.5.2 Weaknesses 11

1.5.3 Opportunities 12

1.5.4 Threats 12

1.6 Conclusion 12

1.7 Recommendations 13

References 14

List of Figures

Figure 1: Industry performance of leading retailers 7

Figure 2: Costco market capitalization as at 2012 9

9Figure 3: Costco market share

Figure 4: Costco Profitability and net income 10

1.0 Introduction

Costco is a UK retail company that uses membership only service and operates through warehouses based on wholesale cash and carry. The company has internet site operation in Canada and US and other operating divisions in Australia, Korea, Japan, Taiwan, UK and Mexico. In the warehouses, the company handles hearing aid centers, travel desks, photo centers, opticians, food courts and pharmacies. Furthermore, it operates over 330 petrol stations in Canada and US as well as customer services in financial planning and health insurance (Costco, 2015). Mainly targeting businesses, Costco also sells to specific employment groups at low prices of its private label and high-quality merchandize. The company offers a wide product category in a limited array of merchandize to achieve rapid inventory turnover and high sales volumes. Sam’s club of Wal-Mart, Safeway and B’J’s Wholesale Club are major competitors. The company pursues differentiated business strategy of treasure-hunt shopping environment, limited selection, bulk buying and low prices (Costsco, 2014). Compared to the industry average returns, Costco generates below average profit margins. With low cost strategies, Costco has been able to edge out some of its competitors despite high expenditures on labor. Started in 1983 in Seattle, Washington, Costco provides customers with well established brands and private labels.

1.1 General environment analysis

Costco’s market entry is predicted by demographic factors such as income distributions as well as the population size, density and its age. Major targets of discount retailers like Costco, Kroger and Wal-Mart are women. About 90 percent of women with household income of $55,000 have a median age of 46 years (U.S. Census Bureau, 2015). Unlike the previous, generations many of these women live at home into adulthood and about 38 percent of them have children. Costco stores tend to be located close to each other because counties have industrial composition similar to neighboring counties (Costco, 2015). According toMiniwatts Marketing Group about 2.4 billion global Internet users existed as of June 2012 (Lutz, 2013). Moreover, approximately 3.5 billion users were expected in the list of global Internet users in 2013. Internet is used by 84.1percent of the UK population and 78.1 percent of the US population (U.S. Census Bureau, 2015). In the UK, about 50 percent of internet users use mobile phone devices to access the web with opportunities being similar to e-commerce sales (BBC, 2011).     

Operating margins are also affected adversely by trends (Lutz, 2013).  Changes in government and military policies also affect the profitability of companies. For example,coverage for Costco’s 160,000 plus employees increased owing to the increases in US healthcare costs. With an indefinite time frame to profitability, about 107,000 US employees have a negative impact (YCharts.com, 2012). Also, of great importance is the increase in the US minimum wage of workers. This is because in the past 2 years, the US unit labor costs have increased by roughly 3 percent (YCharts.com, 2012).  Costco is recognized widely for remunerating its employees higher than the industry average wages and maximizing employee benefits (Greenhouse, 2005).

In the retail industry, stores have Radio Frequency Identification and bar code technology available so as to increase the incentives of stores and reduce inventory tracking costs (Stacey, 2011). The face of retail is also being changed by social-media data, the convergence of smartphone technology, and futuristic technology such as 3-D printing. In a matter of a few years, industry experts will upend the bricks-and-mortar model. For example, Big-box stores such as Best Buy, Old Navy and Office Depot will embrace online purchasing as they become test centers.

The retail landscape for established and entering competitors is being shaped by technological innovations. According to Neff (2009), Costco is using smartphone data to predict purchases and make personal suggestions. Today, social media platforms are being used to create social connections and customer convenience based on online shopping ideology. As a convenience for customers, Costco will continue offering online shopping services. However, the company acknowledges the threat posed by smartphone data on consumer privacy. Although smartphones makes shopping potentially available anywhere when combined with touch screen technology, they diminish the use of cash (Neff, 2009).  At the sales floor or points of purchasing, Costco does not use touch screens. On the other hand, touch screen technology and pricing labels allow retailers to offer dynamic promotions and pricing since it is combined with internet capabilities (McKinsey & Company, 2012). However, it lacks the current technology to undertake promotions within warehouses and explore dynamic pricing.

1.2 Industry environment analysis

The retail industry has five observable trends that havesignificant impact such as emerging retail business models, the distribution revolution, personalized marketing multichannel and mobile commerce and demographic changes. Over the next five years, US retail growth as suggested by industry forecasts will average about 3 to 4 percent annually (BBC News, 2011). In the decade prior to the recession, yearly growth was below 5 to 7 percent. Some of the factors that have negative effect on the discount retail industry include an increase in transportation costs or tariffs, trade restrictions and financial or political instability (Costco Wholesale Corporation, 2009). Production for industry participants and foreign trade would be slowed by disruptions in global port security, labor unrest or an outbreak of a pandemic in a foreign country (Duff, 2009). The discount retail industry has also been altered by the growing popularity of social media.

Firms can connect with customers and negotiate great deals.

Costco as one of the leading retailers attract one of the largest population segments, the middle-aged women (Costco Wholesale Corporation, 2012). As more women enter the workforce, they get more disposable income. Generally, retailers are affected by cyclical buying habits of customers. For example, the sales peak is usually during Christmas season which a large share of revenue generated. Costco provides cheaper prices for its services and products compared to other retailers to maintain stable earnings even during the financial crisis (Corona, 2012). After the financial crisis and increased disposable income levels, there is a new opportunity for growth in the retail industry. Nonetheless, there is need for value-added products that go beyond cost savings. Given the product safety concerns from consumers, the broad scope of product offerings among retailers is affected by litigation and other liabilities, product recalls and government enforcement action (Kaplan & Norton, 2008). Other factors are food or drug contamination and non-compliance product safety standards.

Costco Case Analysis

Figure 1: Industry performance of leading retailers

As shown in the figure above, the market share of the top 20 industry players has been growing in the last two decades. However, economic indicators shows to the retailers that the average consumer’s balance sheet remains shaky, unemployment remains high and budget deficits are mounting (Porter & Miller, 1985). For example, in the recent recession, about $16 trillion in net worth US consumers took more than five years to recover after it was lost from peak to trough (Corona, 2012). Furthermore, disposable income continues to be stressed by rising social costs associated with higher education, taxes and health care. Over the five years through 2016-21, supermarket shelf wars will continue to intensify (Costco, 2015). This is because as levels of competition increases between private-label and branded merchandise, the landscape for operators will be more difficult given the changing consumer shopping patterns (Porter, 2008). Over the next five years, annual sales forecasts are expected to rise by 2.4 percent (Costco, 2014). Yet, these forecasts will be affected by competition from convenience stores, changes to trading hour regulations, consumer sentiment and the fluctuations in real household disposable income (Kaplan & Norton, 2008). As such, Costco will be a major player in future supermarket retailing given the continued expansion of external operators.

1.3 Competitor environment analysis

In the past, there were local corner stores that developed into supermarkets and department stores. Later, it grew into suburban shopping malls, and now there are big-box retailers and discount chains. Between 1990 and 2012, six of the ten largest US retailers have given way for new winners such as Walgreens, Costco and Amazon.com as shown in the table below.

Costco Case Analysis 1

Figure 2: Costco market capitalization as at 2012

From the table above, over two decades, the industry shifts have slowly unfolded while providing time to react. In 2012, the total revenue of Costco was $71billion and was in the third place after Wal-Mart stores ($328billion) and Kroger ($92billion). In addition, the Costco Wholesale when compared with the results to its competitors reported an increase of 2.56% in the second quarter of 2015 year of its total revenue. Costco create barriers to consumers since it operates no frill warehouses and members only (Costco, 2015). Furthermore, direct competition and rivalry is high due to a number of competitors such as Sears, Target Corporation and Sam’s Club of Wal-Mart with strong positions. By not supplying many smaller household items, Costco finds it difficult to row the murky waters as it attempts to outdo Wal-Mart.

Costco Case Analysis 2

Figure 3: Costco market share

From the figure 3 above, the market share of Costco was 9% compared to Wal-Mart (43%) and Kroger (12%). In 2015, Costco Wholesale’s sales growth was 1.01% above average revenue growth of its competitors (Costco, 2015). The net income of Costco Wholesale Corp grew by 5.78 % in the 2 quarter 2016 while most of its competitors had their net income contracting by -2.17%.

Costco Case Analysis 3

Figure 4: Costco Profitability and net income

Sales growth, despite the strong competition, is being enhanced by marketing initiatives by industry retailers, the rapid use of weekly specials and consumer demand for private-label goods so as to retain consumer interest. Given the popularity of Costco as a bulk retailer, consumers may increasingly demand bulk-packaged groceries (Cascio, 2006).

The retail industry accounts for 10% derived from sales by other retailers and about 90% of supermarket and grocery items which is estimated at an average $89 billion of the total retail market for grocery goods and supermarket (Goel, 2011). Goods retailed by the industry in terms of total market share are bought from a range of vendors such as specialized food stores, department stores, takeaway food stores, fruit and vegetable stores and the convenience stores.

1.4 Internal environment analysis

1.4.1 Resources

To implement the cost-leadership strategy, Costco’s has adequate human resource skills and physical stores and warehouses in a number of countries. Even during bad economic times, employees’ compensation levels remain constant and also receive higher than average benefits. As a result, the management can make essential daily choices as employees get motivated to accomplish goals of Costco. Costco’s financial resources in 2012, witnessed a 16.9% increase in net income and 11.5% increase in net sales (Costco, 2015).

1.4.2 Core competencies

receiving cost advantages from value addition activities, Costco has greater focus on attaining higher than industry averages throughout the business activities and differentiating core competencies or skills so as to successfully outperform the capabilities of competitors (Goel, 2011). Costco quickly adapts to customer needs based on skills and company culture. The company experiences rapid inventory turnover and low employee turnover. Costco boasts of global warehouse retail management skills in eight countries and a selection of 4,000 high quality, low-cost services and products (Costco, 2014). Despite Costco’s sales and marketing success in eliminating the costs of advertising and frills, it experienced a three-year low in 2011-13. core competency. While  employees are the company’s main Costco

1.4.3 Capabilities

While operational effectiveness is enhanced in the short term, Costco’s capabilities are vulnerable to imitation by competitors in the future. .(Amazon.com, 2014)The Internet and mobile communication devices are some of Costco’s strong technical capabilities that have shaped the recent trends in consumer purchases. Owing to large purchases with single vendors, the company’s supply chain capabilities receive competitive and cost advantages (George & Jones, 2012). For increased consumer safety, Costco developed innovative packaging as part of enhancing its technical capabilities. However, it continues to follow down the inevitable path of competing and coping from Target and Wal-Mart due to lack of significant strategic innovations. Target and Wal-Mart offer the shopper enhanced experiences and shoppers do not require a membership fee to shop for great deals. Other capabilities of Costco include lean manufacturing businesses to produce high quality goods and services at low cost, 617 global warehouses (143,000 sq. ft each), 24-hour distribution centers and low overhead operations

1.4.4 Value chain activities

In every value chain activity, Costco implements sustainable measures to benefit employees, customers, and other stakeholders. Its operations are limited to product storage on the sales floor. Costco pursues best practices in employee compensation, training and hiring (Goel, 2011). Costco infrastructure is founded on an organizational structure that is aligned with level 3 culture. Downstream, Costco forces suppliers to follow the code of conduct, continues research into food packaging and safety, minimizes impact through building construction and their operational environmental footprint. In the upstream, Costco grants extended warranty services to members, focuses on funding and promoting charitable causes and minimizes landfill trash through sale of recyclable products (Porter, 1996). Besides, Costco reports and monitors four greenhouse gases; hydro fluorocarbons, nitrous oxide, carbon dioxide and methane and emission sources as either direct or indirect emission (Meznar, et al., 1990).

1.4.5 Current strategies and objectives

  • Uses ‘word of mouth’ to keep merchandise price down and lower advertising costs

  • Reduced the number of new staff that in need of training and improved on wages to retain employees

  • Allows for maximum sales and merchandise pallet stock to reduce labor

  • On reaching threshold for re-order, the inventory system detects items automatically

  • Just-in-time approach implemented to sent purchases directly to warehouses within 24 hours, buys directly from manufacturers and reduce over stock

  • Through volume buying, Costco provides low prices

  • To gain the best possible price on a product, Costco is willing to change manufacturers

  • Costco pursues private label and innovative technologies to create value

1.5 SWOT analysis

1.5.1 Strengths

Thethree major strengths of Costco include support services (special service for members and extended warranty services), human resource management and firm infrastructure (Costco, 2015). In the second tier of strengths, Costco’s maintains competitive advantage in inbound logistics (custom fleet delivering and depots), outbound logistics (rapid inventory turnover and daily warehouse management) and procurement (partners with suppliers for 4,000 select products in large single orders). In the third tier, the company has invested heavily in sales and marketing activities (no advertising policy and minima expenses), operations, and research and development (Costco, 2014). These strengths have created warehouse operational efficiencies, provided excellent customer services and facilitated global leadership through strong brand loyalty. The company’s strong financial position is because of its operational effectiveness and efficiencies.

1.5.2 Weaknesses 

A 10-year average low profit margin is a major weakness of Costco (Goel, 2011). Similarly, the company relies heavily on US operations to secure member information and obtain membership requirements, support global operations, maintain overall profitability and support quality supplier products. Smaller warehouse operations are potentially cannibalized by the value chain strategy of Costco that seeks to expand into larger warehouses. Nonetheless, the slow global economic growth trends in the UK and the US inhibits this growth potential (Costco, 2015). As a low cost leader, price slashing to remain competitive by Costco is likely to harm its profitability as a retailer.

1.5.3 Opportunities

Growing GDP in Asian markets and demand for private label goods are some of the opportunities at disposal for Costco (Hughes, 2007). The potential action plan is to increase operational effectiveness ratios in domestic operations and use the strong financial position to operate new stores in Asian markets. This will strengthen the overall financial positioning and support growth overseas. Costco can benefit from increased consumer base and additional operations if it enters the South Korean and Taiwan markets that already have strong growth.

1.5.4 Threats

Some of the threats faced by Costco and its competitors include low growth in mature markets, foreign exchange rate and the fluctuations due to increasing labor costs. Others are substitutes, direct rivalry, increased buyer power and low barriers to entry in global markets. Strengthening financial position through operational effectiveness and refining product selection techniques are some of the action plans to defend against threats. Moreover, there is need to expand overall membership base, match current market trends and secure foreign exchange spot rates that are acceptable.

1.6 Conclusion

The strategic management analysis of Costco as one of the leading wholesale suppliers shows that the business pursues a cost leadership strategy. It has developed over time to be a strong brand because it believes in high turnover and low priced goods besides the wide product range. Costco expresses the willingness to lower prices and satisfy customers. With suitable employee skills and core competencies, the company have been able to out-do its competitors in terms of customer service and employee benefits. Costco employs a strategy of merging innovative ideas with high wages. Also, with the low cost products and cost-leadership strategy, the company has been confident in satisfying its shareholders, workers and consumers. The just-in-time approach implies that products are paid in on cash even before suppliers are paid (Minztberg & Hunsicker, 1988). Apart from creating a high operating cash flow, Costco has long lasting product value difference and high working capital and efficiency.

1.7 Recommendations

  • Costco Company ltd should continue the current ‘low prices and high turnover’ which is a successful pricing strategy. This will not only further international expansion but also allow for growth in revenues.

  • Costco should manufacture abroad and compete through lower operating costs. This will serve to increase the power of existing buyers and lower the threat of substitutes posed by hypermarkets and discount stores.

  • Invest in online specialty stores as an alternative to embracing digital platforms and increase online sales capabilities.

  • Pursue global expansion to stay ahead of competitors and avoid cannibalization in the event that the industry becomes saturated in the US

  • Pursue joint ventures or open subsidiaries, for instance, in Mexico 50% joint ventures involve more than 31 warehouses.

  • Increase integration and brand loyalty by adopting growth strategies within the foreign Indian and Chinese markets.

  • Costco should enter the Chinese market and enjoy more logistical capabilities since some of the networks are partially formed through transportation.

  • Form strategic alliances with manufacturers in India, Mexico and China in a bid to build loyalty, revenue base and reduce risks of foreign direct Investment (FDI).

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