Costco Case Study

The chief elements of Costcos strategy are low pricing, limited product selection, and a treasure hunt shopping environment. Pricing: a key element of their pricing strategy is to cap its markup on brand-name merchandise at 14% and markups on their private label items can be no higher than 15%. This strategy keeps customers coming in to shop by enticing them with low prices. Product Selection: this portion of the strategy only provides members with a selection of about 4000 items. Their product range covers a broad spectrum but the selection in each product category is limited based on fast-selling models, sizes, and colors. Treasure-Hunt Merchandising: while the product line consists of 4000... Costco goes out of its way to surprise and excite its visitors with limited availability designer items. This solves two major challenges faced by warehouse stores with products sold in such huge quantities, why visit regularly and why buy now. While Costco strives to beat the competitions pricing, it also delivers exceptional value in its high-end offerings and customer service, giving consumers more for their money. This strategy works well for Costco, given its customers are the most affluent of all the warehouse clubs, with average incomes around $75,000. However, these customers are also value conscious, as evidenced by the members who opt for executive memberships, although it costs more per year, to take advantage of a 2% discount on most purchases. While this group only accounts for about a fourth of the companys memberships, they represent nearly half of its net sales. Financial Perspective The gross margin currently falls into the normal range for this industry. In 2001 the gross margin was 10.4% and as of August 2010 the margin was 13.8%. The increase indicates Costco has become more efficient in their negotiation of pricing when purchasing goods. The industry average is 20.1%, which Costco is well below that. When compared to the competitors 2010 gross margin Sears (27.7%), Wal-Mart (24.5%), and BJs (10.9%),, Sears and Wal-Mart exceed the industry average, however BJs falls below just as Costco. As of August 2010 the ROE and ROA for Costco was 12.0% and 5.5% respectively. The industrys ROE was 20.7% and ROA was 8.3%. The percentages for this point in time are lower, however if you compare the 5 year average Costco 12.5% ROE and 5.7% ROA compared to the industry 18.9% ROE and 7.9% ROA the percentages are somewhat closer. The current ratio for Costco went from .94 in 2001 to 1.16 in 2010. This increase is an indication that Costco has improved its level of current assets to current liabilities. This

increase also signifies Costco is more liquid in 2010 than it was in 2001. Costcos competitors current ratio for 2010 is Sears (1.3), Wal-Mart (.87), and BJs (1.17). The current ratio for the industry is 1.1. Costco, BJs, and Sears are in line with this; however Wal-Mart may want to research why they are falling below the industry average. The inventory turnover ratio indicates how effective the business is at selling its products. The more effective the company is the higher the inventory turnover ratio is. Costco went from a turnover ratio of 11.6 in 2001 to 12.1 in 2010. The increase signifies Costco has increased its effectiveness in selling its 4000 different products. The competitors are currently at Sears (3.7), Wal-Mart (9.2), and BJs (9.8). In comparison to the industry average of 8.6, Costco, Wal-Mart, and BJs are very effective with their selling strategies. Sears on the other hand should develop a better strategy. Costcos receivable period was 3 days in 2001 and 4 days in 2010. This indicates Costco collects funds in a relatively short period of time, which will reduce the chances that the receivable will need to be charged off. The competitors are relatively consistent with Sears at 5 days, Wal-Mart at 3 days and BJs at 5 days. Trends Below are some ratio trends and graphs. Based on the trends you can see each of the categories have been relatively constant. The ROE decreased in 2009 to 10.83% compared to 13.95% in 2008. However as of August 2010 ROE has increased to 12.03%. The ROA decreased as well in 2009 to 4.94% compared to 6.20% in 2008. Again like ROE, the ROA has increased to 5.47% as of August 2010. The Financial Leverage, Profit Margin and Asset Turnover have been relatively consistent over the past 10 years. In 2009 Costco struggled just as all business did due to the deep recession. While their sales and profits were less than in fiscal 2008, Costco remained solidly profitable in fiscal 2009. During the past fiscal year they opened twenty new warehouses; increased their membership cardholder base by 2.3 million members, with membership renewals remaining strong at over 87%; and their employees continued to have job security along with one of the best wage and benefits packages in the retail industry. Fiscal 2009 was the first time in their history when sales did not achieve record highs. Sales were $69.9 billion, a 1.5% decrease from 2008s results, and for the first time they reported a year of negative comparable sales in warehouses open more than a year: 4% in 2009. Net earnings again exceeded $1 billion, but were down from the previous fiscal year by 15%. As of August 2010 sales were at $77.9 billion which indicates recovery over 2009. The ROE, ROA, and Financial Leverage have also increased from year end 2009 to August 2010. These ratios also indicate a rebound from the recession. After reviewing the information that was presented above my recommendation to Margarita Torres would be to continue to monitor the performance of Costco and to keep her existing shares of Costco stock. If Margarita would like to diversify Wal Mart would be a potential investment perspective.

References Brigham, E. & Houston, J. (2009). Fundamentals of Financial Management, SouthWestern Cenage Learning, Mason, OH Tayan, B (2003). Costco Wholesale Corporation (Case: A-186A), Stanford Business School of Business, Stanford, CA http://finapps.forbes.com/finapps/jsp/finance/compinfo/Ratios.jsp?tkr=cost http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=COST