1 Caso 1_Costco Wholesale

8/4/2019 1 Caso 1_Costco Wholesale

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Costco WholesaleCorporation: Mission,Business Model, and Strategyrthur A. Thompson Jr.he University of Alabamaim Sinegal, cofounder and CEO of CostcoWholesale, was the driving force behind Costcos23-year march to become the fourth largest re-tailer in the United States and the seventh larg-st in the world. He was far from the stereotypicalO. A grandfatherly 70-year-old, Sinegal dressedasually and unpretentiously, often going to the

ffice or touring Costco stores wearing an open-llared cotton shirt that came from a Costco bargainck and sporting a standard employee name tag thataid, simply, "Jim." His informal dress, mustache,ray hair, and unimposing appearance made it easyor Costco shoppers to mistake him for a store clerk.e answered his own phone, once telling ABC Newseporters, "If a customer's calling and they have aripe, don't you think they kind of enjoy the fact thatpicked up the phone and talked to them?"!Sinegal spent much of his time touring Costcotores, using the company plane to fly from locationlocation and sometimes visiting 8 to 10stores dailythe record for a single day was 12). Treated like alebrity when he appeared at a store (the news "Jim'sthe store" spread quickly), Sinegal made a point ofeeting store employees. He observed, "The employ-es know that I want to say hello to them, becauselike them. We have said from the very beginning:We're going to be a company that's on a first-name

sis with everyone.' "2 Employees genuinely seemedlike Sinegal. He talked quietly, in a commonsensi-al manner that suggested what he was saying waso big deal.3 He came across as kind yet stem, but

he was prone to display irritation when he disagreedsharply with what people were saying to him.In touring a Costco store with the local store man-ager, Sinegal was very much the person-in-charge. Hefunctioned as producer, director, and knowledgeablecritic. He cut to the chase quickly, exhibiting intenseattention to detail and pricing, wandering throughstore aisles firing a barrage of questions at store man-agers about sales volumes and stock levels of partic-ular items, critiquing merchandising displays or theposition of certain products in the stores, comment-ing on any aspect of store operations that caught hiseye, and asking managers to do further research andget back to him with more information whenever hefound their answers to his questions less than satisfy-ing. Itwas readily apparent that Sinegal had tremen-dous merchandising savvy, that he demanded muchof store managers and employees, and that his viewsabout discount retailing set the tone for how the com-pany operated. Knowledgeable observers regardedJim Sinegal's merchandising expertise as beingon a par with that of the legendary Sam Walton.In 2006, Costco's sales totaled almost $59 bil-lion at 496 stores in 37 states, Puerto Rico, Canada,the United Kingdom, Taiwan, Japan, Korea, andMexico. About 26 million households and 5.2 mil-lion businesses had membership cards entitling themto shop at Costco, generating nearly $1.2 billion inmembership fees for the company. Annual salesper store averaged about $128 million, nearly dou-ble the $67 million figure for Sam's Club, Costco'schief competitor in the membership warehouse re-


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C a se 1 C o ste o W h ole sa le C o rp ora tio n : M is sio n, B us in e ss M o de l, a n d S tra te gy

OM PANY BACKGROUNDhe membership warehouse concept was pioneeredy discount merchandising sage Sol Price, whopened the first Price Club in a converted airplaneangar on Morena Boulevard in San Diego in 1976.rice Club lost $750,000 in its first year of opera-on, but by 1979 it had two stores, 900 employees,00,000 members, and a $1 million profit. Yearsarlier, Sol Price had experimented with discountetailing at a San Diego store called Fed-Mart. Jiminegal got his start in retailing there at the age of8, loading mattresses for $l.25 an hour while at-ending San Diego Community College. When Solrice sold Fed-Mart, Sinegal left with Price to helpim start the San Diego Price Club store; within aewyears, Sol Price's Price Club emerged as the un-hallenged leader in member warehouse retailing,ith stores operating primarily on the West Coast.Although he originally conceived Price Club as

place where small local businesses could obtaineeded merchandise at economical prices, Sol Priceoon concluded that his fledgling operation couldchieve far greater sales volumes and gain buyinglout with suppliers by also granting membership tondividuals-a conclusion that launched the deep-iscount warehouse club industry on a steep growthWhen Sinegal was 26, Sol Price made him the

anager of the original San Diego store, which hadecome unprofitable. Price saw that Sinegal had apecial knack for discount retailing and for spottinghat a store was doing wrong (usually either noteing in the right merchandise categories or not sell-ng items at the right price points )-the very thingshatSol Price was good at and that were at the root ofhePrice Club's growing success in the marketplace.Sinegal soon got the San Diego store back into thelack.Over the next several years, Sinegal continuedobuild his prowess and talents for discount merchan-dising.He mirrored Sol Price's attention to detail andabsorbed all the nuances and subtleties of his men-tor's style of operating-constantly improving storeoperations, keeping operating costs and overheadlow,stocking items that moved quickly, and charg-ingultra-low prices that kept customers coming backtoshop. Realizing that he had mastered the tricks ofrunning a successful membership warehouse busi-nessfrom Sol Price, Sinegal decided to leave PriceCluband form his own warehouse club operation.

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Costco was founded by Jim Sinegal and Seattleentrepreneur Jeff Brotman (now chairman of theboard of directors). The first Costco store began oper-ations in Seattle in 1983, the same year that Wal-Martlaunched its warehouse membership format, Sam'sClub. By the end of 1984, there were nine Costcostores in five states serving over 200,000 members.In December 1985, Costco became a public com-pany, selling shares to the public and raising addi-tional capital for expansion. Costco became the firstever U.S. company to reach $1 billion in sales in lessthan six years. In October 1993, Costco merged withPrice Club. Jim Sinegal became CEO of the mergedcompany, presiding over 206 PriceCostco locations,which in total generated $16 billion in annual sales.Jeff Brotman, who had functioned as Costco's chair-man since the company's founding, became vicechairman of Price Cost co in 1993 and was elevated tochairman in December 1994. Brotman kept abreastof company operations but stayed in the backgroundand concentrated on managing the company's $9 bil-lion investment in real estate operations-in 2006,Costco owned the land and buildings for almost 80percent of its stores.

In January 1997, after the spin-off of most ofits nonwarehouse assets to Price Enterprises Inc.,PriceCostco changed its name to Costco CompaniesInc. When the company reincorporated from Delawareto Washington in August 1999, the name was changedto Costco Wholesale Corporation. The company'sheadquarters was in Issaquah, Washington, not farfrom Seattle.

Exhibit 1 contains a financial and operatingsummary for Costco for fiscal years 2000-2006.

CO STCO 'S M ISS IO N,BUS INESS MODEL , ANDSTRATEGYCostco's mission in the membership warehouse busi-ness read: "To continually provide our memberswith quality goods and services at the lowest pos-sible prices." The company's business model wasto generate high sales volumes and rapid inventoryturnover by offering members low prices on a limitedselection of nationally branded and selected private-label products in a wide range of merchandise cat-egories. Management believed that rapid inventory


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Exhibit 1 Financial and O perating S ummary, C ostco W holesale C orporation, FiscalYea rs 2000-2006 ($ in m illions, except for per share data)Fiscal Years Ending on Sunday Closest to August 31

---------------------------------------2006 2005 2004 2002 2000

Income Statement DataNet sales $58,963 $51,862 $47,146 $37,993 $31,621Membership fees 1,188 1,073 961 769 544Total revenue 60,151 52,935 48,107 38,762 32,164

Operating expensesMerchandise costs 52,745 46,347 42,092 33,983 28,322Selling, general, and administrative 5,732 5,044 4,598 3,576 2,755Preopening expenses 43 53 30 51 42Provision for impaired assets and store closing costs 5 16 1 21 7

Operating income 1,626 1,474 1,386 1,132 1,037Other income (expense)Interest expense (13) (34) (37) (29) (39)Interest income and other 138 109 52 36 54

Income before income taxes 1,751 1,549 1,401 1,138 1,052Provision for income taxes 648 486 518 438 421-- --Net income $ 1,103 $ 1,063 $ 882 $ 700 $ 631Diluted net income per share $ 2.30 $ 2.18 $ 1.85 $ 1.48 $ 1.35Dividends per share $ 0.49 $ 0.43 $ 0.20 $ 0.00 $ 0.00Millions of shares used in per share calculations 480.3 492.0 482.5 479.3 475.7Balance Sheet DataCash and cash equivalents $ 1,511 $ 2,063 $ 2,823 $ 806 $ 525Merchandise inventories 4,569 4,015 3,644 3,127 2,490Current assets 8,232 8,238 7,269 4,631 3,470Current liabilities 7,819 6,761 6,170 4,450 3,404Working capital 413 1,477 1,099 181 66Net property and equipment 8,564 7,790 7,219 6,523 4,834Total assets 17,495 16,514 15,093 11,620 8,634Short-term borrowings 41 54 22 104 10Long-term debt 215 711 994 1,211 790Stockholders' equity 9,143 8,881 7,625 5,694 4,240Cash Flow DataNet cash provided by operating activities $ 1,827 $ 1,776 $ 2,096 $ 1,018 $ 1,070Warehouses in OperationBeginning of year 433 417 397 345 292Opened 28 21 20 35 25Closed (3) (5) (6) (4)End of year 458 433 417 374 313Primary members at year-endBusinesses (OOOs) 5,214 5,050 4,810 4,476 4,358Gold Star members (OOOs) 17,338 16,233 15,018 14,597 12,737

Sources: Company 10-K reports 2006, 2005, 2002, and 2000.


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over-when combined with the operating ef-ncies achieved by volume purchasing, efficientribution, and reduced handling of merchandise inrills, self-service warehouse facilities--enabledtco to operate profitably at significantly lowers margins than traditional wholesalers, masschandisers, supermarkets, and supercenters.Examples of Costco's incredible annual salesmes included 96,000 carats of diamonds (2006),million televisions, $300 million worth of dig-cameras, 28 million rotisserie chickens (over,000 weekly), 40 percent of the Tuscan olive oilght in the United States, $16 million worth ofpkin pies during the fall holiday season, $3 bil-worth of gasoline, 21 million prescriptions, andmillion $1.50 hot dog/soda pop combinations.tco was also the world's largest seller of finees ($385 million out of total 2006 fine wine sales805 million)." At one of Cost co's largest volumees, which had annual sales of $285 million and,000 members, annual sales volume ran 283,000sserie chickens, 375,000 gallons of milk, and 8.4lion rolls of toilet paper-this store had an aver-customer bill per trip of$150.5Furthermore, Costeo's high sales volume andd inventory turnover generally allowed it to sellreceive cash for inventory before it had to payy of its merchandise vendors, even when vendorments were made in time to take advantage ofy payment discounts. Thus, Costco was able tonce a big percentage of its merchandise inven-through the payment terms provided by vendorser than by having to maintain sizable workingital (defined as current assets minus current li-ities) to facilitate timely payment of suppliers.

stco's Strategycornerstones of Costco's strategy were lowes, limited selection, and a treasure-hunt shop-environment.

Costco was known for selling top-qualityonal and regional brands at prices consistentlyw traditional wholesale or retail outlets. Thepany stocked only those items that could beed at bargain levels and thus provide membersh significant cost savings; this was true even ifitem was often requested by customers. A keyent of Costco's pricing strategy was to cap itskup on brand-name merchandise at 14 percentmpared to 20 to 50 percent markups at other

c-sdiscounters and many supermarkets). Markups onCostco's 400 private-label (Kirkland Signature) itemscould be no higher than 15 percent, but the sometimesfractionally higher markups still resulted in KirklandSignature items being priced about 20 percent belowcomparable name-brand items. Kirkland Signatureproducts-which included juice, cookies, coffee,tires, housewares, luggage, appliances, clothing, anddetergent-were designed to be of equal or betterquality than national brands.

Costeo's philosophy was to keep customers com-ing in to shop by wowing them with low prices. JimSinegal explained the company's approach to prieingas follows:

We always look to see how much of a gulf wecan create between ourselves and the competi-tion. So that the competitors eventually say, "Theseguys are crazy. We'll compete somewhere else."Some years ago, we were selling a hot brand ofjeans for $29.99. They were $50 in a departmentstore. We got a great deal on them and could havesold them for a higher price but we went downto $29.99. Why? We knew it would create a riot."

At another time he said:We're very good merchants, and we offer value. Thetraditional retailer will say: "I'm selling this for $10.I wonder whether we can get $10.50 or $1l." We say:"We selling this for $9. How do we get it down to$8?" We understand that our members don't comeand shop with us because of the window displaysor the Santa Claus or the piano player. They comeand shop with us because we offer great values.'

Indeed, Costco's markups and prices were so lowthat Wall Street analysts had criticized Costco man-agement for going all out to please customers at theexpense of increasing profits for shareholders. Oneretailing analyst said, "They could probably get moremoney for a lot of the items they sell." Sinegal wasunimpressed with Wall Street calls for Costco toabandon its ultra-low pricing strategy, commenting:"Those people are in the business of making moneybetween now and next Tuesday. We're trying to buildan organization that's going to be here 50 years fromnow,"? He went on to explain why Costco's approachto pricing would remain unaltered during his tenure:

When I started, Sears, Roebuck was the Costco of thecountry, but they allowed someone else to come inunder them. We don't want to be one of the casual-ties. We don't want to turn around and say, "We gotso fancy we've raised our prices, and all of a suddena new competitor comes in and beats our prices.':"


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To encourage members to shop at Costco morefrequently, the company operated ancillary busi-nesses within or next to most Costco warehouses;the number of ancillary businesses at Costco ware-houses is shown in the following table:

C-6 P art 2 C as es in C ra ftin g a nd E xe cu tin g S tra te gyProduct Selection. Whereas typical supermar-kets stocked about 40,000 items and a Wal-MartSupercenter or a SuperTarget might have as manyas 150,000 items for shoppers to choose from, Cost-co's merchandising strategy was to provide memberswith a selection of only about 4,000 items.Costco's product range did cover a broadspectrum-rotisserie chicken, prime steaks, caviar,flat-screen televisions, digital cameras, fresh flow-ers, fine wines, caskets, baby strollers, toys andgames, musical instruments, ceiling fans, vacuumcleaners, books, DVDs, chandeliers, stainless-steelcookware, seat-cover kits for autos, prescriptiondrugs, gasoline, and one-hour photo finishing-butthe company deliberately limited the selection in eachproduct category to fast-selling models, sizes, andcolors. Many consumable products like detergents,canned goods, office supplies, and soft drinks were soldonly in big-container, case, carton, or multiple-packquantities. For example, Costco stocked only a 325-count bottle of Advil-a size many shoppers might findtoo large for their needs. Sinegal explained the reasonfor the deliberately limited selection as follows:

If you had ten customers come in to buy Advil, howmany are not going to buy any because you justhave one size? Maybe one or two. We refer to thatas the intelligent loss of sales. We are prepared togive up that one customer. But if we had four or fivesizes of Advil, as most grocery stores do, it wouldmake our business more difficult to manage. Ourbusiness can only succeed if we are efficient. Youcan't go on selling at these margins if you are not. 1 1

Costco's selections of appliances, equipment, andtools often included commercial and professionalmodels because so many of its members were smallbusinesses. The approximate percentage of net salesaccounted for by each major category of itemsstocked by Costco is shown in the following table:

2006 2005 2004Total number of warehouses 458 433 417Warehouses having stores withFood court and hot dog stands 452 427 412One-hour photo centers 450 423 408Optical dispensing centers 442 414 397Pharmacies 401 374 359Gas stations 250 225 211Hearing aid centers 196 168 143Print shops and copy centers 9 10 10

Treasure-Hunt Merchandising. While Costco'sproduct line consisted of approximately 4,000 items,about one-fourth of its product offerings were con-stantly changing. Costco's merchandise buyers re-mained on the lookout to make one-time purchasesof items that would appeal to the company's clienteleand that would sell out quickly. A sizable number ofthese items were high-end or name-brand productsthat carried big price tags-like $2,000-$3,500 big-screen HDTVs or $800 leather sofas. The idea wasto entice shoppers to spend more than they mightotherwise by offering irresistible deals on luxuryitems. According to Jim Sinegal, "Of that 4,000,about 3,000 can be found on the floor all the time.The other 1,000 are the treasure-hunt stuff that'salways changing. It's the type of item a customerknows they better buy because it will not be therenext time, like Waterford crystal. We try to get thatsense of urgency in our customers.':"

2006 2005 2004 2003Food (fresh produce, meats and fish, bakery and deli products, and dry and 30% 30% 31% 30%institutionally packaged foods)Sundries (candy, snack foods, tobacco, alcoholic and nonalcoholic beverages, 24 25 25 26and cleaning and institutional supplies)Hard lines (major appliances, electronics, health and beauty aids, hardware, 20 20 20 20office supplies, garden and patio, sportlnq goods, furniture, cameras andautomotive supplies)Soft lines (apparel, domestics, jewelry, housewares, media, home furnishings, 12 12 13 14and small appliances)Ancillary and other (gasoline, pharmacy, food court, optical, one-hour photo, 14 13 11 10hearing aids, and travel)


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In many cases, Costco did not obtain its luxuryofferings directly from high-end manufacturers likeCalvin Klein or Waterford (who were unlikely towant their merchandise marketed at deep discountsatplaces like Costco); rather, Costco buyers searchedfor opportunities to source such items legally on thegraymarket from other wholesalers or distressed re-tailers looking to get rid of excess or slow-sellinginventory. Examples of treasure-hunt specials in-cluded $800 espresso machines, diamond rings andotherjewelry items with price tags of anywhere from$5,000 to $250,000, Italian-made Hathaway shirtspriced at $29.99, Movado watches, exotic cheeses,Coach bags, cashmere sports coats, $1,500 digitalpianos, and Dom Perignon champagne.Marketing and Advertising. Costco's low pricesandits reputation for treasure-hunt shopping made itunnecessary for the company to engage in extensiveadvertising or sales campaigns. Marketing and pro-motional activities were generally limited to directmail programs promoting selected merchandise toexistingmembers, occasional direct mail marketingtoprospective new members, and special campaignsfor new warehouse openings. For new warehouseopenings, marketing teams personally contactedbusinesses in the area that were potential wholesalemembers;these contacts were supplemented with di-rectmailings during the period immediately prior toopening. Potential Gold Star (individual) memberswere contacted by direct mail or by promotions atlocal employee associations and businesses withlarge numbers of employees. After a membershipbasewas established in an area, most new member-shipscame from word of mouth (existing memberstelling friends and acquaintances about their shop-ping experiences at Costco), follow-up messagesdistributed through regular payroll or other organi-zational communications to employee groups, andongoing direct solicitations to prospective businessandGold Star members. Management believed thatitsemphasis on direct mail advertising kept its mar-ketingexpenses low relative to those at typical retail-ers,discounter, and supermarkets.Growth Strategy. In recent years, Costco hadopened an average 20-25 locations annually; mostwerein the United States, but expansion was underwayinternationally as well. The company opened 68newwarehouses in the United States in fiscal years2002-2006; 16 new warehouses opened in the firstfour months of fiscal 2007 (between September I

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and December 31, 2006), and management plannedto open another 20-24 by the end of fiscal 2007. Fivenew warehouses were opened outside the UnitedStates in fiscal 2005, fivemore were opened in fiscal2006, and four were opened in the first four monthsof fiscal 2007. Going into 2007, Costco had a total of102 wholly-owned warehouses in operation outsidethe United States, including 70 in Canada, 18 in theUnited Kingdom,S in Korea,S in Japan, and 4 inTaiwan. Costco was a 50-50 partner in a venture tooperate 30 Costco warehouses in Mexico. Exhibit 2shows a breakdown of Costco's geographic opera-tions for fiscal years 2003-2006. (The data for the 30warehouses in Mexico are not included in the exhibitbecause the 50-50 venture in Mexico was accountedfor using the equity method.)

Costco had recently opened two freestand-ing high-end furniture warehouse businesses calledCostco Home. Sales in 2005 at these two locationsincreased by 132percent over 2004 levels, and prof-its were up significantly. So far, however, rather thanopening additional Costco Home stores, managementhad opted to experiment with adding about 45,000square feet to the size of selected new Costco storesand using the extra space to stock a much biggerselection of furniture-furniture was one of the topthree best-selling categories at Costco's Web site.A third growth initiative was to expand thecompany's offerings of Kirkland Signature items.Management believed there were opportunities toexpand its private-label offerings from the presentlevel of 400 items to as many as 600 items over thenext five years.

Web Site Sales. Costco operated two Web sites-www.costco.com in the United States and www.costco.ca in Canada-both to provide another shop-ping alternative for members and to provide mem-bers with a way to purchase products and servicesthat might not be available at the warehouse wherethey customarily shopped, especially such servicesas digital photo processing, prescription fulfillment,and travel and other membership services. At Cost-co's online photo center, customers could upload im-ages and pick up the prints at their local warehousein little over an hour; one-hour photo sales were up10 percent in fiscal 2005, a year in which the in-dustry overall had negative sales growth. Costco'se-commerce sales totaled $534 million in fiscal 2005and $376 million in fiscal 2004. (Data for fiscal 2006e-commerce sales were not available.)
http://www.costco.com/http://www.costco.com/


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Exhibit 2 Geographic Operating Data, Costco Wholesale Corporation, Fiscal Years2003-2006 ($ in millions)United States Canadian Other International

'Vpercl'ilun~ 'Vpercl'il~ ~Jirum; lotalYear Ended September 3, 2006Total revenue (including membership fees) $48,465 $8,122 $3,564 $60,151Operating income 1,246 293 87 1,626_Q~P.!~f::j~~qn_?'Qd~i'I(TIo!.ti~~ljon 413 61 41 515Capital expenditures 934 188 90 1,213Property and equipment 6,676 1,032 855 8,564Total assets 14,009 1,914 1,572 17,495Net assets 7,190 1,043 910 9,143Number of warehouses 358 68 32 458Year Ended August 28, 2005Total revenue (including membership fees) $43,064 $6,732 $3,155 $52,952Operating income 1,168 242 65 1,474Depreciation and amortization 389 51 42 482Capital expenditures 734 140 122 995Property and equipment 6,171 834 786 7,790Total assets 13,203 2,034 1,428 16,665Net assets 6,769 1,285 827 8,881Number of warehouses 338 65 30 433Year Ended August 29, 2004Total revenue (including membership fees) $39,430 $6,043 $2,637 $48,110Operating income 1,121 215 50 1,386Depreciation and amortization 364 40 36 441Capital expenditures 560 90 55 706Property and equipment 5,853 676 691 7,220Total assets 12,108 1,718 1,267 15,093Net assets 5,871 1,012 742 7,625Number of Warehouses 327 63 27 417Year Ended August 31,2003Total revenue (including membership fees) $35,119 $5,237 $2,189 $42,546Operating income 928 199 30 1,157Depreciation and amortization 324 34 34 391Capital expenditures 699 69 44 811Long lived assets 5,706 613 642 6,960Total assets 10,522 1,580 1,089 13,192Net assets 5,141 630Number of warehouses 309 27

Source: Company 10-K reports, 2004 and 2006.

Warehouse OperationsIn Costco's 2005 annual report, Jim Sinegal summedup the company's approach to operations as follows:Costco is able to offer lower prices and better valuesby eliminating virtually all the frills and costs histori-caIly associated with conventional wholesalers and

retailers, including salespeople, fancy buildings, de-livery, billing, and accounts receivable. We run a tightoperation with extremely low overhead which ena-bles us to pass on dramatic savings to our members.Costco warehouses averaged 140,000 square feetand were constructed inexpensively with concretefloors. Because shoppers were attracted principally


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C a se 1 C o st co W h o le sa le C o rp or atio n : M is sio n , B u sin e ss M o de l, a n d S tr at eg yby Costcos low prices, its warehouses were rare-ly located on prime commercial real estate sites.Merchandise was generally stored on racks abovethe sales floor and displayed on pallets containinglarge quantities of each item, thereby reducing laborrequired for handling and stocking. In-store signagewas done mostly on laser printers, and there were noshoppingbags at the checkout counter-merchandisewasput directly into the shopping cart or sometimesloaded into empty boxes. Warehouses generally op-erated on a seven-day, 69-hour week, typically beingopen between 10:00 a.m. and 8:30 p.m. weekdays,with earlier closing hours on the weekend; the gaso-line operations outside many stores generally hadextended hours. The shorter hours of operation-ascompared to those of traditional retailers, discountretailers, and supermarkets-resulted in lower laborcosts relative to the volume of sales.Costco warehouse managers were delegatedconsiderable authority over store operations. Ineffect, warehouse managers functioned as entrepre-neurs running their own retail operation. They wereresponsible for coming up with new ideas aboutwhat items would sell in their stores, effectivelymerchandising the ever-changing lineup of treasure-hunt products, and orchestrating in-store prod-uct locations and displays to maximize sales andquick turnover. In experimenting with what items tostock and what in-store merchandising techniquesto employ, warehouse managers had to know theclientele who patronized their locations-for in-stance, big-ticket diamonds sold well at some ware-houses but not at others. Costco's best managerskept their finger on the pulse of the members whoshoppedtheir warehouse location to stay in sync withwhatwould sell well, and they had a flair for creat-inga certain element of excitement, hum, and buzzintheir warehouses. Such managers spurred above-averagesales volumes-sales at Costco's top-volumewarehouses often exceeded $5 million a week, withsalesexceeding $1million onmany days. Successfulmanagers also thrived on the rat race of running ahigh-traffic store and solving the inevitable crisesofthe moment.Costco bought the majority of its merchandisedirectlyfrom manufacturers, routing it either direct-ly to its warehouse stores or to one of nine cross-docking depots that served as distribution pointsfor nearby stores. Depots received container-basedshipments from manufacturers and reallocatedthese goods for combined shipment to individual

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warehouses, generally in less than 24 hours. Thismaximized freight volume and handling efficien-cies. When merchandise arrived at a warehouse, itwas moved straight to the sales floor; very little wasstored in locations off the sales floor, thereby lower-ing receiving costs by eliminating many of the costsassociated with multiple-step distribution channels,which include purchasing from distributors as op-posed to manufacturers; using central receiving,storage, and distribution warehouses; and storingmerchandise in locations off the sales floor.Costco had direct buying relationships withmany producers of national brand-name mer-chandise (including Canon, Casio, Coca-Cola,Colgate-Palmolive, Dell, Fuji, Hewlett-Packard,Kimberly-Clark, Kodak, Levi Strauss, Michelin,Nestle, Panasonic, Procter & Gamble, Samsung,Sony, KitchenAid, and Jones of New York) and withmanufacturers that supplied its Kirkland Signatureproducts. No one manufacturer supplied a sig-nificant percentage of the merchandise that Costcostocked. Costco had not experienced any difficulty inobtaining sufficient quantities of merchandise, andmanagement believed that if one or more of itscurrent sources of supply became unavailable, thecompany could switch its purchases to alternativemanufacturers without experiencing a substantialdisruption of its business.Costco warehouses accepted cash, checks,most debit cards, American Express, and a private-label Costco credit card. Costco accepted merchan-dise returns when members were dissatisfied withtheir purchases. Losses associated with dishonoredchecks were minimal because any member whosecheck had been dishonored was prevented frompaying by check or cashing a check at the point ofsale until restitution was made. The membershipformat facilitated strictly controlling the entrancesand exits of warehouses, resulting in limited inven-tory losses of less than two-tenths of 1 percent ofnet sales-well below those of typical discount re-tail operations.Costeo's Membership Baseand Member DemographicsCostco attracted the most affluent customers in dis-count retailing-the average income of individualmembers was about $75,000, with over 30 percentof members having annual incomes of $100,000or more. Many members were affluent urbanites,


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living in nice neighborhoods not far from Costcowarehouses. One loyal Executive member, a crimi-nal defense lawyer, said, "I think I spend over$20,000-$25,000 a year buying all my productshere from food to clothing-except my suits. Ihave to buy them at the Armani stores.?" AnotherCostco loyalist said, "This is the best place in theworld. It's like going to church on Sunday. Youcan't get anything better than this. This is a reli-gious experience.':"Costco had two primary types of member-ships: Business and Gold Star (individual). GoldStar memberships were for individuals who did notqualify (or a Business membership. Businesses-including individuals with a business license, retailsales license, or other evidence of business exist-ence-qualified as Business members. Businessmembers generally paid an annual membershipfee of $50 for the primary membership card, whichalso included a spouse membership card, and couldpurchase up to six additional membership cardsfor an annual fee of $40 each for partners or as-sociates in the business; they could also purchase atransferable company card. A significant number ofbusiness members also shopped at Costco for theirpersonal needs.Gold Star members generally paid an annualmembership fee of $50, which included a spousecard. In addition, members could upgrade to anExecutive membership for an annual fee of $100;Executive members were entitled an additional2 percent savings on qualified purchases at Costco(redeemable at Costco warehouses), up to a maxi-mum rebate of $500 per year. Executive membersalso were eligible for savings and benefits on vari-ous business and consumer services offered byCostco, including merchant credit card processing,small-business loans, auto and home insurance,long-distance telephone service, check printing,and real estate and mortgage services; theseservices were mostly offered by third-party provid-ers and varied by state. In 2006, Executive mem-bers represented 23 percent of Costco's primarymembership base and generated approximately 45percent of consolidated net sales. Effective May 1,2006, Costco increased annual membership fees by$5 for U.S. and Canadian Gold Star, Business, andBusiness Add-on members; the $5 increase, the firstin nearly six years, impacted approximately 15mil-lion members.

At the end of fiscal 2006, Costco had almost 48million cardholders:

Gold Star members (including Executivemembers)Business membersTotal primary cardholdersAdd-on cardholdersTotal cardholders

17,338,0005,214,00022,552,00025,127,00047,679,000

Recent trends inmembership are shown at bottomofExhibit 1. Members could shop at any Costco ware-house; member renewal rates were about 86.5 percent.

Compensation and WorkforcePracticesIn September 2006, Costeo had 71,000 full-timeemployees and 56,000 part-time employees, includ-ing approximately 8,000 people employed by CosteoMexico, whose operations were not consolidated inCostco's financial and operating results. Approxi-mately 13,800 hourly employees at locations inCalifornia, Maryland, New Jersey, and New York,as well as at one warehouse in Virginia, were rep-resented by the International Brotherhood of Team-sters. All remaining employees were non-union.Starting wages for new Costco employees werein the $10-$12 range in 2006; on average, Costeoemployees earned $17-$18 per hour, plus biannualbonuses. Employees enjoyed the full spectrum ofbenefits. Salaried employees were eligible for ben-efits on the first of the month after the date of hire.Full-time hourly employees were eligible for benefitsof the first of the month after working a probationary90 days; part-time hourly employees became benefit-eligible on the first of the month after working 180days. The benefit package included the following:

Health and dental care plans. Full-time em-ployees could choose from among a freedom-of-choice health care plan, a managed-choicehealth care plan, and three dental plans. Amanaged-choice health care and a core dentalplan were available for part-time employees. Thecompany paid about 90 percent of an employee'spremiums for health care (far above the morenormal 50 percent contributions at many other


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Case 1 Costeo WholesaleCorporation:Mission,BusinessModel,and Strategyretailers), but employees did have to pick up thepremiums for coverage for family members.Convenient prescription pickup at Costco'spharmacies, with co-payments as low as $5 forgeneric drugs. Generally, employees paid nomore than 15 percent of the cost for the mostexpensive branded drugs.A vision program that paid $45 for an opticalexam (the amount charged at Costco's opticalcenters) and had generous allowances for thepurchase of glasses and contact lenses.A 401(k) plan in which Costco matched hourlyemployee contributions by 50 cents on the dollarfor the first $1,000 annually to a maximum com-pany match of $500~peryear. Eligible employeesqualified for additional company contributionsbased on the employee's years of service and eli-gible earnings. The company's union employeeson the West Coast qualified for matching contri-butions of 50 cents on the dollar to a maximumcompany match of $250 a year; eligible unionemployees qualified for additional company con-tributions based on straight-time hours worked.Company contributions for salaried workers ranabout 3 percent of salary during the second yearof employment and could be as high as 9 percentof salary after 25 years. Company contributionsto employee 410(k) plans were $233.6 millionin fiscal 2006, $191.6 million in fiscal 2005,. and$169.7 million in fiscal 2004.A dependent care reimbursement plan in whichCostco employees whose families qualified couldpay for day care for children under 13 or adultday care with pretax dollars and realize savingsof anywhere from $750 to $2,000 per year.Confidential professional counseling services.Company-paid long-term disability coverageequal to 60 percent of earnings if out for morerhao J$(lm}L" S tu " "LDSlI'--.'H0'iIr~rS~~~'lI"'fh'\!;.0tI'leave of absence.All employees who passed their 90-day proba-tion period and were working at least 10 hoursper week were automatically enrolled in a short-term disability plan covering non-work-relatedinjuries or illnesses for up to 26 weeks. Weeklyshort-term disability payments equaled 60 per-cent of average weekly wages up to a maximumof $1,000 and were tax free.Generous life insurance and accidental death anddismemberment coverage, with benefits based

C-lIon years or service and whether the employeeworked full-time or part-time. Employees couldelect to purchase supplemental coverage forthemselves, their spouses, or their children.An employee stock purchase plan allowing allemployees to buy Costco stock via payroll de-duction and avoid commissions and fees.A health care reimbursement plan in which ben-efit eligible employees could arrange to havepretax money automatically deducted fromtheir paychecks and deposited in a health carereimbursement account that could be used topay medical and dental bills.A long-term care insurance plan for employeeswith 10 or more .years of service. Eligible em-ployees could purchase a basic or supplementalpolicy for nursing home care for themselves,their spouses, or their parents (including in-laws) or grandparents (including in-laws).

Although admitting that paying good wages and goodbenefits was contrary to conventional wisdom in dis-count retailing, Jim Sinegal was convinced that hav-ing a well-compensated workforce was very impor-tant to executing Costco's strategy successfully. Hesaid, "Imagine that you have 120,000 loyal ambassa-dors out there who are constantly saying good thingsabout Costco. It has to be a significant advantagefor you .... Paying good wages and keeping yourpeople working with you is very good business.?"When a reporter asked him about why Costco treatedits workers so well compared to other retailers (par-ticularly Wal-Mart, which paid lower wages and hada skimpier benefits package), Sinegal replied: "Whyshouldn't employees have the right to good wagesand good careers .... It absolutely makes good busi-ness sense. Most people agree that we're the lowest-cost producer. Yet we pay the highest wages. So it

.mnst .mean ,WPgp Jv>.t.1flxr~1.!'.t;H\_?! J.~~"w.liI.n:u\I.;.0in our business-you get what you pay for,"!"

About 85 percent of Costco's employees hadsigned up for health insurance, versus about 50 per-cent at Wal-Mart and Target. The Teamsters' chiefnegotiator with Costco said, "They gave us the bestagreement of any retailer in the country?" Goodwages and benefits were said to be why employeeturnover at Costco ran under 6 percent after the firstyear of employment. Some Costco employees hadbeen with the company since its founding in 1983.Many others had started working part-time at Costco


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patronized their particular warehouse-just hav-ing the requisite skills in people management, crisismanagement, and cost-effective warehouse opera-tions was not enough.Executive Compensation. Executives at Costcodid not earn the outlandish salaries that had becomecustomary over the past decade at most large corpo-rations. In fiscal 2005, both Jeff Brotman and JimSinegal were each paid $350,000 and earned a bonusof$100,000 (versus $350,000 salaries and $200,000bonuses in fiscal 2004). As of early 2006, Brotmanowned about 2.2 million shares of Costco stock(worth about $110 million as of December 2006)and had been awarded options to purchase an addi-tionall.35 million shares; Sinegal owned 2.7 millionshares of Costco stock (worth about $140 millionas of December 2006) and had also been awardedoptions for an additional 1.35 million shares. Sev-eral senior officers at Costco were paid 2005 sala-ries in the $475,000-$500,000 range and bonuses of$47,000-$77,000. Sinegal explained why executivecompensation at Costco was only a fraction of themillions paid to top-level executives at other corpo-rations with sales of $50 billion or more: "I figuredthat if I was making something like 12 times morethan the typical person working on the floor, thatthat was a fair salary?" To another reporter, he said:"Listen, I'm one of the founders of this business.I've been very well rewarded. I don't require a sal-ary that's 100 times more than the people who workon the sales flOOr."26Sinegal's employment contractwas only a page long and provided that he could beterminated for cause.

C-12 P art 2 C as es in C ra ftin g a nd E xe cu tin g S tra te gywhile in high school or college and opted to makea career at the company. One Costco employee toldan ABC 20120 reporter, "It's a good place to work;they take good care of'us."" A Costco vice presidentand head baker said working for Costco was a fam-ily affair: "My whole family works for Costco, myhusband does, my daughter does, my new son-in-lawdoes."? Another employee, a receiving clerk whomade about $40,000 a year, said, "I want to retirehere. I love it here.?" An employee with over twoyears of service could not be fired without the ap-proval of a senior company officer.Selecting People for Open Positions. Costco'stop management wanted employees to feel that theycould have a long career at Costco. It was companypolicy to fill at least 86 percent of its higher-levelopenings by promotions from within; in actuality,the percentage ran close to 98 percent, which meantthat the majority of Costco's management teammem-bers (including warehouse, merchandise, administra-tive, membership, front end, and receiving manag-ers) were homegrown. Many of the company's vicepresidents had started in entry-level jobs; accordingto Jim Sinegal, "We have guys who started pushingshopping carts out on the parking lot for us who arenow vice presidents of our company.'?' Costco madea point of recruiting at local universities; Sinegalexplained why: "These people are smarter than theaverage person, hardworking, and they haven't madea career choice.?" On another occasion, he said, "Ifsomeone came to us and said he just got a master'sin business at Harvard, we would say fine, would youlike to start pushing carts'?" Those employees whodemonstrated smarts and strong people managementskills moved up through the ranks.But without an aptitude for the details of dis-count retailing, even up-and-coming employeesstood no chance of being promoted to a position ofwarehouse manager. Sinegal and other top Costco ex-ecutives who oversaw warehouse operations insistedthat candidates for warehouse managers be top-flightmerchandisers with a gift for the details of makingitems fly off the shelves; Sinegal said, "People whohave a feel for it just start to get it. Others, you lookat them and it's like staring at a blank canvas. I'mnot trying to be unduly harsh, but that's the way itworks.?" Most newly appointed warehouse managersat Costco came from the ranks of assistant warehousemanagers who had a track record of being shrewdmerchandisers and tuned into what new or differ-ent products might sell well given the clientele that

Costco's Business Philosophy,Values, and Code of EthicsJim Sinegal, who was the son of a steelworker, hadingrained five simple and down-to-earth businessprinciples into Costco's corporate culture and themanner in which the company operated. The follow-ing are excerpts of these principles and operatingapproaches:1. Obey the law-The law is irrefutable! Absenta moral imperative to challenge a law, we mustconduct our business in total compliance withthe laws of every community where we do busi-

ness. We pledge to: Comply with all laws and other legalrequirements.


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C a se 1 C os tc o W h ole sa le C o rp ora tio n: M is sio n, B u sin es s M o de l, a nd S tra te gy Respect all public officials and theirpositions.o Comply with safety and security standardsfor all products sold.o Exceed ecological standards required inevery community where we do business.o Comply with all applicable wage and hourlaws. Comply with all applicable anti-trust laws. Conduct business in and with foreign coun-tries in a manner that is legal and properunder United States and foreign laws.o Not offer, give, ask for, or receive any formof bribe or kickback to or from any person orpay to expedite government action or other-wise act in violation of the Foreign CorruptPractices Act.

o Promote fair, accurate, timely, and under-standable disclosure in reports filed withthe Securities and Exchange Commissionand in other public communications by theCompany.Take care of our members-Costco member-shipis open to business owners, as well as individ-uals. Our members are our reason for being-thekey to our success. Ifwe don't keep our membershappy, little else that we do will make a differ-ence. There are plenty of shopping alternatives forour members, and if they fail to show up, we can-not survive.Our members have extended a trust toCostco by virtue of paying a fee to shop with us.Wewill succeed only ifwe do not violate the trustthey have extended to us, and that trust extends toevery area of our business. Wepledge to:o Provide top-quality products at the bestprices in the market.o Provide high-quality, safe, and wholesomefood products by requiring that both vendorsand e r . . f J J p J D y e e s he ikl} {)[AWp)j_l&lrceFi~i~ tiWhighest food safety standards in the industry.

o Provide our members with a 100 percentsatisfaction guaranteed warranty on everyproduct and service we sell, including theirmembership fee..- Assure our members that every product wesellis authentic in make and in representationof performance. Make our shopping environment a pleasantexperience by making our members feel wel-

C-13

o Provide products to our members that will beecologically sensitive. Provide our members with the best customerservice in the retail industry.o Give back to our communities throughemployee volunteerism and employee andcorporate contributions to United Way andChildren's Hospitals.

3. Take care of our employees-Our employeesare our most important asset. We believe we havethe very best employees in the warehouse club in-dustry, and we are committed to providing themwith rewarding challenges and ample opportuni-ties for personal and career growth. We pledge toprovide our employees with: Competitive wages.o Great benefits.o A safe and healthy work environment.o Challenging and fun work.o Career opportunities.o An atmosphere free from harassment ordiscrimination. An Open Door Policy that allows access toascending levels of management to resolveIssues.

o Opportunities to give back to their communi-ties through volunteerism and fundraising.4. Respect our suppliers-Our suppliers are ourpartners in business and for us to prosper as acompany, they must prosper with us. To thatend, we strive to:

Treat all suppliers and their representativesas you would expect to be treated if visitingtheir places of business.o Honor all commitments. Protect all suppliers' property assigned toCosteo as though it were our own.o ~ l 'W A txce fA '" {7 :Awi tks of &'i'J' .t'i,'i\1 firOt'll 85r.iWt\.,": Avoid actual or apparent conflicts of interest,including creating a business in competitionwith the Company or working for or on be-half of another employer in competition withthe Company.

Ifwe do these four things throughout our organization,then wewill achieve our ultimate goal, which is to:5. Reward our shareholders-As a company withstock that is traded publicly on the NASDAQstock exchange, our shareholders are our busi-


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Sam's ClubC-14 P art 2 C as es in C ra ftin g a nd E xe cu tin g S tra te gy

as we are providing them with a good return onthe money they invest in our company .... Wepledge to operate our company in such a way thatour present and future stockholders, as well asour employees, will be rewarded for our efforts.

COMPET I T IONIn the discount warehouse retail segment, there werethree main competitors-Costco Wholesale, Sam'sClub (671 warehouses in six countries-the UnitedStates, Canada, Brazil, Mexico, China, and PuertoRico), and BJ's Wholesale Club (165 locations in16 states). At the end of 2006, there were just over1,200 warehouse locations across the United Statesand Canada; most every major metropolitan areahad one, if not several, warehouse clubs. Costco hadclose to a 55 percent share of warehouse club salesacross the United States and Canada, with Sam'sClub (a division of Wal-Mart) having roughly a 36percent share and BJ's Wholesale Club and severalsmall warehouse club competitors about a 9 percentshare. The wholesale club and warehouse segmentof retailing was estimated to be a $110 billion busi-ness, and it was growing about 20 percent faster thanretailing as a whole.

Competition among the warehouse clubs wasbased on such factors as price, merchandise qual-ity and selection, location, and member service.However, warehouse clubs also competed with awide range of other types of retailers, including re-tail discounters like Wal-Mart and Dollar General,supermarkets, general merchandise chains, specialtychains, gasoline stations, and Internet retailers. Notonly did Wal-Mart, the world's largest retailer, com-pete directly with Costco via its Sam's Club subsidi-ary but its Wal-Mart Supercenters sold many of thesame types of merchandise at attractively low pricesas well. Target and Kohl's had emerged as significantretail competitors in certain merchandise categories.Low-cost operators selling a single category or nar-row range of merchandise-such as Lowe's, HomeDepot, Office Depot, Staples, Best Buy, Circuit City,PetSmart, and Barnes & Noble-had significantmarket share in their respective product categories.

Brief profiles of Costco's two primary competi-tors in North America are presented in the followingsections; Exhibit 3 shows selected financial and op-erating data for these two competitors.

In 2007, Sam's Club had 693 warehouse locationsand more than 49 million members. Wal-MartStores opened the first Sam's Club in 1984, andmanagement had pursued rapid expansion of themembership club format over the next 23 years,creating a chain of 579 U.S. locations in 48 statesand 114 international locations in Brazil, Canada,China, Mexico, and Puerto Rico as of February2007. Many Sam's Club locations were adjacent toWal-Mart Supercenters. The concept of the Sam'sClub format was to sell merchandise at very lowprofit margins, resulting in low prices to members.

Sam's Clubs ranged between 70,000 and190,000 square feet, with the average being about132,000 square feet. All Sam's Club warehouseshad concrete floors; sparse decor; and goods dis-played on pallets, simple wooden shelves, or racksin the case of apparel. Sam's Club stocked brand-name merchandise, including hard goods, somesoft goods, institutional-size grocery items, and se-lected private-label items sold under the Member'sMark, Bakers & Chefs, and Sam's Club brands.Generally, each Sam's Club also carried software,electronics, jewelry, sporting goods, toys, tires andbatteries, stationery and books, and most clubshad fresh-foods departments that included bakery,meat, produce, floral products, and a Sam's Cafe. Asignificant number of clubs had a one-hour photoprocessing department, a pharmacy that filled pre-scriptions, an optical department, and self-servicegasoline pumps. Members could shop for a broadassortment of merchandise and services online atwww.samsclub.com.

Like Costco, Sam's Club stocked about 4,000items, a big fraction of which were standard and asmall fraction of which represented special buys andone-time offerings. The treasure-hunt items at Sam'sClub tended to be less upscale and carry lower pricetags than those at Costco. The percentage composi-tion of sales was as follows:

2006 2005 2004Food 32% 30% 31%Sundries 29 31 31Hard goods 23 23 23Soft goods 5 5 6Service businesses 11 11 9
http://www.samsclub.com./http://www.samsclub.com./


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C as e 1 C os te o W ho les ale C orpo ration : M iss io n, B us in ess M od el, a nd S tra te gy C-lS

3 Selected Financial and Operating Data for Sam's Club and 8J's WholesaleClub, 2000-20062006 2005 2004 2002 2000

S am 's C lu b"S ale s in U nite d S ta te s- ($ i n m i ll io n s ) $41,582 $39,798 $37,119 $31,702 $26,798O p er at in g in c om e ($ i n m i ll io n s ) $1,512 $1,385 $1,280 $1,028 $942Assets ($ i n m i ll io n s ) $6,345 $5,686 $5,685 $4,404 $3,843N um be r o f lo ca tio ns a t y ea r-e nd 693 670 642 596 564

U n ite d S ta te s 579 567 551 525 500In ternat iona l 114 103 91 71 64

A ve ra ge s ale s p er U .S . lo ca tio n ($ i n m il li on s ) $71.8 $66.7 $67.4 $60.4 $3.6A ve ra ge w are ho us e s ize (s qu a re fe e t) 132,000 129,400 128,300 125,200 122,100BJ's WholesalebN e t s a le s $8,303 $7,784 $7,220 $5,729 $4,767M em be rsh ip fe es a nd othe r $177 $166 $155 $131 $102To ta l r evenues $8,480 $7,950 $7,375 $5,860 $4,869S ellin g, g en era l, a nd a dm in is tra tive e xp en se s $698 $611 $556 $416 $335O p er at in g in c om e $144 $204 $179 $220 $209N e t i n co m e $72 $129 $114 $131 $132To ta lasse t s $1,993 $1,990 $1,892 $1,481 $1,234N um be r o f c lu bs a t y ea r-e nd 172 165 157 140 118Num ber of mem bers (OO O s) Not ava il. 8,619 8,329 8,190 6,596A ve ra ge s ale s p er lo ca tio n ($ i n m i ll io n s ) $48.3 $47.2 $6.0 $40.9 $40.4is c a ly e a rs e n d i n J a n ua ry 31; d ata fo r 2 006 a re fo r y ea r e nd in g Ja n ua ry 31, 2 00 7; d a ta f or 2 00 5 a re fo r y e ar e n d in g J an u ar y 31, 2006;s o o n .

F is c aly e ar s e n din g o n la s t S a tu rd a y o f J an u ar y; d a ta fo r 2 00 6 a re fo r y e ar e n din g J an u ar y 2 7, 2 00 7; d a ta f or 2 00 5 a re fo r y e ar e n din gn u ar y2 8, 2 00 6; a n d s o o n .F o rf in a n c ia l r e p o rt in g p u rp o s es , W a l -M a r t c o n s ol id a te s t he o p e ra ti on s o f a ll f or e ig n -b a se d s to re s in t o a s in g le " in t er n at io n a l" s e g m en tg u re ; hu s , f in a n c ia l i nf or m a ti on f or f or e ig n - ba s e d S a m 's C l ub l oc a ti on s i s n o t s e p ar a te ly a v ai la b le .

2006, Sam's Club launched a series of initiativesrowits sales and market share:Adding new lines of merchandise, with moreemphasis on products for the home as opposedto small businesses. Inparticular, Sam's had putmoreemphasis on furniture, fiat-screen TVs andother electronics products, jewelry, and selectother big-ticket items.Instituting new payment methods. StartingNovember 10, 2006, Sam's began acceptingpayment via MasterCard credit cards; priorto then, payment was limited to cash, check,Discover Card, and debit cards. Early resultswith MasterCard were favorable; company of-ficials reported that in the week following theMasterCard acceptance, the average ticketcheckout at Sam's increased by 35 percent.

Running ads on national TV. Sam's spent about$50 million annually on advertising and directmail promotions. During the 2006 holiday sea-son, Sam's ran national TV ads on high-profileTV programs likeDeal or No Deal, NBC's cov-erage of the Macy's Thanksgiving Day Parade,and the Thanksgiving Day NFL matchup be-tween the Detroit Lions and Miami Dolphinson CBS. The TV ads and companion print adsfeatured Sam's Club shoppers showing off theirpurchases with a background sound track play-ing "God Only Knows" by the Beach Boys-scenes included a young man watching sharkshows on a fiat-screen TV from his bathtub, awell-dressed woman buying a hot dog roaster,and a Florida couple buying a supersize inflat-able snow globe.


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C-16 P art 2 C ases in C rafting an d Execu tin g S tra tegy

The annual fee for Sam's Club business mem-bers was $35 for the primary membership card,with a spouse card available at no additional cost.Business members could add up to eight busi-ness associates for $35 each. The annual mem-bership fee for an individual Advantage memberwas $40, which included a spouse card. A Sam'sClub Plus premium membership cost $100 and in-cluded health care insurance, merchant credit cardprocessing, Web site operation, personal and finan-cial services, and an auto, boat, and recreationalvehicle program. Regular hours of operations wereMonday through Friday 10:00 a.m. to 8:30 p.m.,Saturday 9:30 a.m. to 8:30 p.m., and Sunday10:00 a.m. to 6:00 p.m.Approximately two-thirds of the merchandiseat Sam's Club was shipped from the division's owndistribution facilities and, in the case of perishableitems, from some ofWal-Mart's grocery distributioncenters; the balance was shipped by suppliers directto Sam's Club locations. Like Costco, Sam's Clubdistribution centers employed cross-docking tech-niques whereby incoming shipments were transferredimmediately to outgoing trailers destined for Sam'sClub locations; shipments typically spent less than 24hours at a cross-docking facility and in some instanceswere there only an hour. The Sam's Club distributioncenter network consisted of 7 company-owned-and-operated distribution facilities, 13 third-party-owned-and-operated facilities, and 2 third-party-owned-and-operated import distribution centers. A combinationof company-owned trucks and independent truckingcompanies were used to transport merchandise fromdistribution centers to club locations.BJ's Wholesale C lu bBJ's Wholesale Club introduced the member ware-house concept to the northeastern United States inthe mid-1980s. Since then it had expanded to 163stores operating in 16 states in the Northeast and theMid-Atlantic; it also had two ProFoods RestaurantSupply clubs and three cross-dock distribution cent-ers. BJ's had 144 big-box warehouses (averaging112,000 square feet) and 19 smaller-format ware-houses (averaging 71,000 square feet); the twoProFoods clubs averaged 62,000 square feet. Clubswere located in both freestanding and shoppingcenter locations. Construction and site developmentcosts for a full-sized BJ's Club were in the $5 to $8million range; land acquisition costs could run $5

to $10 million (significantly higher in some loca-tions). Each warehouse generally had an investmentof $3 to $4 million for fixtures and equipment. Pre-opening expenses at a new club were close to $1 mil-lion. Full-sized clubs had approximately $2 millionin inventory. Merchandise was generally displayedon pallets containing large quantities of each item,thereby reducing labor required for handling, stock-ing, and restocking. Backup merchandise was gener-ally stored in steel racks above the sales fioor. Mostmerchandise was premarked by the manufacturer sothat it did not require ticketing at the club.Like Costco and Sam's, BJ's Wholesale soldhigh-quality, brand-name merchandise at prices thatwere significantly lower than the prices found atsupermarkets, discount retail chains, departmentstores, drugstores, and specialty retail stores likeBestBuy. Its merchandise lineup of about 7,500 itemsincluded consumer electronics, prerecorded media,small appliances, tires, jewelry, health and beautyaids, household products, computer software, books,greeting cards, apparel, furniture, toys, seasonal items,frozen foods, fresh meat and dairy products, bever-ages, dry grocery items, fresh produce, flowers,canned goods, and household products; about 70per-cent of BJ's product line could be found in supermar-kets. Food categories and household items accountedfor approximately 59 percent of BJ's total food andgeneral merchandise sales in 2005; about 12percentof sales consisted ofBJ's private-label products, whichwere primarily premium quality and typically pricedwell below name-brand products. Insome product as-sortments, BJ's had three price categories for mem-bers to choose from-good, deluxe, and luxury.There were 125 BJ's locations with home im-provement service kiosks, 130 clubs with VerizonWireless kiosks, 44 with pharmacies, and 87 withself-service gas stations. Other specialty products andservices, provided mostly by outside operators thatleased warehouse space from BJ's, included photodeveloping, full-service optical centers, brand-namefast-food service, garden and storage sheds, patiosand sunrooms, vacation packages, propane tank fill-ing services, discounted home heating oil, an auto-mobile buying service, installation of home securityservices, printing of business forms and checks, andmuffler and brake services.BJ's Wholesale Club had about 8.6 millionmembers in 2006 (see Exhibit 3). It charged $45peryear for a primary Inner Circle membership that in-cluded one free supplemental membership; members


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C ase 1 C osteo W ho lesa le C orpora tion : M iss ion , B usin ess M ode l, an d S tra tegy

in the same household could purchase additionalsupplemental memberships for $20. A businessmembership also cost $45 per year, which includedonefree supplemental membership and the ability topurchase additional supplemental memberships for$20.BJ's launched amembership rewards program in2003that offered members a 2 percent rebate, cappedat $500 per year, on most all in-club purchases;members who paid the $80 annual fee to enroll inthe rewards program accounted for 5 percent of allmembers and 10 percent of total merchandise andfoodsales in 2005. Purchases with a co-branded BJ'sMasterCard earned a 1.5 percent rebate. BJ's wasthe only warehouse club that accepted MasterCard,Visa,Discover, and American Express cards at alllocations;members could also pay for purchases bycash,check, and debit cards. BJ's accepted returns ofmostmerchandise within 30 days after purchase.BJ's increased customer awareness of its clubsprimarily through direct mail, public relations ef-forts, marketing programs for newly-opened clubs,and a publication called BPs Journal, which wasmailed to members throughout the year; during theholidayseason, BJ's engaged in radio and TV adver-tising, a portion of which was funded by vendors.Merchandise purchased from manufacturerswas shipped either to a BJ's cross-docking facilityor directly to clubs. Personnel at the cross-dockingfacilities broke down truckload quantity shipmentsfrommanufacturers and reallocated goods for ship-mentto individual clubs, generally within 24 hours.

Endnotes

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Strategy Features that Differentiated Bps. Topmanagement believed that several factors set BJ'sWholesale operations apart from those of Costcoand Sam's Club:Offering a wide range of choice-7,500 itemsversus 4,000 items at Costco and Sam's Club.Focusing on the individual consumer viamerchandising strategies that emphasized acustomer-friendly shopping experience.

Clustering club locations to achieve the benefitof name recognition and maximize the efficien-cies of management support, distribution, andmarketing activities.Trying to establish and maintain the first orsecond industry leading position in each majormarket where it operated.Creating an exciting shopping experience formembers with a constantly changing mix of foodand general merchandise items and carrying abroader product assortment than competitors.Supplementing the warehouse format with aislemarkers, express checkout lanes, self-checkoutlanes and low-cost video-based sales aids tomake shopping more efficient for members.

Being open longer hours than competitors.Offering smaller package sizes of many items.Accepting manufacturers' coupons.

Accepting more credit card payment options.

'As quoted in Alan B. Goldberg and Bill Ritter, "Costco CEO Finds Pro-Worker Means Profi tabi li ty; ' an ABC News original report on 20120,August 2, 2006, http://abcnews.go.com/2020/Business/story?id-1362779 (accessed November 15, 2006).'Ibid.'As described in Nina Shapiro, "Company for the People," SeattleWeekly, December 15, 2004, www.seattleweekly.eom (accessedNovember 14, 2006).'2005 and 2006 annual reports.5Matthew Boyle, "Why Costco Is So Damn Addict ive," Fortune, October30, 2006, p. 130.'As quoted in ibid., pp. 128-29.'Steven Greenhouse, "How Costco Became the Anti-Wal-Mart," NewYorkTimes, July 17, 2005, www.wakeupwalmart.com/news (accessedNovember 28, 2006).'As quoted in Greenhouse, "How Costco Became the Anti-Wal-Mart."'As quoted in Shapiro, "Company for the People.""As quoted in Greenhouse, "How Costco Became the Anti-Wal-Mart.""Boyle, "Why Costco Is So Damn Addictive," p. 132.

"Ibid., p. 130."As quoted in Goldberg and Ritter, "Costeo CEO Finds Pro-WorkerMeans Profitability."14lbid."Ibid."Shapiro, "Company for the People.""Greenhouse, "How Costco Became the Anti-Wal-Mart."18Asquoted in Goldberg and Ritter, "Costco CEO Finds Pro-WorkerMeans Profitability.""Ibid.,oAs quoted in Greenhouse, "How Costco Became the Anti-wal-Mart""As quoted in Goldberg and Ritter, "Costco CEO Finds Pro-WorkerMeans Profitability.""Boyle, "Why Costeo Is So Damn Addictive," p. 132."As quoted in Shapiro, "Company for the People.""Ibid."As quoted in Goldberg and Ritter, "Costco CEO Finds Pro-WorkerMeans Profitability."'6As quoted in Shapiro, "Company for the People."
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1 Caso 1_Costco Wholesale