COSTCO BUS800 Ted Rogers School of Management, Ryerson University Paper ID: 277859818

SUBMITTED TO: ISABELLE GIROUX SUBMITTED BY: SIMON CAMPBELL, DARON MCKENZIE, MELANIE MICALLEF, MANOJ OOMMEN, MICHELLE ZINGARO SUBMITTED ON: TUESDAY, OCTOBER 23, 2012

Appendix A: External Analysis Key Economic and Industry Variables - Industry Analysis: • Costco is competing in the discount warehouse retailing industry. • In 2010, industry size is $125 Billion in North America. • Compete on price segmentation – using the lowest possible price to attract customers away from

indirect competition (i.e specialty retailers, big box stores, etc) • Industry is highly concentrated - three main players who compete directly and make up 100% of the

$125 Billion industry in North America. • Indirect competition is highly fragmented as players such as Wal-Mart, Dollar General, Target, etc.

all provide competition for specific goods, services or product categories offered at the three warehouse discount retailers.

• Industry is mature in North America - Sam’s Club closed 10 stores and is planning on opening 5-10 new locations, which includes relocations - BJ’s is planning on opening only 7-9 stores through 2010 including one relocation.

• Revenues in North America have slowed in growth/declined among all three players - Costco’s revenue dropped to $71,442MM (2009) from $72,483MM (2008) in overall operations - Sam’s Club and BJ’s both experienced very modest growth in 2009 over 2008, consistent with the initial phases of a mature market - Sam’s Club’s revenue grew from $44,336MM to $46,899MM, while BJ’s revenue increased from $8,792MM to $9,802MM over the same period.

• Asian markets are in a growth stage - Costco plans to double its number of locations in Taiwan from 6-12 over the next 5 years and revenues in International markets grew from $5,052MM (2008) to $5,137MM (2009) (the only segment showing growth) - sales in Taiwan tripled between 2004 and 2009, increasing from $250MM to $747MM.

• Growth in the retailing sector in Taiwan grew by merely 8.3% - Sam’s Club increased its international locations to 125 (2009) from 122 (2008) and 133 locations in 2010 - BJ’s has no international operations.

Implications for Costco are that since the North American market is matured and the International market is growing, the firm can expect to see increasing levels of competition in the domestic market and threats of new entry in the International segment. Further, with a saturated North American market, the firm must find unique ways to attract customers from their competitors, while increasing the switch costs to current customers to ensure further growth in this market. Key Forces in the Macro-Environment (PEST Analysis): • Global forces: 2/3 players are highly invested in international markets - with international markets

offering growth opportunities, these markets are expected to play an increasingly important role in the future.

• General economic conditions: impact the international firms heavily in host countries, as well as their overall operations.

Implications for Costco are that it must pay increasing attention to political, economic and socio-cultural factors in all countries it has operations. Competitive Analysis - Porters 5 Forces: Rivalry among Competing Sellers: Buyer demand is growing slowly in North America, increasing competition. However, buyer switch costs are fairly high due to the membership fees, product differentiation is low, sales are concentrated among a few large sellers, and exit barriers are low. With

! 2

all of this in consideration, the rivalry among competing sellers can be classified as weak-moderate. Firms in Other Industries Offering Substitute Products: Good substitutes are readily available and offer comparable features. Buyers also have low costs in switching to these substitutes offered by other industries, however these substitutes are higher priced relative to performance and features (which are generally the same). The threat of substitutes from other industries can be classified as strong. The Threat of New Entry: This industry includes; high economies of scale, significant experience-based cost savings, high capital requirements, and industry members who are willing and able to contest new entry. Because of this, the threat of new entrants is weak in North America. The growth of the industry in Asia suggests that the threat of new entrants in that market is strong. Bargaining Power of Suppliers: The items supplied are commodities, which are readily available from many suppliers. Industry member switch costs are low, and good substitutes to supplier products exist. Further, industry members account for a fairly large percentage of supplier sales (at least in unit figures as they buy in bulk), and the number of suppliers is large relative to industry members. The final consideration is that industry members do have the ability and potential to integrate backwards and eliminate the need for some of their suppliers. Due to these factors, the bargaining power of suppliers is weak. Bargaining Power of Buyers: Buyer switch costs are relatively high due to memberships. Buyers are also small and numerous relative to industry members. However, buyers are inherently price sensitive due to the nature of the industry, and industry products are standardized and undifferentiated. With that, the bargaining power of buyers can be classified as moderate.

The implications for Costco are that since the majority of the forces are weak or moderate, the industry is relatively attractive and outsiders could expect to make appealing potential profits. Because of this Costco should expect increasing competition, particularly in growth markets, and it must continue to compete heavily in North America to reduce the potential profitability to outsiders and maintain it’s market leadership position. Forces Driving Industry Change: • Globalization provides increased access to new/growth markets. This can be expected to increase

the number of firms in the industry as well as the competition level. • Product innovation is also important as all industry members have been actively increasing their

product offerings by adding specialty service departments to their warehouse outlets as they try to become one-stop-shops. This change can be expected to increase the competition among the industry members as well as increase competition between industry members and their indirect competitors.

• Technological change and manufacturing process innovation is also driving change in the industry. The use of the internet as a distribution channel is becoming increasingly popular among industry members. This can be expected to further increase industry competition, expand industry member’s reach, and increase competition among industry members and their indirect competitors.

The implications for Costco are that it must ensure that these driving changes are embedded into their strategy going forwards. With that, Costco must include being a leading one-stop-shop retailer as part of their vision, include online distribution as part of their growth strategy, and further develop and establish supply chains and supplier relationships internationally to support growth in International markets.

! 3

Competitive Position - What Market Position Do Rivals Occupy: Costco and Sam’s Club are both unfavourably positioned because they are competing in the exact same segment based on the two variables specified. BJ’s is in a unique position, with its wide product breadth and its uniquely geographically located Club stores, which avoid areas where Sam’s Club and Costco compete for customers. Costco should consider differentiating from Sam’s Club with product line breadth to ensure they can continue to out compete them and retain their market leader position. The KSF in the Industry: Distribution, supply chains and logistics are the foundation for success in this industry. These activities allow the firms

to offer bulk products at extremely low prices, the essence of their value proposition. Costco performs very well in this area. The firm efficiently utilizes supplier relations to have many goods sent directly to the warehouse outlets, and in tandem efficiently utilizes its distribution centers with methods such as cross-docking, to ensure a constant and effective supply of all goods not directly delivered by suppliers. Competitor Analysis:

Sam’s Club has a strong incentive to acquire BJ’s as they are competing directly with the market leader, Costco, and possesses the resources required to complete this acquisition. BJ’s is a likely candidate to enter new geographic markets. BJ’s is also highly mobile and versatile in this regard as they feature stand-alone and shopping centre-based locations. It is unlikely that BJ’s will extend their product line as it is already wide by industry standards, however as Sam’s Club looks to gain ground against Costco and both firms are diversifying to become one-stop-shops, this may be a viable strategic move for Sam’s Club in the near future. Costco needs to prepare for strategic moves from Sam’s Club, whether it is an acquisition of BJ’s or a product expansion. Further, Costco must be prepared to defend against BJ’s should they choose to expand geographically. Costco must find a way to be unique and appealing to customers in comparison to firms (both Sam’s Club and BJ’s) that may potentially have both a wide geographic reach and a wide product offering.

Company Strengths Weaknesses Threat

Sam’s Club

- Subsidiary of Wal-Mart - Immense resources & capabilities (distribution & logistics) - 36% of market share - low membership fees ($35 & $40) - Gold Key Program, business members can shop at 7am

- Relatively unattractive selection of treasure hunt items - Closed operations in Canada

Big Threat - Likely to increase their market share, and/or acquire BJ’s

BJ’s

- Geographically focused, can increase brand familiarity & recognition - Customer-focused shopping experience, with broader product selection, aisle markers, longer hours, smaller packaging, 3 price categories - Accept manufacturer’s coupons & all methods of payment & extensive online offerings - Relatively low membership fee ($45) - Loyalty program & charitable foundation - Highly advanced IT system

- Geographically concentrated in Eastern U.S.A., implies loss in market investment - Extensive marketing investments, only controlling 8% of market

Potential Threat - potential to expand into new markets

! 4

Appendix B: Internal Analysis Vision: implied vision – “to be the world’s best discount warehouse retailer”. Mission: “To continually provide our members with quality goods and services at the lowest possible prices.” Costco’s Value Chain:

! Secondary activities in Costco’s supply chain include: marketing, and general administration.

Site Selection: Costco adds value by imposing their internal criteria - locations on high traffic routes, near upscale suburbs, ones that are easily accessible by small businesses and residents who have above average income and avoids prime real estate sites to keep overhead costs low. Human Assets: Costco adds value with their training, culture, and internal development, which stresses efficiency and merchandizing capability. Heavily empower its warehouse managers to the point where they are essentially running their own organization. Costco is committed to internal development, therefore, saves on training expenditures. Product Sourcing and Supply Chain Management: Costco effectively sources luxury items for their treasure hunt selection and utilizes efficient logistics, having most products delivered directly to their stores to reduce storage costs, further adding value through efficiency to their operations. Distribution: Costco utilizes nine cross-docking depots, which serve as distribution points for near by stores. Costco is able to turn over inventory in these depots in under 24 hours. Inventory Management: Costco keeps items on the sales floor to further reduce storage costs to add value to their customers. Profit Margins: Costco’s margins are 14% on brand name items and 15% on private label items. These low margins are the final step in adding value for customers. VRIO analysis:

Costco has no significant s o u r c e s o f c o m p e t i t i v e advantage. Their supply chain, an industry KSF, provides them with only competitive par i ty. Brand name and reputation as well as customer l o y a l t y a l s o r e s u l t i n competitive parity, providing a performance level normal for

the industry. Although Costco has strong supplier relations, these are not rare in the industry, and the competitors are also able to source directly from brand name manufacturers. Human capital and incentive systems are the only area that Costco has a rare industry resource and capability. Costco develops its managers internally to be excellent merchandisers who are able to effectively execute operations in a manner conducive to the company’s strategy. Costco also provides above normal compensation and benefit packages to keep its employees motivated and committed to the organization and its success. The implication of this is that Costco has no sustainable competitive advantage. There is also no real incentive for BJ’s or Sam’s Club members to switch to Costco. This implies that Costco

Site Selection Human Assets

Supply Chain Management Distribution Inventory

Management Profit Margin

! 5

will have to differentiate from these competitors in order to sustain their market share. As is, Costco has no competitive resources or capabilities that will ensure its future success. Financial Analysis:

Inventory turnover ratio: shows the average amount of inventory that is held over a year and second the total cost of inventory that has been sold. The average inventory amounts for over 50% of Costco’s current assets. Given their current growth strategy liquidity is not an issue; however if the company runs into financial difficulty they will have a difficult time converting their inventories into cash to pay creditors as indicated by their .54 quick ratio. Inventory turnover ratio: indicates that Costco will go through it’s in inventory 11.94 times a year, which is 15% more than BJ’s Wholesale. Given that BJ’s carries 75% more items that Costco, it indicates that they are able to go through their inventory efficiently. This is an indication that Costco has the opportunity to expand its product variety in order to attract various customers from different demographics. Days Sales inventory ratio: indicates how long it takes Costco to convert their inventory into sales. This is of importance because it indicates their ability to take advantage of supplier payment terms. Most suppliers provide discounts to retailers if payments are made within 15 or 30 days. Since it takes Costco just over 30 days, on average they should be able to add to their revenues by way of discounts. By stocking fewer items one can note the shorter cash conversion period, when comparing Costco to BJ’s. Return on assets: is lower than BJ’s because of Costco’s 14% margin cap. If Costco was to increase their margins, net income would be higher which would in turn produce a higher ROA ratio. In comparison to BJ’s and Sam’s Club, Costco is creating stores at a faster rate. As a whole they increased the number of stores by 2.93%. This is in line with their expansion strategy.

2009 Costco Sam's Club BJ's

Sales $69,889 $401,224 $9,802

Inventory $5,405 $860

Current Assets $10,377 $1,076

Current Liabilities $9,281 $909

Net Income $1,086 $135

Cost of goods Sold $62,335 $9,004

Warehouses

Beginning 512 713 177

Ending 527 727 180

Inventory Turnover 11.94 n/a 10.37

Days sales inventory 31.65 n/a 34.86

Current Ratio 1.12 n/a 1.18

Quick Ratio 0.54 n/a 0.24

Return on Assets 5% 0% 7%

Return on Equity 11% n/a n/a

Growth in terms of warehouses 2.93% 1.96% 1.69%

! 6

SWOT Analysis:

Strategic issues: • Costco must also find a way to turn its capabilities and resources into sustainable competitive

advantage or develop new distinctive capabilities to help generate sustainable competitive advantage.

• As profit margins are low and customer membership fees represent a significant portion of revenue, Costco must focus on increasing its retention rate to ensure future financial viability and success.

• Costco must continue to utilize effective sourcing/distribution/supply chain management for continued success and international expansion.

Strengths: • Distribution related activities and supply chain

management. • Strong growth strategy. • Strong brand name and reputation. • Customer loyalty and large customer base. • Revenues from membership fees generate a large

portion (70%) of operating profits (ensuring future revenues and profits).

• Revenue growth rate, especially internationally. • Human assets. • Market leader position. • Wide geographic coverage, number of locations. • High quality Kirkland private label.

Weaknesses: • Heavy reliance on membership fees for profits due to

extremely low margins. • Offer relatively low payment options for members. • Slow growth in membership acquisition. • Lack of relative strength in information technology

capabilities. • 87% retention rate, as membership fees are a substantial

portion of revenues, Costco should be focused on increasing retention to maximize profitability.

Opportunities: • Growth in new geographic markets. • Online sales channel increases product offering

and distribution. • Expand into other sections of the strategic group

map by expanding offerings. • Possibility to vertically integrate backwards into

supply chain.

Threats: • Mature North American market intensifies competition. • Increasing competition in growth markets such as Asia. • Ease of substitution from other industry members and non-

industry members. • Sam’s Club potential acquisition of BJ’s. • Potential geographic expansion of BJ’s. • Changing political, economic and socio-cultural conditions

in international markets. • Currency fluctuations.

! 7

Key Strategic Issues:

Costco must find a way to turn its capabilities and resources into sustainable competitive advantage or

develop new distinctive capabilities to help generate sustainable competitive advantage. As profit

margins are low and customer membership fees represent a significant portion of revenue, Costco must

focus on increasing its retention rate to ensure future financial viability and success. Finally, Costco

must continue to utilize effective sourcing/distribution/supply chain management for continued success

and international expansion.

Rationale for Issues:

Presently, Costco does not a sustainable competitive advantage over the competition because it does

not have any differentiating capabilities or resource have any capabilities or resources. Costco has only

one capability which provides it with above normal industry performance and temporary competitive

advantage. This lack of competitive advantage jeopardizes Costco’s market leader position going

forwards and the sustainability of the business in the long term. In order to ensure the firm is able to

maintain its market leader position, it must focus on further developing its capabilities and resources. A

key capability Costco must consider developing is its supply chain and distribution capabilities, which

are discussed next.

An important key success factor to this specific industry is supply chain management. In order for a

discount warehouse retailer to become or remain competitive they must have a high inventory turnover

and low supply chain and distribution costs. Since most discount warehouse retailers store their

inventory on the sales floor and not in distribution centers, the need for effective and efficient supply

chain management and a high inventory turnover is crucial. Costco has excelled in this area. As noted

in the financial analysis, Costco’s inventory turnover was 11.94. This means that approximately once a

month Costco clears their inventory. Since Costco is continuing to expand internationally, they must

! 8

maintain or even improve this number, while keeping costs minimal, to remain competitive in the

discount warehouse retailing industry.

Although the membership renewal rate of 87% seems high for any company, the question remains as to

where the other 13% of these members are going, and what is causing them to defect? In order for

Costco to increase profits, competitiveness, and longevity, it is extremely important for retention to be

as high as possible. This need is heightened by the fact that Costco relies so heavily on membership

fees, which make up the vast majority of the firms Net Income. An increase in Costco’s customer

retention reflects increased satisfaction, which also leads to an increase in word of mouth business and

the attraction of new members.

Recommended Strategy for Costco:

As part of our recommendation for Costco’s integrative strategy, our team suggests that in order to help

provide Costco with a competitive advantage in the industry, it should focus on its major strength and

industry key success factor; supply chain management. Specifically, our team feels that the vertical

integration of key suppliers could be extremely beneficial. If Costco were to acquire one of the key

suppliers of its Kirkland private label (for instance one which supplies one of the most popular

products), it would have a rare resource compared to industry members. To further develop the supply

chain, our team feels that it would be beneficial for Costco to invest further in information technology

to help reduce costs and increase the efficiency of operations. This IT resource should be developed

and implemented with the intention of eliminating the 9 distribution centers. Specifically, this system

should allow them to manage their supply chain in such a way that they are able to source all products

directly to their stores, without the need for these centers. With an even more efficient IT system, along

with the elimination of their 9 distribution centers, Costco would realize a significant reduction in over

head expenses and increased profits. Money saved from this strategy could be directed elsewhere

! 9

within Costco to continue promoting growth to remain the industry leader.

Our team feels that there are several initiatives Costco can implement to increase customer retention.

First of all, Costco should focus on enhancing the customer experience by making it easier for them to

shop at Costco. To do so, a key, yet simple change, Costco should make is to increase the number of

payment methods accepted. Another way to enhance the customer experience is to increase on-line

presence and offerings. Presently, Costco only offers products through its on-line distribution channel

that cannot be easily displayed on the sales floor. Increasing the product selection available on-line

would make it easier for customers to buy from Costco and encourage them to increase the frequency

of their purchasing. Further utilizing on-line distribution would allow Costco to reach more of the

population and more of its members in a cost effective way, thereby increasing customer satisfaction

and retention. Finally, to further develop customer loyalty and increase purchase frequency, our team

feels it would be beneficial for Costco to offer a stand-alone rewards program to its members.

Providing customers an incentive to spend more and purchase more frequently would increase

customer loyalty, and help Costco improve even further on its already strong inventory turnover ratio.

! 10