Corporate Culture and Costco

Costco

Programs, Budgets and Procedures

Costco's approach to financial improvement will come in the form of a two-pronged strategy. The first is to increase inventory turnover, and the second will come in the form of increasing market share. Inventory turnover is a standard ratio that refers to "how many times a company's inventory is sold and replaced over a period of time," ("Inventory Turnover," (n.d.). Increasing market share usually depends on a multifaceted process that includes "innovation, strengthening customer relationships, smart hiring practices and acquiring competitors," (Investopedia, 2015).

While it is understood that Costco has exceptional inventory turnover rates, improving these will shorten the cash conversion cycle, and thus have a positive impact on the company's bottom line. There are two potential approaches to lowering the inventory turnover rate. The first is that the company can open more stores and seek to reduce the amount of days' inventory in each store, thereby spreading the existing inventory level over more stores. The other thought is to seek a greater throughput in each existing store, thus increasing turnover without adding to fixed costs. This approach will, however, come with the downside of decreasing margin. That said, if Costco can reduce inventory as a percentage of its assets, this will result in more cash, which in turn can end up reinvested in the business.

The three-year budget shows how this can occur in the context of increasing sales. The three-year budget assumes steady sales increases that come from new stores. But over the course of this expansion, Costco will also gradually reduce the amount of inventory as a percentage of total assets, by way of increasing the inventory turnover rate. The objective of the strategy will be to decrease inventory from 23% of assets to 20% of total assets by the end of the 2019 fiscal year. Inventory levels will still increase during this period, but they will increase at a slower rate than the size of the company overall.

Another tactic that is part of the three-year plan is to reduce long-term debt to around 20% of total liabilities. At present, long-term debt represents 23% of total liabilities. The key to this will be to pay off debt when it matures, and then to not take out any more debt to replace it, but to replace that capital through ongoing operations, or through cash. The cash, naturally, will come from the inventory turnover reduction, where inventory is converted to cash more quickly; that cash is then used to pay down long-term debt more quickly. The overall goal will be to reduce the interest payments.

A number of tactics have been proposed to increase inventory turnover. A number of these represent discounting strategies. Deeper discounts reflects lower prices, or tighter margins. It is believed that there are products for which lower margins would be noticed by consumers, and thus would generate an increase in sales. These are products where there is price competition in the market, and where there is generally a higher-than-average price elasticity of demand. By focusing on cutting margins on products where this matters, Costco will bring more people through the door. In effect, such discounts serve as loss leaders. To encourage purchase of such goods, bundling strategies might be utilized.

Other tactics that could potentially support this initiative include releasing older inventory at clearance prices -- get rid of things that aren't selling, a sound merchandising strategy. Further, Costco could offer rewards as an enticement for consumers to purchase slow-moving goods. A tactic that was rejected was accepting more payment cards, such as Mastercard or Amex. At the end of the day, accepting more cards might entice a higher rate of turnover on the inventory, but the fees on those cards are sufficiently high that the fees would offset any gains made by increasing turnover. Thus, that idea was rejected.

Another thought was increasing non-member purchases, something that might entice more buyers. Some have speculated that this would be a bad business move -- so there is pushback at certain levels of management. But this move would increase turnover, especially for items that maybe do not move as quickly -- the big ticket items.

Part VIII. Control Procedures, Standards and Feedback

Internal control procedures help to ensure that goals are being met, and that the tactics that have been designed to help reach those goals. As Ingram (n.d.) points out, inventory control refers to "policies and procedures put in place to ensure the continued reliability of accounting systems," (p. 1). The biggest element of control is that the company's inventory is tracked in real time. Costco utilizes a system where each item is tracked as it enters the system, right through checkout when it leaves the system. So the company has fine-tuned data on each asset in its inventory.

To ensure that those counts are correct, it is recommended that the company conducts quarterly audits of data. The audits can be either internal or external, but both should occur with a certain regularity -- external perhaps on an annual basis. The purpose of the audits would be to ensure that the systems are working as intended, and that inventory levels are accurately reflected in the company's financial data, as well as any operating data that are used in managerial decision-making.

One thought that was rejected was monthly inventory counts. While appealing in principle to ensure accuracy, manual inventory counts are phenomenally expensive to conduct, and then subsequently reconcile with computer data, and the benefit is actually less than the cost of the count. At best, an annual count could be conducted, but spot counts are the more likely solution, where one store might be subject to inventory count, or a set of SKUs across the system. These counts can be designed to yield a statistically significant sample size to data analysis.

As Merchant (1982) points out, managerial control "can be a critical determinant of organizational success," (p. 1). Part of the managerial control function that should be implemented, if it has not been already, is that all employees, from managers down to front-line employees -- should have performance targets and evaluations against those targets. These are used to ensure that each member of the company's personnel is contributing in line with expectations to the overall performance objectives that the company has.