Costco's Business Model Is to Undertake a Essay

Excerpt from Essay :

Costco's business model is to undertake a cost leadership strategy. The company operates with a warehouse store concept. The warehouse store concept focuses on offering large volumes of goods at low prices. A typical Costco warehouse has a relatively low number of SKUs available, and any given product is usually only available in a single SKU. Consumers are attracted to the low prices associated with volume buying. Each store has a set number of permanent items, with other items rotated through on a temporary or seasonal basis. This keeps the selection of goods relatively fresh for consumers.

Costco is able to achieve cost leadership through a number of different strategies. The first of these strategies is volume buying. Costco gets discounts over what other retailers get because of its ability to buy large quantities of any good. Thus, the company's size allows it efficiencies of scale in purchasing, distribution and sales that in turn allow it to offer low prices to consumers. Frills such as store design are eliminated as needless in the Costco business model. In addition, Costco does not have carrying costs for debt and has very low carrying costs for its inventory as part of its cost leadership strategy.

The business model is appealing for a couple of reasons. Consumers find the Costco business model to be appealing because of the low prices that Costco offers. The cost leadership strategy, no matter how applied, is typically very popular with American consumers. The business model is also appealing for investors because any company that can successfully apply this model is likely to enjoy a strong market share. The business model has built in feedback loops wherein the low prices facilitate growth in volume, which in turn improves the company's buying power, allowing it to lower prices further. Smaller competitors have difficulty matching prices of a firm as large as Costco because they lack the buying power and operating efficiencies. Costco was able to establish dominant market position in warehouse retail with its first mover advantage, which has facilitated its ability to stay ahead of its competition.

The biggest difficulty with the Costco business model is with respect to the difficulty of executing it. Cost leadership demands excellence in all aspects of the business, especially operating efficiency. A single-minded pursuit of cost-cutting is typically required in order to properly execute this model. In addition, there is generally room for only one or two highly successful retailers with this strategy, as market share is a key determinant in efficiency and buying power. As such, this business model would not be attractive to a new firm in the industry today because there are three major competitors in the U.S.; but for established firms the model remains highly attractive.

One of the elements of the cost leadership strategy that is particularly appealing is that the strategy requires the company to be a best-in-industry performer. Working on a top cost leader is challenging, but successful implementation of the strategy allows a firm to be a volume leader with high market share. In short, the cost leadership strategy is a "go big or go home" strategy, and that has tremendous appeal to both consumers and to potential managers considering working in the industry.

2. There are several chief elements of Costco's strategy. These include efficiencies of scale, merchandising, working capital management and human resources. Efficiencies of scale allow Costco to purchase goods at low prices, and then pass those savings onto customers. Costco also enjoys significant savings from its economies of scale in distribution and logistics as well. The store locations are typically in lower-rent suburban areas, which allows the company to minimize the cost per square foot of its stores, increasing profit per square foot.

Costco's merchandising strategy is another key element. In addition to the standard range of products, Costco also rotates through a number of limited time products. Some of these are loss leaders, such as major label goods that are not normally found at discount prices. These products represent substantial savings, and bring customers into the store. In addition, the limited stock of goods allows for faster inventory turnover. The variety of goods that Costco sells allows for the company to have a high average ticket because consumers can find savings on a broad range of goods -- they may come in for cheap food but they leave with electronics, furnishings and other items as well.

Working capital management is a significant source of savings for Costco. The company sells goods quickly, which allows it to pay its suppliers with the cash generated from the sale of the good, and sometimes even capture the early payment discount. This allows Costco to operate with almost no accounts receivable. Thus, Costco is able to cycle its earnings back into the business immediately, tightening the working capital turnover cycle and improving working capital efficiency. The high rate of inventory turn also allows Costco to operate with a minimal amount of inventory, lowering the costs associated with warehousing and logistics.

In order to execute its strategies, Costco needs to have a high quality workforce that makes the right decisions, supports the customers and makes few mistakes. As such, Costco has chosen human resources as the one area not to cut costs. This engenders strong loyalty to the company, giving Costco a very low turnover rate for a retailer. This lowers the costs associated with training and employee learning curves, something that the company considers to be important given the need for perfection in executing the firm's management systems.

The strategy has proven to be excellent for Costco. Each element of the strategy contributes to the ability of Costco to maintain a cost leadership stance. The company has the lowest costs associated with inventory and working capital management of any retailer, and its low turnover and high employee loyalty allow it to perform well on customer service and to execute its systems with a high level of effectiveness. The evidence of the success of Costco's strategies has been in its ability to deliver low prices to customers, which in turn has fueled strong growth in revenues, profits and market share. In addition, it is worth noting that in its history, Costco has never changed the core elements of its strategy. This, combined with the company's success, indicates that the strategy has been successful and the company believes that there is no reason to make adjustments to the strategy.

3. I believe that Sinegal is an effective CEO. There are two main reasons for making this claim. The first is the company's success in terms of revenues, profits and market share; the second is the esteem in which Sinegal is held within the company. Sinegal is the clear leader of Costco. He leads by example, following the same strategies to which he expects the rest of the organization to adhere. This has earned him a strong following within the company, and Sinegal is received well at every Costco store as a result. If Sinegal was not an effective leader, his reputation among Costco workers and managers would be poor.

Ultimately, however, Sinegal owes his duty to the shareholders of Costco. His leadership is measured by his ability to deliver financial results. In that, Sinegal has also proven to be a highly effective leader. In the 2010 fiscal year, Costco recorded sales of $77.946 billion and profits of $1.303 billion. These figures are both company records, and both show evidence of steady growth over the past five years (MSN Moneycentral, 2010). Earnings per share are also high, and the company's returns, which although below industry averages are consistent with those of a high-volume, low-margin retailer. Costco's balance sheet is equally healthy, again indicating the success of Sinegal's strategies.

I would give Sinegal an A in both crafting and executing Costco's strategy. The strategy that Sinegal laid out for Costco was risky and courageous at the time. There were few successful firms attempting this strategy, but Sinegal had enough vision to realize that it could work on a large scale. The strategy combines disparate elements -- logistics and purchasing, merchandising, human resources, information technology, working capital management and leadership -- and each serves a specific purpose within the overall strategy at Costco. This indicates that the strategy was well-conceived from the outset, especially given that there have not been any major strategic changes over the course of the company's growth.

Executing this strategy represented another challenge. The margin for error is very low at Costco (the company has a gross margin of just 12.8% and a net margin of 1.7%) so executing is critical to the company's success (MSN Moneycentral, 2010). The biggest challenge with respect to executing Costco's strategy is probably scaling the strategy up from a small regional operation to a national (now international) powerhouse. Scaling up a strategy that relies on flawless execution is difficult because of human resources constraints, but Costco has been able to clearly and effectively communicate its vision and its processes…

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