Costco business model and operations

Costco

The case notes that Costco's mission is "bringing the highest quality goods at the lowest possible prices while providing excellent customer service and adhering to a strict code of ethics…" and then the mission outlines the code of ethics. The company's operations clearly stick to this mission statement. This is possible because the mission statement is clear, and it specifically relates to what the company does. It hits upon a number of different elements of the business that essentially define what it is that Costco does.

The second element is that Costco does these things. The strategy of the company is to be a low cost provider, so a lot of what Costco does is related to that. When we examine the mission, we see that Costco is basically framing the low cost strategy against a backdrop of relatively high quality goods, good customer service and solid ethics. These last three things are basically a framing mechanism, however, that explains the parameters of the business. The business itself is still a low cost provider and so most of what Costco does supports that. It utilizes its strong bargaining power with suppliers to get low prices while delivering a reasonable standard of quality.

One of the more interesting aspects of the strategy is the human resources policy. Costco differs from other low cost providers in that it doesn't try to have a low labor cost, but rather it wants to have low labor turnover, because it believes that the costs associated with turnover are higher than the costs associated with good wages (McArdle, 2013). The result is that Costco has about the same productivity from its workers as other low cost providers do with their low-wage workers. The result is that Costco is able to fulfill more than one aspect of its mission -- it can provide low costs with higher service standards, something that other low cost providers struggle with.

2.

The business model for Costco is to offer a cost leadership position (Quick MBA, 2010). There are many aspects of Costco' business that specifically support this. The first is that it pays its employees a living wage, and this creates a high degree of loyalty. Costco therefore has much lower turnover than many of its peers, and the result is that the company has a higher level of efficiency from its employees, and they provide good customer service for a company with a low cost strategy.

Costco further supports the low cost strategy by offering relatively few SKUs. What this means is that the products that it does offer tend to sell quickly. Costco is therefore able to actually sell goods before it has to pay for them, creating a situation where it can get early payment discounts on goods that it has already sold, something that is of tremendous financial benefit. Further, this means that Costco is able to offer very low prices, which helps it to compete, because in the low cost business having the absolute lowest prices is an essential component of gaining market share.

Another element is the treasure hunting. This serves two purposes. The first is that it actively engages the customers in looking for bargains, which engages them bit more in the shopping process, giving them something of a value-added shopping scenario. Further, it reinforces in the minds of the customers that Costco is a steep discounter with the lowest prices, because they can go looking for these incredible bargains in the Costco store. Finding one incredible bargain is something that customers are more likely to remember than the fact that some items are the same price at Costco as they are anywhere else.

The low cost of the stores is also a key part of the business model. To succeed as a low cost provider, you really have to build the low cost mentality into the corporate culture. Everything from not heating the warehouses to having a CEO that takes relatively little salary gives the impression that Costco is determined to do everything in its power within its ethical framework to deliver on the lowest prices.

3. The Exhibits 1-4 do not tell much about the financial performance of Costco. They indicate that the company is growing still, that it sells a variety of products, that is growing (again), and again that it is growing. So the exhibits tell the same story a few different ways. But growth is not really enough for evaluating financial performance. The financial statements are better for telling that story. The first critical financial statement is the income statement. On the income statement, it shows that top line growth has been quite impressive, going from $71.4 billion in FY2009 to $105 billion in FY2013. Bottom line growth has been more rapid, as Costco has doubled its net income during the same period, even though it didn't double its revenues (MSN Moneycentral, 2014).

The balance sheet shows steady growth in both assets and liabilities, but equity growth has stagnated. This is probably not a good thing, as it indicates that the company's leverage has increased despite the steady increase in profitability. Growth appears to be faster than is possible to achieve simply be reinvesting profits, so Costco is increasing its debt in order to finance this growth -- there was a spike in long-term debt in FY2013, for instance. However, it is important to understand what extenuating circumstances there might be with respect to the balance sheet and the taking on of this debt. For example, debt is associated with higher risk but debt also comes with a low cost of capital. In recent years, interest rates on debt have been very low, and this might mean that Costco management specifically sought out this higher debt in order to lower its cost of capital. Alternatively, the company might have seen a real opportunity for growth and simply wanted to move fast, and therefore required some financing to make that happen. The overall result might be, therefore, that the increase in debt reflects specific managerial decision-making rather than simply unfavorable performance.