Offering frequent news and analysis from the majestic Evergreen State and beyond, The Cascadia Advocate is the Northwest Progressive Institute's unconventional perspective on world, national, and local politics.

Monday, July 25, 2005

The Costco Business Philosophy

Several days ago, I read a New York Times article about Costco (How Costco Became the Anti-Wal-Mart) which was subsequently picked up this weekend by Daily Kos and David Goldstein of HorsesAss.org.

The article was old news to me. It was almost like a more up to date version of an article I read which was published in the December 15th 2004 issue of Seattle Weekly, or even the original article I saw in the November 2003 issue of FORTUNE. That article was entitled, "The Only Company Wal Mart Fears" and it started off like this:
In the world of retailing, Wal-Mart is the unstoppable, insatiable force. With $247 billion in revenues—and growing 15% a year—it reduces downtown shop owners to quivering jelly and once-formidable competitors, like Kmart, to bankruptcy. Wal-Mart CEO Lee Scott rules the commercial strip the way Julius Caesar once ruled the Roman republic.

Except, that is, for a solitary rebel-held province where a company 20% the size of Wal-Mart has made a monkey of the 800-pound gorilla. In the retail niche of warehouse clubs, the irresistible force is an irresolute flailer. During the past ten years Wal-Mart has gone through five CEOs and countless stratagems at Sam's Club trying to assume its customary command.

All have been thwarted by Costco Wholesale, the master of the cavernous space.
Yes, Costco Wholesale, our local warehouse titan, is increasingly becoming known as the anti-Wal Mart because of the way it runs its business. But unlike the New York Times article, the 2003 FORTUNE article offered a a lengthy, powerful glimpse into what makes Costco so successful.

Before I get to those excerpts, though, here's an excerpt from FORTUNE which gives you some idea of how Costco does business:
Consider some figures. Sam's Club has 71% more U.S. stores than Costco (532 to 312), yet for the year ended Aug. 31, Costco had 5% more sales ($34.4 billion vs. an estimated $32.9 billion). The average Costco store generates nearly double the revenue of a Sam's Club ($112 million vs. $63 million).

Costco is the U.S.'s biggest seller of fine wines ($600 million a year) and baster of poultry (55,000 rotisserie chickens a day). Last year it sold 45 million hot dogs at $1.50 each and 60,000 carats of diamonds at up to $100,000.
Costco has been beating Wal Mart at its own game. And people love shopping there:
Chef Julia Child [used to] buy meat at Costco. Yuppies seek the latest gadgets there. Even people who don't have to pinch pennies shop at Costco. "I like bargain securities," says Berkshire Hathaway vice chairman Charlie Munger, a Costco shopper, investor, and director. "Why shouldn't I like bargain golf balls?"
Indeed. My family has patronized Costco Wholesale for years. We shop there at least every month, mostly buying food, but also occasionally books, outdoor and recreational equipment, clothing/accessories, and electronics.

Now to FORTUNE's profile of Costco's leader:
James D. Sinegal, the president and CEO of Costco, has no palace guard and no profile to speak of, particularly compared to a retail legend like Sam Walton.

Yet he's the guy who in 20 years has taken Costco from a startup to the FORTUNE 50 using, as surely as Mr. Sam, highly distinctive practices. He caps Costco's markups at 14% (department store markups can reach 40%).

He offers the best wages and benefits in retail (full-time hourly workers make $ 40,000 after four years). He gives customers blanket permission for returns: no receipts; no questions; no time limits, except for computers — and even then the grace period is six months.
There can be no doubt - Mr. Sinegal is truly a great man who understands that good business means treating your workers well.

As in the New York Times article by Mr. Greenhouse, FORTUNE's writer noted that Costco has come under attack by Wall Street suits:
Analysts have pounded on Sinegal to trim the company's generous health benefits and to otherwise reduce labor costs. But he's taken only limited steps in that direction, like modestly increasing employees' share of health-insurance premiums. That doesn't satisfy critics like Deutsche Bank analyst Bill Dreher, who recently wrote, "Costco continues to be a company that is better at serving the club member and employee than the shareholder."
Yeah - shareholders are entitled to always be treated better than customers and employees - right, Mr. Dreher? That's how Wal Mart works.

Well, James Sinegal says - Not at Costco! A quote from the FORTUNE article:
"We think when you take care of your customer and your employees, your shareholders are going to be rewarded in the long run. And I'm one of them [the shareholders]; I care about the stock price. But we're not going to do something for the sake of one quarter that's going to destroy the fabric of our company and what we stand for."
Admirably stated - and an excellent philosophy.

The FORTUNE article then delves into what makes Costco different from Sam's Club, noting how Costco set its sights on small business owners while Wal Mart executives ended up defaulting to their comfort zone: the mass middle class market.

And playing catch up is difficult:
On a recent reconnaissance mission to Sam's Club, [Costco Chairman] Jeff Brotman was near a stack of Ralph Lauren Polo shirts when he overheard a customer say, "Can you imagine? Who in their right mind would buy a T-shirt for $39?" Says Brotman: "It was actually a very good deal; it would have cost $59 in a department store. But she didn't see the value, and Sam's built its customer base on people like that. It's very difficult to shift gears."
As someone who has studied marketing, I was intrigued by this article when it came out two years ago. What Costco understood was what its primary target market should be - the target market it could build its business around.

The FORTUNE article then describes Costco's roots and the "axioms" that its business model is built on. One of the most important ones:
AXIOM NO. 3: Take care of your employees...Costco pays the top wage in retail, starting employees at $ 10 an hour. In the minds of Price and Sinegal, high wages yield high productivity, low turnover — Costco's is a third of the retail industry average of 64%, according to the National Retail Foundation — and minimal shrinkage; that's retail-speak for theft, which at Costco is about 13% of the industry norm.
Costco proves that treating your workers well is good business and reduces costs.

I especially enjoyed this part from the FORTUNE article about CEO Sinegal's energy and leadership style:

Sinegal reinforces [the business philosophy] by traveling 200 days a year, trying to visit every store twice annually. He's got energy that leaves people half his age floundering in his wake. (Must be the near-daily racquetball games.)

He doesn't inspect the troops; he interrogates them. CFO Richard Galanti, who sometimes goes along, recites the typical Sinegal rat-a-tat to store managers: "What's hot? What's Sam's beating us on? Have you seen that item in Best Buy? Don't you think we should have that?" All the while Sinegal scribbles notes that, upon his return to headquarters, will become the basis of memos and more questions that he will fire off in all directions.
Amazing. What a leader. He certainly sets the standard for other executives.

And he's humble, something that's almost unheard of for an executive:
Sinegal has also kept himself in the good graces of subordinates by limiting his pay. His $350,000 salary last year was practically cause for drumming him out of the FORTUNE 500 CEO club; and at his own request, he took no bonus for the third consecutive year.

He does have $ 16.5 million worth of options, but he's intent on capping his salary and bonus at about twice the level of a Costco store manager.
Neither does he care that Wal Mart - through Sam's Club - is trying its very hardest to challenge Costco:
[Sinegal] loves keeping his troops in "a state of healthy paranoia," and there's no better motivational tool than telling them the superpower's missiles are aimed at them. "We've succeeded by being a moving target, by hitting them where they ain't," says Sinegal. "We need constant reminders to keep us on our game. I say at our management conferences that the amount Wal-Mart grows in just one year is the equivalent of Costco's size."
Here's to James Sinegal, here's to Costco, here's to good business, and here's to its future.

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