Sticking to the Plan – Costco’s Recession Success

By: Tommy Chan

Costco, the fifth largest retailer in the United States (second in Canada), is maintaining its focus on the low price component of their retail value proposition. The recent changes in the retail environment have caused many retailers to rethink their strategies. Costco, however, have only focused on improving on its initial retail value proposition and is having success in this recession.

Value is created by passing cost-savings down the value chain to the end consumers through a retail value proposition that offers low prices above all else - every component of the well-oiled Costco machine is carefully designed to lower cost, in alignment with the firm’s value proposition. Suppliers are given bare-minimal margins. Costco carries approximately 4500 SKUs, around 10% the amount of competitors (Wal-Mart & Target), for economies of scale advantages. Marketing and store decorations are practically non-existent. Margins on branded and private label items are 10% less than most supermarkets and 30+% less than department stores.

Costco’s retail strategy involves more than just price discounts. Costco warehouses are optimized to maximize sales. Luxury items are placed at the front entrance of the store to instil impulse buys. These product line-ups are rotated constantly to further encourage shoppers to buy them now. Food and other essentials that make up 60% of Costco’s sales are placed in the very end of the store. Comfort and ambience are virtually non-existent. To capture value from the end consumer, Costco charges a fixed membership fee and offers their products in bulk quantities. Both of these components decreases convenience but further improve the low prices. The stores’ set up clearly compromises convenience and experience in order to maximize sales and keep prices low.

This complete alignment towards a simple but effective strategy is the key to Costco’s success. There are many retailers with price-driven value propositions, but none as successful as Costco, whose commitment towards lowering cost in every aspect of the business gives them an operating efficiency that is hard to match.

Costco’s strategy relies on very precise management of cost, leaving their value chain vulnerable to any severe external changes. Up to this point, Costco is performing exceptionally in this recession despite external pressures on their position: supplier prices have increased; rival firms are vying for Costco’s market share; buyer demands are at an all time low. To compensate for these external changes, Costco has employed even more rigorous and innovative cost cutting techniques – i.e. round peanut jars were repackaged into cubic containers to reduce transportation, storage, and shelving expenses. By focusing on its operating efficiency, Costco has managed to maintain its retail value proposition.

While other retailers (Wal-Mart, Hudson Bay) are succumbing to the pressure of altering their core retail strategies to adapt to the new environment, Costco is stern on maintaining its tested retail formula. Can Costco continue to employ this same strategy and survive? The warehouse giant’s current value proposition clearly appeals to a sustainable market segment in a way none of Costco’s competitors can. With demand shrunk, large retailers like Costco are now defending their consumer base from competition. This creates a situation where Costco may have to continuously reinvent or improve itself to remain in the number one position of warehouse sales. Will Costco have to change its core strategy to survive?

I personally believe that with cost savings so fully integrated into Costco’s value chain, it would have been very risky for Costco to initiate changes in its value proposition. Neither consumers nor managers may react well to a sudden change in this fundamental component of Costco’s business plan. Furthermore, the changes within the external environment continue to align with Costco’s retail strategy and managerial preferences. While a price driven value proposition is not the only option to survive this recession, it is the strategy that best-aligns with Costco’s resources and capabilities. Strategic change should be anticipatory rather than responsive, but it should never compromise the alignment between a retailer’s value proposition and its internal capabilities. For now, as long as Costco maintains its discipline towards maximizing their retail value proposition, they will be successful.

Sources:
· (Put Costco on Your “To-Buy” List, Kiplinger.com, 2008 ) http://www.lexisnexis.com/us/lnacademic/results/docview/docview.do?docLinkInd=true&risb=21_T5763071634&format=GNBFI&sort=RELEVANCE&startDocNo=1&resultsUrlKey=29_T5763071641&cisb=22_T5763071640&treeMax=true&treeWidth=0&csi=146142&docNo=1
· (Costco’s Artful Discounts, Business Week, 2008)
http://www.lexisnexis.com/us/lnacademic/results/docview/docview.do?docLinkInd=true&risb=21_T5751320963&format=GNBFI&sort=RELEVANCE&startDocNo=1&resultsUrlKey=29_T5751320980&cisb=22_T5751320979&treeMax=true&treeWidth=0&csi=7923&docNo=2
· (Managing Costco in a Tough Economy – Business Week, 2008) http://feedroom.businessweek.com/?fr_story=5d7681157aafa9ed796cb26519a17eaa07311398
· (How Costco Became the Anti-Wal-Mart – New York Times, 2005) http://www.nytimes.com/2005/07/17/business/yourmoney/17costco.html?pagewanted=all
· (The Perfect Storm, Super Market News, 2009) http://www.lexisnexis.com/us/lnacademic/results/docview/docview.do?docLinkInd=true&risb=21_T5751433499&format=GNBFI&sort=BOOLEAN&startDocNo=1&resultsUrlKey=29_T5751320980&cisb=22_T5751320979&treeMax=true&treeWidth=0&csi=257989&docNo=5
· (A Satisfied Customer isn’t Enough – Harvard Business School Press, 2006) http://www.bain.com/bainweb/publications/publications_detail.asp?id=24313&menu_url=publications_results.asp