Case Study on "Costco Company"

Case Study 7 pages (1927 words) Sources: 0

[EXCERPT] . . . .

Costco competes in the $120 warehouse retail segment, a business category that it virtually pioneered. The company continues to grow rapidly and earns healthy profits. Costco runs on a tight margin/high volume business model. This means that cost control is critical to success. Costco is now faced with the decision of where next to take its business.

Core Problem/Issue

There are very few problems at Costco. The company has been a runaway success and is dominating the segment. The competitive environment is moderately intense with two major competitors, although neither represents a serious threat to Costco's business. The major issue facing Costco is, essentially, "What next?" The company must determine its future course of action in light of its past success.

Internal Descriptive

Costco's market dominance derives from a number of critical strengths. The company has strong financials, including a solid balance sheet and steadily increasing revenues. Costco's operations are tight -- it spends only tiny amount of money on warehousing and logistics, sells its good before it pays for them and has a very low cost structure. In its short existence, Costco has developed strong brand equity. This has been tested with ancillary products such as gasoline and home products. The management team is also very strong, guiding efficiency and organizational culture. The employees are another strength, as they act as promoters for the brand.

Costco may not have any weaknesses. There are points of complaint, such as the small selection of goods or the high wages paid to employees, but at present no firm has been able to identify an exploitable area of weakness. Sam's Club and BJ's have managed to get a foothold into the market, perhaps only by virtue of Costco's lack of total saturation. Its format does prohibit it from entering smaller markets, which remain unserved, though it remains to be seen if any warehouse competitor could succeed in these markets.

The company's strategy is a low cost strategy. As such, Costco places considerable emphasis on reducing costs at every turn. Tactics include rapid inventory turnover, merchandising, pricing, lack of decor and operational simplicity. Almost everything the company does, save for its wage policy, supports the low cost, high-volume strategy.

Costco has a relatively flat organizational structure with a minimum of management. The company operates with geographic units as its major structure, with Canada and international as units. Costco has some degree of vertical integration in that it owns its land and buildings.

Costco's systems drive its competitive advantages. The company places strong emphasis on merchandising systems to move product quickly. The distribution system is designed to ensure that a minimum level of inventory is held. The accounts payable system is designed to gain the maximum financial advantage from supplier discounts. The human resources system emphasizes employee loyalty under the premise that loyal employees will help to market the company.

Costco has many shared values. The corporate culture is strong. For example, cost-cutting is an important share value. A high level of customer service is another share value. Loyalty to the company -- and loyalty from the company to employees in return -- is another shared value. Loyalty to suppliers and shareholders is another shared value, completing the value of treating all major stakeholders well.

Costco's style is a lack of style. The company executes its strategy by adopting a no-frills approach to its entire business. This reinforces the cost-cutting element of the company's culture and strategy. Costco has a policy of treating its staff well. The result is that Costco staff treat customers well. Costco also has a very low turnover rate for the industry. The company benefits from this because the more experienced employees know better the ways to cut costs.

The most important skill needed for employees at Costco, especially managers, is merchandising. The company is also skilled at logistics management and purchasing. Each of these skills supports an element of the company's strategy.

Financial Ratios

2008

2007

2006

2005

2004

Current ratio

1.06

1.08

1.05

1.21

1.02

Quick ratio

0.49

0.51

0.46

0.62

0.28

Collection Period

3.37

3.29

5.76

5.35

0.72

Inventory turnover

12.8

11.9

12.3

14.2

11.3

Asset utilization

3.43

3.2

3.3

3.1

3.6

Fixed asset utilization

6.13

6.6

6.8

6.6

6.5

Debt/equity

0.25

0.25

0.02

0.08

0.18

X Interest earned

21.4

32.9

16.5

20.9

20.2

Contribution margin

2.7%

2.5%

2.7%

2.8%

3.2%

Profit on sales

1.8%

1.7%

1.8%

2.0%

2.0%

ROA

6.2%

5.5%

6.3%

6.4%

7.3%

ROE

13.9%

12.5%

12.0%

12.0%

14.8%

Costco has good liquidity ratios. The current ratio and quick ratio have generally been rangebound at healthy levels for the past five years. Inventory turnover levels have also remained strong over the past five years. Last year's total of 12.3% is historically strong for the company. These ratios are not spectacular, but they are healthy.

The company's asset management is good. Asset utilization is 3.43, which represents the highest level since 2004. Fixed asset utilization is 6.13. In contrast to the asset utilization ratio, this figure is at the low end of the company's historic range. Both of these ratios are solid, indicating that the company does well in converting its assets to revenue.

Costco's capital structure is good. The debt to equity ratio is 0.25. The times interest earned is 21.4. The company has a low debt rate. For a company that is in a business with a low margin for error, a low rate of debt is appropriate. In addition, Costco views its business as a relatively mature cash cow rather than a rapidly growing entity. This fuels the risk aversion that results in this low debt-to-equity ratio. The company had almost no debt a couple of years ago, but can handle much more than their current level, should they so choose.

Costco's profitability ratios are good. The contribution margin is 2.7%. The profit on sales is 1.8%. Both of these margins have deteriorated in recent years. The slight decline in margins could indicate an increased level of competition in the industry, leading to some price cutting. It could also indicate an increase in the cost of goods sold combined with a desire to hold the line on prices. The return on assets is 6.2%. Return on equity is 13.9%. Both of these figures are at their strongest levels since 2004, indicating that the company performed particularly well last year. It is impossible to calculate the P/E ratio as the market price of the company's stock is not given. The margins are slim, which is to be expected given the business model. The returns are reasonable, again given the dependence on volume to drive profits.

There are a number of opportunities for Costco. The most important of these is geographic expansion. As the U.S. And Canadian markets become saturated, Costco will need to begin looking further afield for expansion. There are many markets, in Europe, Asia and Latin America that could provide growth opportunities. Another opportunity lies in different formatting. Costco has experimented with different products, from gasoline to home supplies. The company has considerable brand equity that it could lend to these alternate projects. This strategy would emphasize stealing market share from companies in other retail segments.

There are a number of credible threats to the Costco business. The first is competition. Both BJs and Sam's Club are relatively strong competitors. Competition in the industry is still in the form of monopolistic competition but this could revert to a highly competitive oligopoly situation where firms with high exit costs drive prices lower. Another threat is the risk of unionization. Although Costco compensates its employees well, union employees typically earn more in pay and benefits. An increase in the company's cost structure would put its margins at risk. Lastly, the company could be threatened by shifts in consumers' tastes. The Costco model has succeeded on the back of a rise in suburban living, but a shift to other lifestyles or other preferred store types remains a threat. Substitutes such as Wal-Mart, Target or European-style hypermarkets also represent a threat to Costco.

Costco seems relatively impervious to the state of the economy. Its discount model is attractive to shoppers even during good times and especially during bad economic times. The political/legal environment has little influence over Costco's business at present. That may change if the company decides to enter new emerging markets in search of growth. Social/demographic trends are in Costco's favor. The country, save for the recent recession, has been on a long-term growth trajectory. Rising incomes put more people into Costco's core market. Aging consumers also tend to seek value, which is to Costco's benefit. Costco does not invest heavily in technology. It has dabbled in online sales and uses modern logistics technology to reduce logistics costs, but technology is not a key driver of Costco's business. The ecological environment is generally not a major factor in Costco's business. The company exceeds all local environmental regulatory requirements.

Supplier power in the industry is low. Costco is not a price taker -- their buyer volume… READ MORE

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