CASE 17 COSTCO CASE STUDY
Case study questions
1. What generic business level strategy (Chapt 5) is Costco pursuing. Explain your choice.
Companies that target one or a few segments and try to be the low cost player in that segment are perusing a focus-low cost strategy. Such companies tend to produce a more basic offering that is relatively inexpensive to produce and deliver. This helps to drive down their cost structures. Costco sells a limited range of merchandise in large warehouse type stores. A Costco store has about 3,750 SKU’s compared to the average 124K SKU’s at an average Walmart supercenter. Costco offers consumers the ability to make bulk purchases of basic goods like dog food and breakfast cereal at lower prices than found elsewhere. As of 2011, Costco maintains the number 1 spot in industry inventory turnover ratio, and number 3 in the retail sector. Thus, we can conclude that Costco definitely does a good job tailoring its products to the needs of the segment and, in doing so, is able to successfully undercut the cost structure Walmart achieves with their colossal economies of scale.
2. Describe four functional-level strategies that Costco has implemented to support their business level strategy. Label the function (marketing, production, R&D, etc - see Chapt 4) under which the strategy falls.
Human Resources Strategy - Costco pays their employees substantially more than what other competitors in industry as well as the sector pay. Along those same lines Costco offers better health insurance and pays more on the premiums than its competitors. Competitors like Sam’s Club, JB’s, and even competitors within the segment like Walmart tend to want to keep employee wages as low as possible in order to spread those savings on to you. Costco sees this vantage as myopic because Costco believes in investing in employees for the long term, and thus being able to draw more performance from tenured employees and save money on expensive training cost those results from high employee turnover. These figures challenge the common assumption that labor rates equal labor costs. Costco’s approach shows that when it comes to wages and benefits, a cost-leadership strategy need not be a race to the bottom. This adds value to the customers as the associates they deal with are knowledgeable and friendly, which tends to be qualities that are less apparent in low-paid employees. This more efficient use of human resources saves money in the long run and helps the low cost focus strategy.
Marketing – In order to sell as much volume as Costco does, it has to provide its customers with the confidence of having buyer’s remorse. As Costco is a club and must secure memberships in order for their customers to be their customers, they offer this “no questions asked” buyer’s remorse on all items with some exclusion; electronics have a 90 day return policy. This is unique in itself as most companies in the retail sector offer a thirty day return period with the exception of certain electronics that have a 14 day return period. What’s even more amazing is how Costco will return the membership fee to any dissatisfied customer at any time. This allows the customer to have no reservations about becoming a member because they can cancel at any time and get their money back. This is one reason Costco’s market share has become as large as it has. R&D- Costco has less than .2% shrinkage which rates it number one in the industry compared to shrinkage rates of other retailers. This is largely due to the process innovations Costco has implemented that basically monitor everything that goes in and out the building. This is a simple way Costco achieves such low prices and still generates such high returns.

Production –Costco has direct buy/seller relationships with its suppliers and then manages to get this merchandise to warehouses and stores within around a 24 hour window, which actually reduce holding and freight costs. Beyond this cost reduction, Costco’s ability to turnover inventory within the discount window that its suppliers offer for discount allow Costco to take advantage of early payment discounts more frequently because working capital funds don’t have to be used to make the early payment. This 1 to 2 % industry discount can add up to a 1 -2 reduction of cost of goods sold if it is always taken advantage of. This is another strategy Costco implements to support its business level strategy.
3. Based on its financial performance, Costco has a competitive advantage. Describe two distinctive competencies that contribute to Costco's competitive advantage.
Based on financial performance, Costco has competitive advantage. We can see that Costco pays much higher rates to their employees in salary and benefits than industry standards reflect. In conjunction to this, we see that Costco manages to maintain lower labor and overhead rates (10%) vs. Walmart’s 20%. Costco also manages to sell more than twice in revenue per square foot than Walmart. An explanation for both the reduced labor cost and increase in revenue sales is because Costco pays their employees so well, which is rare in the retail industry, Costco recognizes reduced costs due to employee turnover, which is a less than a third of Walmart’s recognized employee turnover (12% vs 37%).Simply put, paying the employees more works out to produce long term committed employees that perform better.

Another distinctive competency Costco maintains is mastery of the value chain within the retail industry. Even though Costco does not have anywhere near the economies of scale that Walmart possesses, Costco is able to undercut pricing of retailer giant by reducing COG’s in other areas. One way Costco achieves lower cost is Costco purchases directly from manufacturers and routes merchandise directly to cross docking consolidation points or directly to its warehouses and manages to streamline this in under 24 hours, which maximizes freight volume efficiencies. Costco’s marketing department ensures that their relative limited product mix of around 4000 items, 1000 items limited to create a sense of scarcity. Costco also focuses on offering merchandise of a quality just beyond that of its major competitors. Remarkably, Costco turns its inventory over so quickly that it is able to use current profits from current revenues to pay its trade debts early enough to take advantage of timely payment discounts. 1 or 2% provides a major impact on Costco’s bottom line.

4. Is Costco's competitive advantage sustainable? Durability of competitive advantage depends on three factors: Barriers to imitation, capability of competitors, and industry dynamism ( p. 103 in textbook). Be sure to address all three factors in your answer.
The literature makes it seem as if other retailers shudder at the idea of paying employees decent living wages, but the proof is in the pudding. I imagine it would be very costly for Walmart, or other established competitors, to increase employee wage structures given their already high labor costs. A new contender would still view this as a high cost barrier to imitate. Even harder to imitate would be the capabilities Costco has in streamlining the value chain by providing excellence in customer responsiveness as Costco clearly does a better job of quickly identifying and satisfying its customer’s needs as evidenced by their ability to dominate the industry in inventory turnover, among other metrics.
Because Costco’s has the ability to see beyond its myopic competitors, Costco recognizes the value in investing in their people. Because this is not typical for the industry, and potentially the sector, we can conclude that the capability of competitors to imitate Costco’s HR strategy of paying their people well to take advantage of reduced turnover costs and increased performance of the employees.