Costco’s warehouse clubs model used in the case of Costco (COST) was proved to be very well-liked throughout the U.S. In the 17th of March, 2022 Costco had 820 stores, with the majority of them within North America, and had 114.8 million members. It’s likely that the majority of these members who pay their dues are regular consumers of Costco’s massive-sized products.
What’s the secret behind Costco’s growth? There are three things that help to make Costco an outstanding business.
The most important takeaways
Costco earns a tiny portion of its revenue from its merchandise, however the majority of its earnings are derived from membership fees. Only members are able to purchase items at Costco.
The model of membership lets Costco to beat out the competition by offering bulk items with lower prices, ensuring the loyalty of customers.
Costco’s advertising budget is nil because customers keep coming back to reap the maximum benefit from their membership fees.
Costco offers its employees a generous salary and offers hourly wages that are higher than that of the minimum federal wage, and over many other retailers.
While Costco has many great qualities as a business However, the stock could be costly for certain investors due to its high price-to-earnings ratio.
It Earns Profits Prior to Selling the item
In the fiscal year 2021, Costco was able to sell $192 billion of merchandise, and earned $3.9 billion in fees for membership. The gross margin, which excludes membership fees, was approximately 11%, which is the same as the case since the year 2014.
It is a lot less than the margins that are of traditional retailers. Walmart for instance, was able to achieve 24.3 percent in 2021.
However, Costco isn’t making much of its profits by selling products. Costco members pay an annual fee to enjoy access to shopping in its stores. These fees make up a substantial part of Costco’s operating income. The year 2021 was the last time Costco’s costs for merchandising totaled $170 billion, based on $192 billion in revenue. General, selling, and administrative costs totaled $18.5 billion. The profit total during this year came to $5.2 billion.
Other retailers should be concerned that a drop in sales at the same time could cause a drop in profits. However, not Costco. Its success is based upon its capability to convince consumers to pay $60 per year for its regular Gold Star membership or $120 to upgrade to Executive status.
A High Retention Ratio
With prices that are often lower than other retailers It’s easy to convince people, especially when Costco’s average Costco member earns an income of almost $93,000. This results in a solid base of customers, with retention rates of in excess of 91.3 percent.
It’s not surprising that Costco’s profits have been steady over the decades.
No advertising? No Problem!
The majority of retailers spend massive amounts of money in marketing to attract customers to their stores.
Walmart has spent $3.2 billion in advertising between 2021 and 2021. Target has spent more than 2 percent of its earnings on marketing. For 2020, Target has spent $1.5 billion roughly the same amount that it has invested since.
Costco has a budget of essentially nothing. There is no budget for advertising however, it does use offer mailers that are targeted at new members, and offers for existing members.
This Argument Against Advertising
How did Costco be able to totally avoid traditional advertisements? There are two main reasons.
The first is that Costco provides a membership that promotes itself. Costco’s membership provides fantastic value to people who frequent Costco and conventional retailers aren’t able to compete with Costco in cost.
Costco has operations in 12 countries, and has 288,000 employees across the world.
The second reason is that driving existing customers to visit the store more frequently via marketing isn’t going to improve the bottom line, because fees for membership are the main source of profit and investing a lot of money to increase membership isn’t a good idea.
In reality If Costco were to invest 0.5 percent of its revenues for marketing, it would erase 17% of its operating profits. If it was to allocate the equivalent of 2% of its revenue in marketing, which is what Target does, this spending could erase 70 percent of Costco’s operating profits. It’s not worth it.
High Pay and High Productivity
Costco provides its employees with a salary that is unusually when compared to other retailers. In the early part of 2019, the company increased its minimum hourly rate to $15. In 2021, it increased it to $16 and in the following year, it increased its minimum wage to $17. Its hourly average is around $18.04 an hour, as compared to around $13.99 in the average of retailers, as per Payscale. The majority of Costco employees can avail health insurance that is provided by the company. healthcare.111213
For Costco it’s an extremely motivated workforce. This is how Costco’s earnings per employee ranks against other retailers:
A typical Costco employee earns more than triple the amount of revenue generated by the typical Walmart or Target employee. This can be attributed to the business strategy of Costco. The warehouse stores are small and have significantly fewer workers than typical big-box stores.
What makes customers come back and also keeps them renewing their memberships is an unquestionably good shopping experience. With highly-paid, satisfied workers, Costco delivers better than its competitors in the retail market.
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Great Company Excellent Company, Expensive Stock
Costco is a great company , but it doesn’t mean that it’s a fantastic stock. At the time of writing, March 28 2022, Costco had a ratio of price to earnings of 44.64. Its historical mean for S&P 500 is 21.92. The median for department stores and discount stores is 32.29 and the average for food stores, it is 10.44.
It’s not unreasonable to pay high prices for high-quality, but there’s an upper limit. Costco is a company which ought to be on the radar of every investor and if it goes back to sensible levels, it ought to be bought quickly.
What is Costco’s Competitive Advantage?
If you compare Costco with other retailers of the same type Costco’s competitive advantage is in its own brand and its low prices and membership fees. It has given customers an item they can count on with low costs. It’s also a reliable firm that many investors are looking for as a great investment.
Does Costco offer free or reduced memberships?
Costco doesn’t offer discounts or free memberships. Costco believes that its annual membership fees are quickly recouped through its affordable prices and a variety of items that lead to savings overall if customers were to shop at comparable businesses.
Who is the owner of Kirkland?
Kirkland Signature is a private label that is that is owned by Costco. Kirkland products are priced around 20 percent less than those sold by national brands which makes both Costco as well as Kirkland an appealing destination for shopping.
The Bottom Line
Costco has developed its own business model that has proven to be successful. Costco sells bulk goods with discounts, but it requires the purchase of a membership to make use of these affordable costs. The company does not spend money on marketing since memberships bring shoppers into stores, saving an enormous amount of money , and passing it on to consumers through lower costs.
Costco is also able to pay its employees well, with an hourly wage that is more than Federal minimum wages as well as numerous other retailers that are comparable. Although Costco has lots of great things about it but the stock is thought to be too expensive and overvalued for certain investors.