Costco Business Model and Their Strategy

Walmart and Target can’t touch Costco. They are consistently being outperformed by this warehousing discounting company. Quarter after quarter, Costco sees growth while other giant retailers are trying to discover why their sales rates have grown stale. At the core of the Costco business model is one simple strategy: drive better sales.

Costco believes that if sales are good within the store, then everything else will basically just take care of itself. It’s a rather unorthodox strategy for this membership club business for sure, but it is one that is definitely working. In 2008, revenues for Costco, Target, and Walmart were essentially the same. Since then, Costco has nearly doubled up on the competition.

What’s even more remarkable about this fact is that as Walmart and Target are dumping huge sums of cash into marketing, Costco does not advertise at all. Why is this business model working, even under the pressure of other large discount retailers?

Costco Focuses on Supply and Scarcity

Costco is known to sell very few brands of supplies in their store. If one compares virtually any product that is sold at Costco and at Walmart or Target, Costco is going to be selling fewer brands. This actually helps Costco because it allows them to drive down pricing because they are increasing their overall sales volume. They also limit the number of actual items that are being sold as well.

Because driving sales is at the core of the Costco business model, this company is also focused on the customer experience. Costco pays more than most discount retailers do because they want good people on the sales floor that will make it so customers want to come back into the store. Instead of cutting salaries and hours to save money, Costco wants to drive sales by paying their people more.

For the American consumer especially, salaries have been stagnant for a number of years. Consumers are focused on combining value and convenience so that the best products at the best prices can be obtained. Costco outperforms Walmart and Target because their business model provides a better per-product discounting model. The mom and pop corner stores provide more convenience for consumers. This leaves stores like Walmart and Target out in the uncomfortable middle where they’re the second choice of the consumer every single time.

Good People Equates To Good Sales

In 2012, Walmart’s CEO earned $18.1 million. In comparison, Costco’s CEO earned $650,000. People on the front lines are a point of emphasis for Costco because a good customer experience results in repetitive customer revenues. A good example of this is how the pay scales are structured in Ontario, Canada.

In Ontario, there is a minimum wage of $11 per hour that is in effect – for the record, that’s almost $4 more than the US federal minimum wage of $7.25 per hour. Costco could pay the minimum wage and point out that they’re paying people a fair living wage based on government regulations and everyone would be satisfied with it.

They don’t. They go ahead and take the extra step. Ontario earners start at $12 per hour instead of $11. Workers that are on the schedule for Sunday will earn an extra $4 per hour that they work. There are also incentives within the Costco salary structure to reward employees based on their performance, reliability, and consistency. Employees with around 10 years of experience in an Ontario Costco location could be earning a $27 per hour wage.

Globally, Costco pays 13% more than their closest competitors. This is in an era when Walmart and Target are blaming stagnant wages of the American middle class for their own stagnant revenues. The Costco business model focuses on driving sales through value and scarcity and it is working. Add in the membership fees that bring in additional revenues and Costco has created a business recipe that smells like sweet success.

Different Membership Levels Also Drive the Costco Experience

For the basic membership fee of $55, consumers can become part of the discount membership warehouse where products are marked up by 15% at most. This membership fee gives consumers access to everything that Costco has to offer. This includes a pharmacy, and optical department, a food court, and even fueling stations at some locations.

Costco also offers an executive level membership that rewards consumers for spending money at their stores. All purchases at Costco on the executive membership plan earn 2% cash back. Some products are able to earn 3% cash back in some geographical locations, with a maximum cash back reward of $750. It takes about $400 of spending per month at Costco to make the membership pay for itself.

There’s also ongoing value that’s been provided in the Costco business model as well. Costco has formed strategic partnerships with a number of other brands and companies that help consumers save money in other aspects of life. Costco members, for example, are able to receive a $1,000 discount on a brand new Ford vehicle just because they are members.

Costco Has Trained Their Consumers To Execute

To say that the Costco business model is a recent innovation would be inaccurate. There have been some low, desperate times over the past decades for this membership retailer. For a long time they were coming behind the big box discounters like Walmart and Target. With Sam’s Club being promoted by Walmart as well, it looked like Costco would be headed out the door. Yet they never gave up on their business model and continue to keep putting one foot in front of the other.

It has taken 40+ years for Costco to reach this point, but it has finally paid off. Not only have they almost doubled up Walmart and Target from 2008-2015, but they’ve effectively insulated themselves against future attacks because they’ve trained their consumers to execute buying trends in their store. Who cares if Walmart has 60 brands of toothpaste? Costco has 4 brands and they all work to clean a person’s teeth.

By training their consumers to accept certain purchasing habits by pointing out the value of those products and having good people do this consistently, Costco has set the stage for future success with their business model. They just need to shore up a few weaknesses in their model of business to make this happen.

The “Poof and It’s Gone” Problem

People who have shopped at Costco for some time are familiar with the sudden problem of a certain item not being in stock. This is the one flaw that is in the scarcity model that Costco practices. Because limited brands are being carried, the removal of just one brand can have a devastating effect on the consumer. Costco might be stocking a certain item for several years and then, without warning, the item is permanently gone from store shelves.

This is the one advantage that Walmart and Target have over Costco. If one brand goes missing at the discount retailers, it is easily replaced. When it goes missing at Costco, it is easily noticed. For some consumers, their brand loyalty is enough to drive them away from the warehouse discounters for good.

How can Costco solve this problem with their business plan? With few brands and a focus on scarcity, this actually plays into the effectiveness of how they drive sales to other products. Although some consumers will leave, other consumers will purchase more products of their preferred brands because they’re afraid the same thing will happen to their favorite products. They may stock up to a year’s worth of goods in their freezer just to make sure there is access to it.

The success or failure of these incidents is dependent on the attitude that Costco takes. If the “poof and it’s gone” occurrence is made without apology, then the consumer feels insulted and is more likely to not return after their membership expires. If Costco is apologetic, offers alternatives that are viable, and it doesn’t cost extra money, then there’s a chance to experience forgiveness.

How Does the Costco Business Model Apply To Everyone?

Most businesses are not going to be able to charge a membership fee. They’re not going to be able to drive down a price point to be the lowest in their industry. What they can do is drive sales by focusing on the consumer’s experience every single time.

Although it is accidental, many businesses put the focus of their marketing efforts upon themselves. They talk about their rewards, years of experience, and other accolades that have come their way. It’s done under the auspices of proving “experience,” but consumers want something tangible. They want proof of value. Costco demonstrates that value by putting it right up front for their consumers to see.

Scarcity drives the Costco business model, but so does discount pricing and exclusivity. By combining these three traits, Costco has created a powerful business model over the last 40 years that will be insulated against failure. Every other big box discounter is on notice – Costco took the time to build a solid foundation. They’re here to stay.