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I like Costco. Let’s talk about why over a Twitter thread.
1. Costco does so many things extremely well. While it's a place often seen as a go-to for bulk food, they've built an incredible model over their 35 years in operation
2. They are one of the largest retailers in the world. We so often hear that “retail is dead” yet Costco is thriving with $149 billion in Net Sales for 2019. They’re a retailer… but a different form. They don’t make much margin on product sales.
3. Those margins are around 11%. After paying for employees and warehouse costs... They barely come out break even. How can they operate that way? Aren’t low margins a sign of weakness?
4. Not when done intentionally. You need to pay their $60 annual membership fee. Customers love it because they receive more than $60 in benefit each year. Costco loves it because there is no real incremental cost to provide a membership, so it mostly falls to their bottom line.
5. Costco has just under 100 million members and a 91% renewal rate in North America. In 2019, membership fees generated $3.35B in revenue… most of which is pure profit.
6. This model allows Costco to reduce margins and undercut competitors on price, as they don’t need to make money on the sale of goods.
7. Low prices > more members > more sales. Instead of keeping the margin, they increase membership value by decreasing prices and investing in higher-quality products. They forgo short-term profits on sales to capture the long-tail on memberships. At a 91% renewal rate, why not?
8. Ok, ok, ok. This is already long. And it’s going to keep going. Buckle up. Let’s talk about operations:
9. Costco is fairly unique among its retailer kin. They sell a low number of high-quality items in bulk sizes. Products arrive in custom packaging for Costco and are sold through barebones warehouses staffed by highly compensated employees. Let’s unpack this.
10. Costco only stocks ~3,700 SKUs. Walmart is something like 70M and Amazon a kajillion. They don’t really have any overlap in a category… you get one choice for shampoo (I’m not ICP) and one choice of mayonnaise. Why does this matter?
11. Costco gets the best prices from suppliers. They are often the largest or second largest customer for a brand since they don’t stock competitors, which gives them leverage. Employees spend less time ordering, coordinating shipping and receiving, stocking, etc.
12. Costco only sells high-quality items. Read that again. They don’t sell products of varying quality or price points. This increases satisfaction, reduces the likelihood of returns, and because customers know they’re getting the best, Costco can spend less on advertising.
13. Coupling low product overlap with a reputation for high quality makes customers more confident and satisfied with their selection. Consumers don’t want choice, they want confidence in their decisions. That confidence runs rampant when I fill my cart.
14. Back to bulk: that’s the norm. For customers, it’s pretty obvious that buying in bulk is cheaper. But for Costco, it gets customers to spend more while feeling like they’re saving. Brilliant.
15. Have you ever tried to steal a 4-pack of Ketchup? Costco loses something like a fraction of a percent to inventory shrinkage, which is massively lower than the retail average.
16. What about Costco’s merchandising? They sell products right off the shipping pallets. Suppliers get products to Costco in display-ready custom packing. This lets Costco operate more efficiently and reduce labor costs. Products go directly from the delivery truck to the floor.
17. Warehouses aren’t pretty, they’re practical and enable a more efficient use of space. There’s no secret back-room stash of hidden goods. This lets Costco rip through more business per square foot and per store than most other retailers.
18. If the last 17 notes weren’t neat enough, less idle inventory and faster turnover means that Costco generally sells their inventory before they’re even required to pay for it. So they get to take advantage of early payment discounts with suppliers.
19. We’ve all heard that Costco pays well and gives great benefits. It turns out that treating employees well leads to low rates of attrition, reduced hiring and training costs, a better talent pool…. And oh ya, better customer service.
20. I forgot Kirkland. We talked about category overlap, but where does their Kirkland brand come in? Those products can be had at incredible prices and are top quality. How? Shouldn’t lower prices mean lower quality? That’s how we’ve been trained.
21. The thing is, Costco gets the best manufacturers in the world, who are already in Costco, to make Kirkland products. Word on the street is Kirkland products must be at least 1% better on some metric of their choosing.
22. Costco essentially forces producers to compete with a better version of themselves. Not only that, but it must be sold at a ~15% discount. This means that the shelves have two choices: your products or your products at worse margins.
23. Low margins aren’t always a sign of weakness. For Costco, it’s a choice they’ve made for their business model. This has allowed them to operate on such slim margins and on such a massive scale, that they can starve out other retailers. How do I end a Twitter thread? Goodbye?
