Thursday, March 01, 2007

Nobody Doesn’t Like Costco

Yeah, yeah! I know — never use a double negative. So what’s the worst that can happen? Someone will get the grammar police on my tail — or I’ll be reported to William Safire? But let me ask you, doesn’t accuracy override the use of the double negative in the headline? More to the point, do you disagree with the premise? I’m willing to defend the headline’s assertion on the basis that rarely do I visit that retail emporium without meeting at least one resident of Boca Pointe, who as we all know, are recognized as world-class shoppers.

If more proof is needed, in its February 12 th issue, Barron’s, a publication that does not suffer fools gladly, featured on its cover a picture of the CEO of Costco, naming him the “World’s Best Discounter.” The headline over the inside article proclaimed Costco as “Everybody’s Store,” elaborating in a sub-headline, “Move over Wal-Mart. A maverick in merchandising and management, Costco Wholesale is the new name to beat.”

The basic problem is that I’m obsessed with Costco, perhaps “addicted” is a better description of the relationship. As an ex-retail executive, I know the symptoms well. I suffer from the dread CS syndrome — Yes, I’m a “compulsive shopper.” Note however, that there is a difference between that malady and the next (more problematic) level which is termed CBD, “compulsive buyer disorder.” As proof that all is not yet lost, I might point out that at times I visit Costco, just to look, and remarkably end up buying nothing — pretty weird, huh?

According to UBS, the average customer visits Costco 22 times a year. My visits must number at least double that. I know it will be difficult to convince female readers that a male actually loves to shop — in fact I even go shopping with my wife, and believe it or not, help her in her selections — but hey, that was my business. I hope you guys won’t hold that against me when your wife complains “Why won’t you come shopping with me? Why can’t you be more like Bob? — perfect in every way.” Sure! Just ask my wife.

So how did Costco become so addictive, not only for me, but for the 47 million members who pay either $50 or $100 to join, making Costco, with $59 billion sales volume the fourth largest retailer in the country, and the eighth largest in the world? The success of Costco can be attributed to its co-founders, CEO Jim Sinegal and Chairman Jeff Brotman; Sinegal a long–time retailer, and the latter, an attorney who launched three different retail operations, and whose father was a menswear retailer. But they in turn will readily credit the genius of another, now legendary retailer, Sol Price, who literally invented the warehouse club concept.

Price, born in 1916, went to high school in San Diego and earned a law degree at University of Southern California in 1938. He was the senior partner in his own successful law practice when, in 1954, he serendipitously turned into a retailer. Failing to find a tenant for a large warehouse that he bought, he took advantage of the new wave of retailing that had just emerged with the creation of the discount store. In those days, fair-trade laws prohibited retailers from discounting branded goods beneath the list price. As an attorney familiar with, but detesting those laws, he circumvented them by opening a store that charged an annual membership fee, thereby making owners out of his customers, and that entitled them to discounts. No other discounter had taken a similar route.

That one store in San Diego developed into a flourishing regional chain of 45 discount stores under the name, Fed-Mart. In the mid-70’s, Price sold the chain to a German retailer, but shortly thereafter, Price and his two sons who worked at Fed-Mart were fired. Ironically, while under Price’s management Fed-Mart grew and prospered, whereas within a few years of the new management, the entire chain was forced to close, with many of the stores purchased by Target.

Just how influential was Sol Price and the Fed-Mart model as it related to the then burgeoning discount store industry? Sam Walton, the legendary founder of Wal-Mart once said in an interview, “I guess I’ve stolen — I actually prefer the work ‘borrowed’ — more ideas from Sol Price as from anybody else in the business.” Walton then revealed how Wal-Mart got its name by admitting, “I really liked Sol’s Fed-Mart’s name, so I latched on to Wal-Mart right away.”

When Price was fired from Fed-Mart, he and his son Robert— to whom he gives much of the credit — tinkered with the Fed-Mart concept and created a new chain with the eponymous name, Price Club. The Prices had concluded that by stocking a relatively small group of highly selective products, inventory turnover could be accelerated — up to 20 times a year — and goods could be priced utilizing very thin margins. The margins could be offset in part, by charging a membership fee. Even more important however was how Price treated his employees and the type of loyalties this developed. Price actually invited unions to represent Price Club workers. Wal-Mart by comparison, was and is totally unorganized by unions.

A book titled, In the Company of Good or Evil, provides as good a description of Sol Price and his effect on employees as I can find: “Price Club was a special place. It’s founder’s charisma, his noble corporate mission of serving brands and consumers alike, his willingness to share the wealth [every employee received stock options], all came together to give the firm a wonderful atmosphere, almost a religious fervor. It was as if the entire staff had become knights embarked on a noble crusade.”

You may find the following totally slanted, politically far left description of Sol Price’s legacy as amusing as it is probably accurate. This is how he is viewed in an article published just weeks ago by the nation’s largest Socialist organization, Democratic Socialists of America: “One way to recognize the reactionary particularities of the Wal-Mart business model is to briefly contrast it with that of COSTCO, a Seattle-headquartered warehouse/retailer whose Fed-Mart and Price Club predecessors Walton frequently acknowledged as the model that he incorporated into his own retail operations. But there was one big exception: Wal-Mart would have no truck with the Fed-Mart-Price Club-COSTCO personnel program. COSTCO owes its character to Sol Price, the Jewish New Deal Democrat whose social and cultural values were those of Depression-era New York. Price became a multimillionaire, but even in the era of Ronald Reagan, he favored increased taxes on high incomes, enhanced social welfare spending, and a confiscatory tax on wealth.”

One of Price’s first hires at Fed-Mart had been Jim Sinegal, an 18-year-old kid just starting college whose job was to unpack mattresses as they arrived. Sinegal recalls, “It wasn’t that great a job. I was getting a buck and a quarter an hour. But it was exciting. Sol was a major part of that excitement.” Within a few years, Sinegal was promoted to store manager and ultimately rose to the position of executive vice-president.

When Price left Fed-Mart in 1979, he convinced Sinegal to join him in his new venture. As executive vice president of Price Club, Sinegal helped Price establish that organization, but in 1981 Sinegal decided to leave. At that point, he had been working for and with Price for a period of 27 years. By 1983, Sinegal had started his own warehouse club in Seattle with the help of Jeff Brotman, an attorney who was the son of an ex-menswear retailer. Together they also opened in an old unused warehouse, adopting basically, the exact same principles advocated so successfully by Sinegal’s old mentor, Sol Price. Ironically, 10 years later, Price Club and Costco merged under the name Price/Costco. Despite the close relationship previously formed by Sinegal and Price, by 1993, Price took control of the non-retail portion of the company and left to start an international operation. He subsequently retired in order to oversee his influential philanthropic foundation.

Some 54 years have passed since Sinegal’s first venture into retailing and it is apparent that he has taken up the mantle from Sol Price. He is now considered the sage and master of the discount industry. Yet, unlike today’s notoriously greedy CEO’s, Sinegal has a one-page contract that is valid only on a year-to-year basis. It provides for a salary of only $350,000 with a small bonus possibility. He refuses to make any more than double that of his store managers. Even his total Costco stock holdings are worth only around $150 million, lower than the annual salaries of many less worthy CEO’s. Other than Warren Buffett, whose salary is a mere $100,000, Costco shareholders get as big a bargain with Costco as its customers do.

Treatment of Costco employees still reflect Sol Price’s influence. They enjoy far and away the best health insurance plan in the industry. Average wages are $17 an hour, 40 percent more that Wal-Mart. After only four years on the job, cashiers can make as more than $40,000 a year; 92 percent of employee health plan costs are covered; and 95 percent of all promotions are from within. This results in a mere six percent turnover rate for employees with the company for more than one year, (estimated to be about one fifth of Wal-Mart); productivity is at $500,000 per employee, and Costco has the lowest shoplifting rate in the industry (.02%).

So, Costco, why do so many love thee? Perhaps it’s because unlike so many other merchants who consistently seek higher profit margins, Costco’s main goal is to lower prices rather than raise them. In the case of its famous Kosher hotdog/soda $1.50 combination (that includes a soda refill), Costco has maintained that same price for the past 18 years, and as Sinegal has promised — will do so forever. Take a guess as to how many hot dogs Costco sells as a result — how about (hold your breath) 65 million, last year. Costco’s well-deserved reputation of having the lowest prescription drug prices enabled them to fill 26 million prescriptions in 2006. Yet Costco customers were apparently more eaters than medication takers since they also bought 28 million rotisserie chickens. And how about the 1.5 million TV sets sold in 2006, as well as the $300 million worth of cameras, and one billion photos it printed. Oh yes! Costco is also the largest wine merchant in the world. Another unique procedure that endears Costco to customers is the most liberal return policy in the industry. (That is changing with a 90-day return limit on all electronics, still more liberal than anywhere else.) The major key to Costco’s success is its hard and fast rule that no branded item is marked up more than 14 percent, and its private Kirkland brand 15 percent. Since these are markups that other retailers find impossible to match, it would be unusual to find a similar product priced lower elsewhere.

But here is where I must make two disclosures. First, it’s necessary to acknowledge that I own stock in Costco (although, with 452 million shares outstanding, I doubt this article can do much to move the stock.) The second admission is that not quite everyone loves Costco. Wall Street is annoyed that the company treats its customers and employees better than shareholders. For example, the retailing analyst at Deutsche Bank is quoted, “From the perspective of investors, Costco’s [employee] benefits are overly generous.” However, Warren Buffett’s Berkshire Hathaway owns 500,000 shares of Costco, and Jim Sinegal takes the rather quaint position that, “I happen to believe that in order to reward the shareholder in the long term, you have to please your customers and workers.” In other words, don’t fix what ain’t broken. This day, for a CEO to adhere to that philosophy is really quite bizarre, yet, that’s exactly why nobody doesn’t like Costco.


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