Thursday, November 01, 2018

Nobody Doesn’t Like Costco – Part I

Author’s note: Over 11 years ago, in March 2007, this blog ran the article below. It ran again in 2012. In each of these time spans, through today, the numbers have changed so dramatically (as has the readership of this newspaper), that I thought it would be interesting to reflect on these new permutations, some of which are in parentheses below. Because of the addition of new information, it is also necessary to split the article into two parts, the second of which will be published next month.

The History of 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 whoever replaced William Safire as the grammar expert?  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 basic premise?  I’m willing to defend the headline’s assertion on the basis that I have yet to meet anyone who would disagree with that assertion.

The essential 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 will finally admit that I am a Costcoholic.

My addiction

According to UBS, the average customer visits Costco 22 times a year.  My visits must number at least double that.  In fact I know it will be difficult to convince female readers that a male actually loves to shop (actually I joke that if I don’t show up in Costco at least once a week, they call to see if I’m ill.)  I even go shopping with my wife, and believe it or not, help her in her selections — but hey, women’s’ apparel 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 (now 90 million) members who pay either $50 (now $55) or $100 (now $110) to join, making Costco, with $59 billion sales volume (now $138 billion) the fourth largest retailer (now the second largest) in the country, and the eighth (now the second) largest in the world?

The Investopedia Analysis

Here is how Investopedia describes Costco’s success: “Ask people who have shopped at Costco Wholesale Corporation (NASDAQ: COST) store if they liked it, and you will likely hear exuberant songs of praise, along with a list of great deals they found on their last shopping trip. More than 90 million people pay $55 for annual memberships for the privilege of shopping at Costco, with fewer than 10% each year deciding the experience isn’t worth the price of membership.

To some, Costco shopping is a religious experience, which might explain why Sunday is its busiest day. For others, going to Costco is like going on a treasure hunt. They may be going to stock up on cereal or wine, but to get there they need to walk past large aisles packed floor to ceiling with new inventories of cool stuff. When you walk into a Costco, you never know what you are going to find, which is one of the reasons why Costco shoppers spend nearly 150% more per shopping trip than at the average retailer. Another reason is that the retail markup at Costco is never more than 15%, so shoppers know they are getting a bargain.

The Genius––Sol Price

The success of Costco can be attributed to its co-founders, CEO Jim Sinegal (recently retired) and Chairman Jeff Brotman (recently deceased); 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. (When asked in an interview how it felt to be the father of warehouse club retailing, he quipped, “I wish I had worn a condom”).

Price, born in 1916, went to high school in San Diego (graduating at 15) and in 1938 earned a law degree at University of Southern California.  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 his mother-in-law owned, he took advantage of the new wave of retailing that had just emerged with the creation of the discount store. However, he developed a twist on the discount concept that was unique.

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 in 1954 by opening a store named FedMart 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.  It was an immediate success based on the unusually low prices it charged.

Ten investors in FedMart had each put up $5,000 with the expectations that first year sales would be about $1 million; instead it was $4.5 million. That one store in San Diego developed into a flourishing regional chain of 45 discount stores under the name FedMart. In the mid-70’s, FedMart went public on the stock exchange.

In 1975 Price sold the chain to a German retailer, Hugo Mann. However, shortly thereafter, Price and his two sons who worked at FedMart were fired.   Ironically, while under Price’s management FedMart grew and prospered, whereas minus Price, within eight 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 FedMart model as it related to the then burgeoning discount store industry?  Sam Walton, the legendary founder of Walmart 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 Walmart got its name by admitting, “I really liked Sol’s FedMart’s name, so I latched on to Walmart right away.”

The Price Concept

When Price was fired from FedMart, he and his son Robert— to whom he gives much of the credit — tinkered with the FedMart 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.  (For example, the highest markup charged at Costco is 15% on Kirkland products and 14% on everything else).

These low 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.  Walmart 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.”  As a result of Sol Price’s institutionally mandated philosophical policies originally established at FedMart.  Costco pays the highest average wages in the industry, and its employee turnover rate at 5% is by far the lowest.

Price as a Social Democrat

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 Walmart business model is to briefly contrast it with that of Costco, a Seattle-headquartered warehouse/retailer whose FedMart and Price Club predecessors Walton frequently acknowledged as the model that he incorporated into his own retail operations.

“But there was one big exception: Walmart would have no truck with the FedMart/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.” (Next month you will learn about Price as the Democratic King-maker––if I remember).

“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.”

Unlike most CEO’s, in viewing his priorities Price valued his customers as first, his employees as second, and his shareholders last. This reverses the traditional approach that reveres the shareholder as the prime factor.”

Next month’s article will provide the details as to how Costco itself came into being.


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