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Example Case Study on Costco

Case Study on Costco

Costco products have one of the highest values for the dollar spent. As long as Costco can deliver a very strong value to its shoppers, people will continue to shop at Costco. Creating an association with quality is why Costco has been so successful. For example, consumers associate Costco with quality, which has in turn made Costco an established brand.

Costco’s customers have a wide array of demographics with the common denominator being that people are looking for value. However, saving people money over the course of a year isn’t the entire part of a value equation, as value is the intersection between product satisfaction, which includes the service components at Costco, product utility, and price. Costco’s customers have confidence that they will find high quality at a good value.

Costco has several advantages over its competitors. First, Costco has very large sales volumes that allow the company to make higher volume purchases than most. Considering the size of Costco’s stores, it’s interesting to note that they only stock a very limited number of products. That’s very few compared to the large variety of products Costco presents because Costco only focuses on a few products in each category. Overhead is minimal with no advertising, and limited service, as Costco’s number one goal is keeping cost low. Indeed, Costco is able to deliver a low cost yet high value to its customers. This allows Costco to achieve very high product turnover, i.e., 14 times per year.

Costco utilizes a high volume, low margin, high value product approach. This approach appears to give Costco an advantage over the lowest cost retail competition. By stocking only a few branded goods in each product category, Costco is in essence doing the customer’s comparison shopping and demanding the best terms from the vendor. Even when it comes to the company’s private mark, Kirkland Signature, the company is very serious about the brand equity it is building. For instance, its private label products, Kirkland Signature, compare themselves to the best and Costco is particularly careful not to abuse its customers’ trust by using the signature label on something second-rate.

To achieve its most important goal of keeping cost down – – so that Costco adheres to its iron-clad rule that margins would stay between 1% and 14% – – Costco works in a simple building usually in a warehouse location. Costco’s average store has about 4,000 SKUs, in contrast to 30,000 in a typical supermarket, 40,000 to 60,000 in a discounter like Kmart, and 200,000 in a supercenter, in a 129,000 square foot store warehouse. Fewer SKU’s means less duplication and less variety, more efficient use of shelf space, faster turns, and lower carrying costs for inventory.

Reducing choice has made life simple for everyone. Large packages, even at a low per-serving cost, have allowed Costco to leverage its expense for labor and overhead across a higher average transaction value. Other ways in which Costco creates value is by having a great inventory control system, which basically tracks all inventories when products either enter or leave the building all of which facilitates cross-docking. “Cross-docketing occurs when a distribution center does not store the merchandise but immediately re-ships it to the stores.”

In all, the more Costco sells, and creates efficiencies, the stronger Costco grows its bargaining position with its suppliers. This process creates value, which is passed on to Costco’s customers.

As noted generally above, Costco is a wholesale provider of products and services to a group of clientele who purchase an annual membership to be part of the wholesale club. The underlying objective of Costco is to save its members money on purchases by negotiating with retailers to procure bulk items at the lowest possible price. Costco, in turn, passes the savings to its members. Typically Costco can get bottom line prices by focusing not on many products that many supermarkets do, but by focusing on individual products.

A. Costco’s Profit Formula is Profit=Price (No greater than 14% * Cost of Goods) – Cost of Goods
Costco’s profit formula is very simplistic. Its profit is derived by the price that it obtains the product, plus a markup on that product of no more than fourteen percent. In other words, Profit=Price (No greater than 14% * Cost of Goods) – Cost of Goods. This formula has enabled Costco to keep its member base, offer them the best savings, and keep a high inventory turnover rate.

B. The Value of Costco’s Public Customer is $2000/year and the Value of its Business Customer is $1995/year
Costco can also measure the value of its customer in dollars annually. This is computed by taking their average sales ($94 every 2 and half weeks) and adding it to the annual membership fee ($35 per business account and $40 per public membership). Using this formula the value of a public customer is $2,000 annually and the value of a business member is $1,995 annually. In 1997, there were a total of 3,537 business members and 7,845 public members. Using these figures, we see that on average Costco’s members spend $22,746,615.

C. Costco’s Business Model is somewhat Risky as it is Based on Maintaining Various Critical Relationships
Costco relies on its bargaining power to procure merchandise at below most cost by purchasing the merchandise in bulk. The company also offers a limited number of products to its members in hopes that they will purchase those items only. At any point several things may happen that might cause Costco to loose business. First, Costco may loose some of its bargaining power with its distributors. This would cause Costco to have to offer some products at a higher price than it would charge normally and this would in turn lead its member to see less value. Secondly, consumer buying habits may change. Although presently people see that buying in bulk is a cost savings, sometime in the future they might not see it so. This would force the warehouse to loose its member base and loose profits.

It is still undetermined whether Costco’s business can be seen as a fad or a great new way to shop. While Costco certainly has a very innovative and disciplined business model, it is clearly conditioned upon elements that are beyond Costco’s control, to wit, an economic downturn, consumer buying habits, and its ability to negotiate with manufacturers to keep product costs down. Therefore, just because Costco has been successful in the past and is currently successful, it is somewhat risky to assume that Costco will continue to be successful in the future, as its business model is conditioned upon maintaining strong relationships with its customers and suppliers.

Costco’s operating philosophy is based on the principals of organizational buying. It acts as a “buying agent for its members,” focusing on high-volume, bulk packaged goods. Therefore, Costco is able to consolidate consumer demand for popular products and work closely with their vendors to achieve the best possible cost. This in turn translates into lower prices for Costco members and increased membership for Costco.

Consumers actively seek out membership to these efficient, no-frills, industrial warehouses. Shoppers are required to verify membership upon entry and once again upon exit, contributing to the “serious shopping, serious bargains” allure. In 1997, Costco finally realized the power behind their membership approach. The market research Costco gathered with each and every member’s trip to a Costco facility was priceless. This information details consumer preferences, buying behavior, and demographics, all of which can be used to target market new products. “Costco realized that its list of loyal members was a natural market for anything that required the purchaser to trust the supplier.”

In 1998, Costco introduced Executive Membership at the request of its members. For a $100 annual fee, “a portfolio of services including auto insurance, mortgage and real estate services, long distance telephone plans, credit card processing, check and business form printing,” became available at a 20% to 40% savings. Business members identified these services as desirable in the annual Costco survey.

The logic behind Executive Membership is directed towards the “committed, high-value Costco member.” With its higher membership fee, Costco knew that the added cost must be offset by greater savings in each of the aforementioned services, without compromising value and efficiency. Executive memberships are often used to increase revenues by appealing to a select group of individuals. It is not geared at the masses, hence the high cost to entry. This enables the supplier to provide exceptional service to those that are interested since there is a smaller group of consumers to which they have to cater. In addition, members receive special privileges, discounts, services, and bragging rights.

In Costco’s Executive Membership plan, Costco simply acts as the liaison between the consumer and the service provider. Costco once again has to negotiate the best possible price with reputable, high quality suppliers, on behalf of its members. The members are then able to pick and chose which services they would like to use. The savings are significantly lower then what is readily available in the marketplace (ie: 20% to 40% less). This is much more difficult to achieve on services as compared to food products. Costco was able to attain these savings due to its strong reputation and loyal consumer following. The real concern, however, is can Costco provide these savings on an ongoing basis?

A. Services are a Good Idea for Costco so long as it Remains Focused on its Core Mission to Provide Value to its Customers
Costco has always had a strong corporate philosophy. “If we can’t do it better, we won’t do it at all.” Therefore services initially seem like a good idea for Costco. They are able to offer significant savings in areas that affect consumers’ daily lives. With a proven track record in providing the lowest cost on large volume food products, as well as peripheral services such as optics, pharmacy, and photo processing, the addition of auto insurance, mortgage and real estate services, long distance telephone plans, credit card processing, and check and business form printing, services are definitely feasible. Costco has built its success by continually analyzing their relationships with key suppliers in pursuit of the lowest price on high-volume, quality merchandise. If an offering does not prove to be beneficial to their members or sustainable in the long run, Costco looks to exit the product or find an alternate. So long as Costco continues to remain focused on its core mission to provide value to its customers and constantly evaluate its business portfolio, then Costco should be able to provide services via an Executive Membership program successfully. If not, then Costco will terminate this offering and ensure that the consumer is made whole (ie: refund their membership fee). Costco must keep an eye on the costs and the quality of service that is provided by their affiliates. This is difficult task since both aspects are out of their direct control. However Costco is aware that this onus ultimately lies with them. Therefore they must be prepared to face the consequences whether good or bad.

Costco’s expansion was planned through offering different products such as auto & home insurance, mortgage services, real estate services, phone service, check and forms printing, credit card processing, and health insurance through its executive member services. Costco used a “try before you buy” approach, and used a method for the members to experience the benefits of the membership before they had to pay for it.

Table seven illustrates the marketing effort of Costco towards its executive membership program. A majority of the marketing effort was concentrated by direct mail and also several small kiosks were set up in some warehouses staffed by associates who encouraged shoppers to sign up for the new executive membership. There were several problems with these marketing efforts. First, using direct mail yielded a very poor response for Costco at 1%, when its expected response rate was 20%. Costco’s offerings in its new membership did not rise above the sea of junk mail people received on a daily basis. Second, problems arose when associates were unable to explain the benefits of more complex financial products. This method only yielded a response rate of 10% to 12%.

The direct marketing had been successful in the past due to the nature of the products and services the company was offering. It was easier to convey the benefits and cost savings of Costco’s household products through direct mail than it was for the services offered under the executive membership program. As exhibits 6, 6A, and 6C illustrate Costco has a comparative price advantage in the industries of credit card processing, auto and home insurance, and real estate. There are several ways Costco can market these new services and to prevent the prospective consumer from feeling that Costco’s cost savings are too good to be true.

1. In order to make existing customers aware of the new executive membership Costco could continue with the direct marketing campaign. Costco could also increase the awareness of its new executive membership through its web site. In order to keep existing customers informed and to handle any inquiries regarding any complicated questions the customers may have, Costco should hire experienced consultants. These consultants are more knowledgeable than a regular Costco employee and can handle customer inquiries with more detail. This would lead to more credibility for the new services and offer a focus group like approach that could be met with ways to improve the new services.

2. In order to reach customers that are not existing members, Costco can take several cost effective approaches. First would be to advertise in local newspapers which are flexible, timely, have broad acceptance, have good local coverage, and high credibility. Second Costco can market its new services in trade magazines. Since Costco has access to information of its small business customers it can target non-existing customers in similar industries in trade magazines. This medium provides for high geographic and demographic selectivity, credibility, and prestige, high quality reproduction, long life, and good pass along leadership.

3. Costco can also use incentive type approaches to attract new users of their services. This approach would also aim to reward loyal customers and to increase the repurchase rate of occasional users. Sales promotions should be aimed to attract brand switchers who are primarily looking for the lowest price, good values, and premiums. Proper use of sales promotions can increase consumer awareness and because of Costco’s excellent reputation it can lead to an increase in market share.

The services that are offered under the new executive membership should first be slowly rolled out and targeted to Costco’s existing customers in test markets across the United States. Costco has chosen to roll out its new services in smaller U.S. markets such as Washington, Arizona, Colorado, and Oregon. These markets should slowly be expanded to include mega markets such as New York, California, and Florida and eventually the international market.

Costco should continue to target its affluent, upscale, and thrifty market segment but also realize that there are other markets that could benefit from its new services under executive membership. Costco can continue to increase its customer base, which currently includes households and small businesses to include small and large corporations, which can also benefit from large cost savings in today’s economical climate.

A. Costco must Roll out its Services Slowly so that Costco is certain that it Maintains its Core Mission of Creating Value for its Existing and Prospective Customers
Costco’s new membership services should be rolled out slowly so that customer feedback could be analyzed and used to fine-tune the services before they are nationally launched. The launch of these new services should also target consumers that are not Costco customers. These include segments such as corporations and lower income consumers. Targeting these segments will benefit Costco in the long run because attracting new customers would increase Costco’s bargaining power among suppliers and in turn enable the company to pass on additional cost savings to existing and prospective customers.

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