Upon completion of the in depth analysis of Costco and the industry in which it operates, two major issues were identified. These issues relate to the long term sustainable growth of Costco and needs to be addressed by management.
One issue that that was evident throughout the analysis was the stagnating profitability. One aspect that is causing this issue is the above-average employee compensation (relative to industry standards) offered by Costco. Being accumulated into the selling and administrative expense line on the income statement, it places a downward pressure on profitability. Much of the manual work accomplished within the store environment (cashier, stocking clerk) is not skilled and therefore does not require a premium wage. In keeping such costs to a minimum, Costco would be able to increase the productivity of its operations and increase in profitability. This will ensure that it will achieve its strategic objective. A second aspect of the profitability issue is its impact on its shareholders. As a public company, Costco has to have the maximization of shareholder wealth as one of its objectives. However, it would appear that shareholder wealth maximization is being treated as a low priority objective. When this was brought up by a Wall Street analyst, Jim Sinegal defended his position as being long term. However, this will not hold true if profitability continues to decline. Where as sales continued to increase in the 2008-2009 year-over-year (YoY) for Sam’s Club and BJ’s, Costco saw a decline. This translated into a 3% decline in ROE. While the recession of 2008-2009 would have contributed to this decline, it raises questions about Costco’s resilience to the cyclical business environment.
A second issue that was identified is Costco’s reliance on the North American market (United States and Canada). In terms of geographic profitability, 90% of Costco’s operating profits are earned in the US and Canadian markets. This is further evidenced in the number of warehouses broken down by geography (Total warehouses: 567, US warehouses: 414, Canadian warehouses: 77, rest of the world: 76). The lack of geographic diversification seems especially like an opportunity being missed, when the fact that the two most profitable stress are in Taiwan and Korea are taken into consideration. The high concentration on the North American market increases the risk to Costco due to the relatively slow economic growth that has persisted in recent years. While Costco has made strides in expanding into the global marketplace, further diversification is necessary to reduce the risk of overreliance on the North American market. Integrated Strategy:
In responding to the above stated issues, management has to be careful not to make drastic changes within a short time frame. Also, the changes should be consistent with the existing business model that Costco has as their value proposition remains a best cost warehouse retailer.
In terms of dealing with the profitability issues, management should implement a two pronged approach. First, the exuberant employee compensation system for employees working the floor should be modified. Reducing wages of existing employees will result in rapid deterioration in employee morale and lead to high employee turnover. Rather, this change should be managed by grandfathering the old system and implementing new wage scales for new hires. This process should be gradual as a drastic shift would result in high inequality among employees. The new system should start employees out at lower wages and/or take them longer to raise their wage level in comparison to the existing system. This will lead to cost savings (Costco can further enhance its low cost position), better productivity and result in higher profitability. Second, in terms of shareholder maximization, the obvious limitation is the capped margins at 14% and 15%. While this policy is consistent with Jim...
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