Costco Case Study

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1. Describe Costco’s business model: according to the case, “Costco’s mission in the member warehouse business read: “to continually provide our members with quality goods and service at the lowest possible prices.” The company’s business model was to generate high sales volumes and rapid inventory turnover by offering members low prices on a limited selection of nationally branded and selected private-label products in a wide range of merchandise categories. (CMU, 390)”. The overall Costco model is set up to function profitably at significantly lower gross margins (compared to traditional wholesalers, mass merchandisers, supermarkets & supercenters) through means of operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling, as well as rapid inventory turnover.

a. Include discussion of how each component impacts profit generation.

i. Volume purchasing: cuts purchasing costs from manufacturers, allowing Costco to pass savings to members through bargain pricing; this component feeds directly into efficient distribution and reduced handling strategy.

ii. Efficient distribution: bypass traditional distribution channels, purchasing directly from manufacturers and routing products either straight to the store or to one of the 9 cross-docking stations. Once products arrive at a docking station, they are placed in a combined shipment; therefore maximizing freight volume and handling efficiencies.

iii. Reduced handling: upon delivery, the majority of shipments are placed directly on the sales floor stacked on pallets. This reduces the need for off-floor storage as well as shelving accommodation and handling. Limited selections of only high-volume sales items (in regard to size, color and model) further reduce handling and increase efficiency.

iv. Rapid inventory turnover: high sales volume is generated through bargain pricing method; accordingly, producing profits before vendor bills are due, allowing Costco to take advantage of early-pay discounts. Thus, a large percentage of Costco’s merchandise inventory is able to be financed through payment terms defined by vendors (rather than a sizable working capital).

2. Describe Costco’s strategy: “The cornerstones of Costco’s strategy were low prices, limited selection, and a treasure-hunt shopping environment (CMU, 390)”.

a. Identify strategy elements; include specifics that communicate how Costco employs each element & what each is designed to accomplish.

i. Pricing: items at Costco are always priced at bargain levels, providing a significant savings for members. Costco has a policy to cap brand name mark-ups at 14% and private label products at 15%. By maintaining a low-price strategy, and continually cutting costs for members whenever possible, Costco has developed a sustainable pricing strategy based on their commitment not to be undersold.

ii. Product selection: each store stocks approximately 4,000 items, about 3,000 regularly available products and the remaining 1,000 is considered “treasure-hunting merchandise”. The selection of regularly available items is limited to fast-selling models, sizes and colors. My maintaining a smaller stock of select items, Costco effectively simplifies inventory processes thereby increasing efficiency.

iii. Treasure-hunting merchandising: The ¼ of the product inventory which constantly changes is made up of special buy “one-time purchase” items. These are usually high-end brand name items with larger price tags ($2,000-3,000). The limited supply of treasure-hunting merchandise is intended to instill a sense of urgency in the customers, knowing it probably won’t be there on the next visit.

iv. Marketing/advertising: due to the nature of Costco’s business model, large-scale advertising and sales campaigns are unnecessary; conversely, most of the advertising is achieved through word-of-mouth from existing members. Marketing and promotions are generally...
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