Analyzing Costco Wholesale: Challenges And Opportunities

MGT 603 Business Operations Management

Costco’s sales model

Costco Wholesale is one of the largest warehouses in America. It provides a large selection of products ranging from organic foods, beef, wine and rotisserie chicken. The organization which has its headquarters in Washington opened its first store in Seattle back in 1983. Since then the growth of Costco has been exponential. By February 2017, the company has opened a total of 727 warehouses spread across different countries including Mexico, Spain, Australia, and Japan among others. Costco has created a name by offering moderately priced, luxury goods which have touched base with the general public especially in America who are majority consumers of Costco’s products.

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Costco’s prides itself on being the first company in the Unites States to register upto 3 billion dollars in sales in a spun of less than 6 years. In 2014 the company was ranked as the third best wholesale retailer company in the United States. In the same year, the business was ranked top in the specialty retail store industry. This according to report released by the National Retail Federation in 2014. These begs the question, what has been Costco’s secret to success? This paper, therefore, seeks to identify some of the problems that the organization may face and affect its profit margin in the near future. The paper will also analyze some of the macroeconomic environment influencing the growth of the company and finally gives a recommendation on solutions to some of the challenges.

The main sales strategy being use by Costco aims at selling its goods at low prices. The goods are sold at low prices below the market price and very high volumes. The products are usually sold to families and large businesses and are packaged in bulk (Burt & Starlin, 2003). The company also runs with a very lean budget when it comes to its operations. The operational costs are estimated at 10% of the company’s revenue. Also, it does not operate any public relation department, neither has it outsourced advertising. Approximately 80% of Costco’s gross profit comes from the annual fees remitted by its members. As a result, the company makes its profits 11 months in advance as compared to other retrial stores (Neal, 2016).

Analyzing Costco’s business model reveals that the company has no strategic issues facing it at the moment. This is because their business model is watertight in the sense that they have a lean operation budget and they enjoy profit at a very low gross margin. However, its strategy is prone to future threats as seen below.

  •    Membership

Problems facing Costco’s wholesale

One of the biggest threats posed by Costco’s business mo is its overdependence on its memberships. The company enjoys a membership renewal rate of over 85 %. Fr instance, in 2015 alone, its members paid over $ 2 billion in the membership fee. This translated to about 17 percent of the company’s $15 billion in gross profit in that financial year. This means that this strategy will always work as long as this customer maintain their loyalty to the company. Customers, however, may choose to shift their allegiance to competitors thus affecting the profit margin of the enterprise (Kotler & Armstrong, 2010). Costco’s may also be facing a challenge from a company like Walmart’s Sam’s Club which offers a similar product. Moreover, the cost of their goods and discounts are relatively the same as those of Costco. The only difference is the selection which is largely dependent on consumer preference.

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  •    Multi-channel business experiences.

The current retail market is offering a variety of options for retailers to increase customer experience. This has pushed companies to adopt multichannel business focus. Moreover, most customers are moving from the tradition method of buying products from retail stores to shopping online. This paradigm shift might hurt the profit margin of Costco who still depend on warehouse sales (Albaum & Duerr, 2008 ). While Costco’s emphasis on warehouse sales allows it to sell its products at relatively low prices, it cannot match up with the type of multi-channel experience that many customers enjoy when they shop online. Costco has identified this emerging challenge, and they are putting a lot of effort to mitigate the effect of online wholesale stores. However, there is no guarantee that the strategy that will be adopted will be timely for the organization to retain its control of the market and at the same time keep its customers.

  •    Delivery of Bulk Goods

Transporting goods purchased in bulk from Costco’s wholesale warehouses can be a real issue especially for those people living in the urban areas or those who may be unable to park near their wholesale stores. Despite Costco offering some online services, it cannot match the discounts being provided by other bulk service providers such as Amazon and Jet. These providers not only offer similar deals and on top also offer free shipping. For instance, Amazon gives a discount to bulk customers and further offers free two-day shipping for the products purchased. This convenience has also moved a lot of former Costco’s customers to these online bulk service providers. This may in the long-run affect the profit margins of Costco bearing in mind that the world is slowly moving from traditional methods of purchasing goods to online shopping.

  •    Consumer taste and preference

Macro-environment affecting Costco Wholesale

They dynamic nature of customer taste could affect Costco’s sales anytime. Costco warehouse approach is a risky way of doing business, especially where a deal largely depends on customer’s preferences. In a nutshell, Costco’s business model focuses on purchasing items in bulk quantities and try selling them as quickly as possible. However, this can only work if it can maintain these high volumes. The danger of this is that if the customer preferences changes, the company might be left with the huge amount of unwanted goods that may translate to multiple losses.

Changes in the environment may affect a business either positively or negatively. As a results organization will need to always think of how to mitigate the effect brought about by this factors. This explains why organizations will have to take into account its external environment when formulating its strategies. A closer look at the strategy being implemented by Costco Wholesale reveals that the business has adopted a formula that concerns itself with increasing profitability while at the same time maintaining a lean operation budget. Costco Wholesale, just like any other business is affected by the external environmental factors that have impacted on its operations. In this analysis Porters, five force ad PESTEL analysis was used to identify some of the threats, opportunities and environmental factors that affect the operation of the business.

Porters five force analysis has been used in this report to assess the threats and opportunities facing the business currently. This theory was developed by, Michael E. Porter to assist organizations in the evaluation of the risks and opportunities the organization faces as it struggles to remain afloat in a volatile environment (Porter, 2010).

 While using this strategy in Costco’s case, the following observation was made;

  •    Bargaining power of Buyers

A closer scrutiny of the US  retail market where Costco has most of its warehouses shows that the bargaining power of  buyers in this market is at all-time high due a large number of wholesale retail stores that offers similar goods that are are  basic needs to consumers. This has been as a result of consumers having a wide range of warehouses to make preference from thus affecting the bargaining power.

  •    Rivalry among businesses

Stiff competition among businesses selling similar goods is another phenomenon being witnessed in the US retail market. This has made the threat of competition in this market to be relatively high as firms try to compete in a bid to control the market share. Costco Wholesale will have to compete with organizations such as Walmart’s Sam’s Club which offer similar commodities and discount offers. As a result, apart from raking in big from its annual membership fee, Costco Wholesale will need to employ new strategies that will see it edge out its competitors and have the lion’s share in the ever competitive market that it operates in

  •    Threat of New entry.

Porter’s Five Forces analysis of Costco Wholesale

A closer observation at the U.S retail market, shows the threat of new entry is at its lowest level. This means that the market has zero room for new players (Cadle, Paul, & Turner, 2010). This has been made possible the bullying effect that large firms like Costco have on new players. The large companies have made it pretty difficult for new firms joining the market to differentiation strategy of products that is existing in this market. Another hostile environment that the new players are facing is that established businesses adore high levels of brand loyalty from consumers. As a result new businesses joining the market must use the brands that are existing in the market before breaking even.

  •   Suppliers’ bargaining power

An analysis of the retail market in which Costco operates in reveals that the market is being controlled by the larger firms who control a bigger share of the market. This control of the retail industry by a few players has raised the suppliers’ bargaining power to a manageable level

  •    Substitute threat

Observing the consumption patterns of customers in the U.S retail market reveals that Costco Wholesale has nothing to worry about since the threat brought about by substitute goods is rather inconsequential (Costco Business Centre, 2017). This is due to the fact that products being offered by Costco are perishable products which are vital making their demand very high. Also, there are no substitutes available since the consumers have to use this product every day.

Costco Wholesale Company remains one of the most profitable business in the U.S retail market and its neighboring countries.

Economists note that any business that is serious about breaking even in a volatile market must always put into consideration on the external environment and how to mitigate the effects that this factors will have on the operation of the business (Voiculet et al., 2010). The U.S retail market presents some external factors which have a direct impact on the operations and growth of the company (Hollensen, 2007). Most of this factors the business has no control over them but can only reduce the level of impact it has on them. Some of the environmental factors include;

  1.    Political factors.

 Change in policies effected by the U.S government that do not support the retail industry may affect operations of Costco Wholesale and in turn affect the productivity and growth of the business (Doug, 2003). Major changes in laws and policies initiated by a local government may have serious implication on the operations of Costco. Implementation of trade laws and policies by government should, therefore, be monitored since the effect always trickle down to affect the local retail firms

  1.    Economic:  

Economic factors may have an adverse influence on the productivity of a business. Factors such as inflation rate, the rise in interest rates, exchange rates and trade regulations can have a negative effect on the productivity of a firm. An analysis of the U.S retail industry has indicated that economic indicators such as weakening of the dollar and exchange rates depreciation have negatively affected the productivity of Costco Wholesale in the recent past (Kotler & Armstrong, 2010).

  1.    Technological:

Technology has become a major point of focus for companies in the retail industry today. Costco can embrace the use of technology, especially in its bids to go online and compete for the market share found in the online platform. Despite technology being used as a tool to enhance productivity to great firms like Costco it can also drag the company into millions of losses if used for the wrong reasons (Feenberg, 2001).

  1.    Social:

While Costco seeks to increase its market share in the ever competitive market, it has to consider social factors and cultural barriers that may influence its productivity in the market it operates in. Looking at the U.S retail market, the social factors such as demographic lifestyle is having a direct effect on the market. As a result, retail firms like Costco will have to work extra hard to develop ties with the local communities residing in the areas they operate in through community engagement and other social events (Johnson, Whittington, & Scholes, 2009).

  1.    Environmental:

The environmental factor is also believed to have a direct influence on the productivity and growth of Costco. An analysis of the retail industry shows that Costco is affected due to its nature of business and disposal of perishable goods from its warehouses that may lead to environmental degradation (Kotler, Keller, Brady, Goodman, & Hansen, 2009). The government has also been on the neck of most retailers dealing with perishable goods to comply with local regulatory requirements that at times are seen to hurt the profit margins of such businesses. Costco stock these goods in bulk and at times lack of proper disposal mechanism may end up allowing some of the waste products contaminating the ecosystem

  1.    Legal;

The legal factor has also been pointed out as a factor affecting the retail Market in the U.S. An evaluation of Costco in reference to its productivity under new policies that do not favor the business has affected its profit curve and growth in the long term.

An analysis of the strategy being used by Costco Company reveals that the organization has caused an approach that focuses on attaining double growth and profitability for the business. The research further reveals that the organization is affected by macro-environmental factors that effect on its operations

Looking at the challenges facing Costco, the company will need to develop strategies that are dynamic and can fit in any economic situation. Costco will need to shift their focus on online retail stores as more customers are moving to this platform (National Retail Federation, 2014). This needs to happen soon since they are already a big chunk of customers migrating to online bulk stores who are offering better discounts and attractive after sale services such as free shipping and pay on delivery options (McDonald & Wilson, 2011).

Costco will also need to check economic indicators regularly and develop plans that will help the company adapt to the economic changes. This will also allow the company to have a clear view of the where the market is heading in regards economic indicators.

The analysis has also revealed that the firm is still reluctant to embrace the use of technology. This explains why Costco is still pushing customers to visit their stores physically. There are also opening new branches instead of channeling their marketing to online stores. These means that if the status quo remains the same, the company stands a risk of losing a chunk of its customers to upcoming players who are using technology to push their products (Arthur, 2009). These companies include Amazon online bulk store which has become a favorite store with many online volume customers. The organization should, therefore, repackage itself to embrace technology in all aspects of its operations.

The issue of overdependence on member annual fee as the primary source of revenue is risky especially in the retail environment that the business operates in. Taste and preferences of customers will always be a changing factor. Unfortunately, this factors can have a direct influence on the decision of a member either to keep his loyalty with Costco. As a result, I recommend that Costco employs another strategy as a new plan apart from the membership strategy which is dependent on the renewal rate and customer preference at any given time.


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