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What Makes Costco a Great Company?

Warehouse club models utilized for Costco (COST) is proved to be very well-liked across the U.S. In the 17th of March, 2022 Costco was operating 820 stores, primarily located in North America, and had 114.8 million members. It’s safe to say the majority of members who pay dues are regular purchasers of Costco’s massive-sized products.

What’s the secret behind Costco’s growth? There are three things that are what make Costco an excellent business.

Important Takeaways

Costco earns a tiny portion of its revenue from its products, but the majority of its earnings are derived from membership fees. Only members are able to buy from Costco.
The model of membership permits Costco to beat out the competition by providing bulk products with lower prices, ensuring loyalty to customers.
Costco’s advertising budget is nil since customers are returning to enjoy the maximum benefit from their membership fees.
Costco offers its employees a generous salary and offers hourly wages that are higher than what the Federal Minimum Wage, and over many other retailers.
While Costco is a great company with many positive qualities as a business However, the stock could be costly for certain investors because of its high price-to earnings ratio.

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It Earns Profits Prior to Selling the item

In the year 2021’s fiscal year, Costco was able to sell $192 billion of merchandise, and earned $3.9 billion in fees for membership. Costco’s gross margin, including fees for membership, was about 11%. This is what is the norm since 2014.

It is a lot less than the profit margins of traditional retailers. Walmart is an example. Walmart was able to achieve 24.3 percent by 2021.

However, Costco does not actually earn much of its revenue from selling merchandise. Costco members pay an annual fee to enjoy convenience of purchasing in its stores. These charges make up a significant part of Costco’s operating income. The year 2021 was the last time Costco’s costs for merchandising was $170 billion on $192 billion in revenue. General, selling, and administrative expenses were $18.5 billion. The profit total during that year was $5.2 billion.

Other retailers must be worried that a drop in sales at the same time could result in a decline in profits. But not Costco. Its success is based upon its capability to convince consumers to pay $60 annually for its daily Gold Star membership or $120 for an upgrade to Executive status.

A High Retention Ratio

With prices that are often lower than other retailers it’s no problem to sell the benefits to customers, particularly since Costco’s average Costco member earns the household income of $93,000. This creates a solid base of customers, with retention rates of in excess of 91.3 percent.

It’s not surprising that the company’s profit has been steady over the decades.

No advertising? No Problem!

The majority of retailers spend massive sums of money marketing to attract customers to their stores.

Walmart invested $3.2 billion advertising dollars in 2021. Target has spent more than 2 percent of its earnings on marketing. The year 2020 was the most successful for Target. Target has spent $1.5 billion roughly the same amount as it spent since 2010.

Costco has a budget of essentially nothing. There is no budget for advertising however, it does use send out mailers to new members, and offers that are sent out to members already in the company.

This Argument Against Advertising

How does Costco achieve to completely avoid traditional advertisements? There are two main reasons.

In the first place, Costco offers a service that is self-sales. Costco memberships offer excellent value for those who frequent Costco and other traditional stores aren’t able to compete with Costco in cost.

Costco is present in 12 countries, and has 288,000 employees across the world.

In the second place, bringing existing customers to visit the store more frequently via marketing isn’t going to improve the bottom line, because membership fees are the primary source of profit and spending a lot to increase membership isn’t a good idea.

In reality If Costco was to allocate 0.5 percent of its revenue on marketing, it could erase 17% of its operating profits. If it spent the equivalent of 2% of its revenue in advertising, like Target does, that amount will erase almost 70 percent of Costco’s operating profits. It’s simply not worth it.

High Wages and Productivity

Costco provides its employees with a salary that is unusually as compared to other retailers. In the early part of 2019, it increased the minimum hourly wage to $15. Then in 2021 it increased it to $16 then the next year it raised the amount to $17. Its hourly average is around $18.04 per hour, which is compared to around $13.99 per hour for retailers, as per Payscale. The majority of Costco employees can benefit from healthcare benefits provided by the company. healthcare.111213

For Costco this means an employee population that is highly motivated. Here’s how Costco’s profit per employee ranks against other retailers:

Costco employees are the most profitable. Costco employee is able to generate nearly three times the amount of revenue generated by the typical Walmart as well as Target employee. This result is due to Costco’s model of business. The warehouse stores are small and have significantly fewer workers than the typical big-box retailer.

What keeps customers returning, and also keeps them renewing their memberships is an consistently great shopping experience. With well-paid, cheerful workers, Costco delivers better than its competitors in the retail market.

Great Company Excellent Company, Expensive Stock

Costco is an amazing business, but it doesn’t mean that it’s a good stock. At the time of writing, March 28 2022 Costco had a ratio of price to earnings of 44.64. Its historical mean for S&P 500 is 21.92. The median for department stores and discount stores is 32.29 and the average for food stores, it is 10.44.

It’s not unreasonable to pay a premium for high-quality, but there’s an upper limit. Costco is a company which ought to be on the radar of all investors and if it drops back to more sensible levels, it ought to be purchased immediately.

What is Costco’s competitive advantage?

If you compare Costco with other retailers of the same type Costco’s competitive edge lies in its private label as well as its discounted prices and membership fees. It has given customers the product they can trust with low costs. It’s also a reliable company model, which investors look for as a solid investment.

Does Costco offer free or discounted memberships?

Costco doesn’t offer discounts or free memberships. Costco believes that the annual costs of membership are easily recouped due to its low costs and numerous products that provide savings overall if customers were to shop at comparable organizations.

Who is the owner of Kirkland?

Kirkland Signature is a private label that is that is owned by Costco. Kirkland items are sold for around 20 percent less than the national brands and make both Costco as well as Kirkland an appealing destination for shopping.

The Bottom Line

Costco has developed its own business model that has proven to be successful. Costco sells bulk goods at a discount, and requires the purchase of a membership to make use of these affordable costs. The company does not spend money on marketing since memberships bring shoppers into stores, saving the company a substantial amount of cash and transfer that savings to customers with lower costs.

Costco is also able to pay its employees well by providing the highest hourly wage, which is higher than that of the minimum federal wage as well as several other similar retailers. While Costco has many positive features but the stock is thought to be too expensive and overvalued for certain investors.

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