The Costco Business Model

Megan McArdle writes,

Costco really is a store where affluent, high-socioeconomic status households occasionally buy huge quantities of goods on the cheap: That’s Costco’s business strategy (which is why its stores are pretty much found in affluent near-in suburbs). Wal-Mart, however, is mostly a store where low-income people do their everyday shopping.

I went to Costco for the first time a couple of months ago. My first reaction was that I did not understand the business model. I thought that in the grocery business, you wanted to have lean inventories, and they seem to have the opposite. McArdle explains,

Costco has a tiny number of SKUs in a huge store — and consequently, has half as many employees per square foot of store. Their model is less labor intensive, which is to say, it has higher labor productivity. Which makes it unsurprising that they pay their employees more.

My local grocery store, Giant, is filled with employees, who are constantly restocking shelves. Giant keeps on hand relatively low inventories of a much larger number of products.

Eventually, I could imagine an equilibrium in which a store like Giant pares back on the number of items it sells in the store, keeping only the most popular items available. You would have to order less-popular items on line. That way, they could cut back on those restocking costs.

Of course, for all I know, Giant’s business model is to charge a big markup on stuff, and they figure once they get you into the store they make a profit. And if stocking a great variety of items gets you into the store, then that is the right strategy.

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8 Responses to The Costco Business Model

  1. jseliger says:

    Eventually, I could imagine an equilibrium in which a store like Giant pares back on the number of items it sells in the store, keeping only the most popular items available

    Costco also charges a membership fee. I’ve never signed up and likely never will, because the fee only makes sense if you buy a LOT of stuff from them. That alone will keep the Giants of the world stocking toilet paper and so forth, because a sizable portion of their customer base is unlikely to move to Costco.

  2. Handle says:

    Giant is really trying to reduce it’s labor intensity, which, gradually, seems to be becoming the preferred option for many shoppers. I’m not sure if they’re nudging people towards this preference or whether they’re just satisfying a pent-up demand with newly affordable tech, or what.

    The one where I live has a very high self-checkout to cashier ratio, and has introduced some fun combination of a scanning-gun and Motorola smart phone (See here)

    Giant also does Peapod, with online selection and both free pickup or delivery, which adds another wrinkle to the strategy.

    I wish they would combine the online ordering on peapod with the ability to order special, low-frequency items, like I can do on Amazon, and perhaps in bulk. I’ve heard Amazon fresh was also pretty awesome from some friends in Seattle.

  3. CJC says:

    Costco sells memberships, and, more or less, makes all its profits from memberships, with the goods sold at cost.

    From the point of view of selling memberships as your real line of business, you probably want to carry excess inventory compared to a traditional supermarket, as paying members likely get pissy over shortages.

  4. George says:

    The equilibrium has already been reached. Costco competes with Sam’s club and Giant competes with stores like Safeway. You’re being fooled by the apparent overlap in some of their inventories. Partial competition is happening but these businesses occupy different niches in the economy.

    Honestly, I marvel at the assumptions that economists make when discussing things. You ought to have a few conversations with real people running real businessss once in a while.

    And I’m complaining to a guy who gets it right most of the time! Most liberals and quite a few conservatives are hopelessly lost in their offices.

  5. R Richard Schweitzer says:

    As a displaced Virginian now in the territory of another Royal Dutch Ahold sister operation (Stop & Shop) to Giant, one can observe that the marketing techniques are entirely reactive.

    Experience with my sons family’s inclusion in the Costco niche market system convinces me that McArdle is right on target; that would include SuperTarget which was developed to compete with Walmart, particularly in the Atlanta area.

    It is difficult to build a Buffett “moat” around a niche market. But Costco still outdoes Sam’s Club and BJ’s.

  6. K Webb says:

    Stocking a large variety of items attracts picky shoppers with limited time. If a shopper finds a regularly consumed item is not carried at his current grocer, he is likely to take all of his business to the grocer that does carry what he wants. People don’t like making two trips when one will do.

  7. JKB says:

    It seems to be being overlooked that the warehouse club, like Costco, started and is aimed to serve small businesses, who don’t move or use enough product to buy direct from suppliers and concession at sports fields, fairs and other such events. Sure they’ve expanded into individual bulk consumer items but look at their snack/candy set up, their produce and even vacuum pack meats. Enterprises that need one, two or six cases of something for the counter or the pancake breakfast.

    They have lucked into the survivalist/apocalypse genre.

  8. DensityDuck says:

    “Eventually, I could imagine an equilibrium in which a store like Giant pares back on the number of items it sells in the store, keeping only the most popular items available. You would have to order less-popular items on line. That way, they could cut back on those restocking costs.”

    And this is exactly how Best Buy, Barnes & Noble, and the media departments of Target and Wal-Mart operate, and those are the only national-brand retailers that still sell media (books, movies, music.) Stock the top twenty, everything else is online.

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