Costco Cashes In on Bargain-Hungry Shoppers

May 29, 2008— -- In a nation clearly showing signs of recession, with several retailers reporting declining sales and some declaring bankruptcy, Costco is thriving. As consumers continue to seek bargains, the bulk discount store reported that its third-quarter profits increased 32 percent and sales were up 13 percent, beating Wall Street's expectations -- suggesting that, while other retailers are struggling, Costco has got to be doing something right.

Credit goes to the company's buyers -- its mostly unknown employees who scour the globe looking for the special merchandise that will entice shoppers to buy a membership for at least $50 just for the privilege of shopping.

So successful is the formula, that Costco management is even confident enough to admit that it does make the occasional mistake.

Example: the Opus patio furniture set.

"It was white, the fabric on it was white," said Kim Thomas, Costco's assistant general merchandising manager for lawn and gardening, who described the Opus as "a set that we all just absolutely loved."

Costco bet that it would sell thousands. That turned out to be a big miscalculation.

"We started out; it was like a $600 set," Thomas said. "It was probably one of the worst-performing sets we've ever put on the floor anywhere."

She said the retailer finally got rid of the last of the inventory when the company opened stores in Puerto Rico and sold the set for $99, "hoping we could give it away," she said with relief.

"You know, we won't make that same mistake, but we'll make other mistakes," she said. "That's the only way we learn."

Put that way, to shop at Costco is to take part in an experiment in trial and error. Its buyers will try to guess what you'll buy in bulk, from cashews by the carload to toilet paper by the ton. If Costco gets it right — and that happens more often than not — it gets to stay in business.

The track record, so far, has been outstanding.

Fewer Items, Better Items

Part of the secret to the retailer's success is how few items Costco actually has on its stacks and stacks of shelves. Tim Rose, senior vice president for food and sundries, pointed out that "we only carry about one-tenth of the number of items that a typical supermarket carries."

The implication is that Costco doesn't actually offer that much stuff.

But that's hard to believe, considering that Costco is the nation's fourth-largest retailer. It sold 1.7 billion gallons of gasoline last year. It is the single largest buyer of USDA-Choice meat. And on any given day, the retailer sells 103,000 rotisserie chickens, more than 37 million a year.

What sets Costco apart from its competitors is that it only offers about 4,000 unique products for sale at any one time. Compare that to a typical supermarket, which carries about 40,000 products, or a Wal-Mart store with about 125,000 products.

What's the biggest seller of all at Costco? Toilet paper. That one single product accounts for $375 million in annual sales.

Buying only one or two of any given product leads to the secret behind Costco's success: It selects what it believes to be the high-quality products its customers want. Even when it comes to toilet paper.

"Every year to every two years, we try to upgrade the quality of this product," Rose explained. "Make it softer, make it stronger, everything that we can do to just make it a better quality product and our members, you know, obviously the reward is with the sales on this item."

From a maze of nondescript beige cubicles in the company's headquarters just outside Seattle, Costco's buyers go forth around the globe searching for merchandise and then return to decide what should make the final list of 4,000 items that the store sells.

Shannon West, who oversees apparel for the store, says that only about 15 percent of what the buyers bring back actually makes it onto the floor.

She admitted there is pressure to choose the right item, because if you get it wrong the mistake is magnified. But she's stoic about it. "That's kind of our life that we deal with, and I've been here 24 years, and so I don't know a different way," she said.

Choosing so few items is almost easier, she said. "I'm not used to buying like a department store would buy, where they're buying whole collections of, you know, different lines or whatever."

Size Matters

The Costco way was honed by Jim Sinegal, who founded the company a quarter century ago. As the number of stores increased to more than 529 stores in seven countries, he tries to visit every one, every year.

A few weeks ago at company headquarters, he was checking out the patio furniture for sale in 2009 and explained why, at Costco, you have to buy so much of something, using Advil pain medication as an example.

"We sell it for about $15," he said — "325 pills in a bottle."

That's a lot, he admits, but went on to say, "We could probably sell it in 25s, 50s, 100s," but the company doesn't because it sees something different.

"We look at it from the standpoint that if 10 customers come in and they're looking to buy Advil, the fact that we have 325 maybe turns off one of those customers, but nine of them will buy that large size of Advil."

Buying such big quantities of products can lead to Costco practically dominating certain products. For one variety of large cashew, Costco is among the biggest buyers on earth.

The other tenet Sinegal insists Costco follow is that it never sells anything at more than 14 percent above cost. If a hypothetical pair of socks cost them a dollar, they sell it for $1.14. Not a cent more.

"If you study the retail business you will find all sorts of examples of people who thought that they could charge another dollar for an item, and another dollar here, and they could cut the wages on their employees, and the net result is that you have lots of companies that wind up going out of business," Sinegal said.

The point is to stay in business and make the right decisions on what makes the list of 4,000 products. Costco's profits come largely from their customers' membership fees.

That explains why Sinegal was examining patio furniture for next year. Costco buyers from around the world had met to review the furniture finalists. It is still deciding which sets will make the final cut. And as long as it's not another Opus, the company is on track to keep ringing up healthy sales.