An Interview With Jim Sinegal, Co-Founder of Costco

Join The Motley Fool for a conversation with retired Costco CEO Jim Sinegal. In love with retail since his first job as a bagger in 1954, Sinegal co-founded Costco and served as president and CEO of the retail giant from 1983 until his retirement in January 2012.

In this informal chat, Sinegal shares the experiences of nearly three decades at the helm of industry leader, Costco. We discuss the retailer's history and growth, its approach to employee compensation, its product offerings, and its forays -- some more successful than others -- into other markets.

Brendan Byrnes: Hey, Fools, I'm Brendan Byrnes and I'm joined today by Jim Sinegal. Jim is the co-founder and the former CEO of Costco. Thank you so much for your time.

Jim Sinegal: My pleasure, Brendan.

Byrnes: I was wondering if you could walk us through the Costco business model and how it has evolved over time.

Sinegal: Well, when we started in downtown Seattle, we had a building that was 100,000 square feet. It was a pretty simple facility. We didn't have many of the enhancements that we've added to the business since then.

It was clearly a warehouse; an open-beam ceiling and cement floors and industrial steel and forklifts moving around in the facility. As time has gone on, the model has incorporated a lot of new things that we've put into the business.

We added the fresh foods -- the meat department and the produce and the bakery in there -- we've added a pharmacy, we've added gasoline, we've added a food court with a pretty significant menu of products; maybe about eight products that we're offering in our food court. We've added one-hour photo processing and optical and enhanced a lot of the departments that we had in the general merchandise area as well.

That's all been an evolutionary process that gets you to the model that we have today, that is generally about 145 to 150 thousand square feet, compared to the 100,000-square-foot facility that we had in downtown.

Byrnes: Could you talk a little bit about managing growth, both in the early years and more recently -- not wanting to expand too aggressively and too fast, but also maintaining solid growth -- how do you marry those two?

Sinegal: Well, we're very pleased with our growth. The growth in the 27 years since we've gone public, since we became a public company, our growth in revenues has been at a 13.8% compounded rate, so we think that's pretty healthy.

But we've always been very mindful of not outdistancing the management team that we have to be able to grow the business intelligently. We have, as I suggested, put the brakes on from time to time. People often have asked us, "Gee, these things do so well. Why don't you open 100 of them in one year?"

Well, we don't have the appetite and the management team because we home-grow all of our management. All of the people that are running the Costcos today are people who have been with us 10 and 12 and 15 years prior to becoming a warehouse manager.

When you're going to promote from within and grow the talent from within the company, you have to be mindful of what your limitations are.

Byrnes: Obviously you've built Costco into such a successful retailer. What's it like now to be outside the driver's seat, and what kind of involvement do you still have, day-to-day?

Sinegal: Well, there's very seldom a day that I don't go into a Costco, as you can probably imagine. To the extent that I'm helpful to Craig [current CEO Craig Jelinek] and to his management team, then great. To the extent that I think that I'm meddling a little too much -- I've got to be very careful not to engage in that -- then I want to back off a bit.

But I still have an office here. I still come into the office. I'm handling some things, some projects that Craig has asked me to participate in, and I'm happy to do that. I'm still on the board of directors. I'm still a shareholder. I still have a very keen interest in the success of the company, as you can imagine.

I will be easing off a little more over the next year, and probably be spending less than full time.

Byrnes: Could you give us a background, how Costco's economics differ from other retailers and how you use that to your advantage?

Sinegal: Well, the economics of our business is pretty simple. High volume -- we do well when we generate high volume and high revenues out of our businesses. We don't do nearly as well when the revenues are low.

We count on very significant productivity. We pay high wages and have a very healthy benefit plan. If you buy into the concept that Costco is the low-cost provider of goods and services -- and I hope you'll buy into that concept -- if you buy into that concept, and if we also pay the highest wages in retail and have the richest benefit plan, then we must be getting better productivity, because of every dollar that we spend on our business, $0.70 is on people.

That is clearly the most significant expense item that we have, and it's clearly the ratio that we have to watch most carefully, but we do it, and we do it because we're able to generate high volume and high revenues.

The economic model is great value on a consistent basis, driving up the revenues, getting people to shop with us more frequently than they did the year before, and we've been pretty successful in the last couple years in accomplishing that.

Byrnes: Could you walk us through how a new product gets onto Costco's shelves, what the process is behind that? Do you make little bets and try some out in some stores and see if that works, or do you go all-in and purchase in big bulk? How do you buy it from suppliers when you're looking at new products?

Sinegal: There's a multifaceted answer to that question.

Let me just say that, in many instances when we want to try and test a product, and perhaps we're going to buy less than a trainload or a boatload, we'll price the product as though we bought it right, just to determine whether or not we think it has the ability.

We're going to put it in one or two or three locations and test it out and we want to know whether or not, if we're pricing it right, we can really move it in quantity. That's one of the aspects of looking at it.

Our product mix of the roughly 4,000 items that we have is made up of about 3,000 items that are basic -- the kind of items that you're going to walk in and you're going to find just about every day.

Now, the characteristics of that product might change. You might come in one time and see that we have Chicken of the Sea tuna and you come in the next time and it's Bumblebee tuna. It's always in a convenient eight-pack or 10-pack, but we're going to have a good brand of tuna that's going to be available for you when you shop with us.

That's kind of a basic item. It could be Prego spaghetti sauce one time and it could be Ragu the next time -- the best buy that we can find in that category. Those are basic items that you're going to come in and find on a day-in and day-out basis. The customer is always going to find that we have copy paper available.

Then about 1,000 of the 4,000 items that we carry are what we refer to as the "treasure hunt" items. Those are the items that are constantly changing. If you came in one time, you might see that we have some Under Armour garments, and you come back the next time and we don't have the Under Armour garments but maybe we have some Coach handbags that are available.

Those 1,000 items are the items that, as I mentioned earlier, are the treasure hunt. Those are the types of things that continue to bring customers in shopping with us. We try to create an attitude in those kinds of products that if you see it you'd better buy it, because chances are it's not going to be there next time -- so create an urgency in the customer.

When we're doing our job best, when we're doing the best job of purchasing and doing the presentation of our product mix best, that's when we're doing the best job on the treasure hunt.

Customers love the fact that we're going to save them $0.50 or $0.60 or $0.75 on a jar of peanut butter, and they would never forgive us if we didn't save them that, but that's not enough to bring them out of the hills.

What really gets them in there is when they see something like the Under Armour garment that we're selling for $20 that they know is $40 in a department store. Or the Coach handbag that we're selling for $159 that they know is $300 at a department store. That's what really gets the customers really excited. That's what makes them talk about us at cocktail parties.

Byrnes: When you look back at Costco over all the years from when you co-founded it to today, what do you think is the biggest thing that's changed over those years?

Sinegal: I think we've gotten better at doing our job. I think that we've been able to instill the types of things in the corporate DNA that are going to ensure that we're successful in the future, and that we understand as well today as we ever have the disciplines that are necessary in our business.

Anybody can sell merchandise for low prices. The trick is to be able to do it well and to make money while you're doing it. I think that we've matured. We've become better. We've become better merchants. We've become better at selecting the right type of merchandise for the customers. I think we've improved some of our departments significantly over those years.

Byrnes: Taking more of a 30,000-foot view of this space, obviously e-commerce is getting much more popular, with the likes of [Amazon.com]. Where do you see retail going, over the next decade or so? Do you see e-commerce getting more popular and becoming a threat to Costco, or do you think you both coexist and do separate things?

Sinegal: I think e-commerce will become more popular, but I think there's always going to be a place for Costco. I think that people have been going to the marketplace for millenniums, and I think it's a social thing as well.

One of the comments that we get oftentimes, from women shoppers, is, "Costco is the only place where I can get my husband to shop with me."

I think that as long as we're doing our job ... there are no annuities in this. The guarantee for us is if we continue to do our job and we do it well. E-commerce is going to survive, just as other retailers are going to survive.

There are other competitors out there, like Aldi, who are going to continue to grow and do well. Trader Joe's is going to continue to grow and do well. Some of the supermarkets like Wegmans are going to continue to grow and prosper, and there are others as well. Home Depot recently has shown some very significant improvements, so there's kind of a resurrection that's taken place there.

There's always going to be tough competition from every aspect. E-commerce is just one aspect of the competition, and we watch an awful lot of people. You'd probably be amazed at the number of people that we go to look at, relative to competition.

Byrnes: When we look at retail overall, some retailers are struggling. Best Buy maybe not doing so well as they have in the past, Radio Shack along the same lines, Circuit City going out of business.

When you look at retail overall, is that just kind of what happens in the space? Some companies get better, some companies get worse, or do you see big monumental shifts that are happening right now in retail?

Sinegal: If you study the evolution of the retail business, if you go back far enough, years ago Sears, Roebuck was the Costco of the land. My parents, everybody in Middle America, shopped at Sears and Roebuck.

They've obviously changed over the years, as has J.C. Penney, but the graveyard of retailers, with people like Mervyns and W.T. Grant and many, many others that we could name -- Montgomery Ward and others -- are filled with people who didn't stay up with the times, and who lost their way relative to what their original concept was.

We're pretty mindful of that. We look at the history and the evolutionary process of business and we say, "Boy, you'd better recognize why it is that customers shop with you." They don't shop with us because we have a Santa Claus at the front door, or fancy window displays or escalators or piano players. They shop with us because we have great value on great products, and you'd better not forget that.

Byrnes: How would you define a competitive advantage, and what would you say is Costco's biggest competitive advantage?

Sinegal: Well, the competitive advantage is that you've got loyal customers who believe in you. We think -- this was a tag that was hung on us a number of years ago by an analyst at Goldman Sachs -- we think that we have established what we refer to as "absolute pricing authority."

This analyst said that "Costco, more than any other retailer in the world, has established absolute pricing authority." What he meant by that was that, when a customer sees a product in Costco, they expect that it's going to be the best value that they can find.

We really very zealously work on protecting that image. That's what we're all about, saving customers money. We don't want to just be better, in terms of price. We want to be demonstrably better on every single product that we sell.

Byrnes: One of the things Costco is known for is a strong culture, and also you've made some great strategic decisions over the years. Could you talk about which one of those do you think is more important, culture versus strategy, and how those come together?

Sinegal: I've stated this in the past, and my comment is that culture is not the most important thing in the world. It's the only thing.

It is the thing that drives the business. That's what drives the strategy of our business, is our culture. Recognizing what we stand for in the customer's eyes, and what we mean to all of the stakeholders in our business.

That is the culture of our business, and we would hope that we'll continue to sustain that. If we do that, if we think in those terms, then I think the strategic planning will come right along with that. We recognize that you've got to continue to be better. Every day when you open the doors, it's like show business. It's another show.

We have to stay on top of our game because, as I mentioned to you earlier, there are no annuities in this business. It's not a guarantee that they're going to shop with you next year if your presentation is ho-hum.

Byrnes: Could you talk about how you maintain that strong culture, growing as fast as you have? You have thousands and thousands of employees both here, also abroad in Asia and the United Kingdom. How do you maintain a strong culture with being spread out and having so many employees?

Sinegal: You have to work at it. One of the things that we try to do, we think of ourselves as a small company. I know you say, "Well, you've got 175,000 employees. How could you possibly think of yourself as a small company?"

We like to think like a small company. It's more and more difficult. Every year that goes by makes it more difficult, but we think that if you're thinking and if your mentality is such, that you're more adroit, that you're nimble and that you can move quickly.

We want to always try to stay in that position, in that posture -- to be very adroit and very nimble, and able to react quickly and stay ahead of the competition. How well we do that will determine how successful we are in the future.

Byrnes: One of the things Costco is also known for is their low turnover. Other than financial incentives, what are some non-financial incentives that keep that number low, that your employees really count on?

Sinegal: We love them.

Byrnes: Yeah.

Sinegal: Listen, these are great people. Many of them have been with us since the early days of our business. They've helped bring Costco to where it is today. They've developed it. They've played a pivotal role in everything that has been established over the last 30 years.

We want to keep them. We want them to stay with it. We want to turn our inventory, but not our people. Part of that is, people are happy with a job for more reasons than money. There's generally a pride in the organization.

There's an attitude that there's security, that somebody does care about them, that we're offering careers. We're not offering jobs; we're offering careers. Anyone who wants to become an officer of our company has that opportunity available to them.

One of the greatest satisfactions that I think, if you ask the many of us who have been here in management, one of the greatest satisfactions is to see young people who started working with us, who maybe were college students and were chasing shopping carts out in the parking lot, who have advanced to the point where they're senior managers of our company. That's a great feeling, to see that.

Byrnes: One of the things that we love at The Motley Fool is strong leadership, great management. We actually name all our conference rooms after different leaders that we admire. You actually have one at our headquarters.

Could you maybe give us a couple other business leaders that you admire, and why, and what they do right?

Sinegal: Well, sure. I'm going to give you the obvious answers, because they're the people that pop into my mind immediately. You admire different people for different reasons, but Warren Buffett clearly just jumps right off the page there, and his partner, Charlie Munger, who's on our board.

But Tony James, who is also on our board, is somebody who I admire greatly. I really have a tremendous amount of respect for him. I had an enormous amount of respect for Steve Jobs. The genius there was just incredible and to see that, see the performance there, was really something.

There are lots of very significant people out there who do great jobs. I don't know Frank Blake at Home Depot, but I sure like the numbers that I'm seeing out of that business, and that was a turnaround situation. That was a company that had started to slide a little bit. I think he's not only done a good job, but you can generally tell when people talk well about the boss, that something is going right there.

Byrnes: What do you think are some common traits or characteristics that these CEOs have? Maybe an investor out there is looking at a lesser-known CEO and they want to say, "Hey, what are some great CEOs? What kind of traits do they have that you can emulate and look for in a company that might have a great leader?"

Sinegal: It's always the same thing. Obviously any manager that we look for, we're always looking for somebody who's smart and who's hard-working. But the thing that really stands out in most instances is the passion.

If you don't have somebody who is passionate about the business, no matter how smart and how creative and how diligent and how much money they have, if they don't have the passion for the business you're not going to see the business driving in the right direction, in my view.

I would always look for that. You want those other traits, clearly, but you need someone ... Jamie Dimon is another guy who I think is a really good manager. I know he's gone through a little bit of a hassle there, but he seems to have come through it pretty well.

Byrnes: I think he's on the other side of that now.

Sinegal: I think he's an extraordinarily bright guy.

Byrnes: Could you talk about all the stakeholders of Costco and how you balance the different needs, be it employees, customers, suppliers. How do you balance those needs? They can be diverging at times, but are any more important than others? What do you think about that?

Sinegal: Our philosophy, Brendan, has always been that we've got essentially four things to do in our business. We have to obey the law, we've got to take care of our customers, take care of our people, and respect our suppliers.

We think if we do those four things, pretty much in that order, that we're going to do what we have to do in the long term, which is to reward our shareholders. We think it's possible to reward them without paying attention to those four things in the short term, but if you don't pay attention to them in the long term, we think you stub your toe somewhere along the line.

We could have sold this business, Jeff [co-founder Jeffrey Brotman] and I, when we started. We could have sold it dozens of times, I'm sure. We probably couldn't any longer -- and we don't want to -- but we never had an exit strategy. That was never part of the equation.

We wanted to build an organization that was going to be here 50 and 60 years from now. We thought we owed it to all of the stakeholders in our business, that they have that assurance -- including the suppliers. The suppliers are investing money to take care of our business. They've got families, also, working in their organization that, if we were to stop buying from them, would be out of business or would be out of jobs.

We think that we have an obligation to be fair to those individuals and to be concerned about the stakeholders, and they are definitely a stakeholder in our business.

Byrnes: When you build such a successful business like Costco over the years, you come up against a huge number of challenges. Could you talk about some challenges that you've faced, and how you've overcome those? Maybe some business leaders you're watching right now?

Sinegal: Gee. There are challenges every day. When we failed with a couple of places in the Midwest and we had to admit to ourselves that we'd failed, that was really a setback. It was a touch of reality there, that you're not going to go into every market and be a success.

We had to look at that. Self-examination was very important at that point. Why did we fail? You can blame it on a lot of different things, but obviously we own at least 50%, and we owned 100% of that 50% in terms of what we did wrong there. We went back and we are subsequently better, but we've had challenges like that in different things.

We recognize that, as a businessperson, you're always going to have to take some risks. The problem is, you've got to make sure that you're calculating what the risk-and-reward ratio is, and that you're not taking a risk that's betting the company, that you're going to take risks that are calculated, and that you're going to evaluate them quickly. When you're going to make a mistake, you'll admit you made a mistake and move on.

What we don't want to do is make that same mistake time after time after time, because that's when, of course, you fail.

The other thing that -- you had mentioned small businesses -- is that you're not going to be an overnight success. It took us a long time to build this business and, from a personal standpoint, I was 46 when we decided to do Costco, so it wasn't like I was an overnight success coming out of college.

I had to work for a long period of time to learn my craft, how to run a retail business and how to perform as a manager in a retail business. People that are starting, entrepreneurs, should recognize that. They should also recognize that somewhere along the line there is some good fortune that works.

A lot of bright people out there, a lot of very creative, hard-working, bright people who have good ideas but don't get the right break at the right time to be able to succeed. We were fortunate that we got the right breaks at the right time.

Byrnes: Obviously there are a ton of items in your typical Costco. I know you visit them all the time. What do you think's the best deal at Costco right now?

Sinegal: Well, we've got some prime steaks right now, New York steaks that we're selling at $11.99. I would rush over and get them right away.

Byrnes: We've got one right next door. Maybe we'll head over and do that.

Sinegal: They're fantastic.

Byrnes: What's your favorite, personal, product at Costco?

Sinegal: Well, I have a lot of them. There are some great TVs. I don't happen to be in the market for TVs right now, but if I were I'd be buying one right now, because we've got some great values in there. Of course this shirt that I'm wearing, which is a Kirkland Signature shirt, is fantastic.

Byrnes: I think the whole executive team is wearing Kirkland shirts.

Sinegal: I probably have, hanging in my closet, 200 of these.

Byrnes: Really.

Sinegal: I've bought every color that we have.

Byrnes: I was going to say, are there that many different styles?

Sinegal: Well, we've had the shirt for a number of years. I buy two and three of each style, and hang them in my closet. I told people at the shareholders meeting recently, this Kirkland Signature, $17.99, that they shouldn't judge it by the way it looks on me. It's actually a very good garment.

Byrnes: In the past you tried out a concept called Costco Home. Is that something -- not necessarily that exact same thing, but stuff like that -- are those things that you would think about doing in the future, or are you more focused on your core operations and moving what Costco is right now into new markets?

Sinegal: Gosh, Brendan, I would hope that we're always going to be open-minded enough to look at different things like that and consider them.

To give you some history relative to that project, we were very -- and have been -- very successful in the furniture business in all of our warehouses around the world, typically in windows of time.

Generally from about Dec. 20 through the end of January, when we're getting out of the Christmas business and before we get into any garden or patio business, that's a window. Then in the summertime, when we're getting out of the patio and before we start to bring in the fall goods, that's another window of six to seven weeks.

We were very successful with it, and we said, "Gee, we've got a place up here in the Northwest where we've got 100,000 members that shop with us. Maybe we could get into home furnishings in a big way in that place, and have it available for our customers on a year-round basis."

We opened there, and we opened another one in Tempe, Ariz. Both of the businesses were successful, from the standpoint that they made money. But the more we looked at it -- and we had hoped, also, that this was going to teach us something about that business, maybe even set up some suppliers that we could buy direct from and learn a little more about the furniture business.

I think we learned a little more about the furniture business, but as time went on we said, "You know, this is not something we're going to expand. We're not looking to start another chain." We thought that maybe we'd learn some things that maybe eventually we'd see a Costco that was 200,000 square feet, that had 50,000 square feet of furniture in it.

But the further we got into it, we decided that we were in a marketplace that we didn't really belong in, and we weren't going to continue to grow it. Rather than spend time and resources and all the people that were involved there, let's put them onto things that work better in our core business.

That's the reason we did it. We're not sorry we did it. It was profitable, but it was not the type of thing that we were going to expand. We think focus in the business is very important.

Byrnes: So it's fair to say the vast majority of the executive team's time is focusing on core business, expanding that out, versus new ventures?

Sinegal: Absolutely. Now we're in another business -- two other businesses -- as you know. We're in the e-commerce business, and that's pretty successful for us and pretty profitable for us, so we're going to continue to grow that but that really is aligned with the core business.

An awful lot of the stuff that we have there is done, and we also have the ability of having warehouses where customers can bring goods back -- a lot of advantages in our portion of the e-commerce business, and we're going to continue to grow that. It is profitable.

Then we also have the business delivery, which is a profitable business for us as well and we're going to continue to look at that and see if we can develop that as well.

But those we consider to be very closely aligned to what our core business is.

Byrnes: More bolt-on than completely new ventures.

Sinegal: Exactly.

Byrnes: One of the things that, when we were talking to current CEO Craig Jelinek, he said that it's not rocket science what Costco is doing, yet it's outperformed its peers dramatically over the past few decades. What's the secret? What are those other big retailers doing wrong, or what are you guys doing so right?

Sinegal: I would prefer to address it from the standpoint of what do we do right, as opposed to what they do wrong, because our business model doesn't work for everybody.

Paying our wages isn't going to work for everybody. Doing the different things -- limited selection is not going to work for everybody. There are certain things that we do that work in our model, and we're going to continue to do that.

What are we doing right? I'm hesitant to say this, because you're going to think I'm rather dim-witted, but we're just trying to sell stuff for lower prices than everybody else.

But there's a lot behind the curtain that makes that up. You have to be diligent. You have to really believe in it. When I mentioned here earlier that we want to be demonstrably better than everyone else, we have a video that we have been showing on generic drugs.

One of them showed a generic drug for a 30-day supply that was selling for $277 in all of the drugstores in this particular city, and Costco had it for $15. Well, anybody can look at that and say, "Well, $15. Why don't you charge $85 for it? You're still going to be $200 under."

Well, that's not the way we make our living. We make our living by being incredibly good on every one of the things, and by making sure that we consistently have the attitude and the mind-set that we're going to bring those goods to market at the lowest possible price. Not at the lowest price where we think we can still get another bite out of the apple. We're going to bring them in as low as we possibly can, and customers can count on us for that.

I mentioned earlier the absolute pricing authority. That's what it is. That's how we develop it, is doing that type of thing on a consistent basis. If we do that, and if we maintain that attitude -- and I have no reason to believe we won't, because I think Craig and his team are dedicated to that; they understand how we got here and why we're here -- then we'll succeed.

Byrnes: Now, obviously, you buy millions and millions of dollars of goods every year. You have pricing power versus suppliers. You can get it for cheaper because you're buying in bulk. What about the early days? How do you keep prices low first starting out, when maybe you're not buying as many goods, you can't get them quite as cheap from the supplier?

Sinegal: One of the reasons that we selected Seattle to begin our business was that it was one of the least competitive markets in the U.S. At that time -- and it still exists today -- they would run surveys on a typical market basket of food and get an average price by market.

In every survey that was run, Seattle and Portland were the two highest-priced market baskets, of a basket of food, in the 48 contiguous states, forgetting Hawaii and Alaska for the moment. We said, "That's a pretty good sign. That means that this is a less competitive market than most of the others," so we started there, so our pricing looked very good on a continual basis.

Now, our entry into a market lowers the prices throughout the market. Let me give you an example. When we opened in Kauai, the island of Kauai in Hawaii, our gas prices were anywhere from $0.80 to $1.00 less than anybody else in the marketplace.

After a period of time in operation, I think today we're generally about $0.40 less than most people. You say, "What's the big deal?" Well, the fact of the matter is we lowered the price by $0.40 for everybody on that island. Anyone who is in the community where we're doing business, benefits.

Competition, good competition, whether it's from us or from Trader Joe's or from Aldi or from Wal-Mart or from whoever, is very significant for the consumer. It saves them money.

Byrnes: At The Motley Fool, one of our most admired companies is Berkshire Hathaway, obviously Warren Buffett and Charlie Munger. Charlie Munger is on your board. What's it like working with him? I've been to the Berkshire annual meeting, and he's definitely a character. What is he like when it comes to the meetings and when you get to hang out with him?

Sinegal: I'm a Charlie Munger fan. He's fantastic. Not only is he fantastic because he's such a neat person, but there is hardly a business experience that you can mention that he hasn't got some knowledge about, and he expresses that.

He's incredibly supportive of the company. He loves Costco, he truly does, but he's able to be critical with those points when it's necessary to get us into reality, to ask the right questions relative to what we're doing in the business.

He's just a marvelous director. I hope that he'll be here for many, many years -- despite the age, which you know -- he's great. He's got a great sense of humor. I'll just tell one story.

Recently I was talking to him and he told me, "I still have a photographic memory." Then he looked and he said, "Unfortunately, I no longer get same-day service."

Byrnes: That's awesome.

Sinegal: That's the kind of ... but he is a great board member. We're very, very lucky to have him.

Byrnes: Does he ever say, "I have nothing to add," when you're just having a conversation, like he does in the meetings?

Sinegal: Of course he will. What you see is what you get with Charlie. He's very ...

Byrnes: One of a kind.

Sinegal: He is one of a kind, and he's so supportive and such a good ... what a clarity of thought that he has. It never hurts to be surrounded by really smart people.

Byrnes: Certainly.

You're famous for spending a lot of time out in Costcos, walking around, seeing the stores, getting really boots on the ground. Do you ever spend time walking through competitors, checking out the landscape to see what they're doing?

Sinegal: Sure. We do it all the time. That's part of the business. There is hardly a week that goes by when Craig and I aren't in a [Sam's Club]. It would be unusual. If we're on the East Coast, we're going to be in a BJ's.

Byrnes: I'd love to be a fly on the wall when you two are walking through.

Sinegal: We do that with a lot of the competitors that we admire. We're going to be making a trip to Canada here, week after next, and I will guarantee a major portion of the trip Craig and I and Joe Portera [executive vice president and COO of Costco's Eastern and Canadian divisions] are going to spend -- and our Canadian team -- will spend in the new Targets that are up there. We're going to be looking at everything that they're doing.

When we opened up in Wheaton, in Maryland here a couple weeks back, the first thing we did that day was go into the Target. That was easy, because it's only about 50 yards away. You have to be in the competitors. We're in the Trader Joe's all the time. They're a neighbor of ours over here. We admire them a lot.

You've got to be checking the competition, and not just to satisfy yourself that you're better than the competition, but what is it that they're doing that really makes a hell of a lot of sense that we should be incorporating into our business? We tell our people, "When you go into a competitor, be looking for the really good stuff."

Byrnes: Right. How much of it is, "Oh, they're actually doing this pretty well," versus, "Oh, they could do this so much better. They're doing this all wrong." Is it 50/50?

Sinegal: You know, we have to guard against that. It's very easy to take the attitude, "Oh, we're great. We can do anything, and the competition's not close to us." That's not the attitude you want to have. You want to look at the competition that they're out to get you.

As I've often said, you're not paranoid if they're really out to get you. We have the attitude that every single competitor out there is trying to kick our brains in, and we're trying to do likewise.

Byrnes: We talked about earlier, in the Midwest you were having some troubles at first. You've reattacked that area recently. What were the problems then, and how have you fixed them now?

Sinegal: The problems at that point in time, I think, it can directly be on us, that we didn't do it well. We thought we had reasonably good sites. We thought our product mix was reasonably good.

We think that the concept was not as well known in the Midwest as it was on both coasts. We certainly recognize that oftentimes what happens is that ideas that start on either of the coasts have a tendency to work toward the center of the country, but that's alibi-ing for why you didn't do well in the first instance.

I think that we had some flaws in what we were doing and underwhelmed the whole trade area in both Milwaukee and Minneapolis.

Later when we went back in there, we had done a lot of enhancements to our business. We added the whole fresh food category, as an example. We'd added food courts to our product selection presentations. We'd added one-hour photo processing and we'd added the optical. We hadn't yet added gasoline, but we've since added it.

We were a better product, and we were much better known at that point. When we went into Minneapolis and Milwaukee, generally the attitude was, "Costco who? Who are these guys?" Today we're a known commodity across the country. It doesn't hurt to get that type of notoriety in the newspapers when they're writing a story about you, or when you're going in there.

Byrnes: How do you approach advertising? Do you approach it as an unnecessary expense?

Sinegal: We consider it evil. Because it costs money; anything that is going to raise our price on merchandise is bad. We've got to have that type of an attitude.

Now, you can get a little goofy about that and cut out some things that you have to do relative to your business. We have to communicate with our members and things like that, but the net result is anything that's going to significantly increase the cost of merchandise and our cost of operations and the pricing of our goods, is bad for our business.

Byrnes: Plus, word of mouth is the most powerful advertising, right?

Sinegal: We have always said that the most significant advertising is when other people are saying nice things about you.

Byrnes: Sure.

We talked about how your first foray into the Midwest market wasn't as successful as you would have liked. How does that play into how you look internationally and think about where you expand and how you do it internationally?

Sinegal: If we had it to do over again in the Midwest, we probably would not have eliminated those units. We had started to add fresh foods to some of our operations on the West Coast, and in Florida for that matter, and we were reluctant to sink more money into those two markets.

If we had it to do all over again, I think we would have gone in with the fresh foods at that point, would have offered a better product, and would have steeled ourselves to get through the tough times there to ultimately win the game.

Now, the same thing is true in markets. We were not an overnight success in Taiwan when we started. We were in Kaohsiung, which is kind of a second city in that country. We were in Hisayama in Japan, which is way to the southern part of the country. But they were places where we could get into business and get started.

It took us a while to develop both of those businesses, but as we went on, one of the things that we recognized is that if we're doing our job well -- that's a caveat, obviously, because there's no guarantees that we're going to do it well -- but if you're doing it well we're a very compelling story.

People have to shop with us. If we're really offering the types of values that we know that we can offer, customers have to shop with us. It is compelling. But you've got to get there. You've got to get to that point and you've got to be performing.

Byrnes: Certainly.

When you first started expanding internationally, obviously it's a much farther plane ride to Japan, to Taiwan, than it is a couple hours down to California. Did your management style change when it got more decentralized? How did you go about thinking about that?

Sinegal: Well, it's an emotional tug of war here. We want to be in these places, frequently, and yet we recognize that it takes 15 hours to get to Australia. That's not a day trip. You're going over there, you've got to make a commitment to be there, so we try to tie a lot of things together when we're there.

We're going to be looking at different sites. We're going to visit our locations. We're going to go for a grand opening this summer. You try to manage your time much better.

One of the things we do when we go to Australia, as an example, is we stop to refuel in Hawaii so we can visit the Hawaii locations while they're refueling, then head on down to Australia. You learn how to schedule your time and prioritize.

But it is more difficult? There is no question. You're not going to get into all of the -- every single day that I'm in town I'm across the street, much to the chagrin of the people across the street, but we're over there all the time, and working with them.

Every warehouse in the company is not going to get that type of attention. You can't expect it. But recognizing those places you haven't been for a long time, making sure that when you go someplace you get the best mileage out of that trip.

Craig and I went to Chicago here, a couple weeks ago. I was going because I was going to speak at Northwestern, at the Kellogg School.

We made sure that we scheduled the trip so that we got in there, we got around to about eight to 10 of our places while we were there, as opposed to just going to Chicago and coming back. You've got to take advantage of the fact that you've just invested eight hours of traveling -- four going and four coming back -- and get the most out of it.

Byrnes: Do you tell them when you're coming, or do you pop in and kind of scare the crap out of the store manager?

Sinegal: We prefer the crap theory.

Truthfully, we want to see the places in the best light, like they look to the customer every day, when we're in there. We try to make our trips unscheduled so that they don't know, but trust me, it doesn't take very long for us to be in one of these markets that everybody doesn't know.

There is a code among the warehouse managers that if you don't call ...

Byrnes: If you're in Chicago, all the stores would be talking.

Sinegal: Everybody'd better be talking to one another, or they sleep with the fishes because their peers are going to get on them pretty good. We understand that. We recognize it. When we go to Hawaii, and every time I go to Hawaii on vacation, the car companies all know on all of the islands when I'm scheduling, and the car companies call the warehouses.

Byrnes: They're tipping them off.

Sinegal: Of course. Those islands are small, and they're all neighbors and they know one another, so they tell them. It doesn't matter. If somebody can clean the place up in three hours ...

Byrnes: They're shining the floor.

Sinegal: ... then they've done a pretty good job.

Analyst: That's funny you mentioned ... I've always wondered if the manager there, his blood pressure's about 50 points higher because you're constantly in there.

Sinegal: By the way, I would just add to that story that we have very good managers. There aren't many times, even on an unscheduled visit when we absolutely surprise them, and we know we have, that we don't find that the places are in pretty good shape.

Now, are there some improvements that can be made? Of course.

Byrnes: I'm sure you let them know that.

Sinegal: Yeah, of course. Of course. But generally speaking, we don't walk away ashamed of what we see, because we've got good managers. These are people who have been with us for a long time. We trust them to do their job.

Analyst: I just wanted to know, too, we've asked about your favorite piece of merchandise and everyone loves $1.50 hot dogs, but from the more treasure hunt kind of aspect, what's the coolest thing you've seen at a Costco store in the past year?

Sinegal: Let's see here. You know, I wish I had it here with me, but I just picked up something very simple, and I bought four of them. It's a pressure hose -- just the nozzle that goes on a hose -- that ... he didn't ask me the question.

Analyst: Oh, that's fine.

Sinegal: It's such a cool item because it sprays the water at four different intensities -- just a gentle spritz, a jet, a wide mouth like a fire hose -- it's really a great item.

Byrnes: You just click it on.

Sinegal: Yeah, you click it and you move it around, and assuming that you have reasonable water pressure from your hose you get a great product that, if you were cleaning off a deck or cleaning your car, it would be great to be able to change around as opposed to just having the water come out of the hose.

I just bought five of them.

Byrnes: Five of them?

Sinegal: I gave one to Craig and I gave one to my assistant and I've got three, and I'm going to give one to my son-in-law for his house, because he's got a place up in the islands here, because I know he'll be out there cleaning the deck and everything, but it's just a cool item. And it's not very expensive. It was only $14.99.

Byrnes: There you go.

Sinegal: It's one of those things that you look at and you say, "Who in the hell invented this?"

Analyst: I believe paper products are your largest seller, right? Toilet paper or paper towels, am I correct on that?

Sinegal: Yes.

Analyst: Given that it is such a potentially commoditized product, what does the future of paper look like at Costco?

Sinegal: Well, everybody knows that every time they do a TV program on us, one of the things they show is the toilet paper. Every time, there's a gag about it. Somebody says, "They have 106 rolls of toilet paper."

It's a basic item, and we have gotten the package up now -- it's now 30. It was 36, but we had to make it a little smaller in the count because we made the paper softer and it was a bigger roll. It's a very basic product for us.

It is, on an overall basis, the biggest-selling product that we have. Paper towels are also one of the very biggest selling products that we have. It depends on the community, however. In Palm Springs it's vodka which is No. 1 and No. 2 -- two different types of vodka.

But that's a unique market there. But we'll always have those kinds of products, and I would expect that if you were to ask us 10 years from now, toilet paper would still be the No. 1 item that we sell.

Byrnes: One of the things that we love at The Motley Fool is long-term -ocused companies. We don't like when companies maybe try to artificially inflate earnings for a quarter or two. Costco's certainly focused on the long term.

Having interacted with Wall Street over so many years, is there one thing that you would change about Wall Street and how they look at a company?

Sinegal: You know, first of all that's not my business. We have been in the business of trying to build a company that's here for years and years and years. Wall Street is generally in the business of trying to make money between now and next Tuesday, so there is that difference.

That's not a knock on them. The system has been very good to us, so we recognize it. Oftentimes a lot of excellent questions -- many times -- great questions that come at you that make you think about your business.

The system is good, and it works, and it has been very good for us. I think that there's an enormous amount of pressure relative to parts of Wall Street, relative to "What have you done for us lately?" and "What's happening?" and the immediate gratification aspect.

To managers who succumb to that type of thing, they're going to have difficulty running their business, in our view.

But on an overall basis, the system is not such a bad system. Today we have a lot more friends on Wall Street than we did when we first got started. But that's because the company has performed over the period.

Byrnes: Do you think that's changed, the short-term-ism versus long-term-ism? Do you think it's gotten worse, as far as going toward short-term on Wall Street?

Sinegal: I think the people on Wall Street are smart enough to recognize the companies that have performed on the long term and recognize that this is their M.O. and the way they're going to run their business, and appreciate and respect that.

I think at the same time there's a healthy skepticism about some of the new businesses that come up and really do. They have a plan that's going to develop and they have to take a look at them more on a short-term basis.

Byrnes: Costco is famous for paying its employees more than they have to, above the going wage, you could say. Recently we've seen that becoming more of a trend. Whole Foods, Trader Joe's, are a couple of companies that you look at to do that.

Why do you think that's just starting now to become more and more off a thing? Have you seen this in the past? Why is it just becoming big now?

Sinegal: I think there have been other companies who have had an attitude of being very good with their employees over the years. J.C. Penney's always had that type of a reputation, and was a good model.

But businesses become models for a lot of different reasons. Some for quality; some, in the case of Whole Foods, they really introduced this whole organic food program to America and have become very popular.

There are different things that become popular relative to businesses, but in the final analysis relative to wages, our feeling has always been, "You get what you pay for." If you're going to pay low wages, you're not going to get the productivity that you're going to get if you hire really good people.

We've always said, "If you hire good people and provide good wages and good jobs, and a good career possibility, something good is going to happen in your business." If you buy the premise that Costco is the low-cost provider, and if we pay the highest wages, then it follows that we must be getting higher productivity.

We think that's the case, and these people that run some of these other businesses are very smart. Trader Joe's is great. They're a great competitor. We really love to go into their place. They pay outstanding wages, and you see it reflected in their business.


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