An Interview With Costco CEO Craig Jelinek

The Fool chats with Costco (COST 1.01%) CEO Craig Jelinek. Craig first joined the company as a warehouse manager in 1984, quickly rising to become a regional manager and then advancing through various executive posts over the years. He became president and COO in 2010, and took over from longtime CEO Jim Sinegal in January 2012.

Craig shares his experiences with Costco, the philosophy behind the retail giant's success in the U.S., and its experiences in markets from Canada to Taiwan.

Austin Smith: Hey, Fools, Austin Smith here and I'm joined by Craig Jelinek, the new CEO of Costco. First of all, thank you so much for taking the time to sit down with us today.

Craig Jelinek: Glad to do it.

Austin: I'm not sure if you're aware of this, but I believe Costco was the first-ever recommendation in our flagship newsletter, by our CEO, so we have a deep love for the company. We've loved Costco for years, so we really appreciate you taking the time to talk to us and our members today.

Jelinek: Well, we appreciate that, and I hope you shop with us also.

Austin: I am a proud Costco member, and please keep the price of the hotdog and soda at $1.50. I know it hasn't changed, and I hope that now that you're at the helm you don't want to shake it up and make it $1.75.

Jelinek: Trust me, that's never going to change. If I have to subsidize it personally, it's not going to change.

Austin: I like that. I'm wondering; obviously a big transition. Now that you're at the helm, I'm wondering what's changed for you, as you're leading this great company forward?

Jelinek: Well, I don't know that a lot has... Obviously, a lot's changed because the buck stops with me. But as you know we've got Jim was a founder. We've got a very strong culture. Most of us have worked with the company in key executive positions for 28-29 years.

I'm very fortunate. Obviously, those are big shoes to fill, but we've got a great management team and things have moved on accordingly. Before Jim stepped down, I was president for two years, and we talked about what the future looked like and thought through a game plan, so I think we're well equipped for the next 15-20 years.

Austin: Obviously, you and Jim worked very closely over the years.

Jelinek: We have.

Austin: You've probably learned a lot from each other. What other really great retail executives -- or executives in general -- have you guys found inspiration from, that you admire in the industry?

Jelinek: Well, I think when you talk about Sol Price, who was the originator or founder of Price Company, and FedMart, one thing that we both learned from him is continue to always do what's right for your employees and always try to do what's right for the consumer.

If you keep the consumer and your employees and do the right thing, things have a way of working out for you. You build trust with your employees, you build trust with your consumer -- which is really just common sense and good business -- but I think that's probably what we learned the most. Just always do the right thing.

This isn't rocket science. You just want to continue to bring the value to the consumer. You want to pay good wages, you get good people, treat people fairly, and if you can keep your expenses down, you keep your prices down, you're going to sell a lot of merchandise and that's what we do: buy and sell goods.

Austin: Pretty simple formula, it sounds like.

Jelinek: It's simple. The hard part is keeping it simple.

Austin: You guys are one of the rare companies that left all your stakeholders very happy -- your customers, your employees, your shareholders. As you think about all the people who are affected from Costco's day-to-day operations, where do you start? Is it with the customer? Is it with your employees? Who do you start with?

Jelinek: Well, it's a combination of both. Obviously, before you ever open up your doors, you have to start with your employees and you have to have suppliers. But the bottom line is, if you look at our mission statement, you take care of your customer, your member. You take care of your employees. You take care of your suppliers. Actually, the first thing is always, obey the law.

Then if you do all those things, you're going to reward the shareholders. That's always been our philosophy. If you get too short-sighted and you want to reward your shareholders as the most important thing, chances are you're not going to be in business in five or 10, 15 years.

Our view is we want to have a company for the long haul and continue to grow the sales and grow the profits fairly and make sure there's always opportunity for our employees to grow. If you look at the last 30 years, our stock has grown about 15%-16% a year in value, and we think we've got a pretty fair return for our shareholders.

Austin: Pretty good clip. You can't be upset with that sort of return.

Jelinek: No. We think it's been more than fair, and we think we've got a business model that's going to last us for a long time.

Austin: One of the, in my opinion, most impressive statistics that I see about your company is the amazing renewal rates -- upward of 90%, I believe, most recently.

Jelinek: Right. We're 89 high, so we're close. If you round it, we're at 90% in the U.S. and in Canada and we're in the mid-70s in our international part of the business, which is Asia, which actually is considered to have improved considerably.

Austin: Interesting. How do you guys achieve that amazing retention? It's absolutely phenomenal customer retention. How do you guys cultivate that number year after year after year?

Jelinek: Well, the consumer pays for a membership and they make that decision based on what they figure the value of the membership is. I think if you continue to bring value to the consumer and bring quality to the consumer, and know the consumer knows if the item doesn't perform well they can bring it back.

You build trust with the consumer, and I think it's really that simple. They like what they see, and they continue to renew. If they won't like us, they don't like what they see, they're not going to renew, so I think if you look at it they like it, so they're renewing.

Austin: Right.

Jelinek: It's kind of simple. I don't know how else to put it.

Austin: When I think about your company, I think of things like high renewal rate, great customer service, low prices -- but then I also think about Amazon the very same way. I'm a happy Costco member and an Amazon Prime member.

You guys both have phenomenally low prices, you're both notoriously very customer-focused, keep Wall Street at arm's length and focus on the products and service first.

How do you guys see Amazon? Are they a threat? Are they a complementary retailer? How do you think about them in the landscape today, because they seem to be the retailer that has the most closely espoused your virtues of low prices and customers first?

Jelinek: Well, if you look at anybody that sells anything, they're a threat. Anybody in business that sells merchandise is a threat. What we have to continue to do, we think we offer two avenues.

We have our core brick-and-mortars, where you can come in and shop particularly and buy a lot of fresh foods, a lot of wine, health and beauty aids, things like that. Then we've got the non-food assortment. In fact, if you want to buy online, you have the ability to also shop with us online, in terms of buying TVs and general merchandise.

We still think, day in and day out, we bring the best value in the marketplace, and you've got two options. You also have an easy option if you want to bring the merchandise back. You can bring what you bought online and you can bring it into the warehouses to return.

We think we can compete well with Amazon. There's always going to be, in my view, two forms of retail: brick-and-mortars and online. But I think it's always going to be very difficult -- although people test it -- I think buying and distributing food and sundries and fresh foods in the marketplace, overall, is going to be difficult to do and very expensive.

Austin: Looking at your positioning, then, the retail landscape is obviously changing dramatically. A lot of things being done online.

Do you view a brick-and-mortar competitor like Wal-Mart or an online-based competitor like Amazon as maybe a bigger concern or a bigger threat to Costco's model?

Jelinek: I think, like I said before, they're both threats, as is Target a threat, as is Whole Foods a threat.

The key is being the low-cost provider. That's going to be the key for anybody winning the battle long term. It's whoever can bring value and bring the best quality of merchandise to the marketplace at the best price. I think that's really the key.

Austin: What do you think is the most misunderstood thing about Costco today, that you just keep hearing and you're like, "Oh, that's not the case"? Is there a common misunderstanding about your business that you see?

Jelinek: I don't think there's really a misunderstanding. We're always... you used the word, "They're a discounter." Well, when you say that we are a discounter, we bring quality merchandise to the marketplace at a very good price.

We have department store-type items that we bring to the marketplace. It's not like it's inexpensive or cheap merchandise. I think, over time, that has taken care of itself. The people know that we have quality merchandise at a very good price. They're not seconds, they're not closeouts. It's quality merchandise that you can buy at most department stores or high-end stores at a very good price.

If you look at our jewelry, if you look at our watches, if you look at our sporting goods, if you look at our television sets, it's all quality, name-brand merchandise. If you look at our private-label merchandise, our Kirkland Signature, that's equal to or better than national brands, at a better price.

Austin: You guys obviously participate in a huge spread of the retail space -- electronics and jewelry and food, as you mentioned. What are the biggest defining trends in retail that you guys are seeing going on today? Is it private-label consumption, is it organic consumption, that investors may want to get ahead of, if they see these changes happening?

Jelinek: Well, there's two things. Organic, in my view, is here to stay. But also, organic is also very expensive. Our view is to figure out, always, how to bring organics at a better value or a better price to the marketplace. Kirkland Signature, we're looking at Kirkland Signature Organics. We're looking at being able to do that.

I think both. I think the private label or controlled label, as long as it's quality, is going to become a bigger part of the business because I think, more and more, brands... not so much in the non-food that they'll be big, because brands are still very important because there's so much advertisement out there on brands.

Austin: On the foods end?

Jelinek: No, non-foods. But on the food part of the business, I think more and more if there's trust in the house that sells it, there'll be trust in the brand. I think that's one of the things that we've got going for us, that we've got trust in there in the Kirkland Signature name.

If you look at that name, it's just not in a few items. That Kirkland Signature is from diapers to luggage to meat to vitamins. It's a pretty brand name that covers a lot of merchandise, so you have to be careful to make sure that you protect the integrity of every item that you sell, so you don't lose the reputation on that Kirkland Signature brand.

Austin: Makes a lot of sense.

Jelinek: But we've been able to protect it, and I think there's a lot of confidence in the Kirkland Signature. When we first went to it about 22 years ago, it was very slow, but now anything that we put Kirkland Signature brand on, people are not concerned about trying it.

Austin: Do you see any other big paradigm shifts in retail, that we didn't talk about, just as you observe the landscape?

Jelinek: You know, like I said, I think you're going to probably see a lot more organics. I think people, particularly depending on what economic level they are, are going to buy healthier, cleaner ingredients. I think organic produce is very big for us.

The problem is, if we just dealt in organic produce, we would never have enough produce to get by in a given week, let alone a year. It's all about availability. I think over time you'll see, probably, more production being shifted to organics, but that's going to take time.

Austin: How do you personally evaluate the success of Costco?

Jelinek: I think there's a couple things. You can evaluate... success is a lot of different things to a lot of different people. I think if you look at it, that if you can continue to provide value to the consumer, your business is going to continue to grow.

If your business continues to grow, you're going to provide opportunity for your employees. If you can provide opportunity for your employees, your employees are also going to be able to grow, they're going to be able to support their families, and enjoy a better quality of life.

If those things happen, you will just continue to reward the shareholders. Our whole view is, I want to be able to go in the food court, 25 years from now when I'm old with my walker, and sit down and say, "I remember you when" to some of our employees.

 That's very important, to be able to create a company long term that's going to continue to grow and provide opportunities. Yet you'll do that by taking care of the member and creating them great value.

Austin: In the evaluation of Costco from your perspective, are there any metrics that you look at that investors may not necessarily be aware of? Same-store sales is one of the obvious metrics to look at in retail, but what do you look at internally, in evaluating Costco's success?

Jelinek: Well, certainly you look at your comp business. You also look at your renewal rate. That's very important. We also try to look at the growth that we see. We're always measuring.

We think the model will work, as it has worked in a lot of other countries. No matter what country you live in, you want to be able to buy merchandise at the best possible price, so we certainly are looking at that.

Our employee turnover -- which is less than 1% at the management level and less than 5% in the overall hourly level -- I think is a very important piece for us, which talks about employee satisfaction.

Those are some of the things that we always look at.

Austin: OK. I wonder if you could explain the dynamics, in terms of purchasing power, that allows you guys to continually offer the lowest prices for consumers. Because technically, on paper, it would look like Walmart or Amazon might be able to out-purchase you, but you guys are able to consistently provide a more affordable product in many instances. I'm wondering if you could explain that disconnect?

Jelinek: Well, keep in mind it's not always how you purchase goods. You've got to purchase goods, and you purchase at the best possible price, right?

Now, when you look at our sales per item, they're much greater than Amazon or probably Walmart, because we only have less than 4,000 items, where if you look at our competitors they have substantially more items -- maybe eight or 10 times more than the 4,000, where the math doesn't work in terms of sales.

With that being said, we think we can bring efficiencies to a supplier which allows us to sometimes buy a certain item at a better price, but also our SG&A, which is what it costs us -- our administrative costs -- is less than 10%.

There's probably nobody close to us in terms of SG&A in the retail environment, that has a better SG&A than we do. If you look at Wal-Mart they're probably about 18% and I think Amazon is probably at a 22%-23%, although they both have other means of margin revenue coming in.

But it's just as important to be efficient, to lower your expenses, because then you can work off of less margin in terms of selling merchandise.

Austin: Makes sense. Are there any retailers -- in the broader space at all -- that you really admire, that you see and you say, "Wow, they really got it right," or "I admire their operations?"

Jelinek: I think Amazon's done a good job in terms of building a brand with their customer service. I think they've done a very good job of that. I think Whole Foods has got their niche, in terms of quality merchandise, and I think Trader Joe's is a company that pays very good wages. They've got limited selection and they've got great quality merchandise, and they've got a great reputation out there with the suppliers, so I think they've done a very good job.

Even a company called Aldi, which is starting to come to the U.S. -- they're a private company -- but they're a very simple operation that cuts a lot of overhead out and they've been very good at bringing merchandise to the market at a very low price.

Austin: You've got to appreciate that then.

Jelinek: Absolutely. That's the name of the game.

Austin: What's your favorite item on Costco's shelves today?

Jelinek: You know, I love our hot dog. There's no place else you can get a better item for $1.50.

Austin: That's true.

Jelinek: I like our toilet paper, because obviously that's the No. 1 selling item that we have. And I love our Kirkland Signature shirts. That's the only thing that I basically wear, like this.

Austin: I assume this is one today.

Jelinek: This is it. I think that's become a great item for us. It's become a big volume item for us. When I really notice, when I get excited, is when I go to pick up my dry cleaning and I see all the shirts in there that look like mine. I know that that shirt is being purchased out there in the marketplace.

Austin: I'm a big fan of the Kirkland label, but I have to say I've got trouble with the slim fit. I haven't been able to make it work. If you guys have anything in the pipeline, let me know because I'd buy my shirts there all day.

Jelinek: We have slim fits.

Austin: You're a slim. What about extra slim? European slim?

Jelinek: You're a rarity.

Austin: Yes. No plans for that?

Jelinek: No plans for that at the moment. I don't know how many people would fall into that category.

Austin: There's not many of us. We're not big purchasers. You would not do well to target that niche.

What about, when Christmas time rolls around, what are you putting in the family stockings from Costco?

Jelinek: Well, you know, when I grew up, you put toothbrushes and socks and stuff like that in the Christmas sock. But TVs are becoming very big for us. We sell a lot of Bose speakers. The tablets, Samsung tablets are becoming very big.

We sell a lot of apparel during the Christmas season. We sell a lot of jewelry, we sell a lot of watches during the holiday season, so that will continue to be big for us. Our domestics business... I would say vacuum cleaners, but that's probably not a good thing as a Christmas present or Mother's Day present.

Austin: No, that gets you in the doghouse pretty quickly.

Jelinek: This day and age, but our jewelry business continues to grow, our apparel business, items like that.

Then again we're very big during the holiday season, particularly with our prime rib and our fish items, our shrimp, items like that. We do a big job -- hams -- during the Christmas season.

Austin: You mentioned your electronics section and the strong Samsung presence you have. When I look across the consumer electronics landscape today, it's hard to ignore the Apple presence that Apple has. But Apple seems notably absent from Costco.

How is that dynamic shaking out? Are you guys trying to target Apple? Have you thought about bringing them in?

Jelinek: I think it's ... we always continue, occasionally, to have dialogue and to see if somehow we can show a value for the Apple products. So far we haven't been able to work out something. Time will tell if that happens, but we seem to be doing well without each other.

Apple's doing well without being in Costco, and Costco seems to thrive with not having Apple. It's going to work out for each one, one way or the other. If it doesn't work where we can work with each other, it doesn't work. That's OK. Life goes on.

Austin: Looking at some of your operating metrics, it's hard to miss the extreme efficiency you guys seem to be getting out of Canada, compared to your U.S. business. I think the average sales per Canadian citizen compared to a U.S. citizen are about two times, approximately. What are you guys doing up in Canada that's working so well?

Jelinek: Well, there's a couple things.

If you compared Canada to the West Coast, you would probably see that they're pretty similar because we're so well entrenched in the West Coast. We're not really going into any new markets in Canada. Everything's basically tied around the Vancouver, the Winnipeg, smaller markets.

If you look at the Midwest and the Southeast, some of those buildings are doing less sales volume, which brings it down, because we're relatively new in those marketplaces. If you look at Canada, the expansion has been less. We've been entrenched a lot longer in just that Canadian market, in terms of the big markets in there, where we just open up buildings close by.

You open up another building anywhere from here to San Diego, and they start out very strong from day one. When you go into places like Fargo and Rochester, Minnesota, and East Peoria, Illinois, those buildings it just takes time to build because you don't have any membership base.

We don't open up a building in Canada where we don't already have a huge membership base nearby.

Austin: Interesting. Do you expect over time those numbers to maybe converge a little bit?

Jelinek: Absolutely. No question. No question.

Austin: What sort of different dynamics have you seen operating internationally? We know that many retailers when they try and go abroad it can be the kiss of death, because they try and apply the same strategies, with difficultly. Have you guys run into that?

Jelinek: Well, what you have to do is -- when we went international -- what you have to do is just be who you are, what got you there. We know the model that works. Now, you may sell a little bit different product line, but the packages are big.

One of the things that we've done is brought U.S.-type goods over there. You didn't see many people eat bagels in Japan when we went in there. We took the same bagel recipe that we have here and created it in Japan and it's one of our biggest items over there.

What makes us successful in these countries I think is because we're different than everybody else. Just like when we start in the U.S., we're just different than everybody else. In Canada we're just different than everybody else. Mexico, we're different. It's a unique type of business that there's not a lot of people that look the same and do business the same.

Whenever you're different and you can bring value, the consumer tends to like it.

Austin: Great. Just a follow-on to that; you look at a Wal-Mart going international, it's because they're running out of U.S. space. You look at a map of your company -- Seattle we might have 15 locations; Boston, we might have two or three over on the East Coast -- basically, what kind of upside do you think you still have in America? Could you see Costco doubling its presence from this point?

Jelinek: Over a period of time, I think that's very possible to do. I would think that we could ... you never know what's going to happen in the marketplace. You never know what's going to happen in the economy. You never know what kind of situations could happen in different countries.

But we feel very comfortable, over the next 15-20 years, we could double the size of the company. We think there's a lot of opportunities still left in the U.S.

Austin: That's just doubling domestically.

Jelinek: No. I would say domestically ... we could probably come close in 20 years.

Austin: A lot of the bigger retailers out there -- companies like Target and Wal-Mart -- are chasing customers into their ... the urbanization that we've seen, Target City has been popping up, seems to be pretty successful. Walmart's had some smaller locations as well that have exceeded their expectations for success.

As a big-footprint retailer, are you guys looking at a similar strategy? Would you consider moving to smaller formats to catch that urbanization trend?

Jelinek: If you look at, where we're not exactly in downtown Seattle, we're awful close. We're probably three miles from downtown, which works just fine for us. People will come to us and shop.

We want to continue to keep what we do simple. If you start to drift and become complicated, it costs you a lot of money to be complicated. Then what starts to happen? It costs you more goods, your cost of labor -- when I say "cost of labor," your SG&A starts to go up -- and then all of a sudden where you were under 10%, now you start getting up to 11%, 12%, which means you have to start raising your prices to get you there.

At the moment, I don't see us going there. We don't like to be on multi levels. Even in foreign countries, we have a few where we have two-story shopping, but we don't want that. We're doing everything to get to one-story shopping, no escalators for having to move customers up and down because, frankly, the escalators break down. They're very expensive to maintain.

What we want to do is, if property is hard to come by, we'll go one-floor sales and maybe have two or three floors of parking, but we want to try to keep everything very simple.

Austin: I've often wondered the dynamic of these multi-level stores. City Target we went in the other day is, just checking it out, it's three levels. What does the dynamic look like as far as customer behavior? Do people just not make it up to those second and third levels or is it merely just transporting carts that is a big difficulty?

Jelinek: I think they make it up there, but not as often. I think ... Transporting the carts is an issue but in our business particularly, we're very strong also in the food and sundries part of the business, so you have to go up there with a shopping basket because you're carrying meats and items like that.

I think in our business it's just more difficult to do. We'd just as soon stay away from it. We have found where we do have multi levels it's considerably more expensive over a year's time to run that business.

Austin: Especially with the huge pallets. I can imagine those just don't translate very well.

Jelinek: Not only ... they don't go by escalator, but you have to take those huge pallets down by storage elevators. There's a big expense to putting pallets in a storage elevator and going up and down.

Austin: Makes a lot of sense.

Jelinek: We've chosen to stay away from that as much as we can.

Austin: Seems like a good choice.

Analyst: Everyone has to be intrigued by China, just because it's such an opportunity. You guys haven't explored that yet. I think PriceSmart had actually licensed to China and pulled out within a year. What's your feel on the space? Have you guys looked at it and decided it's not an opportunity right now, or is it you're focusing enough on other opportunities like South Korea and Japan, it's just not on your horizon yet?

Jelinek: Well, we've got us a pretty good business going in Asia where we're at right now. There's lots of opportunities in the countries, in Japan, in Korea, in Taiwan. We're looking at France and Spain. We'll get that going.

You have to be careful. We've always been very conservative not to stretch the management so far where we can't run the business the way we choose to run it. I don't see us ...

China will always be there. China will be there 15 years from now, 10 years from now. At some point, we'll probably look at the opportunities in China. We've been over there, we've looked at it, but right now we think we've got enough in Asia going on right now with Taiwan, Korea, and Japan, and within the U.S. where we can do just fine if we're not in China.

Austin: There are a lot of retailers that have gone to China, certainly, with international experience and they've done very poorly over there. I know Best Buy has done very poorly, Wal-Mart's had a tough time. Why do you think it is that big, ordinarily successful retailers have a really tough time with China?

Jelinek: You know, I think that's a pretty good question. That's one reason that...

It's not fair for me to say, because I haven't spent a lot of time over there. I think when I go in there they all kind of look the same, so maybe you can't tell what's different about them, just because they're from the U.S.

But that's one of the reasons that... we're very successful in Korea, Japan, Taiwan, so we might as well go there. If we knew somebody that was really successful over in China, but we haven't seen that at the moment. More people seem to be cutting back than going in there, which, to me, that's kind of a red flag.

Austin: You talked about, in the U.S. if you go somewhere -- let's say Omaha -- the store is not going to make as much as one on the West Coast because you have to establish yourself there. There's always a cost.

China will always be there, but there's a cost to maybe being later and trying to build your presence there. How do you think about that trade-off, between executing and being able to take advantage of opportunities and be among the first to establish in a market before other companies go and open up warehouse concepts and build up their customer base?

Jelinek: The key is that there's got to be other companies that go in there and build there. Not many people have gone in and been successful in the warehouse business. At one time, there was probably eight different clubs. Now you're basically down to three. You've got BJ's, you've got Sam's, and you've got Costco.

I don't know that you're going to see anybody else jump in the business at the moment. When we feel that the time is ready, then we would go over there and compete, but right at the moment we don't see that being something that we have to do.

Austin: When you went to Japan and Korea before Europe, was that because you had seen more success within the warehouse space, or demographics? What made you go over there before...?

Jelinek: We just saw that Japan, when we went actually over to Japan and Taiwan, we saw a pretty good economy over there. Keep in mind, both of those markets started out very slow for us. Korea was very tough for us, but over time you just whittle away and good things start to happen as long as you continue to bring value in the marketplace and your consumer figures it out.

We don't do a lot of advertising. You have to sell memberships and they have to feel comfortable. It is a little intimidating, when you walk in there to a Costco and you see the big sizes and you start to ask yourself, "How is this going to work for me?"

They used to say you can't sell swing sets over in Japan because they don't have big homes. That's one of our biggest selling items, was a swing set. People figure these things out.

In terms of going in there, it takes time but you build your membership and once you start to get a reputation and a marketplace, and your reputation comes from doing the right thing and word of mouth for the consumer, good things will start to happen.

All those Asian countries, we're now very successful in.