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By gdefelice
August 18, 2003

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I have a friend who's father shops both at Wal-Mart and Costco..."Love 'em both."

But, my friend said, his Pops will go to Wal-Mart for a $7 pair of sweats. Costco sells designer stuff at a discount, so something similar might be $15 at Costco (and $45 at retail)...the Costco pair is a brand, he mentioned FILA. The Wal-Mart version is just plain cheap.

By the time he's left the store, he's spent about $50.

But he goes to Costco to buy his paper towels and toilet paper in bulk. And, he buys the Kirkland brand...so do I -- the prices are ridiculous. Those two items [are] the two largest selling items in the entirety of Costco. Then Dad moves onto a few cheapish but nice wines, some nice meats "Their filets are as good as any", maybe a new book, some frozen foods and some vegetables, etc -- he and the wife make a little morning of it. Like a lot of Costco shoppers, he just keeps buying. (I've asked checkers what their average ticket price is on weekends..."At least $150" or "NO ONE leaves here for less than $100." An exaggeration of course, but he was just making a point.)

He told his son he estimated his average ticket at Costco at $200.

I have strong feelings about the amazing management, business strategy and execution at Costco. I think they are superb. No-nonsense at every turn. And, they understand they must stay cheaper than Sam's/Wal-Mart. Their much lower expense ratios and their higher inventory turns being two important methods, in my book.

Costco has numerous interesting strategies. They charge a higher membership fee than Wal-Mart but appear to have the lowest prices on their products, on average. They pay their workers more than their Wal-Mart but have much lower SG&A (even with this hiccup in Worker's Comp...). They achieve this by having much shorter stores hours than Wal-Mart. It is an interesting strategy. Better quality and more productive workers working shorter hours.

During the recent conf. call an analyst asked a question I had myself wondered. Can't the combo of Wal-Mart/Sam's simply get better pricing through buying power leverage?

After the requisite deference to Wal-Mart's size and power, they offered up the following response: "Since we only offer a few of any major product, we insist that our costs be no higher than those available anywhere else." The implication was clear. Costco's strategy of offering just a few of a given category's best sellers means that a manufacturer of soap or paper towels or vitamins, etc. either proffers their best price or is cut out of the loop entirely. I'd hate to be in charge of losing the Costco account for laundry detergent at Costco. Of course, you get another chance each year.

Most stores think of variety as an important service they provide customers but if manufacturers know this, they have much more leverage than in the Costco approach. That was my big takeaway from the latest call.

As well, I have heard them say before that by offering up Kirkland brands (at absurdly low prices) they have another way of keeping the manufacturers honest. Personally, I only buy Kirkland brand for laundry detergent, paper towels, fabric softener and napkins. I find it just absurdly cheap and of good quality. I did a comparison of TIDE at my local grocery against Kirkland laundry detergent on a per use basis the cost of the Kirkland was just under 17%. If you can tell the difference between clothes washed by each detergent, you should pay the higher price.

I've noticed other things. From my memory here, I think that almost every time, or every time I've read the annual for the last 5 or 6 years, Costco says that all it same store sales growth has come from volume and NOT from price increases. This is necessarily an estimate as SKU's change and product mix shifts but again, to me, its implication is important. In a world of 2.5% inflation, these guys are dropping the real cost of some of these products at an amazing rate.

Finally, since I live in California, there is a Costco within about 15 minutes of almost anywhere I find myself needing their bulk packaged products. It is a level of convenience that is much, much higher than many other places. If I had to drive more than 20 minutes, I'm not sure I would at this point. Certainly not nearly as frequently as I do. Their next major hurdle, in my opinion, is to show that they can continue their expansion nationally. However, if their plan is to fill in the west to maximize their membership out here, I am willing to wait. The competition is clear and currently of virtually unimaginable heft...putting on maximum bulk before a more direct fight seems a bright enough idea.

In short, I believe Costco does everything right to expand its moat and it plans on growing moderately but very steadily for a minimum of a decade. I continue to think it has a decent chance of becoming phenomenally large.

gdefelice

disclosure: long Costco on the recent sell-off


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