Successful companies make both their external customers and their "internal customers" (staff) happy. Costco (NASDAQ:COST), a leading operator of membership warehouse clubs, has managed to deliver consistent profitability to shareholders over the years because it has won the hearts and minds of its customers and employees alike. Costco has been profitable and free cash flow positive in every single year for the past decade. Over the same period, it has grown its revenues and earnings by 10-year CAGRs of 9.5% and 11%, respectively.
There are similarities that one can draw between Costco and other successful retailers like PriceSmart (NASDAQ:PSMT) and The Container Store Group (NYSE:TCS). This helps to provide further insights into Costco's consistent profitability and its popularity with shoppers and staff alike.
Common logic dictates that retailers should provide a wide range of products to meet diverse needs of consumers. In reality, the converse is true. Two professors from Columbia University and Stanford University found in a 2000 study that people are more likely to commit to purchases when they had fewer choices instead of more. It seems that when consumers can't decide on what to buy when faced with a myriad of options, most choose to give up making any decision.
Costco obviously understands this dynamic very well, being well known for its SKU minimization policy where it usually stocks up only one or two brands per product type. It typically carries approximately 3,700 SKUs per warehouse, significantly less than the average 30,000-50,000 SKUs that a grocer will carry. Imitation is the best form of flattery, it seems; Latin America's PriceSmart, founded by Sol and Robert Price (the pioneers of the warehouse store concept in 1996), also carries about 2,200 SKUs per warehouse.
The inventory strategies of both Costco and PriceSmart are validated by their financial numbers and external studies.Costco and PriceSmart turn over their inventories pretty fast, with inventory turnover days of 30 days and 40 days, respectively.
PriceSmart also increased its revenues in every single year since fiscal 2004, while Costco's revenues only fell once in the past 10 years in 2009, when sales fell by an inconsequential 1.5%. Bain's 2007 study also showed that SKU minimization has the potential of increasing the top line of retailers by 40%.
Another key purchase consideration for consumers is price. As PriceSmart and Costco concentrate their purchases with a fewer number of suppliers, they have greater purchasing power and enjoy larger bulk discounts. As a result, they are able to price their products more competitively. Despite this, their profitability is largely unaffected. Both Costco (12%-13%) and PriceSmart (12%-13%) have maintained gross margins within a very narrow range-less than a 100 basis points variation from year to year.
Costco enjoys strong customer loyalty, because its customers find it easier to make buying decisions (less SKUs, fewer choices) and the fact that Costco's products are competitively priced.
If a company can't satisfy its internal customers (employees), employees don't have the motivation to make customers happy. Costco appreciates this fact and makes sure that its employees are well-paid and protected. Costco's staff are considered among the best-paid in the industry (averaging $21 per hour), with the majority of them (88%) covered by company-sponsored health insurance.
The best validation of such employee-friendly practices comes from the staff themselves. Its staff attrition rates are below 10% and 6%, respectively, for all hourly workers and those who have been with Costco for than one year.
Similarly, The Container Store, a specialty retailer of storage and organization products, boasts employee retention rates above 90%. More significantly, no Container Store location has ever had to close because of strikes in its 35-year history. Just like Costco, The Containers Store pays its staff very well, at about 50% above the industry average.
New hires are always worried that they can't cope with the job's demands, and The Container Store ensures that these concerns are addressed. The company provides 260 hours of training to new full-time employees in their first year of work, compared with the retail industry norm of about 43 hours.
Foolish final thoughts
A good company is nothing more than one which is well-liked by both employees and customers. Costco is the best case study of such customer-friendly and employee-friendly practices. For example, it has stood by the low pricing of its $4.99 rotisserie chickens to be aligned with customers' demand, despite rising input costs. Similarly, it has kept salaries high over the years, despite calls to benchmark it with other lower-paying retailers.