Costco (NASDAQ:COST) has materially outperformed Wal-Mart (NYSE:WMT) and other competitors in the retail industry over the last several years. However, the business world is inherently changing and dynamic, so investors may be wondering if Costco has what it takes to continue delivering superior performance as it grows in size over time.
Let's take a look at Costco and some of the aspects which differentiate the discount retailer from Wal-Mart and the rest of the competition in order to find out if Costco can sustain superior growth rates over time or if the best is over for investors in the company.
A tale of two retailers
When looking at sales performance over the last five years, Costco has clearly outgrown Wal-Mart by a considerable margin. And there is no sign of reversal in the trend according to recent financial reports; on the contrary, Costco delivered impressive sales growth for the month of August, while Wal-Mart is reporting lackluster performance.
Costco has recently announced a big increase of 10% in sales during August, to $8.8 billion. Comparable sales during the four-week period ended on Aug. 31 increased 7% in the U.S. and 8% in international markets when excluding currency fluctuations and the impact of gasoline price deflation. This is quite a remarkable performance, reflecting that Costco keeps firing on all cylinders.
Wal-Mart, on the other hand, reported a much more moderate increase of 2.8% in sales during the 13 weeks period ending on Aug. 1. Comparable sales in the U.S. were flat during the period, while Sam's Club, perhaps Costco's most direct competitor, also reported flat comparable-store sales without fuel.
A smart business model
Costco makes most of its profit from membership fees, not margins on product sales. This means the company can sell its products at cost, or sometimes even at loss, which allows it to charge amazingly low prices, providing a crucial source of competitive advantage in the discount retail industry.
Importantly, as Costco grows in size, it gains purchasing power with suppliers, which allows it to negotiate better prices and more flexible financial conditions for its products. In addition, economies of scale and supply chain efficiencies generate additional cost savings as sales volume expands.
The more products the company sells, the bigger the scale and cost advantages. Costco becomes better and more competitive as it grows in size over time, quite a convenient business model for both investors and customers.
A unique culture
A 2005 article in The New York Times named Costco "The Anti-Wal-Mart," explaining how the two companies have chosen very different strategies when it comes to salaries, benefits and other human-resources policies. While Wal-Mart has been widely criticized for paying low wages and providing working conditions which leave a lot to be desired, Costco is a very different story.
Costco pays considerably better salaries than Wal-Mart and most other retailers, and the company provides superior opportunities for professional growth. In The New York Times article, co-founder Jim Sinegal explained that higher productivity, better customer service, and lower employee turnover rates provide an advantage for Costco versus the competition: "This is not altruistic. This is good business."
Costco customers seem to be, in fact, quite satisfied with the service and the business model. The company benefits from extraordinary customer loyalty, retention rates are usually higher than 85% at the whole company level, and more than 90% in big and well established markets like the U.S. and Canada.
Based on data from the American Customer Satisfaction Index, Costco has a customer satisfaction score of 84, the highest one in the industry, and considerably better than the sector average of 80. Wall-Mart's Sam's Club, on the other hand, ranks in line with the industry average, with a score of 80.
Thanks to its smart business model and unique corporate culture, Costco enjoys remarkable customer loyalty, and the company is outperforming Wal-Mart by a substantial margin. There is no reason to expect any changes in the competitive dynamics in the industry anytime soon, so investors should keep this in mind when making investment decisions in the sector.
Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.