Part of the appeal of shopping at Costco (COST 0.59%) is the wide selection of products you can find under one roof. In a single trip, warehouse members can shop for groceries, TVs, tires, furniture, jewelry, toys, clothing, and a whole lot more.
But within that huge selection of categories, your choice for individual products is extremely limited at Costco in relation to other retailers. In fact, the company carries less than 4,000 items in an average store, compared to 80,000 at a typical Target (TGT 0.72%) or 150,000 at a Wal-Mart (WMT -0.87%) Supercenter.
That's completely by design. In fact, Costco believes that a scant product offering is critical to its successful business model. The store concept is built around the idea that Costco can achieve unbeatably low prices through operating efficiencies such as offering a small selection of only the quickest-selling products.
Quick inventory turnover
"We seek to limit specific items in each product line to fast-selling models, sizes, and colors," management says in the company's 10-K report. And by "fast-selling," Costco means lightning fast.
In most cases the company sells its merchandise before the bill even comes due to its suppliers. In other words, the inventory never becomes a drain on working capital because Costco doesn't actually carry the cost on its books. Management explains the strategy like this:
"We generally sell inventory before we are required to pay many of our merchandise vendors, even though we take advantage of early payment discounts when available. To the extent that sales increase and inventory turnover becomes more rapid, more inventory is financed through payment terms provided by suppliers rather than by our working capital."
By turning over its entire inventory 12 or more times a year, Costco lowers its costs to a level that's almost impossible for rivals to match.
Private label sales
Less selection also drives shoppers toward Costco's in-store brand, called Kirkland Signature. That franchise is responsible for about 25% of the selection in a typical warehouse, with national brands making up the rest.
It's a win for both Costco and shoppers when the corporate brand does well. From the company's point of view, it benefits by providing an item that can't be found at competing stores. Costco also earns a higher margin on the Kirkland sale since its costs are significantly lower. From the shopper's point of view, the product is comparable to the national brands, if not better -- except at a lower price.
That's why Costco's management is aiming to push the Kirkland brand up to a higher percentage of sales, 30% or more, over the next few years.
At about $100 billion of annual revenue in the U.S., Costco is second in size only to Wal-Mart. That's an even more incredible stat when you compare the store footprints of these two retailing giants. Costco operates just 474 warehouses in the U.S. while Wal-Mart has 3,400 Supercenters across the country and 650 Sam's Club locations. Not only does Costco move more merchandise per location than its rivals, but it does so with a much more targeted product selection.