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Costco: External and Internal Environment

Costco Wholesale Corporation (COST), a wholesale or membership club store is the second-largest retailer in the U.S. behind Walmart. A large part of Costco’s business membership is foodservice, traditional cash & carry customers and small businesses (Coriolis Research, 2004). Costco offers low prices to attract members and provide them with considerable cost savings enough to more than cover membership fees. Despite the world economic turmoil and downsizing, Costco is an example of thriving that reflects in recent rising of their share price by 30% (Stone, 2013).

 

The Analysis of General Environment Segments

The external analysis discovers that the following external factors of the general environment have the most impact on Costco’s performance.

The economic segment. General economic factors have an adverse effect on the discount/variety store industry. It refers to significant challenges for the industry that include a highly competitive trading environment due to globalization, unsettled financial markets, slowed consumer spending, increased savings rates, and reduced consumers’ confidence (USSEC, 2012). Globally, many markets for consumer products are depressed. Domestically, a weakness in housing and real estate markets exacerbate the issues. All these global and domestic factors lead to decreasing retail sales (PricewaterhouseCooper, 2009).

The health of the U.S. economy is the substantial factor that influences Costco’s performance. Therefore, the fluctuations of prices of certain commodity products including gasoline and other food products affect their operations and financial results. Other important economic factors include the U.S. high labor costs and a highly labor intensiveness of the industry. These factors deteriorate attracting company’s new members and retaining existing member base.

Although the U.S. economy recently indicated some signs of recovering and improving consumers’ confidence, the U.S. consumers are still deleveraging (Shinesrooms.com, 2013). Consequently, this means that consumers’ spending will remain tight making consumers more price-conscious. In fact, it is a competitive factor for the discount stores industry.

Another segment of the general environment that would have a high rank in their influence on Costco is technological segment. Technological factors refer to driving online sales, escalating multi-channel and developing cross-channel based on the advanced IT solutions. It allows the companies in the discount/variety stores industry to be more responsive to consumers’ demands and more competitive in the markets, domestically and internationally (Fischer, 2012). Technological factors are especially important for Costco since the company considers modern technologies as the key to managing their business (USSEC, 2012).

The company relies extensively on information technologies to process transactions and summarize results. However, realizing benefits from excessive technological changes becomes more difficult that could influence the effectiveness of their adoption. The example is Costco experimenting with self-service checkouts that were proved ineffective for large-volume warehouse business (Stone, 2013).

To conclude, the factors that are likely to influence the development of Costco’s competitive advantages are uncertainties in economic conditions in the markets, tight consumers spending, increasing rivalry in the industry, the growth of online sales, and necessity to provide significant technology investments.

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Competition Analysis

This analysis assesses the attractiveness/profitability of the discount and variety stores industry and Costco’s relative position in the industry. According to Porter’s fives forces model, five key factors: threats of new entrants, power of suppliers and buyers; threats of substitutes and competitive rivalry influence the industry performance.

The barriers to a new entrant are high. The sector that has few major players (Costco, Sam’s Club, and BJ’s Wholesale) utilizing sizable scale economies is not easily accessed by a newcomer (USSEC, 2012). Entering the market is related to large capital requirements. In addition, attracting members and building a significant volume of sales need high marketing as well as advertising expenditures.

The bargaining power of suppliers is low, because a small number of large volume buyers control the market. Besides, suppliers bargaining power is limited by the absence of a single supplier that constitutes a large percentage of the merchandise. Although the bargaining power of suppliers is increasing due to developing additional channels in order to get their products to consumers such as online shopping, the suppliers to the wholesale clubs cannot put much pressure on their wholesale club customers in negotiating for better and higher prices.

The bargaining power of buyers is low since numerous wholesale club members buy in relatively small quantities with no single member accounting for a critical share of total sales. Despite low switching costs, buyers cannot negotiate for better prices or benefits beyond what their membership card provides.

The threat of substitute is considered moderate; moreover, it is increasing due to the development of price comparison websites that enable consumers to choose the cheapest alternatives and the availability of many alternative indirect competitors and channels, including online retailer in the market that are viable substitutes to Costco. It can create a serious threat in the future reducing needs of small businesses, and individuals/households might go to warehouse clubs to shop.

The competition in the industry demonstrates a high degree of rivalry, because of the small number of major players and the lack of perceivable differentiation. The competition is intensified due to the maturity of the industry and global business expansions.

Thus, the competitive environment is characterized by weak suppliers and buyers’ positions with increasing bargaining power of buyers, remaining high entry barriers, moderate to strong threat from substitutes, and intensifying competition between players. Among the forces of competitions, the most significant are intensifying competition and the strong threat of substitutes that can reduce a high attractiveness of the industry for Costco to moderate level and reduce Costco’s profitability in the future.

Costco’s Addressing Forces of Competition in the Recent Past

The company successfully addressed the main forces of competition. In contrast to many competitors, which lost customers, Costco demonstrated since 2009 the 39% growth of sales, which is the most important driver of their profitability (Stone, 2010). In 2012, net sales is increased by 11.5% to $97,062 million (USSEC, 2012).

The success of Costco was based on adopting a low-cost strategy (Berman, 2011, p.30). The lowest cost structure allowed the company to benefit by selling products at so low prices that competitors cannot match. Costco achieved low cost structure by reducing their operating cost through providing the efficient use of labor, self-service, use of less-costly locations, and effective supply chain management including reducing product choice (Berman, 2011, p. 16).

It provides faster inventory turnover, lower rental costs, and greater bargaining power with individual suppliers. The efficient use of labor was achieved by good treatment of employees that minimized employee turnover and maximized employee productivity (Stone, 2010). With 70% of their expenses spent for labor costs, Costco has reached an impressive 5% turnover rate (Berman, 2011, p. 88; Stone, 2010).

Another important strategy used by Costco to address forces of competition was a differentiation strategy (Berman, 2011, p.17). It implied the implementation of a well-developed private label program and a very liberal return policy, as well as the use of co-branding on many of its private label products.

Improving the Costco’s Ability to Address Forces of Competition

The analysis of internal and external factors points out the necessity to adapt their marketing strategies to major critical issues that Costco faces. These issues are related to two forces: intensifying competition amongst players and strong threat of substitutes; decreasing consumer spending, quick response to consumers’ behavior changes, product and services differentiation. To address these forces in the near future, the company will be focusing on “vowing to keep prices low, volumes high and employees happy” (Stone, 2013). Costco has to continue a low cost strategy in order to provide members with a wide range of high quality merchandise at prices consistently lower than they can obtain elsewhere (USSEC, 2012).

Another important step will be the implementation of a growth strategy that implies expanding business in existing markets and new markets. The company is going to open their new locations in France and Spain. In addition, Costco considers the business expansion to Asian markets (Japan, Taiwan, and South Korea) (Stone, 2013). However, it would be critical for the company to expand their business to emerging markets.

In addition, Costco will have to develop multichannel retailing, because its members will be more engaged in online shopping using PC, tablets, mobile phones, and other devices. The part of multichannel strategy will be technology investments, developing and refining websites and launching new applications for portable devices (USSEC, 2012).

The Costco SWOT Analysis

The External Threats Affecting Costco and the Opportunities

Threats:

  1. Fiscal uncertainty.
  2. The intensification and growth of competition in the industry and increased international online retail competition.
  3. Lowering consumers spending.
  4. Reducing labor costs as the competitive factor.
  5. Consumers’ movement towards organic product and healthy alternatives.
  6. Changes in the industry trends concerning shifting of channels and products mix.

Opportunities:

  1. The intensive online growth.
  2. Expanding business to new markets including emerging markets.
  3. Cost reduction through supply chain efficiencies.
  4. Developing leading offers through multi-channel and cross-channel that provides the advantages of integrating of all sales channels.
  5. Trend of organic food sales to rise over the long term that provides an opportunity of delivering new healthier products.
  6. Using direct and social networking platforms.

The analysis of threats and opportunities indicates that Costco needs some changes concerning the adaption of their marketing strategies to most serious external threats – intensifying the competition and shifting to channels in order to develop and maintain competitive advantages and outperform competitors. In order to deal with these threats, Costco has to expand business to emerging markets and increase the effectiveness of business in the existing markets through developing multi-channel and cross-channel, and responding to changes in consumers’ behavior trends.

The Costco's Greatest Strengths and Most Significant Weaknesses

Strengths:

  1. Strong market positions.
  2. Valuable and well-known brand.
  3. A strong lead in low cost strategy.
  4. Low operation costs that provide price leadership.
  5. Excellent financial performance.
  6. Effective supply chain management.
  7. Efficient use of labor.
  8. Great members loyalty.
  9. Low employee turnover that reduces the cost of training.

Weaknesses:

  1. Relatively low market share in online sales.
  2. High labor expenses.
  3. High annual membership fee.
  4. Sensitiveness to any perceived slights from its vendors.
  5. Crucial dependence of gross profit on membership fees.
  6. The absence of regular influx of the outside view due to relatively old age of company’s executive team.

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The analysis of strengths and weaknesses indicates that Costco needs to take maximum advantages of its strength – low operation cost, effective supply chain management and efficient use of labor. It can be done through further developing of low cost strategy. The most significant weakness of the company is relatively low market share in online sales. In order to fix this weakness, the company should select the tactics of developing multi-channels and cross-channels platforms.

The Costco’s Resources, Capabilities, and Core Competencies

Costco has the following tangible and intangible resources and capabilities at its disposal. The tangible resources include (USSEC, 2012):

  • Effective Supply Chain;
  • Digital channel platform and 608 physical warehouses;
  • As of September 2, 2012, Net Working Capital was $1,266 million.

The Intangible Resources Include

  • Valuable and well-known brand including the Costco Wholesale® series of trademarks and private label brand Kirkland Signature®.
  • The great service experience;
  • The large members’ base.

Costco’s Capabilities Are As Follows

  • Delivering leading low cost offers without jeopardizing to quality service experience to its customers;
  • Reaching the high key operating metrics in the industry.

The resources and capabilities as sources of the value creation define the Costco’s core competence – an ability to deliver high quality customer experience offers at low prices.

Analysis of the Costco’s Value Chain

Analyzing Costco’s value chain allows understanding how activities can contribute to creating value for customers. Primary value-chain activities of Costco are as follows:

  • Partnering with vendors;
  • Purchasing merchandises;
  • Managing and distributing inventory;
  • Operating stores;
  • Marketing and selling.

Based on the resources, capabilities, and core competencies mentioned above, Costco could create the value that exceeds the total costs involved in the managing and distributing inventory and operating stores. Costco provides better value based on low cost, product quality, differentiation, and customer service experience that is associated with high process quality through offering only those services that absolutely required by buyers (heavily edited selections of merchandise) and services viewed by them as meaningful (unique private label goods) (Berman, 2011, p.2, 188, 195).

In other words, Costco’s operations with extremely low overhead enable the company to provide significant opportunities to members for dramatic savings that make them happy with this better value despite the lack of typical convenience (Berman, 2010, p. 30).

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