Costco Wholesale Corporation Case Study

INTRODUCTION

The Industrial Revolution reshaped the world and expedited how business was conducted through the use of railroads and steam engines. Department stores soon evolved after and revolutionized how shopping was done and centralized a variety of merchandise at one central location (Tayan, 2003). With the introduction of 20th century operational management strategies such as Just in Time (JIT) and Lean Manufacturing, companies had to alter its operational efficiency and the way it conducted its business in order to grow and stay competitive. Costco Wholesale Corporation entered the wholesale club industry in the early 1980s (Tayan, 2003). The idea behind a wholesale club was to maximize profits by minimizing operational costs and maximizing inventory turnover ratio. The company experienced tremendous growth from 1997 up to 2001 and has caught the attention of its competitors. Although growth has been phenomenal, the numbers are deceiving because return on assets, return on equity, and asset turnover ratios have declined within the same time frame.

SUMMARY

This paper focuses on how Costco Wholesales Corporation has become more efficient over time and how the company has financed its growth. In order to effectively address the company’s financial status, four questions needs to be answered: How had the company been affected by growth? Had its operational efficiency changed? How had it financed the growth and how had its capital structure evolved? The paper provides insight about the company and uses ratio and SWOT analysis to answer the case questions.

INDUSTRY ANALYSIS

Within the last 150 years, the retail industry has prospered as one the most profitable industries internationally (Tayan, 2003). Although technology may alter how a company conducts its business and consumer experience can significantly affect how well a company performs, the mature yet saturated retail industry continues to grow in line with the United States’ Gross Domestic Products (GDP) trend (Tayan, 2003). Traditional department stores focused its attention on providing a variety of products at one single location. Further, they differentiated themselves from other retailers by providing superior guest services to its consumers. Department stores not only offered manufactured goods, but they also offered services that complimented the goods to enhance the shopping experience (Tayan, 2003).

Unfortunately, not every consumer could afford to purchase products at retail stores, which limited its revenue to a specific market segment. As a result, discount stores emerged as sensible competitors by targeting its consumers with low costs. Wal-Mart, known for its famous slogan, “Always Low Prices” is an example of a company that flourished within the discount store market segment (Chen, 2004). The company provides its consumers with an abundant amount of merchandise at lowest possible cost. Since price is Wal-Mart’s focus, the company attracts consumers in higher volume compared to department stores.

With the retail industry saturated with companies targeting consumers with low costs or superior guest services, this left little room for growth for potential competitors (Tayan, 2003). However, in the early 1980s, the concept of wholesale clubs introduced a new way for small business owners and regular consumers to purchase goods at low costs (Tayan, 2003). Wholesale clubs differentiated themselves from traditional discount stores by providing the best value to its consumers by offering limited product lines and selling it in bulk (Tayan, 2003). This allowed companies such as Costco to keep operational costs to a minimum and maintain its bargaining power over its suppliers in the supply chain. Although new competition such as online retailers, attempt to grab its share of the retail pie, wholesale clubs such as Costco continue to enjoy revenue growth because the company is focused on providing the best value for all of its consumers by having high inventory turnover and low operating costs.

ORGANIZATIONAL ANALYSIS

How had Costco been affected by growth?

Costco has maintained steady growth as well as healthy finances. The company has maintained its operating expenses at high although steady level ranging from 98%-99%. Operating income has been managed kept its relation to growth. Net income has also been sustained at a level constant to growth. A key factor to Costco’s finances is its membership fees. It accounts for a very small amount in comparison to its net sales, but it is the difference maker between breaking even, (or taking a loss), to making a healthy profit. Costco’s membership fees account for a little less than 2% and is almost equal to its net income. Based on the company’s income statements, Costco is perceived to be in good financial condition, as income to sales ratio remains the same.

Information gathered from Costco’s balance sheet show that it has steadily grew a larger cash reserve. It has a higher rate of outstanding receivables and has sharply increased the rate of inventory kept in stock from 16% in 1997 to 27% in 2001. Another interesting fact to notice is the high increase in property, plants, and equipment increase in proportion to assets, from 31% in 1997 to 58% in 2001. Costco has a much higher ratio of accounts payable in 2001 compared to 1997, which can be explained by the many investments and purchases of property, land, and plans. The amount of short-term liabilities to assets has more than doubled, from 20% to 41%. This may be a troublesome trend if it continues since they need to keep more cash reserves in order not to get into a cash flow problem. The main source of growth has been issuance of stock, which increased the stockholder’s equity ratio to assets from 24% to 48%. Overall, Costco has managed its finances quite well and does not seem to be financial difficulties judged by the income statement and balance sheet. They have maintained their efficiency and operating margin in relations to growth and will most likely maintain sustainable growth.

Has its operational efficiency changed?

The growth of Costco from the years 1997-2001 is very impressive. They have grown into a huge American company, which owns a big portion of the market share in their respective industry. However, if one looks pass growth numbers, they see that Costco’s corporate managers have not handled operational efficiency very well. The company allowed operational efficiency to