Internal+Environment+Analysis

** Costco’s mission statement in the membership warehouse business reads, “To continually provide our members with quality goods and services at the lowest possible prices.” The companies basic business model is too generate high sales volumes and rapid inventory turnover by offering members low prices on a limited selection of branded and private label products in a wide range of merchandise categories. Costco has a simple but differentiated business strategy that works. Their strategy is low prices, bulk buying, limited selection, and a treasure-hunt shopping environment.
 * Internal Environment Analysis:
 * Costco’s Primary Strategy: **

Costco is known for selling top-quality national and regional branded products consistently below traditional wholesale or retail outlets. The company only stocks goods that can be priced at significant cost reductions and thus provides members with the savings. Costco also abides by a strict pricing rule to cap its markup on brand-name merchandise at 14 percent compared to competitors at 20 to 50 percent markups. Yet another price strategy is Costco’s Kirkland Signature products which are a private label designed to be of equal or better quality than national brands, but priced some 20 percent below competing brands.

Product selection is another main aspect of Costco’s business model. Companies such as Wal-Mart and Target may stock some 150,000 different items to give shoppers a wide selection to choose from. However Costco’s strategy is to provide members with a selection of only about 4,000 different items. Costco limits the selection on purpose in each category to only the fast-selling models, sizes, and colors. They also only offer products in bulk quantities which are usually much too big for the single shopper. However, CEO Jim Sinegal’s argument for bulk quantities is that, “if ten shoppers come to buy Advil, how many are not going to buy any because you just have one size? Maybe one or two.” The difference is that Costco is prepared to give up those sales, but make it up by not having to manage the inventory of four or five different sizes of Advil. Finally, the part everyone likes, treasure-hunt shopping. Costco’s product line may only consist of approximately 4,000 items, however, about 25 percent of those are constantly changing. These items consist of huge HDTV’s and leather sofas for irresistible prices. The idea is to entice the consumer to spend more than they might otherwise on luxury items. Also, since approximately 1,000 items are constantly changing members know they had better buy now, because the product may not be their next time.  When looking at the cross-sectional financial analysis between Costco and Wal-Mart between 2005 and 2008, Wal-Mart has had a larger profit margin compared to Costco’s over those years. Costco’s profit margin has ranged from 13.38% to 13.17%, while Wal-Mart’s profit margin has gradually increased from 24.43% to 25.29%. Costco’s average profit margin from 2005 to 2008 was 13.27% compared to Wal-Mart’s 24.80%. This shows that Wal-Mart has better control over their cost. In order for Costco to improve their profit margin, they must control their cost as well as Wal-Mart.
 * Costco’s Financial Analysis: **
 * Cross-Sectional: **

In the cross sectional analysis, Costco’s total asset turnover has been higher than Wal-Mart’s. Wal-Mart’s total asset turnover has ranged from 2.43 to 2.60, while Costco’s total asset turnover has ranged from 3.18 to 3.50. Wal-Mart’s average total asset turn over from 2005 to 2008 was 2.29 compared to Costco’s 3.35. This shows that Costco is doing a better job at turning their assets into revenue than Wal-Mart is.

When comparing each company’s equity multiplier, Wal-Mart tended to have the higher equity multiplier from 2005 to 2008 compared to Costco’s. Costco’s equity multiplier ranged from 1.88 to 2.27, while Wal-Mart’s ranged from 2.43 to 2.60. Costco’s average equity multiplier from 2005 to 2008 was 2.08 compared to Wal-Mart’s average of 2.51. This shows that Wal-Mart is relying more on stockholder’s equity or debt to finance its assets. In order for Costco to increase their equity multiplier they must use more debt to finance their assets.

Costco’s return on equity from 2005 to 2008 is lower compared to Wal-Mart’s. Costco’s return on equity ranged from .80 to 1.05, while Wal-Mart’s ranged from 1.41 to 1.46. The average return on equity was .92 compared to Wal-Mart’s 1.43. This shows that Wal-Mart has done better at creating profits from stockholder’s equity. In order for Costco to increase their return on equity to Wal-Mart’s they must increase their profit margin and equity multiplier. Costco must control cost and use more debt to finance their assets to increase their return on equity.

The average sales for Costco between 2005 and 2008 were $62 billion, while Wal-Mart had average sales of $328 billion. Costco’s average sales growth of 11.07% between 2005 and 2008 is higher than Wal-Mart’s 9.52%. Even though Costco’s sales are not as large as Wal-Mart’s, their sales growth has been growing.

The average income for Costco between 2005 and 2008 was 1.13 billion, while Wal-Mart had average income of 11.37 billion. Costco’s average income growth of 6.80% between 2005 and 2008 is lower than Wal-Mart’s 7.56%. Both companies took a hit to their income in 2007, but Costco had a negative growth compared to Wal-Mart’s.

Costco’s return on assets from 2005 to 2008 is lower than Wal-Mart’s. Costco’s return on assets ranged from 5.52% to 6.38% in this time frame, while Wal-Mart had a range from 7.44% to 8.54%. The average return on assets for Costco was 6.10% compared to Wal-Mart’s 7.98%. This tells us that Wal-Mart is doing a better job at taking their assets and generating earnings. When competing with Wal-Mart, Costco should look into more efficient ways of using their assets so that more earnings can be generated. ** Longitudinal Analysis:  ** When doing a longitudinal financial analysis on Costco, Costco’s profit margin has been slightly increasing between 1999 and 2008. It had a profit margin of 12.79% in 1999 to 13.29% in 2008. This gives the company an average profit margin of 13.16% compared to the industry average of 20.40%. This shows that even though Costco has been gradually increasing its profit margin, it is still below the industry average. The company needs to improve their financial performance by controlling cost to increase their profit margin.

Costco’s total asset turnover has stayed relatively the same from 1999 to 2008. The average total asset turnover in that time period was 3.40 compared to the industry average of 2.85. Compared to the industry Costco has a moderately high total asset turn over. This means that Costco is doing a very efficient job in using its assets in creating sales.

Costco’s equity multiplier has ranged from 1.88 to 2.27 from 1999 to 2008. The average equity multiplier in this time period was 2.06 compared to the industry average of2.34. Costco is slightly lower than the industry average. To increase their financial performance the company should increase their financial leverage and rely on more debt to finance their assets.

The average return on equity for Costco between 1999 and 2008 was .92 compared to the industry average of 1.19. Costco’s below average return on equity is mainly because of its profit margin. Since Costco’s profit margin is significantly below the average, it is affecting the company’s return on equity. In order for Costco to improve on their financial performance, the company needs to handle their cost associated with their operations.

Costco has had gradually increasing sales from 1999 to 2008. The sales growth shows an average growth of 11.43% for Costco compared to the industry average of 10.48%. This shows that Costco is above average in the industry with its sales growth. The average sales for Costco between 1999 and 2008 were 47.38 billion compared to the industry average of 88.53 billion. Costco’s averages sales puts the company in third place for the largest sales right behind Wal-Mart and BJ. Costco also has had a gradually increasing net income from 1999 to 2008. The net income growth shows an average of 15.2% for Costco compared to the industry average of 13.68%. This shows that Costco is above average in the industry with its net income growth. The average net income for Costco between 1999 and 2008 were 846 million compared to the industry average of 2.8 billion. The industry average is much skewed due to Wal-Mart’s average net income of 8.52 billion. Even though Costco’s net income is below the industry average, it is slightly growing every year. **Costco has been generating below average profit margins compared to the industry average. Costco ** generates high sales volumes and rapid inventory turnover by offering members low prices on limited selection of merchandise. This allows Costco to have more sales and fewer inventories. At the same time Costco isn’t controlling their costs which are hurting their profit margins. One of Costco’s highest expenditures is on their labor. The company gives generous pay to their employees higher than the average believing that this will result in lower turnover and saving cost on new hires and training. Another cost for Costco is their inventory and markup on products. Costco marks up their products about 14-20% while competitors are 20-50%. They make less per sale but make more with higher number of sales. This strategy could hurt the company because they might not get a higher number of sales in different economic conditions. If this is the case then Costco is generating more cost with their inventory decreasing profit margins. The key elements of Costco’s strategy and drivers of performance are low prices, bulk buying, limited selection, and a treasure-hunt shopping environment. Another reason Costco has been generating below average profit margins is because they are doing it on purpose. Many times Wall Street has accused Costco’s management for trying too hard to please the consumer with low prices and therefore cutting profits to the shareholders. Sinegal was quoted saying the following about Wall Street, “Those people are in the business of making money between now and next Tuesday. We’re trying to build and organization that’s going to be her 50 years from now.” Sinegal is saying that by keeping prices low they are driving out competitors. If Costco was to raise prices a new competitor may be able to enter the market and beat them.