Shoppers are flocking to warehouse club stores, and no one does this unique brand of larger-than-life retailing better than Costco.

Costco is Confectioner’s 2004 Retailer of the Year, but we aren’t the only ones to note the achievements of the nation’s sixth-largest retailer.      

Costco gets plenty of positive press. In recent months, stories have appeared on the pages of USA Today, The Wall Street Journal and Business Week, to mention just a few of the most celebrated.

“They are one of the strongest merchants in retailing today,” says consultant Neil Stern, a partner at Chicago-based McMillan/Doolittle LLP.

“Costco is clearly the best operator within the club channel,” observes Todd Hale, senior vice president, Consumer Insights, at New York-based  ACNielsen. “With fewer stores, they are able to outsell Sam’s Club,” he continues. “They drive greater shopper frequency, and they drive greater basket ring.”

Costco’s ascent to the ranks of retailing powerhouses has been rather dramatic.

“They weren’t on the map five years ago, and now they’re clearly designated as one of the power retailers of the future,” says Don Stuart, managing director, Cannondale Associates. The retailer’s position will become even more prominent within the next decade or so, Stuart predicts.

For the past seven years, Cannondale, a sales and marketing management consulting firm with offices in Wilton, Conn., and Evanston, Ill., has been conducting a survey designed to provide insights into the operations of top-performing retailers and manufacturers. In the 2004 PowerRanking Survey, Costco made the list of top 10 retailers with a composite score that was up 2.9 percent over the prior year. (Retailers are ranked by vendors on criteria that include achievements in areas such as purchasing and category management, among others.)

One survey participant had these words of praise for the Issaquah, Wash.-based warehouse club store, founded just 21 years ago. “Costco is on a roll,” the survey respondent said. “They have a very clear go-to-market strategy. They are very focused on tightly controlled retail, and they put a great product in the box.”  

 “Costco has about twice the sales per square foot of Sam’s,” which is its main competitor in the wholesale club store class of trade, adds Stuart.

Costco’s success in targeting higher-income consumers with ample discretionary income—both via its merchandise assortment and the location of its stores—contributes significantly to the sales volume per building (which is how Costco executives refer to their warehouse club units).

“This is a chain that does very well in appealing to consumers who can afford to shop in the channel,” Hale observes. “You need to be able to afford the membership, and you need to be able to shop a lot when you’re there,” he says.

The merchandise assortment provides some major clues into the affluence of the Costco customer. For example, it’s not unusual to find a display of Dom Perignon champagne for sale at Costco, notes Brian Harris, founder and co-chairman of The Partnering Group, a Playa del Rey, Calif.-based consulting group.

“One of the things that I think Costco has done very well is to identify its consumer base,” says retail consultant Thomas Aquilina, president of Aquilina & Associates Inc., Crystal Lake, Ill. “I think that’s supported by their (membership) retention rates,” Aquilina continues. He points out that 85 percent of Costco members renew their memberships each year.

“I think consumers know that Costco stands for quality and a great price,” says Aquilina. “And I think consumers feel satisfied that they’re getting that.”

Hale links some of Costco’s appeal to its ability to deliver a shopping experience that is pleasant and relatively straightforward. “I think simplicity and pace of life issues come into play,” he says, reflecting that the sheer volume of SKUs featured in supermarkets and mass merchandisers can lead to mental overload for some shoppers.

Because of the limited number of SKUs featured in the building, the pressure is on warehouse club buyers to get the assortment right, and Costco succeeds admirably at that.  

As Stern points out, warehouse club stores like Costco carry only about 4,000 SKUs per building vs. 40,000 for a supermarket, and up to 100,000 for a mass merchandiser. “The warehouse club model requires the companies to be very, very good about identifying the products they select to sell,” says Stern.  

And that, of course, means that Costco buyers must be exceptionally savvy and well informed.

“Their buyers are very bright people,” says Ted File, managing partner, C2-It Inc. Associates, Naperville, Ill., a management/mentoring advisory company. “The buyers are held responsible for turnover and margin,” he says. “They scrutinize every item.” And they’re particularly well versed about the cost of goods, he adds.

Not surprisingly, breaking into Costco as a new vendor can be challenging. Once an appointment is granted, says Aquilina, “They want to taste the product before they do anything else.” If the taste isn’t first-rate, the process will stop right there. Once taste criteria are met, the buyer will start talking price.

“They’re really tough in their decision-making process, and not always timely,” says Aquilina.

Just as Costco’s appeal to consumers is straightforward, so too is its relationship with vendors. Not counting product quality, which must be a given, it’s all about high-volume sales and rapid turn.

“The good news about Costco,” says Stern of McMillan-Doolittle “is that it’s hard to get in, but you get in based on performance. You’re not working with slotting fees and advertising rebates or all the games that certain channels play. It’s about performance as well as giving them the best price.”

Vendors must also be prepared to satisfy Costco’s stringent supply chain requirements.

“If you sell to Costco, you’d better have 100 percent fill and 100 percent on-time delivery,” says Aquilina.

Amy Paulose, business development manager for Fife, Wash.-based Ames International, gives Costco buyers high marks for creativity and willingness to collaborate. “I think the buyers are very much empowered to come up with their own creative ideas,” says Paulose.

For the holidays this year, Ames International is supplying Costco with chocolate-covered macadamia nuts as well as an attractively packaged nutcracker/nuts-in-the shell item.

Douglas Chu, co-president of Beverly Hills, Calif.-based Taste of Nature/Shari Candies, rates the chain highly for organization and information sharing.

“They’re very forthcoming with vendors as to what their needs and requirements are, which ultimately leads to better merchandising solutions,” he says.

“They seem to have very good communication among their regional offices,” adds Chu.  

Industry players and watchers note that one of the things that sets Costco apart from many other retailers is its effective use of regional buyers to help augment the assortment selected at headquarters. “You can sell to corporate, and you can sell to the regional offices,” says Paulose.

Costco turned in a strong performance for the 2004 fiscal year. Sales climbed 13 percent to $47.15 billion, and net income increased 22 percent to $882.4 million.

In fact, Costco has performed so strongly that it’s tough to find much to criticize. Some would say, however, that its strengths and weaknesses are closely connected.

For example, President and CEO Jim Sinegal is a firm believer in treating Costco employees well. Not only is it the right thing to do, he has said, it also results in a highly efficient and productive work force. According to consultant Aquilina, 85 percent of Costco employees are eligible for benefits, and after four years, the average salary for a cashier is $41,000. Not surprisingly, Costco can claim excellent employee retention. About 80 percent of employees are retained each year.

Sinegal’s commitment to marking products up no more than 14 percent over cost is nearly legendary. It’s a strategy that wins consumer loyalty, but it gives the huge retailer less flexibility when it comes to rising costs in areas such as employee benefits.

As employee costs increase, “Costco doesn’t have the ability to raise margins to reflect that,” Stern reflects. “If they’re vulnerable at all, it’s that the model is very rigid in terms of their ability to get more money from their stores.

“Most retailers have a lot of ways to massage the balance sheet—run more advertising to get more bodies in the store, raise margins to generate higher profits,” Stern continues. “But the club model in general and Costco in particular doesn’t allow for that. They don’t advertise. A lot of retailers take margins where they can get it…Costco doesn’t do that.”  

Harris says that he expects Costco, as well as other key warehouse club store players, Sam’s Club and BJ’s, to continue to refine their respective positions in the marketplace.

Sam’s Club initiated a renewed focus on small business shoppers in 2003 and 2004, and BJ’s has been working to drive more sales among families and also is targeting foodservice operators, according to Hale.

Costco continues to focus on both business and household shoppers. And when it comes to targeting households, Costco enjoys the advantage of targeting more upscale consumers than does Sam’s Club, which tends to focus on consumers of more moderate means.

“I think that what’s going to test the model is their building location selection,” says Aquilina. “It’s not right for every place. Their real estate department has to do a lot of research to make sure that the target audience aligns with the Costco model.”

Hale offers this summary of the not-so-secret ingredients in Costco’s formula for success.

“Consumer research has shown that the channel receives high marks in providing a pleasurable shopping experience,” says Hale. “Who cares if sometimes you have to wait in long checkout lanes and if boxes aren’t always available for your purchases? It is the treasure hunt for bargains, the limited assortment that simplifies the shopping experience, and the constant delivery of value that wins shoppers.”