Several Ways Costco Differs from Other Discounters
Eric is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Discount retailers often sell products to shoppers who can't afford to shop at fancy stores, so hearing how much money Costco (NASDAQ: COST) shoppers made took me by surprise. A 2012 Washington Post article by Danielle Douglas lists an average household income of $96,000 for Costco shoppers. This unexpected advantage seemed like it could help sustain Costco during a weak economy, so I searched for other distinctions that separate Costco from its rivals.
Probably one of the biggest differences between Costco and other discounters is that the chain pays relatively high wages for retail. Luxury department stores can pay higher base wages or high commissions because they can maintain big markups, but Costco's shoppers are more price sensitive. The big advantages for Costco here are shrinkage, turnover, and public relations, but these factors don't seem like enough to convince most discounters to pay higher wages. Costco's wages may have helped boost another financial metric, net income per employee. Dividing $1.58 billion by 92K employees gives a figure of $17,174 for Costco. Dividing $16.08 billion by 2.2M employees gives a figure of $7,309 for Wal-Mart (NYSE: WMT). Costco's earning more than twice as much profit per employee as Wal-Mart, although Wal-Mart might be able to reach this figure if it only operated Sam's Club stores.
Costco's decision to maintain minimal markups is also somewhat unusual. Discounters use low prices to attract shoppers, so Costco does gain a competitive advantage from limiting markups, but most stores will raise the prices on popular items to make up for other products with weaker margins. If a store's supplier cuts its own prices and shoppers are still willing to pay store prices, other stores may keep their prices the same, but not Costco. Steven Greenhouse, for the New York Times, reported that Costco CEO Jim Sinegal set a maximum markup of 15 percent for products in Costco stores.
Deep discounters typically rely heavily on shoppers who use food stamps, but Costco only started accepting food stamps in 2009. This decision provides additional evidence that Costco's customers are relatively wealthy, as many low end grocery stores couldn't have sustained their sales without accepting food stamps. Melissa Alison, at the Seattle Times, reported that CEO Jim Sinegal only decided to accept food stamps during the deep 2009 recession after learning about its harsh effects on Costco shoppers.
Costco's service offerings aren't limited to the pharmacies, gas stations, and auto services that large retail stores often provide. Les Christie, at CNN Money, reported that Costco now offers home loans, already sells insurance, and might provide student and car loans in the future. Many of these insurance and financial services are sold through partnerships with third parties, but seeing them at a discount store is somewhat unusual. Costco's insurance and financial offerings could help it compete with Amazon (NASDAQ: AMZN), because even if Amazon does roll out same day delivery, Amazon might not offer mortgages and car insurance. Amazon's Cloud services are well known, but Costco also announced a new Cloud service last year. Ken Terry, at InformationWeek, reported that Costco launched an electronic health record service through the Cloud, although Sam's Club launched a similar service in 2009 that it canceled in 2011.
Costco's 1.66 percent profit margin is less than half of Wal-Mart's 3.52 figure, which could mean that Costco left some profits on the table, although Amazon's 1.09 percent profit margin is even lower. Wages and benefits might not be the reason for Costco's lower profit margin, though. Amazon has maintained low profit margins and invested heavily in infrastructure so it could continue expanding into new markets, and Costco seems to be following a similar strategy with its loan programs and plans to build new stores. According to Melissa Allison at the Seattle Times, Costco plans to add 13 more stores in Q1 2013, which will be a much faster expansion rate than the discounter maintained in 2012.
As the New York Times article mentions, Costco sells a wide range of products at a discount, including fairly high end furniture and clothing. The food stamp decision and Costco's wage decisions suggest that Costco wants to appeal to higher end shoppers who could have more money to spend during a recession, while other retailers' target customers could be struggling. Costco does trade at a forward P/E of 21.31, but access to wealthier business owners could make the premium worth paying.
enovinson has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and Costco Wholesale. Motley Fool newsletter services recommend Amazon.com and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.