Good Things Do Come Cheap

tarun is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I was going through headlines and I came across an article “10 Amazing Investment Quotes You’ve Probably Never Heard” in which a quote  by Nassim Taleb “People focus on role models; it is more effective to find anti-models --people you don't want to resemble when you grow up" caught my attention. I found the name of two companies mentioned as great companies along with that quote, firstly Apple and secondly Costco (NASDAQ: COST). Undoubtedly both are very good companies, but with recently released earnings of Costco in the picture lets delve a little deeper in it and other retailers.

Costco’s Different Business Style

Retail business has a simple working model buying goods and selling them at a higher price. This model seems to be simple but competition among retailers like Wal-Mart (NYSE: WMT), Target and others in the industry makes things difficult. Costco is a little different from other retailers as it sells its products at a loss or at very low margins (around 0.45% on an average) and generates bulk of its revenue from membership fees.

The membership fee is collected upfront generating sustainable cash-flows every year and also helps in predicting future profitability and value addition. Another benefit for Costco is that it deals in two prime necessities, food and fuel at almost the lowest prices in the market that drives consumers to its stores.

Giants like Costco and Wal-Mart have good bargaining power, leaving their sellers with almost no say in price fixation. Costco stores have fewer Stock Keeping Units (SKU's) then competitor Wal-Mart. Wal-Mart has more than 50000 SKU’s while Costco has about 3,600 SKU's. Costco derives about $60 billion sales from its 3600 SKU’s while Wal-Mart generates average $265 billion from its SKU’s. Costco averages to about $16 million in sales per SKU versus about $5 million per SKU at Wal-Mart. The concentrated product offering provides Costco with almost at par purchasing power with its rival Wal-Mart if not better thus helping it with a sustainable competitive price leadership.

Online Shopping Leadership Still Distant

Costco provides amazing stores service to its customers but it needs to improve on its online segment. Where Costco responds to phone calls in 12 minutes 34 seconds its rival Amazon (NASDAQ: AMZN) does it within a minute’s time. Amazon answers a large percent of its email in less than 45 seconds time. Amazon is not only recognized as one of the best online retailer but also has a tremendous cost advantage over the other store operated retailers. The company has low costs as it runs its business with the help of warehouses saving a lot of capital and revenue expenditure of operating stores that Wal-Mart and Costco have to bear.

Final Words

Costco is a company that aims to provide a quality shopping experience to its customers where other retailers just look for quantitative selling. Costco’s pricing strategy and sustainable revenue generation from membership fees assures great revenues and steady cash flows. The fall in share prices due the announcement of special dividend before the yearend is a good opportunity for investors to invest in Costco. I feel this negative impact on the share price is temporary and Costco, being a terrific company should be able to pay its low interest rate debts with ease.

tarunbachhawat has no positions in the stocks mentioned above. The Motley Fool owns shares of and Costco Wholesale. Motley Fool newsletter services recommend 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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