Costco: Breaking All the Retail Rules

Imagine a store that never advertises, has no signs in its aisles, doesn’t bag what you purchase, and charges you a fee just to walk in the door. With so many choices in the retail universe, who in the world would shop there?

Shoppers at Costco in Nanuet, N.Y.
David Grogen, CNBC
Shoppers at Costco in Nanuet, N.Y.

As it turns about, about 3 million loyal customers every day. The store is Costco Wholesale, and it’s the largest warehouse chain in the world, with more than 600 locations and $93 billion in annual revenue.

Its success has come even though — or perhaps because — it defies so many of the standard rules of retail. It is a distinctly “no-frills” operation. Its floors are bare concrete slabs, which are more durable and easier to maintain than linoleum or carpet; its ceilings steel beams and huge skylights, to save electricity. Merchandise is stacked on the same industrial pallets on which it is shipped, saving millions in labor costs.

“We try to create an image of a warehouse type of an environment,” said Jim Sinegal, Costco’s co-founder and recently retired CEO. “I once joked it costs a lot of money to make these places look cheap. But we spend a lot of time and energy in trying to create that image. This is a value place. But you need to deliver.”

Costco works to keep prices low by buying in huge quantity and never marking up any product more than 15 percent, less than the typical 25 percent at a supermarket or 50 percent at a department store. Costco makes up for those low margins by charging a $55 annual membership fee of its 64 million members. With more than 90 percent of its members renewing each year, the fee is evidently not a significant deterrent.

Despite the store’s cavernous interior, Costco’s members are offered a surprisingly limited array of products. A typical Costco only stocks about 4,000 different items, a small fraction of the 50,000 at a typical supermarket or the 100,000 at the average Wal-Mart . Of the products Costco stocks, almost everything can only be bought in bulk. Advil only comes in a 360-count bottle, much larger than the more common 50 or 100 count sizes found in markets or drug stores. Yet despite that quasi-industrial size, Costco says only one in 10 customers will refuse to buy it.

The Costco Craze - See Show Details
The Costco Craze - See Show Details

“That’s what we refer to as the intelligent loss of sales,” Sinegal explained. “If we had all of those sizes, I could do the math and show you where you would do less business as a result of having all of those sizes available.”

Not only does Costco carry items in one size, but its low product count means it only carries very select brands.

“One ketchup, one bottle, one package, one choice,” explained marketing consultant Pam Danziger. “You don’t have to make those decisions. You don’t choose from a variety of other ones.”

Limited selection, according to Danziger, makes it easier for the consumer to choose. “There was a research study in marketing that if you offer people 24 different types of jellies, you’re not going to sell as many as if you offer them six,” she said. “Making people decide, that causes confusion, and they ultimately decide to walk away. At Costco, you don’t have to make those decisions.”

Danziger says that Costco has, in effect, done the shopping for you.

With such low prices and thin margins, it might be logical to expect Costco’s pay and benefits to be equally bare bones, but that’s one more way the company has defied common wisdom. Costco actually has among the highest pay scales in the industry — its employees earn an average of $20 an hour, and more than 90 percent get benefits, including health insurance. In reward, Costco has some of the lowest turnover rates in retail.

It also has no public relations team — a genuine rarity among Fortune 100 companies. Media inquiries are handled personally by its chief financial officer, Rich Galanti. Senior executives do not travel with a support staff, and it is not unusual for the CEO to answer his own phone. According to Sinegal, it’s all part of culture of Costco.

“We try to create an open door policy around here,” Sinegal said, “open-wall, if you will.”

Open wall is no exaggeration — the offices of Sinegal, CEO Craig Jelinek and other executives are completely open to the hallway.

Despite its peculiar business model, Costco is a runaway success — it is now the second-largest U.S. retailers, behind only Wal-Mart, and its stock has soared more than 5,000 percent since going public in the mid-1980s. For Sinegal, the standard rules may not apply, but a simple idea seems to prevail.

"All we're trying to do is sell stuff cheaper than anybody else,” he said, “but there’s a lot more work that goes into it.”