Chapter 1: Understanding the Business Landscape

Launching a business presents significant challenges. The multitude of tasks can be so overwhelming that if you were to outline them all in advance, it’s unlikely anyone would willingly embark on such an endeavor.

Defining a business model is one critical task on that list. This involves articulating the value your company provides to customers, the methods you'll employ to deliver that value, and how you will generate profits in the process.

One exemplary model that stands out is Costco. The straightforward nature of its business strategy is commendable. Competitors struggle to match Costco's pricing and, more importantly, the overall value it offers.

What, then, is the secret behind such a simple model?

Costco doesn't primarily profit from product sales—especially not from its famous $1.50 hot dogs!

With an impressive revenue of $227 billion, Costco ranks among the largest retailers, trailing only Walmart and Amazon. In comparison, Walmart offers around 120,000 different products, while Amazon boasts a staggering 12 million. Costco, however, operates with just about 4,000 products. Walmart's revenue stands at $611 billion and Amazon's online retail at $220 billion, leading to approximately $57 million per SKU (Stock Keeping Unit) for Costco, while Walmart averages $6 million/SKU and Amazon $18,000/SKU.

Consider the overhead costs tied to managing procurement for 4,000 items versus 120,000 or 12 million. Despite this, the volume of goods sold grants Costco substantial pricing leverage over its suppliers.

Costco's markup on products ranges from 10% to 14%, while Walmart's is around 33%. This pricing strategy is why Costco's products tend to be more affordable, excluding promotional sales from competitors. Additionally, Costco offers high-quality items that command better prices.

This markup supports operational expenses, including salaries, warehousing, and logistics. With 300,000 employees, Costco achieves $757,000 in revenue per employee, compared to Walmart's $290,000.

So, where does the profit originate?

The answer is straightforward: membership.

To access the best prices on high-quality products, customers must travel to a warehouse and purchase a membership. This membership serves as a pure profit source for Costco. It merely requires filling out a form, taking a photo, and receiving a membership card. With around 110 million members renewing annually, this generates approximately $4 billion each year.

Each new member contributes an estimated $2,000 in annual revenue and $60 in profit. As Costco gains more members, it secures better deals from suppliers, allowing for lower prices for customers. Satisfied shoppers often share their savings with friends, creating a continuous cycle of membership growth.

Moreover, Costco's inventory turnover is close to 12, indicating that the entire warehouse inventory is sold roughly every month. Supplier payment terms typically extend to 30 days, meaning Costco finances much of its inventory through supplier agreements rather than its own capital, as noted in their financial statements.

While Costco may lack the instant gratification of Amazon's Prime membership, 110 million customers seem willing to prioritize lower prices over convenience. This convenience is increasingly costing Amazon, which is now offering $10 cashback on orders over $25 for in-store pickups, hinting at a potential shift in its branding and value proposition.

The elegance and simplicity of Costco’s business model present a formidable challenge for competitors.

When contemplating the launch or investment in a company, it's crucial to thoroughly understand the underlying business model, the value it offers, and its competitive positioning within the market. When executed effectively, your venture could become a benchmark that others aspire to emulate.

Chapter 2: Lessons from Costco’s Success

This video discusses seven strategies that have helped Costco avoid failure, illustrating the key elements of its successful business model.

This video explores the unique aspects of Costco's business model and why it has proven to be so successful in the competitive retail landscape.