“Costco’s Dilemma: Be Kind To Its Workers, or Wall Street?”
That was the headline of an article published in WSJ.
The heading was deliberately eye-catching.
In March 2004, Walmart was under fire for paying its workers too little. It was a cause that gained good traction in wider circles.
The workers’ unions and politicians backing them often mentioned Costco.
Their question was, why was Walmart paying its workers so little when Costco was able to pay so much better?
Costco operates in the same space as Walmart and is subject to the same factors.
Walmart is a publicly listed company. On Wall Street, Walmart was a revered giant. Their numbers were closely scrutinized.
So was Costco.
And yet workers, unions, and politicians somewhat admired Costco.
The flipside of this was that some investors did not speak favorably about Costco.
The article published in the WSJ was referring to that.
Some Wall Street analysts and big shots felt Costco was ‘leaving money on the table’.
A company’s purpose is to earn money for its shareholders. They accused Costco of not doing that. It was paying higher salaries and offering more employee benefits than necessary.
The accusation was that Costco was reducing its profits that way.
Many of the vocal Wall Street analysts had already been bitter about Costco’s higher spending on employees’ health benefits.
But while some analysts accused Costco of being irresponsible with money, there was no denying that Costco was a very healthy business — comfortably profitable.
Long-term investors of Costco were not bothered by this article. They were not even bothered by the higher salaries and employee benefits.
They had seen Costco pull off similar moves earlier and later as well.
Business Model
Costco’s business model was born many years before it.
In the mid 1950s, product makers could dictate a minimum selling price for their items. A seller could not legally offer lower prices even if it wanted to.
Sol Price, a lawyer-turned-retailer, found a way around this problem.
The rules prevented retailers from selling items to the public below the floor price. The rules didn’t say anything about selling inside clubs.
At his retail chain, FedMart, he introduced a membership fee. Only some eligible members could buy.
With this, he was able to circumvent the rules and sell items below the floor price.
The subscription fee was just a key to enable them to sell items at a cheaper price.
It was in Sol Price’s next company, Price Club, that they raised the membership fee and realized that the membership fee itself could be a source of income.
And because they were making substantial profits from membership fees, they were able to compromise on their earnings from sales even more — making items even cheaper for customers.
Sinegal was an employee at FedMart. He had joined at the age of 18 years only.
He worked with FedMart, and then at Price Club.
In 1983, he started Costco. The philosophy was the same.
So, Costco makes a huge chunk of its money from the annual membership fee.
Over 50% of its operating income comes from membership fees alone.
This is the main source of income.
Everything else is just to help keep customers renewing the membership every year. Over 90% of existing members renew their memberships. New members also join every year.
Currently, the annual membership fee starts at $65.
DNA
The DNA of Costco was the same as FedMart’s — membership gives you access to rock bottom prices.
One of the most famous/infamous signatures (depends on who you ask) is that they have put a cap on their per-product profit.
Not a floor price — not the minimum price they would sell for.
Costco capped their upper price — the max markup they could make selling an item.
It sits roughly at 14%. For their signature brand Kirkland, this is 15%.
Many other retailers keep this margin roughly in the range of 20-25%.
If an item gets cheaper because of lower raw material costs, Costco lowers its prices accordingly. Most others would simply continue with the existing price.
Another major decision Costco took was to sell fewer items. Instead of offering 10 different shampoo brands, they’d offer only 2 or 3.
Compared to other retail chains, they have 10-30 times less variety across different categories.
This lowered the number of items they had to deal with. Lower costs of handling.
Costco famously has fewer suppliers per category. Thus, they’re able to negotiate lower rates.
Costco famously does not sell small packages. They mostly sell bulk items. This reduces their handling costs per unit.
No/low advertising. Word of mouth only.
Unlike other retail chains, Costco is famous for paying higher wages to its workers.
Internal promotions are common too. Current Costco CEO, Ron Vachris, started his career as a forklift driver.
Costco sells everything from petrol to ready-to-eat cooked items to premium apparel — all with the same philosophy. Max 14-15% markup.
Short Term vs Long Term
Co-founder and CEO Sinegal (till 2011) is famous for his sharp words to investors.
One of his most famous quips against short-term-orientated professional investors was:
“On Wall Street, they’re in the business of making money between now and next Thursday. I don’t say that with any bitterness, but we can’t take that view. We want to build a company that will still be there 50 and 60 years from now.”
This one line set him apart from many other CEOs who were hell-bent on keeping numbers consistent, quarter after quarter. That often meant big sacrifices being made in the long run.
He was careful too.
Sinegal never said he didn’t care about shareholders. He just maintained that ensuring investors got good returns started with keeping customers and employees happy.
Sinegal’s manic quest for keeping customers happy and coming back again and again has done well for Costco.
Over the last 10 years, the Costco stock gave a return of ~22% per annum. This number was 19% per annum for 20 years.
By the way, these returns are in USD. If you convert these returns and measure in INR, they’ll be even higher.
Stocks on the stock markets often suffer from this problem.
Stock prices change every single day, in seconds.
Any small negative or positive news can influence the stocks almost immediately.
Many of the investors buying and selling these stocks do not wish to stick around. They are short-term traders who’d rather make a quick buck and move on to another stock.
To them, any stock that performs poorly even for short durations is unattractive.
Often this group also tends to be very loud and vocal.
Focusing only on the opinions of these traders can lead to good decisions in the short-term that actually end up harming the company in the long run.
Not always. But it definitely happens.
The job of the management of a company is to ensure the company performs well.
It is therefore necessary for them to listen to what investors are saying. It is equally important for them to know when to ignore what investors are saying.
There are companies that listened to traders too much and followed them too closely. So much so that they harmed themselves in the longer run.
Moat
Why don’t others just copy Costco?
It’s clear that the model works. So, might as well copy it.
Well — it is not easy.
This model doesn’t work if you’re small. It only works when you have a gargantuan scale. Most start-ups cannot start off with a giant network of stores. They must start small.
So right there, Costco has removed thousands of tiny competitors from being able to compete.
Now we’re left with the bigwigs.
They surely have the money and scale to compete.
For starters, no large company’s CEO is willing to cut their profits in half or more just to match Costco. That is exactly the kind of short-term (even medium-term) hit most other companies do not dare take.
Then there’s trust.
Costco has built a name for itself playing this exact game for decades. Even the largest of companies cannot replicate this over a short period of time.
Various competitors have copied parts of the Costco model.
But the Costco model isn’t just the various parts. It’s the entire system together.
That is Costco’s 100-feet-tall moat.
Quick Takes
+India’s unemployment rate fell to a four month low of 5.10% in July compared to 5.50% in June.
+RBI advanced the deadline for swap facility for FCNR(B) deposits to 31 August instead of the earlier announced 30 September, after inflows of over $56 billion.
+Regional Rural Banks’ gross loans rose 10.30% to Rs 578,349 crore in FY26 compared to Rs 524,163 crore in the previous year.
+DoT, Government of Chhattisgarh, CSBIL, BSNL and CHiPS signed an agreement worth Rs 3,942 crore for implementation of BharatNet program in the state to strengthen digital infrastructure and expand broadband connectivity.
+The government imposed a minimum import price of Rs 34,000 per tonne on clear float glass with 4mm to 12 mm thickness for a year to protect domestic manufacturers from cheaper imports. Imports below this threshold will face restrictions.
+The government approved upgradation of Muzaffarpur-Sitamarhi-Sonbarsa section of NH-22 in Bihar worth Rs 3,590.73 crore.
+India’s crude oil imports rose 41.24% year-on-year in July to $13.70 billion compared to $9.70 billion a year ago. The volumes rose 13.22% to 21.40 million metric tonnes in the same period.
+UK’s retail inflation rose to 2.90% in July compared to 2.60% in June.
+India’s infrastructure output rose 5.40% in July compared to 6.00% in June.
+SEBI has barred Copthall Mauritius Investment (owned by JPMorgan Chase & Co) and Mansi Share and Stock Broking from the securities market for manipulative trades under the Closing Auction System (CAS) and impounded a combined Rs 3.68 crore.
+SEBI permitted the use of digitally signed power of attorney documents for FPIs, removing the need for notarization and enhancing ease of doing business, effective today.
+India’s forex reserves rose $9.91 billion to $716.90 billion for the week ended on 14 August.
+The government announced measures such as permitting duty free import of 10 LMT of raw sugar, among other measures, to reduce sugar prices and boost supply during the festive season.
+The number of active individual traders fell 20% to 78.60 lakh in FY26 compared to a year ago. Net losses suffered by individuals fell. 87.70% traders still made losses in FY26: SEBI.
+29 FDI proposed investments worth Rs 4,895.65 crore were made under the revised framework as of 20 August. Entities based in Mauritius, the US, Japan, among others, invested across sectors like IT, AI, information and communication, manufacturing etc.
+India’s PMS industry’s AUM rose 2.0% month-on-month to Rs 44.11 lakh crore in July as per APMI. The client base increased 1.30% to 2.23 lakh accounts during the month.
+The government signed an MoU with Brazil to strengthen bilateral cooperation in Telecommunications and Information and Communication Technologies (ICTs) including Artificial Intelligence (AI), 5G and 6G, Open RAN etc.
+The government with Asian Development Bank signed a $230 million loan to modernise and expand Chennai’s water supply and sanitation infrastructure.
The information contained in this Groww Digest is purely for knowledge. This Groww Digest does not contain any recommendations or advice.
Team Groww Digest