7 reasons Costco's Business Model is Perfect
5 min read
The motto that you need to live by is success leaves clues!
So in this article I'm diving into the super successful empire that is Costco.
For context, Disney does around $80b in revenue, Costco does $250b... so many people are shocked to hear the size of this business, but when you find out the tactics behind their business model, it starts to make more sense.
If I could own any business in the world, it would Costco.
Lets find out why.
1. Cash Conversion Cycle
An example: You sell mugs and have 30 days before you have to pay your supplier, but what if it takes you 45 days to sell? That gives you a cashflow pinch. So you might have to use the suppliers as a funding line and pay in 60 or 90 days (supermarkets do this). Alternatively you could get a credit line from the bank if you can prove your profitable.
For context - Most business sell their stock 3 - 4 times year (Walmart sell their stock up to 8 times a year! which is excellent). When we look at 12 sets of 30 day payment terms this means the typical business has a cash conversion cycle of 3.5 x per year.
Costco’s cash conversion cycle is 12.4 x a year.
Let me repeat that - 12.4 x a year!
They will have the standard 30 day credit terms like your Walmart or ASDA but they are selling it before the 30 days, so no funding needed, they have the cash building up in the bank ready for when that 30 day payment cycle is due. AMAZING.
Costco have scaled with stores worldwide. So by selling their stock in 26 days before the 30 day payment is due creates a 4 day float on $260b in worldwide sales = a HUGE cashflow advantage.
Starbucks do something similar with their app. Members put money onto the app and buy their coffees getting membership rewards. In the USA they have $1b of pre loaded cash from the app sitting in the bank which they can use to invest before anyone has actually gone into the store and bought a blinking coffee!
2. Low level SKU’s (stock keeping unit)
The warehouses of Costco are huge! A lot bigger than Walmart or Tescos. But here’s the smart thing - they have reduced their stock keeping unit to around 3,500 sku’s. Places like Tesco have are stocking 100,000+ products!
With a lot of people coming through the door, buying in bulk and staking high and selling at low prices creates a benefit as you’re getting through the stock a lot quicker. Things which regular supermarkets just can’t do.
Having a low number of sku’s and buying efficiently can make you a lot of money.
3. Sticky customers
The holy grail of business!
The Costco membership is the only way you can shop at Costco meaning you are predetermined to buy from them. Big win!
If I need a new tv or electrical appliance Coscto is first place I think of. Fabulous customer service, great returns and I will get the best deal.
They have created this happy marriage of trust with the customer and themselves.
You have to pay up front for the membership. People are prepared to pay every year for the service because they get value for money on the subs they’re charged.
I think (I do not know for certain) that the average order value will also be higher at Costco than your typical supermarket. Every time I go to Costco I spend anywhere between £270-£500 compared to Sainsbury’s where I spend £35-£200. When I visit Costco I want to get value for my membership, making me spend more!
4. Residual income business
But it’s not… let me explain.
Netflix has a residual income due monthly whereas Costco is annually, but this forces you to go regularly or for any big occasion like a birthday or Christmas.
70% profit is membership subs. A $260b business only making 30% profit on that warehouse. That is tight margins and if anything goes wrong they could be in loss making territory. (this has never happened and I doubt it will)
Memberships you pay up front creating another great cashflow advantage!
Year in advance sub creates loyal customers but even better… predictable profits.
Margins are sometimes hard to keep stable as the economy changes. I experience this with one of my businesses ‘Teddy Tastic’ with when manufacturing the teddy bears. Things like currency, shipping, wages, energy prices can all cause issues on my margins.
At ‘Lee Valley’ and ‘Marsh Farm’ I have membership income creating margin in the business with up front cash!
5. Cultural statement
“Obey the law, take care of members, take care of employees and respect our vendors”
Imagine what that does when a potential employee, supplier or customer hears that statement!
You know they will go over line and move mountains for you creating a lovely win win deal.
This will also infect your staff positively - creating a great culture.
6. Proprietary products
Costco sell well loved brands cheaper than the competition! But here’s how they don’t annoy the suppliers.
They’ve created their own version of well loved brands:
2 pack Duracell 9V in Argos is £6.50 = £3.25 each
8 pack Duracell 9V in Costco is £17.98 = £2.24 each
Costco once again is better value for money.
Argos can’t get the hump at Duracell for selling it cheaper to Costco because it's a different product it’s a pack of 8 and Costco customers get it.
Wealthy customers prepared to buy more for less overall because they have the personal income to do so. This is the same with toilet rolls, shampoo, food.
7. Recession Proof
I am amazed how well they do through economic downturns, maybe because people want value for money.
They own this over Google and Disney.
Google have to keep investing in R&D for new tech or software.
Disney have to create new films and brand.
Apple have create new tech and electronics.
Costco just keep getting the memberships, no need to reinvent product because the suppliers are doing that.
Costco can just stay as they are.
This just sums up what an amazing business it is:
“Operating philosophy has been simple. Keep costs down and pass savings on to our customers. Our large customer base and tremendous buying power, combined with our never ending quest for efficiency, results in the best possible prices for our members.”
You need to work harder on yourself. The better you are, the better the business will be read the books, go to the seminars, listen to the podcasts - always stay teachable and open to adapt leading back to the first point and why we have made this content is to learn from those who are or have been successful.
Watch the full video in detail here: