Summary Notes


In this episode of Acquired, hosts Ben Gilbert and David Rosenthal delve into the remarkable story of Costco, a company that has consistently provided extreme value to customers through high-quality products at the lowest possible prices. Costco's success is rooted in its unique business model, which combines wholesale operations with a membership club, allowing the company to operate with low overhead and pass significant savings onto its members. With a strict cap on markup and a culture of internal promotion, Costco has become the third-largest retailer in the U.S., boasting a loyal customer base and impressive financials, including $230 billion in revenue and a membership count of 124 million worldwide. Costco's ability to scale and its strategic approach to e-commerce, including ventures like Costco Next, demonstrate the company's adaptability and commitment to member value. Despite challenges such as the limitations of physical expansion and late adoption of e-commerce, Costco's unwavering focus on customer satisfaction and efficient operations has solidified its position as a retail powerhouse with a strong future ahead.

Summary Notes

Love for a Business Model

  • Ben Gilbert expresses a profound admiration for a company's business model.
  • David Rosenthal humorously compares Ben's admiration to that of Charlie Munger's well-known love for Costco.
  • The conversation suggests that deeper research into a company often reveals problems, but in this case, the more they learn about the company, the more impressive it seems.

"I don't think I have ever been more in love with a company and a business model."

"What are you, Charlie Munger?"

The first quote shows Ben's enthusiasm for the business model, while the second quote by David playfully teases Ben by likening his admiration to that of Charlie Munger, a known Costco enthusiast. This sets the tone for a discussion about a company that seemingly defies the typical venture capitalist experience by being more impressive upon closer inspection.

Introduction to Acquired Podcast Season 13, Episode 2

  • Hosts Ben Gilbert and David Rosenthal introduce themselves and the podcast.
  • The episode will explore Costco and its unique business model, emphasizing extreme value, high-quality products, and the lowest possible prices.

"Welcome to season 13, episode two of acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert."

"I'm David Rosenthal, and we are your hosts."

The quotes serve as the opening lines of the podcast episode, introducing the hosts and the theme of the podcast, which involves discussing successful technology companies and uncovering the strategies behind their success.

Costco's All-in-One Offering

  • The podcast describes Costco's wide range of products and services, from bulk food items to prescription eyeglasses and gasoline.
  • The hosts emphasize the remarkably consistent low price of Costco's hot dog and soda combo over many years.
  • Costco's wide-ranging, value-driven offerings are highlighted as a key part of its appeal.

"What if I told you that there was one place where you could get all these things under one roof? A two and a half pound container of cashews, prescription eyeglasses, a tank of gas, new tires for your car, 96 rolls of toilet paper, a new refrigerator, an outdoor shed, a ten carat diamond ring, some fresh prepared sushi, fine wine at a great price, and you could even grab a hot dog with a soda and a free refill on your way out for just a buck 50."

This quote lists the diverse range of products and services available at Costco, emphasizing the convenience and value proposition that the company offers to its customers. The mention of the hot dog and soda combo's price stability over time underscores Costco's commitment to providing value.

Costco's Business Model and Innovations

  • Costco's simple bulk-selling approach is supported by numerous refined innovations that work together harmoniously.
  • The company's success is attributed to deliberate choices and trade-offs made in pursuit of providing great value to customers.
  • The discussion highlights Costco's meticulous planning and execution in all aspects of its operations.

"But what really makes it work are the 50 clever innovations that they've refined over the years that all work together like an orchestra that's been rehearsing for decades. Nothing about Costco is an accident, from the extra wide parking spaces to the whole rotisserie chickens."

The quote illustrates the strategic thought and innovation that go into every detail of Costco's operations, likening the company's cohesive business practices to a well-rehearsed orchestra. This attention to detail is seen as a key factor in Costco's ability to deliver exceptional value.

Costco's Financial Performance and Kirkland Signature Brand

  • Costco's consistent revenue growth and high revenue per square foot are highlighted.
  • The company's store brand, Kirkland Signature, is noted for its significant revenue, rivaling that of major brands like Nike.
  • The hosts discuss Costco's potential for international expansion and the strength of its business model.

"Costco has grown revenue right about 10% for over 30 years in a row. Their revenue per square foot of their warehouses belongs more in a conversation with Tiffany than Walmart."

"Their store brand, Kirkland signature, does more revenue alone, not including anything else in the store, than all of Nike."

The quotes emphasize Costco's impressive financial performance, with consistent revenue growth and high revenue per square foot indicating efficient use of space and strong sales. The comparison to Tiffany suggests a level of revenue efficiency typically associated with luxury retailers. The second quote highlights the success of Costco's Kirkland Signature brand, which alone generates more revenue than the entirety of Nike, showcasing the brand's immense value and consumer appeal.

Costco's Founding and Influence of Saul Price

  • Costco's origins trace back to retail veterans Jim Senegal and Jeffrey Brotman in Seattle, 1983.
  • The influence of Saul Price through his previous ventures, Fed Mart and Price Club, is acknowledged.
  • The podcast hosts discuss the deep history of Costco and its connection to Saul Price's retail innovations.

"So Costco was founded, as many people know, in Seattle, lovely city of Seattle, in 1983 by retail veterans Jim Senegal and Jeffrey Brotman."

"And although Costco, quote Unquote, was founded in 1983, the organization that we know and Love today is actually the result of a merger between Costco and its predecessor company, Price Club."

These quotes provide a brief history of Costco's founding and its evolution through the merger with Price Club. The mention of Saul Price and his earlier companies, Fed Mart and Price Club, establishes the historical context for Costco's business model and the legacy of innovation in retail that preceded and influenced it.

Saul Price's Background and Influence on American Retail

  • Saul Price's early life, immigrant background, and education are explored.
  • Price's foray into retail began with advising entrepreneurs and led to the creation of Fed Mart.
  • The podcast recognizes Saul Price as a seminal figure in American retail, with direct influence on other retail giants like Sam Walton of Walmart.

"Saul, maybe the most influential american retail capitalist in history, comes out of the triangle shirtwaist factory movement and communism and socialism and everything that's happening in New York and the jewish community at this time."

"Jim Senegal, of course, co founder, CEO of Costco. Jim tells the story that a reporter once asked him if he learned a lot from Saul, and Jim replied, no, that's inaccurate. I didn't learn a lot. I learned everything. Absolutely everything I know, I learned from Saul."

The first quote contextualizes Saul Price's upbringing and its impact on his approach to retail and capitalism. The second quote, from Jim Senegal, underscores the profound influence that Saul Price had on the individuals who would go on to establish Costco, highlighting Price's role as a mentor and a pioneer in the industry.

Initial Business Model of Price Club

  • Price Club began with a focus on selling high-volume items to businesses.
  • They decided to stock only about 3,000 SKUs, contrasting with competitors like Walmart and Kmart who had around 50,000 SKUs.
  • This strategic choice was a non-consensus move aimed at keeping operations tight and maximizing benefits.

"So they decide as they're getting started that in order to keep the operations really tight and realize the maximum benefit, they're only going to stock about 3000 of the highest volume items that they think most other retailers are going to sell to their customers."

The quote explains the strategic choice made by Price Club to limit their SKU count to 3,000 high-volume items. This decision was designed to streamline operations and capitalize on the efficiency of their business model.

Membership Strategy and Consumer Inclusion

  • Price Club initially struggled to attract business customers.
  • The San Diego City Credit Union partnership created a "group membership plan" allowing credit union members to shop at Price Club, albeit at slightly higher prices than business members.
  • This partnership was pivotal in attracting consumers and driving word-of-mouth marketing, which became a cornerstone of Costco's strategy.

"So Giles, the wonderkin Young CFO, he goes over to the credit union hammers out a deal whereby any credit union member can qualify for a new quote unquote group membership plan at price club and be allowed to shop there just at slightly higher prices than the business members."

The quote describes the deal struck between Price Club and the San Diego City Credit Union, which allowed credit union members to shop at Price Club. This deal was a turning point that opened the floodgates for consumer traffic and played a crucial role in the company's growth.

Introduction of the Costco Food Court

  • The concept of the Costco food court originated from the high traffic at the first Price Club store, attracting hot dog vendors.
  • Saul Price decided to manage the food court in-house, leading to the iconic $1.50 hot dog and soda deal.
  • The food court, particularly the hot dog, is considered a loss leader for Costco.

"So Saul calls up Hebrew National hot dogs and asks them if they can supply them with hot dogs to sell at the stores. And Hebrew says, not only will we sell you hot dogs to sell, we'll supply the cart, too."

This quote explains the origin of the Costco food court, starting with the decision to sell hot dogs in-store. The partnership with Hebrew National was a strategic move that led to the creation of a long-standing and popular feature of Costco stores.

The Appeal of Warehouse Shopping to Consumers

  • The success of Price Club indicated that consumers were willing to shop directly from a warehouse.
  • This discovery challenged the traditional retail experience and demonstrated a consumer preference for low prices over a traditional shopping experience.

"There is this interesting question that has now been answered, which is there's this kind of horrible way of shopping where I need to go buy in bulk directly from the warehouse. No good retail experience. Are consumers actually going to do that?"

The quote reflects the initial skepticism about whether consumers would be willing to shop in a warehouse setting. The success of Price Club answered this question affirmatively, showing that consumers prioritize low prices and are willing to forgo the traditional retail experience.

Cash Flow Dynamics and Inventory Turnover

  • Price Club and Costco's business models allowed for rapid inventory turnover and a negative cash conversion cycle.
  • They managed to sell goods before having to pay the supplier, effectively financing their inventory through their vendors.
  • Costco turns their inventory over 12.4 times per year, compared to Walmart's eight times, which means Costco's inventory is sold faster and more often than every 30 days.

"So Costco actually turns their inventory 12.4 times per year. And just for comparison, Walmart turns their inventory eight times per year."

The quote highlights Costco's efficient inventory turnover rate, which is significantly higher than Walmart's. This rapid turnover is a key component of Costco's successful business model, allowing them to operate with minimal capital tied up in inventory.

Supplier Relationships and SKU Count

  • Costco maintains a low SKU count, which contributes to faster inventory turnover and a more efficient business model.
  • They have a strict cap on gross margins and work closely with suppliers to ensure low prices for members.
  • Costco's supplier relationships are based on respect and fairness, contrasting with other retailers who may pressure suppliers for lower costs.

"Costco has kept their SKU count very low... and if you do the math and you start thinking, well, jeez, if you're not selling a lot of SKUs, but you have a lot of customers coming through your stores, what does that mean? It means that any given item is going to turn faster."

This quote explains the relationship between Costco's low SKU count and their inventory turnover. By maintaining a limited selection of items, each product sells faster, contributing to the company's efficiency and customer value proposition.

Costco's Ethical Business Practices

  • Costco's code of ethics prioritizes obeying the law, taking care of members and employees, and respecting suppliers.
  • This code has contributed to Costco's reputation as a fair and principled company.
  • Costco's commitment to these values has played a significant role in building customer trust and loyalty.

"The Costco code of ethics as it exists today, largely inspired by the Fed mart values from 40, 50 years before are in order. Obey the law, take care of our members, take care of our employees, respect our suppliers."

The quote outlines Costco's code of ethics, which serves as the foundation for the company's operations and decision-making. This ethical approach has been key to Costco's success and has helped to foster long-term relationships with members, employees, and suppliers.

Kirkland Signature Brand

  • Kirkland Signature is Costco's house brand, known for its quality and value.
  • The brand has evolved to represent a certain level of quality that is sufficient for Costco members.
  • Costco aims to create value with Kirkland Signature by offering lower prices or better products than branded items.
  • Kirkland Signature products are not necessarily cutting-edge but maintain a standard of quality that customers trust.

"Nobody is attesting that this Kirkland signature sweatshirt is a Lululemon sweatshirt that has fancy materials and the most cutting edge technology in it, but it is of a certain bar of quality that is sufficient for Costco members."

The quote emphasizes that while Kirkland Signature items may not be the most advanced or luxurious, they meet a quality threshold that satisfies Costco's customers and aligns with the company's value proposition.

Wine and Liquor Sales

  • Kirkland Signature wine and liquor are examples of the brand's success, appealing even to aficionados.
  • The brand's wine, tequila, and vodka have gained acceptance among consumers who recognize the quality despite the Costco label.

"You'll get people who are wine snobs that'll drink Kirkland signature wine. They're like, yeah, it's Costco, but this is actually good stuff."

This quote highlights the acceptance and positive reception of Kirkland Signature's wine and liquor among discerning customers, suggesting that the brand has transcended its generic label to become recognized for quality.

House Brand Strategy

  • Costco's house brand strategy involves a limited selection of SKUs, reducing shelf competition.
  • This approach contrasts with other retailers that offer multiple brands within the same product category.
  • Costco's focus is on providing better products for less, leveraging their buying team's expertise to pre-select the best items for customers.
  • The strategy has proven successful, with Kirkland Signature sales constituting a significant portion of Costco's revenue.

"In a standard retail environment, the house brand is going to be one of, like, five or six or ten different brands of a given product category on the shelves at Costco, it's one of two, three, or one of one."

The quote explains Costco's unique retail strategy, where the house brand faces less competition on the shelves, allowing for a more straightforward choice for consumers and better control over product quality and pricing for Costco.

International Expansion

  • Costco has expanded internationally, successfully entering markets like the UK, Korea, Taiwan, Japan, and China.
  • The company's international success is notable given cultural differences, particularly in countries with smaller living spaces and different consumer habits.
  • The core proposition of high-quality products at great value has universal appeal, contributing to Costco's international success.

"It's not exactly obvious that a huge warehouse with bulk packaging would work in cultures like, say, Japan, where people live in tightly packed, dense urban environments, much smaller houses and apartments than in America."

The quote highlights the challenge and subsequent triumph of Costco's international expansion, suggesting that despite initial doubts, the company's value proposition resonates globally.

Limited Selection Philosophy

  • Costco operates with a limited SKU count, a strategy that differs from other retailers that offer extensive selection.
  • The company bets on quality over quantity, ensuring that available items are high-quality and well-priced.
  • This philosophy has led to consumer trust and acceptance of the limited selection, as the pre-selection work is done by Costco's buying team.
  • The "intelligent loss of sales" principle, developed by Saul during the Fedmart days, focuses on offering fewer product sizes to streamline operations and reduce complexity.

"Costco essentially has its entire buying team's ethos sort of shopping for you. They're pre-selecting the best one or two items in every category."

The quote captures the essence of Costco's limited selection strategy, where the company's buyers act as proxies for consumers, selecting the best products on their behalf, leading to a simplified and trusted shopping experience.

Crusoe Cloud Sponsorship

  • Crusoe is a cloud infrastructure provider that specializes in AI training and inference.
  • They focus on quality and specialization, using cutting-edge technology like Nvidia A and Infiniband to accelerate performance.
  • Crusoe's environmental benefit comes from using energy that would otherwise be wasted, such as oil and gas flares, to power their data centers.
  • The company's approach includes vertical integration, manufacturing their modular data centers, and improving rural connectivity.

"Crusoe is a cloud infrastructure provider, just like AWS and Azure. That is 100% purpose-built for AI training and inference."

The quote introduces Crusoe as a specialized cloud provider for AI applications, drawing a parallel to Costco's purpose-built business model that emphasizes efficiency and value.

Costco's Distribution and Labor Efficiency

  • Costco employs a cross-dock system for their distribution centers, allowing for efficient transfer of goods from suppliers to warehouses.
  • The system contributes to Costco's exceptional cash flow dynamics and operational simplicity.
  • Costco's labor efficiency is evident in their high revenue per employee, a result of aligning their trade-offs and minimizing unnecessary labor.

"92% of Costco's merchandise is cross-stocked. Only 10% of Walmart has cross-stocked merchandise on a pallet system like this."

The quote illustrates Costco's unique distribution model, which is vastly different from competitors like Walmart and contributes to the company's efficiency and profitability.

Membership and Executive Membership

  • Costco's membership model is a significant part of its business, with fees representing a substantial portion of operating income.
  • The executive membership offers additional benefits like 2% cash back, encouraging higher spending and loyalty.
  • High renewal rates, especially among executive members, underscore the success of the membership model.
  • The partnership with Citi and Visa for the Costco card is financially advantageous, with Costco likely profiting from the payment processing arrangement.

"Costco generates all their profit on memberships and that retail is just a breakeven business."

The quote reflects a popular view of Costco's business model, where the high-margin membership fees are seen as the primary profit driver, while retail operations maintain thin margins.

Costco's Business Today

  • Costco is a major retailer with $230 billion in revenue, ranking third in the US.
  • The company has a large membership base, high revenue per employee, and efficient use of retail space.
  • Costco continues to grow, with same-store sales increasing and new stores performing well.
  • The "treasure hunt" aspect of the shopping experience, with a rotating selection of items, drives customer engagement and repeat visits.

"Costco is doing somewhere between a third and a half the total revenue of Walmart. But they're doing it with, what, almost an order of magnitude fewer people."

The quote emphasizes Costco's remarkable efficiency and success, achieving significant revenue with a fraction of Walmart's workforce, highlighting the effectiveness of their business model.

Costco's Pricing Strategy and Brand Perception

  • Costco is known for its consistent pricing, particularly the hot dog and drink combo at $1.50.
  • The company's leadership is committed to maintaining low prices, even when margins are thin or negative.
  • Craig Jelenek, who succeeded Jim Senegal as CEO, was advised against raising prices for the hot dog combo.
  • The story of the hot dog combo price being maintained over the years has become emblematic of Costco's approach to pricing and value.

"And when Jim Senegal handed over the reins to Craig Gellanek, Craig went to him and said, hey, we're close on margin here, or maybe we're upside down. Nobody really knows on the hot dogs. We might need to raise the price. And of course, Jim Senegal looks at him and goes, if you raise the price of the hot dog and drink combo, I will effing kill you."

This quote illustrates the commitment of Costco's leadership to keeping prices low for their customers, even for items like the hot dog and drink combo, which has become a symbol of the company's value proposition.

Costco's Branding and Trust

  • Costco's brand is associated with trust and value rather than traditional branding power.
  • Customers trust Costco's selection of pre-selected inventory and the company's buyers.
  • The brand does not generate excess margin from its name but earns customer loyalty and retention, leading to volume sales.
  • Costco's market strategy focuses on long-term gains rather than short-term profits, which is recognized by the market through a higher valuation multiple.

"It's latent branding power and latent scale economies and they sort of choose not to recognize short term profits from those."

This quote summarizes Costco's strategy of focusing on long-term value through branding and scale economies rather than immediate profit maximization, which in turn contributes to the company's high market valuation.

Costco's Business Model and Market Position

  • Costco's revenue is significantly lower than Walmart's, yet it trades at a higher multiple due to its business model.
  • The membership model and the perception of revenue stability contribute to Costco's market position.
  • Costco's approach allows it to thrive in various economic climates, appealing to customers across different income levels.
  • The company's slow and steady growth is a result of its focus on quality and customer value.

"Costco does, what, 240,000,000,000 in revenue today? And Walmart does 620,000,000,000. Costco obviously trades at a much higher multiple than Walmart."

The quote compares Costco's revenue and market multiple with Walmart's, highlighting the impact of Costco's business model and customer trust on its market valuation.

Costco's Expansion and Supply Chain Integration

  • Costco integrates vertically when it benefits members and justifies the overhead.
  • An example is Costco's involvement in chicken processing to ensure fair pricing and quality for its members.
  • Costco's growth is limited by the need for careful hiring, training, and physical logistics, not by cash.
  • The company's culture emphasizes attention to detail, with executives discussing operations in terms of cents rather than dollars.

"They sell 500 million chickens a year. Not pounds—chickens."

This quote emphasizes Costco's large-scale operations in chicken processing, which is part of their strategy to control quality and pricing for their members.

Costco's Corporate Culture and Ethics

  • Costco's culture values consistency, employee development, and long-term commitment.
  • Executives at Costco often have long tenures and rise through the ranks from within the company.
  • The company's ethical approach includes never having done layoffs and maintaining a noble yet fun corporate atmosphere.
  • Costco's return on investment for shareholders has been significant, demonstrating the effectiveness of its business ethics and culture.

"The company has never done a layoff. If they needed to, they would have done a layoff. But they've run the business in such a way and figured out the way that they've never needed to do that."

This quote highlights Costco's ethical approach to business, which includes a commitment to its employees and a culture that avoids layoffs, contributing to its long-term success.

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