Costco's growth and its business model

Shares of Costco Wholesale closed trading up 1.52% to $148.07 on Monday after analysts at BMO reiterated their “outperform” rating on the company’s stock. The stock has not only risen over the past year, but also has done so at a faster pace than the S&P 500, drawing immense interest among investors.

The warehouse clubs and supercentres industry has been one of the fastest growing industries in the retail sector for the past few years. The key players in the sector include warehouse club such as Costco, BJ, Sam’s Club as well as supercentres such as Wal-Mart. The wholesale retail market size is currently estimated to be around $451bn with revenue 5 year average growth of 9.54%. Although Costco has a much lower market share than Wal-Mart, its annual YOY growth is comparable to that of Wal-Mart and the future growth potential is promising because of Costco’s unique business model.

The most crucial growth driver of Costco is its competitive pricing through bulk purchases and sales, keeping low profit margins and adopting a self-service shopping style. The low price will be maintained as Costco expands and experiences higher volumes of transactions which will give Costco greater economies of scale and bargaining power.

Another key factor that sets Costco apart from other retailers is that Costco enjoys a resilient demand.

Consumers and businesses spend freely on discretionary goods when the economic outlook is strong, leading to high demand for retail goods, including those sold at warehouse clubs such as Costco. While most retail industries typically struggle when the opposite conditions occur, the warehouse clubs remain strong because its discounted prices continue to attract households and businesses. Hence, Costco will remain resilient amidst changing economic environment.

The resilient demand provided by the nature of a warehouse club business is also unlikely to be eroded by new entrants due to high barriers to entry. Costco and other incumbent warehouse clubs enjoy sizable scale economies not easily accessed by a newcomer. If an entrant wishes to compete on a scale comparable to the industry incumbents, capital requirements will be sizable. Furthermore, the marketing and advertising costs to attract members and build a significant volume of sales (strategies to overcome the loyalty of existing warehouse club members) would be very high. All these factors make it not attractive for others to enter this industry. Hence, Costco’s current market share will be maintained to capture the increasing demand in the warehouse club industry.

With other expansion plans such as capturing overseas market and establishing online presence in progress, Costco will be an interesting company to look out for.

Lia Wei