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The Costco Effect

What can we learn about relationship management from a discounter?

Under what conditions would a consumer enter a store planning to buy toilet paper, and end up charging $1500 on their AMEX card? The idea is inconceivable. Yet it happens quite regularly at Costco, according to a story in today's Sunday Money section of the NYT. $1500 would buy a lot of toilet paper, a whole truckload.

Costco is a wholesale club and its transactional quantities are large, but owning a house with a loading dock and a forklift are not requirements of membership. Rather, one might spend twenty dollars or so on toilet paper, spend five a tub of salsa, then spend the balance on a plasma television. So suggests an article in the Sunday NYT.

What accounts for this idiosyncratic behavior? Costco is decidedly not the place to go if one has done painstaking research and has one's heart set on a particular model in a particular color with a particular set of features. Need a Kitchen Aid Artisan Mixer in Empire Red? Sorry. You can have them in any color you like so long as that's white. If one's tastes are too carefully refined, if one's expectations are too narrowly set, shopping at Costco can be a perfunctory affair. Or an exercise in futility. The store only stocks 4000 SKU's at a time. Most of them are not "exactly the thing." But all come mighty close.

For over a decade, when I heard the Costco faithful whisper to each other in tones of awe and tenderness about their latest Costco purchases, I discounted the stories. I saw Costco as a kind of temple to rampant consumerism. And I imagined that the faithful were just a little too caught up in the American game of acquiring stuff. I sometimes still hear the excited whispers. And I sometimes still think the same thing. But now I am one of the faithful. And when I point the finger, one end points back at me.

My family's own Costco association started with a white chest, a cooler. We had borrowed one from a neighbor for an annual fete. And we discovered that the item in question came from Costco. So we went on line and found places where it was on sale. We checked the price at Costco. And we discovered that the difference in price would pay for a year's membership.

It did not take many trips to discover that something special was going on. Costco violated the economic principle of "price as a proxy for quality." They stocked brand names and SKU's with the best reputations and reviews. And they did it at prices that were almost always a third less than the items could be bought at retail. Sometimes they were half off. Sometimes more than that. We started by buying things we knew and trusted, like double packages of Heinz Ketchup or Grey Poupon Mustard. It was not long before we were buying sixpacks of bell peppers, or ten pound bags sacks of Yukon Gold potatoes. The gallon jars of mayonnaise, however, we eschew because it does not stay fresh after opening.

Early on we discovered that we could get good prices on HP ink cartriges. Not much later we were charmed that the paperback book section carried "trade" books with high quality bindings and writing to match. We got hooked on the flame cooked chickens for just less than five dollars. And we grew to depend on the boxes of three dollar pizzas, the four pound packages of butter, the cases of V8 and spring water.

We were surprised to find that their house brand, Kirkland, was frequently both better in quality than the best commercially available brand of the same description, and less expensive. Even at Costco.A famous consumer magazine, for instance, rates Kirkland laundry detergent more highly than a famous national brand that took that spot for many years. After some time we joined the crowd. We have yet to purchase a plasma screen TV; but when we were picking up new eyeglasses the other day we did look at one rather fondly.

Our impulse purchase that evenng was a fistful of DVD's to watch while we use the treadmill that we ordered online from Costco a month ago. Why is it, we asked ourselves, that we do this? Why do we buy things from Costco? Why is it that we go into the store for toilet paper and while we are there we pick up a tub of salsa and a plasma television - metaphorically speaking? The answer is as old as selling. Costco removes all barriers to buying. When one has decided that one has a physical need that can be met by some food or manufactured good, what is it that keeps a person from buying at a given point of purchase? Fear. The biggest fears are:

Costco succeeds in completely removing these fears. The items they stock are either the best of type or they are materially similar to the best of type. If they can be purchased at other wholesale clubs for less, the amount less is not material. Costco marks up every item 15%. So going into the store, one expects that every single item will be either a good bargain or the best bargain possible.

Sure, some stores sell the occasional item at a "loss" but often there is a hidden reason that explains why. And that hidden reason makes the apparent discounted price no longer a bargain. At Costco this does not happen. There is no reason for a busy person to look elsewhere. And if a purchase is not satisfactory, things are easily remedied. A coffee grinder that broke was returned, and the refund was in hand before the end of the sentence explaining the problem.

Remember that old Roman saying "buyer beware?" Costco's revolution is to make that saying not just irellevant to its customers, but anathema to its way of doing business. Even the priests who minister in this temple of consumerism display both an uncanny energy in their pursuits and a rather stunning concern for the well being of their customers. Except for the price stickers that never seem to be correctly attached to the Jarlsberg cheese and a frequent problem with freshness of "fresh' button mushrooms, almost everything works.

And if it does not work during one visit; it is not long before it starts working. One day we found there to be a paucity of shopping carts. A week later there were twice as many. Problem fixed. And these are sturdy, expensive carts. They probably cost several hundred dollars apiece, even in bulk.

The biggest problem is the "by the pallet" syndrome. Huge amounts do not always work for perishable items. As the old joke goes: a sharp fellow comes home all excited and he tells his wife "Guess what, honey, I just bought a Lexus at Costco, at an unbelievable price." She replies "That's great dear; but how many did you have to buy?" The joke is so completely believable, because Costco has been quite successful moving high ticket items, things that, in the absence of this store's unique merchandising process would otherwise never share the same mental concept space, like toilet paper and plasma TV's.

Costco has been successful by systematically building a high level of trust with its customers. And this high level of trust allows busy people the space to buy big ticket items without shopping around. Therein lies the secret to its success. Shoppers show up for the potatoes and peppers, but they leave with plasma TVs and exercise machines. Sure, Costco is well run. It selects good products. It operates in a highly efficient way - else 15% markup would not be enough to guarantee a profit. But it has succeeded not just on the basis of being efficient in the Wal-Mart mode. It has succeeded by actively helping busy people make good choices about a wide range of material goods that span virtually all the needs of healthy people.

The secret of its success is trust. That is what makes it successful . It is a model of American enterprise. It succeeds by employing noble principles. That, I find, is a hopeful sign.

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( In the interest of full disclosure, I am a Costco stockholder. It is possible that this has colored my opinion. If the share price doubles as a result of this article I will be able to afford one of those plasma TV's and some salsa. )

Copyright: Stephen R. Brubaker, 2006. All Rights Reserved