David R. Henderson  

Costco vs. Wal-Mart

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The Partialtarian Corporation... The Tears of Termination...
In other words, Trader Joe's and Costco are the specialty grocer and warehouse club for an affluent, educated college demographic. They woo this crowd with a stripped-down array of high quality stock-keeping units, and high-quality customer service. The high wages produce the high levels of customer service, and the small number of products are what allow them to pay the high wages. Fewer products to handle (and restock) lowers the labor intensity of your operation. In the case of Trader Joe's, it also dramatically decreases the amount of space you need for your supermarket ... which in turn is why their revenue per square foot is so high. (Costco solves this problem by leaving the stuff on pallets, so that you can be your own stockboy).

Both these strategies work in part because very few people expect to do all their shopping at Trader Joe's, and no one expects to do all their shopping at Costco. They don't need to be comprehensive. Supermarkets, and Wal-Mart, have to devote a lot of shelf space, and labor, to products that don't turn over that often.


This is from Megan McArdle, "Why Wal-Mart Will Never Pay Like Costco." The whole thing is worth reading.

One comparison that caught my eye is revenue per employee:
Wal-Mart: $211,000
Costco: $620,000.

Megan also links to an earlier piece she wrote on this. My favorite passage:

But Walmart is not just a poor man's Costco. They're very different businesses, with very different labor models, demographics, and revenue streams. And those things work together: the fact that Costco is doing great with a given labor model or profit margin does not therefore mean that Walmart could easily follow the same course. With depressing regularity, you see pundits and activists asking "Why can't Walmart be more like Costco", which is a little like asking why Malcolm Gladwell can't be more like Michael Jordan. I mean . . . um . . . where do I even start?

She does start--and does a great job.


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CATEGORIES: Business Economics



COMMENTS (16 to date)
Thomas DeMeo writes:

Megan's analysis is correct, but I guess I would ask, so what?

Ultimately, business organizations and their customers make a series of choices about what they will be, and what range of market pressures they will respond to, and what they won't. There is ALWAYS a market opportunity for ruthless price cutting. The decision to pursue market share by pursuing the lowest common denominator is a sensibility. Nothing more, nothing less.

By the way, I define ruthless as using leverage aggressively to obtain win/lose deals, vs sticking with win/win arrangements and seeking maximum efficiency.

Mike writes:

Two points about Costco from a believer in competitive free market capitalism.

One, I recall a recent comment about Costco made by a stock analyst. He (or she?) said their earnings were about the same as their membership fee revenue. That tells me that they have squeezed all the profit out of their prices and are passing it all through to their members through their pricing. As a consumer, I know they have vetted all their products to assure quality so I don't need to worry about it. If I like or need the product I buy it knowing it may not be the lowest price but it is always the lowest or close to the lowest price barring a competitor pricing a loss leader.

Second, if a product doesn't move it is quickly removed from the shelves. Walking through a Costco is like an economic anthropologist getting an easy barometer of consumer tastes and preferences. It is quite humbling when you become a regular purchaser of one of their products and for some unexplained reason you discover it no longer is carried. On the other hand, it is reassuring to know you may be ahead of or better informed than the masses.

Record me as a longtime fan of Costco or if you go way back (as I do) Price Club or way way back FedMart.

Ak Mike writes:

Mr.DeMeo - (1) Anyone can cut prices and gain market share, but the genius of WalMart is that it can cut prices and through unique efficiencies, still make a profit. That ability is rare. (2) In WalMart's model, the only losers are its competitors. WalMart wins through profits, the customers win through low prices, the employees win through steady jobs at wages no less than WalMart's mom-and-pop competitors offer, and the suppliers win despite razor-thin margins with big volume orders.

If you think anyone willing to be ruthless could do as WalMart does, you are wrong wrong wrong. It is fundamental to the market that competitors who are unwilling to do what it takes to compete will disappear. All of WalMart's competitors would be just as ruthless; what they can't be is as efficient.

NZ writes:

@Ak Mike:

The competitors' loss isn't felt only by the people who own/work at those mom & pop businesses, but also by the customers who might have enjoyed the more relaxed, intimate, quiet shopping experience.

You may say that if customers truly value that experience, they'd be willing to pay more for it. While some are, the draw of lower prices bleeds most of the customers away to Walmart. And why not? In a fiercely competitive market in which your wages are chipped away at by competition on the one hand and your savings are chipped away at by consumerist commodities on the other, who can afford to spend on such niceties as a decent, civilized shopping experience?

The death of the mom & pop shop indeed has an impact on communities and neighborhoods as well. And this isn't bleeding heart stuff, either. It's of relevance to anyone who has kids and would like to raise them in an environment where people--even strangers--are neighborly and caring. To me it's apparent that the unwashed, tattooed, tank-top-and-flip-flop-clad masses of WalMart do not facilitate such an environment. Unfortunately, the presence of WalMart means that average people will be priced out of that environment. The result is high-income people being able to afford the decent, quiet shopping experience, while everyone else is shoehorned into WalMart. One more deletion from the set of activities that make up the affordable middle class lifestyle.

WalMart's unique efficiencies, by the way, include pressuring their suppliers to cut their own costs, resulting in lower quality goods. WalMart has the leverage to do this because they've destroyed their mom & pop competitors. Consumers, meanwhile, are frequently not rational enough to demand higher quality.

Should they disappear too? Caveat emptor?

Andrew writes:
Consumers, meanwhile, are frequently not rational enough to demand higher quality.

Perhaps you should read what Don Boudreaux had to say yesterday regarding rationality.

Jody writes:

NZ - revealed preferences indicate otherwise, at least for the masses.

Or, if what you said is indeed valued by the market, then there's a niche to be filled and money to be made.

And indeed it is.

By Trader Joe's and Whole Foods and such.

Which is why I'm always confused by why Walmart draws the ire of the mom & pop protectors rather than the chains that are actually capturing the consumer segment they seemingly claim as unfulfilled.

NZ writes:

@Jody:

As I said, the revealed preferences are impacted by other factors outside the control of consumers, especially the rising cost of family formation.

The effect, as I said, is a shoehorning of everyone but the wealthy into a lower-class cultural environment. The upper earners, meanwhile, can afford to shop at Trader Joe's and Whole Foods, who in turn have more incentive to cater to those demographics and less incentive to try to make their products more affordable to regular folks.

Thomas DeMeo writes:

Ak Mike-

I worked for a number of years in management for a competitor of WalMart. I know quite a bit about how special and innovative they are. I am also aware of the fact that a great deal of good also flows from ruthless price cutting.

The only thing I would disagree with is that being a vendor for Walmart makes you a winner. The vendors are asked to adhere to Walmart's value proposition. It is a tough way to do business, and a mixed bag at best.

My point was that they chose to become what they are, and there are any number of other ways to make money that also work well. Megan's premise was that Walmart couldn't be act like Costco. Well, they could, but they would have to change their value proposition to fit those goals.

Walmart is hardly all evil. They've chosen to play the game a certain way and they are better at it than anyone else. But they didn't have to go that way. It wasn't inevitable. They dominate retailing because of their talent, drive, and supply channel management strategies, not their prices.

happyjuggler0 writes:

DH, thanks once again for another insightful post.

Number of US stores for Walmart: 4400.

Number of US stores for Costco: 447.

If Costco has a business model that is superior to Walmart, then why haven't they opened more stores and taken away Walmart's business?

That is the whole crux of the matter as I see it. The people that say that the Costco model is superior never seem to answer that question; indeed I suspect it never occurs to them.

MM's article answers the question but I suspect that most people that read the article won't even see the question, let alone the answer.

MingoV writes:
If Costco has a business model that is superior to Walmart, then why haven't they opened more stores and taken away Walmart's business?
Costco has a business model that is different from Walmart, not superior. There are more Walmarts in part because one metropolitan area can support four or more Walmarts but only one Costco.

There is a grocery store chain that provides a nice environment, quality foods, a broad selection of foods, and superior service (eg: complete bagging service and loading your bags into your car): Harris Teeter. The prices reflect those choices. We went to Harris Teeter to buy items unavailable in other stores and excellent desserts from their bakery. We felt the prices were too high for routine shopping. However, many customers did all their grocery shopping at Harris Teeter because, to them, the service and quality were worth the extra costs.

Thomas DeMeo writes:

I think the context of the comparison here that Costco has the superior business model is in terms of overall social responsibility and treatment of employees.

Price strategy alone is meaningless and has little to do with success. You can be just as huge and dominant being Apple or BMW as you can being Walmart.

MikeP writes:

However, many customers did all their grocery shopping at Harris Teeter because, to them, the service and quality were worth the extra costs.

Even more importantly, not going somewhere else before going home worth the extra costs.

I realized last time I was at Whole Foods that this is the basic model: Provide the highest quality in those goods where quality really matters, and shoppers will pay $5 for bread because they need bread and don't want to make an extra trip to Safeway.

Eric Evans writes:
I think the context of the comparison here that Costco has the superior business model is in terms of overall social responsibility...

I think that requires a pretty loose definition of "social responsibility". I would think keeping life affordable for the poorest people in our society is superior to keeping life comfortable for the middle/higher income people in our society.

Thomas DeMeo writes:

Eric Evans - "I think that requires a pretty loose definition of "social responsibility". I would think keeping life affordable for the poorest people in our society is superior to keeping life comfortable for the middle/higher income people in our society."

I would agree with this as a strong counter argument. Walmart takes the hard line on wages and vendor negotiations, but largely passes those gains on to its customer base, many of whom really need those lower prices. I'm not a huge fan of that style of doing business, but I understand that millions of people benefit from it.

The key issue here is that Walmart could have become the leader in the market pursuing alternate pricing strategies if they executed them equally as well. Megan was wrong.

Tracy W writes:

NZ:
who can afford to spend on such niceties as a decent, civilized shopping experience?

Most people?
Judging by the annual expenditure by income percentile in the USA, the bottom 20 percent spent in 2012 on average US$942 that year on entertainment and $172 on alcoholic beverages, and $231 on non-alcoholic beverages. Presumably, if they really wanted a decent, civilised shopping experience, on average they could skip entertainment and drink water instead. That would on average free up over $1000 a year to increase their food expenditure by over 1/4 (from $3,483).
Personally, I think someone would need very unusual personal preferences to do this. Booze tastes nice, and there is more to life than shopping. Furthermore, while I've only been to a Walmart store in NZ, it struck me as reasonably decent and civilised (admittedly, having two brothers and having been to engineering school, my idea of civilised behaviour may be badly warped). But there's a big difference between "can't afford to" and "can afford to but really would prefer not to."

http://www.bls.gov/cex/22012/midyear/quintile.pdf

It's of relevance to anyone who has kids and would like to raise them in an environment where people--even strangers--are neighborly and caring. To me it's apparent that the unwashed, tattooed, tank-top-and-flip-flop-clad masses of WalMart do not facilitate such an environment.

Really? How interesting. Why do you think that tattoos, tank tops and flip flops are incompatible with being neigbourly and caring? Surely these are matters of fashion? Perhaps not the wisest fashion when it comes to tattoos, given their permanent nature, but given how widespread tattoos are amongst the university-educated of my generation, I think if you want to avoid them you're going to have to raise your kids on the moon.

The death of the mom & pop shop indeed has an impact on communities and neighborhoods as well.

What death? The US census bureau statistics look like a pain to dig through, so I haven't bothered, but this Cato paper finds a higher rate of small retail establishments, employing 1-4 people, in US states with the highest rate of Walmart stores.
And, in my own experience, I haven't seen any disappearance of mom & pop stores as the result of competition from big supermarkets in my lifetime. Where I live now is close to a big Sainsbury, I've heard it's the biggest Sainsbury store in London, though I haven't checked that figure. There's what I would call a dairy, and what the Brits call an off-licence, and what I think Americans would call a mom & pop grocery story just across the road from it.
So what is your evidence that Cato is wrong and that the mom & pop store has died?

http://www.cato.org/sites/cato.org/files/serials/files/regulation/2008/2/v31n1-1.pdf

Tom E. Snyder writes:

Great articles--both you an Megan. Looking at the comments to Megan's article I'm convinced that we need more people to take at least an introductory economics course like the ECON 1301 course that I teach at a community college.

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