Costco
This isn’t a tricky business. We just tried to sell high quality merchandise at a lower cost than everybody else.
Kyle’s Rating: 10/10
This episode is Acquired at it’s finest. It brilliantly reveals how Costco’s seemingly simple business model masks profound strategic sophistication, making clear why Charlie Munger considers it the ultimate example of principled capitalism at scale. Ben and David demonstrate how the company builds enduring value by obsessively serving customers rather than extracting maximum short-term profit—a refreshing contrast to today’s financial engineering and growth-at-all-costs mentality. If you want to understand how great businesses actually work—the trade-offs, the culture, the flywheels—this is the episode to listen to.
Company Overview
Company Name: Costco Wholesale Corporation
Founding Year: 1983 (with roots in Price Club, founded 1976)
Headquarters Location: Issaquah, Washington
Core Business: Costco operates a membership-based warehouse club model, offering high-quality products at low prices through bulk purchasing and a limited SKU count, creating exceptional value for members.
Significance: Its disciplined focus on scale economies, low margins, and member trust has made it the third-largest retailer in the US, with a unique culture and business model that drives loyalty and consistent growth.
Timeline
1916: Sol Price, Costco’s ideological founder, is born in New York City.
1954: Sol Price opens FedMart in San Diego, a for-profit clone of Fedco, pioneering the discounter model.
1959: FedMart goes public, raising $2 million to expand stores and services like gasoline and pharmacy.
1976: Sol and Robert Price found Price Club in San Diego, focusing on wholesale to businesses with a low SKU count (~3,000).
1979: Price Club becomes a public company due to exceeding 500 shareholders, later listing on NASDAQ in 1982.
1982: Sam Walton visits Price Club, leading to the launch of Sam’s Club within 12 months; Bernie Marcus visits, inspiring Home Depot’s founding.
1983: Jim Sinegal and Jeff Brotman found Costco in Seattle, cloning the Price Club model.
1985: Costco goes public, raising $7.5 million.
1993: Costco and Price Club merge to form PriceCostco, with ~200 stores and $16 billion in revenue.
1998: Costco introduces the Executive Membership, offering 2% cashback for a $120 annual fee.
2019: Costco opens its first store in China, gaining 400,000 members in two years.
2023: Costco operates 860 stores, with 124 million members and $230 billion in revenue.
Narrative
Costco’s story begins with Sol Price, a visionary whose principles shaped modern retailing. Born in 1916 to Jewish immigrants in New York, Sol grew up in a socialist-leaning community, developing a fierce commitment to fairness and value. After moving to San Diego as a teenager, he earned a law degree from USC and began advising local entrepreneurs. His exposure to Fedco, a nonprofit membership club for federal employees, inspired him to launch FedMart in 1954, a for-profit discounter offering low prices to members. FedMart’s success, driven by its focus on value and innovative services like gasoline and pharmacy, marked Sol as a retail pioneer, influencing giants like Sam Walton. However, by the late 1960s, FedMart struggled against capital-rich competitors like Kmart and Walmart. A poorly aligned partnership with German retailer Hugo Mann led to Sol’s ousting in the early 1970s, leaving him determined to reclaim his legacy.
Undeterred, Sol and his son Robert founded Price Club in 1976, targeting small businesses with a wholesale warehouse model. By limiting SKUs to ~3,000 high-volume items and leveraging supplier logistics, Price Club achieved a negative cash conversion cycle, selling goods before paying suppliers. Initially struggling to attract business members, a pivotal deal with the San Diego City Credit Union opened Price Club to consumers, sparking viral growth through word-of-mouth. This success validated Sol’s belief that low prices and high quality could drive demand, even in a no-frills warehouse. Price Club’s cash flow dynamics and disciplined operations made it a “cashflow geyser,” enabling rapid expansion across the US Southwest.
In 1983, Jim Sinegal, Sol’s protégé from FedMart, partnered with Seattle retailer Jeff Brotman to launch Costco, a direct clone of Price Club. With Sinegal’s operational expertise and a team of FedMart veterans, Costco scaled rapidly, hitting $1 billion in revenue within three years and going public in 1985. By 1993, Costco and Price Club merged to form PriceCostco, uniting two near-identical businesses under Sinegal’s leadership. The merger, driven by the threat of Sam’s Club, created a $16 billion retailer with 200 stores. Costco’s focus on low SKUs (~3,800 today), disciplined margins (capped at 14%), and a membership model fueled its growth, with Kirkland Signature, launched in the mid-1990s, becoming the world’s largest consumer packaged brand by revenue.
Costco’s culture, rooted in Sol’s FedMart principles—obey the law, prioritize members, care for employees, and respect suppliers—has driven its enduring success. The company’s refusal to use loss leaders, commitment to high wages (30% above industry norms), and low shrinkage (0.15% of sales) reflect a noble yet pragmatic approach. Innovations like the Executive Membership (1998) and a cross-dock distribution system (92% of merchandise) further optimized operations, while strategic vertical integration, such as owning chicken processing facilities, ensured value for members. Despite a slow start in e-commerce, Costco’s focus on big-ticket items and partnerships like costconext.com shows adaptability without compromising its core model.
Today, Costco is a $230 billion retailer with 124 million members and 860 stores, thriving in diverse markets like China. Its “scale economies shared” model, where volume drives supplier discounts passed to members, creates a formidable moat. The treasure hunt shopping experience, with 25% of SKUs as rotating novelty items, drives repeat visits, while a 93% renewal rate underscores member loyalty. Costco’s disciplined growth (10% annually for decades) and refusal to prioritize short-term profits over long-term durability have earned it a premium valuation, with a market cap reflecting investor confidence in its stability. As Ben and David marvel, Costco’s story is one of principled execution, proving that a focus on value and trust can build an enduring retail empire.
Costco’s Code of Ethics
Costco’s Code of Ethics, formalized in the 1980s, is a foundational guide for its operations, deeply rooted in Sol Price’s FedMart principles. The code comprises four tenets:
Obey the law
Take care of our members
Take care of our employees
Respect our suppliers
These principles prioritize integrity, customer value, employee welfare, and fair supplier relationships over short-term shareholder gains. Jim Sinegal emphasized that fulfilling these tenets achieves the “ultimate goal” of rewarding shareholders. Originating from 1980s scrutiny by the Washington State Liquor Control Board, this code ensures a “squeaky clean” culture, supporting practices like capped 14% markups, high wages ($26/hour vs. Walmart’s $19.50), and a 93% membership renewal rate.
FedMart’s four priority order principles, established by Sol Price in the 1950s, are:
Provide the best possible value to customers
Pay good wages and provide good benefits
Maintain honest business practices
Make money for investors
These principles, taught to all FedMart employees, reflect Sol’s socialist-influenced focus on customer value and employee welfare, avoiding loss leaders to build trust.
Comparison: Costco’s Code of Ethics closely aligns with FedMart’s principles, with refinements for modern context. “Obey the law” strengthens “honest business practices,” emphasizing legal compliance post-regulatory challenges. “Take care of our members” mirrors customer value but leverages Costco’s membership model for greater impact. “Take care of our employees” continues FedMart’s wage and benefit focus, with Costco’s 7% attrition and internal promotions (e.g., CEO Craig Jelinek starting as a bagger) showing superior execution. “Respect our suppliers” refines honest practices into “tough but fair” negotiations, ensuring low prices without exploitation. Costco omits explicit investor mention, unlike FedMart, reflecting a long-term view where ethical adherence drives shareholder value, as seen in its 330x stock return since 1985.
“Tough but Fair” Approach with Suppliers
Costco’s “tough but fair” approach to supplier relationships, a core tenet of its fourth Code of Ethics principle (“Respect our suppliers”), balances aggressive price negotiations with fairness to deliver unmatched member value. Unlike Walmart’s confrontational tactics, Costco leverages its $230 billion revenue scale and low 3,800 SKU count—yielding 10x Walmart’s revenue per SKU ($60.5 million vs. $6 million)—to secure the lowest supplier prices while ensuring suppliers maintain honest margins. Costco caps retail markups at 14% (15% for Kirkland Signature), targeting an 11% gross margin, far below Walmart’s 25% or department stores’ 100%. For every $1 supplier cost reduction, Costco passes 89% ($0.89) to members, retaining $0.11, as seen in its $230 billion revenue generating $25.3 billion gross profit. This discipline, rooted in Sol Price’s FedMart ethos, contrasts with competitors’ higher markups, reinforcing Costco’s “extreme value proposition.”
Costco’s buyers, managing only 3–15 new SKUs annually, track commodity prices (e.g., cocoa, milk) to challenge price increases. For example, if a chocolate supplier raises prices, Costco verifies commodity trends and requests justification, later ensuring reductions align with market shifts. This transparency fosters trust, with suppliers benefiting from Costco’s volume—often as their largest customer—and unique SKUs (e.g., Costco-specific blender packs) that prevent comparison shopping. The approach aligns with Costco’s low-overhead model, where 92% cross-dock logistics and 12.4x inventory turnover minimize costs, allowing fair supplier terms to translate into member savings. By prioritizing long-term supplier relationships over short-term margin gains, Costco creates a defensible moat, as competitors like Sam’s Club lag in volume and discipline.
Kirkland Signature: Costco’s House Brand
Kirkland Signature, Costco’s house brand, is a pivotal element of its value proposition. Launched in the mid-1990s, the brand, named after Costco’s former Kirkland, Washington headquarters, generates $52 billion annually, surpassing Nike’s revenue and making it the world’s largest consumer packaged brand (excluding Kirkland Signature gasoline). Unlike typical retail house brands competing with 5–10 alternatives, Costco’s low 3,800 SKU count positions Kirkland Signature as one of one or two options per category, driving high sales velocity. Representing nearly a quarter of Costco’s $230 billion revenue, the brand targets a 15% markup (vs. 14% for other products), slightly higher to reflect its quality focus, yet still far below Walmart’s 25% or department stores’ 100%. For a $10 supplier cost, Kirkland Signature products are priced at $11.50, yielding a $1.50 gross profit, with 89% of cost reductions passed to members.
Costco’s buyers leverage scale economies to ensure Kirkland Signature offers superior quality or lower prices than branded alternatives, as seen in products like wine, vodka, batteries, and coffee, often sourced from top manufacturers (e.g., Duracell for batteries, premium winemakers for wine). This aligns with Costco’s “tough but fair” supplier ethos, where unique SKUs prevent comparison shopping, reinforcing the brand’s “walled garden” appeal. The brand’s unexpected cultural resonance, with executives wearing Kirkland Signature sweatshirts at a NASDAQ bell-ringing event, jokingly dubbed “Kirkland Couture,” reflects a cult following amplified by TikTok influencers. Unlike Nike’s premium branding, Kirkland Signature’s anti-brand identity drives loyalty without exploiting higher margins, supporting Costco’s flywheel and 330x stock return since 1985.
Intelligent Loss of Sales
The “intelligent loss of sales” philosophy, originating at FedMart and refined at Price Club and Costco, involves deliberately forgoing sales of certain product sizes or varieties to reduce SKU complexity, prioritizing operational efficiency and member value. For example, Sol Price chose to stock only 8-ounce cans of household lubricating oil (e.g., WD-40) at FedMart, accepting lost sales from customers needing smaller 3-ounce cans. This trade-off minimized SKU counts—Costco maintains just 3,800 SKUs compared to Walmart’s 100,000–250,000—enabling faster inventory turnover (12.4x annually vs. Walmart’s 8x) and lower overhead (11% gross margin). By focusing on high-volume, high-quality items, Costco ensures members get the best prices, as seen in its $1,800 revenue per square foot versus Walmart’s $600.
This disciplined approach drives Costco’s scale economies, allowing it to negotiate better supplier prices and pass 89% of cost reductions to members. The intelligent loss of sales aligns with Costco’s “extreme value proposition,” fostering trust among its 124 million members (93% renewal rate). The trade-off, exemplified by offering only bulk sizes like 2½-pound nut jars, simplifies logistics (92% cross-dock) and enhances profitability ($7.5 billion operating income). By sacrificing short-term sales for long-term efficiency, Costco creates a defensible moat, as competitors struggle to replicate its low-SKU, high-velocity model.
Strategic Vertical Integration
Costco’s selective vertical integration is a deliberate strategy driven by its commitment to delivering maximum value to members, rooted in Sol Price’s principles. Costco integrates only when it ensures lower prices or better quality without compromising its low-overhead model (11% gross margin, $25.3 billion gross profit on $230 billion revenue). This decision is triggered when supplier concentration or market inefficiencies inflate prices, undermining Costco’s “extreme value proposition.” By taking control of specific supply chains, Costco leverages its scale to reduce costs, passing 89% of savings to members (e.g., $0.89 per $1 cost reduction), reinforcing its 93% member retention and $7.5 billion operating income.
The chicken processing example illustrates this strategy. Costco sells 500 million chickens annually (130 million rotisserie, others as breasts, thighs, etc.). With only four or five major U.S. chicken processors, supplier concentration risked inflated prices. Costco leased 100% of a plant’s capacity in Alabama to learn the process, then built a fully owned facility in Fremont, Nebraska, partnering with 150 local farmers. This facility processes 2 million chickens weekly, with two additional dedicated plants handling 200 million annually. Integration ensures competitive pricing, maintaining affordability while upholding quality. Controlling production reduces reliance on external suppliers, stabilizes costs, and strengthens negotiation leverage. Despite increased complexity, the investment drives repeat visits and boosts sales ($269 million per store), supporting Costco’s moat as competitors like Sam’s Club lag in volume and discipline.
Quotable Costco
Charlie Munger and Warren Buffett’s Costco Joke: David shares a classic anecdote from a Berkshire Hathaway annual meeting: “Warren and Charlie are flying on a plane that gets hijacked. The hijackers grant each one last wish. Charlie says, ‘I would like to give my speech on the virtues of Costco one more time before I die.’ Warren responds, ‘Shoot me first.’” This encapsulates Munger’s legendary enthusiasm for Costco’s business model and its disciplined execution.
Jim Sinegal on the Hot Dog Price: When Craig Jelinek suggested raising the price of the $1.50 hot dog and soda combo, Sinegal famously retorted, “If you raise the price of the hot dog and drink combo, I will effing kill you.” This vivid quote, widely recounted, underscores Costco’s unwavering commitment to member value, keeping the price unchanged for 47 years despite potential margin pressures.
Sol Price on His Legacy: Reflecting on his role as a retail pioneer, Sol humorously remarked, “Maybe I should have worn a condom.” This self-deprecating quip highlights his recognition of birthing modern retailing (FedMart, Price Club, Costco) while acknowledging the challenges of his creations’ scale.
Jim Sinegal on Pricing Discipline: On Costco’s strict margin caps, Sinegal said, “You could raise the price of a bottle of ketchup to $1.03 instead of $1, and no one would know. Raising prices just 3% would add 50% to our pre-tax income. Why not do it? It’s like heroin. You do it a little bit, and you want a little more. Raising prices is the easy way.” This illustrates Costco’s resistance to short-term profit gains, prioritizing long-term member trust.
Jim Sinegal on Business Simplicity: Sinegal cheekily noted, “This isn’t a tricky business. We just tried to sell high quality merchandise at a lower cost than everybody else,” adding, “Anybody can sell goods for cheap. The trick is to make money while doing so.” This captures the deceptive simplicity of Costco’s model, masking the intricate alignment of its trade-offs.
Notable Facts
Largest Consumer Brand: Kirkland Signature generates $52 billion annually, surpassing Nike as the world’s largest consumer packaged brand (excluding gasoline).
Wealthy Customer Base: Costco’s typical shopper has a household income of $125,000, 70% above the US median, despite offering the lowest prices among major retailers.
Employee Longevity: 36% of US employees have over 10 years of service, with most C-suite executives starting as hourly workers, reflecting a promote-from-within culture.
Hot Dog Legacy: The $1.50 hot dog and soda combo, unchanged for 47 years, sells 130 million units annually, symbolizing Costco’s commitment to member value.
Global Wine Leader: Costco is the world’s largest seller of fine wines ($20–$300 bottles), catering to its affluent, value-driven demographic.
Financial Metrics
Revenue: $230 billion (2023).
Operating Income: $7.5 billion (3.3% operating margin).
Membership Revenue: $4.5 billion, ~70% of operating income.
Members: 124 million worldwide, with 93% US renewal rate and 45% as Executive Members (73% of sales).
Stores: 860 globally, averaging $269 million in sales per store.
Revenue per Square Foot: $1,800, compared to Walmart ($600) and Target ($450).
Revenue per Employee: $750,000, reflecting high efficiency (vs. Walmart’s ~2 million employees for $620 billion revenue).
Inventory Turnover: 12.4 times per year, enabling a negative cash conversion cycle (vs. Walmart’s 8 times).
Same-Store Sales Growth: 14% in 2023.
Market Cap: ~$250 billion, trading at a premium multiple due to durability.
Shareholder Returns: 80% of net income returned via dividends/buybacks over the past decade.
Bear Case & Bull Case
Bear Case:
E-commerce Lag: Costco’s late entry into e-commerce (15 years behind competitors) reflects its low-margin model’s incompatibility with high-overhead online logistics, potentially limiting growth in a digital-first retail landscape.
Growth Constraints: Physical expansion is bottlenecked by real estate, supplier scaling, and internal promotion culture, limiting growth to ~10% annually despite significant cash reserves (80% of net income returned to shareholders).
Demographic Concerns (Debunked): Past concerns about younger generations not adopting Costco are false, as membership rates remain consistent, bolstered by TikTok-driven popularity.
Bull Case:
Unassailable Flywheel: Costco’s scale economies shared model, with high volume driving supplier discounts passed to members, creates a widening gap over Sam’s Club, which generates half the revenue per store.
Unsaturated US Market: New stores in existing markets perform as well as those in new regions, with management continually surprised by domestic growth potential.
International Expansion: Significant runway in markets like China (first store: 400,000 members in two years vs. 68,000 per US store), with deliberate strategies ensuring success.
Costco-Flavored E-commerce: Investments in big-ticket logistics (e.g., Costco Logistics for sheds) and partnerships like costconext.com extend value without compromising the low-overhead model.
Enduring Culture: A promote-from-within, cent-focused culture ensures consistent execution, outlasting economic cycles and leadership transitions.
Powers
Scale Economies (Primary, “Scale Economies Shared”): Costco leverages its massive volume (10x Walmart’s revenue per SKU due to ~3,800 SKUs vs. Walmart’s 100,000–250,000) to secure the lowest supplier prices, which are passed to members via low markups (11% gross margin, capped at 14%). As Nick Sleep coined, “scale economies shared” means Costco uses its purchasing power to negotiate discounts and shares 89% of savings with members, driving loyalty (93% renewal rate) and further volume ($269 million per store). This flywheel creates a moat, as competitors like Sam’s Club (half the revenue per store) cannot match Costco’s supplier leverage or low overhead (10–11% vs. Amazon’s 30%).
Branding (Latent): Costco possesses latent branding power, akin to Nike’s, but chooses not to maximize margins, instead using it to reinforce low prices and member trust. The Costco brand signifies curated, high-quality products at unbeatable value, fostering loyalty (e.g., 124 million members, 93% renewal). Kirkland Signature, dubbed “Kirkland couture” when executives wore branded sweatshirts at NASDAQ, has evolved into a cultural phenomenon, with $52 billion in sales. Unlike traditional branding, Costco invests in enterprise durability by keeping prices low (e.g., $1.50 hot dog for 47 years), earning organic advocacy via TikTok influencers and word-of-mouth, not advertising.
Counter Positioning (Modern, as Incumbent): As a $230 billion incumbent, Costco counter-positions against e-commerce giants like Amazon by emphasizing physical warehouse shopping, prioritizing absolute lowest prices over convenience. This stance, rare for an incumbent, leverages its affluent customer base ($125,000 median income) and high renewal rates (93%) to maintain a moat. Unlike Walmart’s heavy e-commerce investment, Costco’s Spartan online presence (e.g., costconext.com, Costco Logistics for big-ticket items) preserves its low-overhead model (10–11% vs. Walmart’s 20%), making it uncopyable by digital-first competitors who prioritize convenience over price.
Switching Costs: Switching costs are minimal, as members could join Sam’s Club or BJ’s Wholesale, but Costco’s value proposition (lowest prices, high-quality SKUs) and membership psychology (e.g., endowment effect from $60–$120 fees) drive retention (93% renewal). The Executive Membership (45% of members, 73% of sales) and Citi Visa card further lock in high-spending members, but the primary retention driver is trust in Costco’s unmatched value, not contractual or structural barriers.
Playbook
Scale Economies Shared: Costco uses its volume to negotiate supplier discounts, passing 89% of savings to members, reinforcing loyalty and driving further volume (e.g., $269 million per store).
Disciplined Margins: A strict 14% markup cap (6–8% for electronics, 15% for Kirkland Signature) ensures trust, distinguishing Costco from competitors like Walmart (25% markup) or department stores (100%).
Walled Garden: Unique SKUs (e.g., Sonicare two-packs with extra heads) prevent comparison shopping, preserving brand value for partners like Apple or Dom Perignon while delivering member savings.
Intelligent Loss of Sales: Limiting SKUs (3,800 vs. Walmart’s 100,000–250,000) and product sizes (e.g., 2½-pound nut jars) simplifies logistics and boosts inventory turnover (12.4x annually), accepting lost sales for efficiency.
Vertical Integration for Value: Costco integrates selectively (e.g., chicken processing for 200 million birds annually) to ensure quality and price control, balancing complexity with member benefit.
Cent-Focused Culture: A meticulous focus on every cent (e.g., $180.89 pricing) aligns with low margins, enabling consistent execution across 860 stores.
Promote-from-Within: Most C-suite executives started as hourly workers, fostering loyalty (36% with 10+ years) and operational expertise, with market managers meeting monthly in Issaquah to share learnings.
Implications: These themes drive Costco’s durability, enabling 10% annual growth, high retention (93%), and international scalability, though physical expansion constraints limit growth speed.
Carveouts
Ben’s Carveouts:
Tifosi Sunglasses: Affordable running sunglasses with grippy nose pads to prevent slipping, solving a common annoyance.
Dwells Mash-Up: A DJ mash-up of Radiohead’s “Everything In Its Right Place” and Kendrick Lamar’s “N95,” praised for its nostalgic and innovative appeal.
David’s Carveouts:
Invest Like the Best with Jeremy Giffon: A dense, insight-packed podcast episode with friend Jeremy Giffon, offering 30+ mind-blowing one-liners.
Dogpatch, San Francisco: A vibrant neighborhood for date nights, with wine bars, ice cream at Humphrey Slocombe, and a rich history (e.g., former Hells Angels HQ).
Additional Notes
Episode Metadata:
Number: Season 13, Episode 2
Title: The Complete History & Strategy of Costco
Duration: 3 hours, 1 minute
Release Date: August 20, 2023
Related Episodes:
Berkshire Hathaway Part I (Season 8, Episode 5, 4/20/2021)
Walmart (Season 11, Episode 1, 7/18/2022)
Nike (Season 13, Episode 1, 7/24/2023)
Fantastic writeup on Costco's business model! The scale economies shared concept is so powerful - passing 89% of cost savings to members creates a self-reinforcing flywheel that competitors can't match. What strikes me most is how their strict 14% markup cap and refusal to use loss leaders builds such genuine trust with customers. The intelligent loss of sales philosophy is counterintuitive but brilliant - accepting lower revenue to achive higher efficiency. Sol Price's principles continue to shape modern retail in remarkable ways.
Fantastic summary of the Acquired episode! Jim Sinegal's quote about not being a 'tricky business' is deceptively simple but captures the genius of Costco's model. What really resonates is how they resisted the temptation to optimize for short-term profits - maintaining that discipline for decades is incredibly rare. The private label stratgy with Kirkland Signature has been masterful in creating both value and brand loyalty simultaneously.