Costco: Analysis of Achievements and Failures

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Costco: Analysis of Achievements and Failures

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I will be looking at the company Costco as an outside analyst and will be examining the problems they are currently experiencing with keeping their rotisserie chicken at a price of US$4.99. I would like to first start off by providing some background information on the company.

Costco, one of Canada’s largest retailers, started off in San Diego with its first location under the name Price Club in 1976. Entrepreneur Sol Price came up with the concept of providing memberships exclusively to business members so that they could benefit from unrivaled saving on supplies and wholesale items. Several years later, Jim Sinegal, who was the vice-president of merchandising, distribution, and marketing at Price Club, co-founded Costco Wholesale with Jeff Brotman and had Costco memberships open to individuals in addition to business owners. They opened the first warehouse location in Seattle, Washington in 1983. In 1993, Price Club and Costco Wholesale merged which eventually lead to Costco becoming the largest profitable warehouse club globally. Costco, being the second-largest retailer after Walmart, generated on average USD$141.6 billion in 2018 ranking it #14 on the Forbes Fortune 500 list. Costco is able to sell products at low prices by purchasing very large volumes, therefore reducing their cost per unit. Another reason they can sell products at low prices is that they carry only a few thousand unique products while a company like Walmart carries several thousand products that are not necessarily unique which means Costco has bargaining power over its suppliers. Many of the products they sell are packaged in bulk and is marketed for the most part to large families and businesses. The company also has its own private-label brand called Kirkland Signature where they provide top quality products with the lowest achievable prices.

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It’s only US$4.99, but Costco’s rotisserie chicken comes at a huge price, the company’s Kirkland Signature rotisserie chicken seems to be a good way to bring customers into the store to shop. With an attractive price that is lower than its competitors and with the increase of Americans eating chicken, this could be looked at as a good trade-off where the company may be sacrificing some revenue from its chicken but gaining revenue by customers coming into the store to buy the chicken in addition to other items. Like is stated in the article, “Costco was willing to sacrifice ‘US$30 million, US$40 million a year on gross margin by keeping it at US$4.99′. Another challenge that Costco faces when it comes to keeping costs low is related to supply like stated in the article, there has been an increase in Americans eating chicken and this has resulted in Costco heavily relying on their suppliers who therefore have a lot of power over the price they set on the chicken they sell to Costco. As stated in the article, “A small number of massive producers dominate America’s chicken supply: Tyson, Pilgrim’s Pride, Sanderson Farms, Perdue and Koch Foods. Together, those companies control more than 60% of America’s $65 billion poultry market”. Another issue that Costco is currently dealing with is the fact that bird weights are increasing, and they need birds around six pounds to cook in stores. Birds that are seven or eight pounds would not be able to fit on their rotisserie line, so it is becoming increasingly difficult to find suppliers that carry six-pound birds. With the plans to open a poultry plant in Nebraska, Costco has been getting backlash from environmentalists and farmers’ advocates as many people are worried about the health risks associated with the plant. For instance, a poultry farm in Iowa, which is near Fremont where the poultry farm will be constructed for Costco, had high levels of nitrates in tap water which can potentially kill pets and make people sick. From what I have read in the article, Costco is dealing with multiple issues when it comes to keeping the price of their rotisserie chicken at US$4.99.

I will now conduct my analysis. I will start off by using an analytical tool that examines the external environment and that is Porter’s 5 forces model. The threat of entry is moderate even though the barriers to entry are high because Costco’s competitors Walmart, Target, and Kroger have the capabilities and cash flows to enter the business as they are massive retailers. If Costco’s experiment turns out to be beneficial, other retailers will attempt to mimic it. We already see, however, that Walmart has vertically integrated with part of its Angus beef supply chain and has done the same with their milk supplies so the possibility of Walmart vertically integrating its chicken supply chain is high.

The power of suppliers, who in this case would be the farmers in Nebraska, is low. From the article it states, “Although Nebraska is not known for chicken production, corn prices have fallen in recent years, leading to interest from farmers looking for new opportunities. The United States’ trade war with China has also taken a toll on farmers”. This quote shows that farmers need to diversify in order to survive, which can be seen as desperation in the eyes of Costco, therefore, the company can provide lower wages. In addition to this, the farmers need to build barns to raise chickens and if operations do not turn out to be successful, farmers are not able to use these barns for other uses which further reduces their bargaining power.

The power of buyers, who would be the end consumers, is high. As rotisserie chicken is a standardized or undifferentiated product, the end consumer has negotiating leverage. Many stores carry rotisserie chicken such as Walmart, Kroger & Ralphs, Whole Foods, Sam’s Club, ShopRite, and Fairway. Costco managing to keep its price at US$4.99 while its competition has raised its price to US$5.99 shows you how much bargaining power the customers have.

The threat of substitutes is high in the poultry business. The producers that mostly dominate the poultry market are selling fewer whole birds and are instead chopping them up into breasts, thighs, legs, and wings as they make more profit from this. Although this may be a threat, since Costco will be vertically integrated, they can shift their focus to providing chicken breasts, thighs, etc. if need be.

Rivalry among existing competitors is high. As stated in the article, only a handful of producers make up 60% of America’s $65 billion poultry market. This would not be a concern for Costco as they will not be supplying chicken to outside companies as it will be entirely in house.

Another analytical tool I will be using is the strategy which looks at the internal environment as well as the external environment. Costco’s plans to vertically integrate can be looked at as a smart move as they can save up to 35 cents per bird when compared to purchasing from chicken suppliers as they are currently doing. This also gives Costco much more control over the production process and gives them the opportunity to sell to other retailers if they wish to do so to increase revenues. Another strategy Costco uses to reduce costs is using skylights in their warehouses. An activity that Costco performs differently than rivals do is packaging products in bulk and having shipping pallets put on the sales floor for customers to view without removing the pallet or individually stocking products on shelves. Investing in a poultry complex can be viewed as a trade-off, and trade-offs are essential to strategy, where those funds could have been used elsewhere.

Another analytical tool I will be using looks at the internal environment and that is efficiency. Overemphasizing efficiency can lead to a host of problems and with Costco opening a poultry complex in Nebraska which will be producing nearly half of its annual chicken needs, this could be considered one of the problems. An article by the Journal Star states that Nebraska has had a long history with natural disasters such as tornadoes, blizzards, and floods and this could potentially wipe out half of Costco’s chicken supply. When management solely focuses on efficiency, this makes businesses less able to cope with or recover from difficult situations.

In addition to the analytical tools I have already used, I will be using a tool that looks at the external/internal environment through climate strategy. As global warming worsens, governments will be cracking down on carbon-emitting companies with tougher regulations. Strategy companies can implement to be prepared for the future is internal carbon pricing. This way they can set a price on each ton of carbon dioxide emitted based on forecasts of future carbon prices in their area of authority so that they can better assess investments and mitigate risk. With the plans to open the poultry complex in Nebraska, this will most definitely result in CO2 emissions from the electricity and transportation linked with running this sector of the business. By incorporating internal carbon pricing, this will encourage the company to shift to cleaner sources of power and Costco will gain a long-term advantage over its competitors if they wish to also enter the poultry business.

The last analytical tool that I will be using is the one that looks at the internal environment, and that is a shared value that drills down on the network between societal and economic progress. Based on the article, Costco will be working with chicken farmers in Nebraska under a contract system where the farmers will need to invest in building the barns and maintaining it while Costco would be providing them with chicks and feed. An example of shared value would be Costco educating and guiding the farmers on how to raise the chickens as the majority of them have not grown chickens before. This would result in increased efficiency, quality, and sustainability which directly correlates to increased revenues that both the farmers and Costco can benefit from. Many companies deter from creating this type of shared value as the initial cash outflow to improve their supplier’s production process is large and only look at the short-term costs, not the long-term payoff. I would like to now propose three alternative solutions to Costco’s problem of keeping its rotisserie chicken at a price of US$4.99.

First off, sustainable management is a big one. Costco’s biggest source of carbon emissions is purchased electricity. This is no surprise as forty-one percent of CO2 emissions in America comes from this. Recently, Costco has been using solar panels (which convert sunlight into electricity) on new warehouse locations to reduce emissions. They can also implement these solar panels at their poultry complex to further reduce costs and these savings can be passed on to Costco, its customers, and its farmers, therefore providing shared value in the process. In addition to solar panels, Costco can invest in electric/hybrid modes of transportation (such as Tesla’s semi-trucks or Daimler’s Cascadia trucks) to move the chicken from the poultry complex to the several Costco warehouse locations they have across the country. If the company were to implement internal carbon pricing, this would encourage them to look for ways to reduce their carbon emission output.

Second, Costco can provide a financial incentive to the Nebraska farmers by providing them with a percentage of its revenue based on rotisserie chicken sales. Let’s say, for instance, Costco makes $200 million in a given year from rotisserie chicken sales and they provide the farmers with an end of year bonus of 0.25% based on the chicken sales. The farmers would then split the $500,000. This way the farmers are encouraged to work efficiently and to provide good quality chickens as their end of year bonus is directly tied to the sales of those chickens. With these factors considered, rotisserie chicken sales would then increase, and cost per unit would decrease.

Third, Costco should open four small factories with each producing twenty-five percent of its annual chicken needs in different parts of the United States. This way, they are reducing the risk of a natural disaster wiping out their only production facility. The company obtains resilience by having four small factories so that if one is wiped out by a natural disaster, three are remaining, therefore they can recover from this difficulty. If the factories are strategically placed around the U.S., this can reduce transportation costs as a semi-truck would not have to travel from one side of the U.S to the other and back to the only facility they plan on building in Fremont, Nebraska. In addition, with smaller factories, management can focus better on smaller groups rather than one big factory overseeing 950 workers (as stated in the article) to improve their production process eventually leading to an increase in chickens being processed in a shorter time frame.

I believe Costco should implement the first alternative as they are already working on reducing their carbon footprint. Since the company will be saving up to 35 cents per bird with the completion of the complex, these savings should be enough to offset the loss in increasing the price of their rotisserie chicken to US$5.99 as their competitors have done. By installing solar panels on the poultry complex, they are able to reduce the cost of electricity for the farmers which means those cost savings could be passed on to Costco as they would not have to pay the farmer’s as much money through their salary or hourly wage to maintain the premise. Costco could invest in SunPower solar panels which have are the best solar panels that are currently on the market and have an efficiency rating of 22.8%. Although the price tag may be high for these solar panels, and Costco will need plenty of them to install on their nearly 400,000 square-foot plants, it will pay off in the long run as there are no signs of the poultry business slowing down.

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