I was listening to the Acquired podcast episode on Costco, and found myself nodding in wonder: it’s such a different company, and there were so many lessons there that I found myself wishing I had taken notes.

Lo and behold, the podcast has an entire transcript on its website! So I took the liberty of selecting some excerpts (which resonated with me), and typing up some comments here.

Each block has an excerpt, my TLDR, and some comments ‘bout implications or questions I have as a result of each excerpt.

Many thanks to Alan Tien for sharing this wonderful podcast episode on his LinkedIn!

Source of notes: https://www.acquired.fm/episodes/costco

1. Stick to your principles, and apply them in your operations

One more piece of FedMart playbook, shall we say, that clearly makes its way over, as Sol is running the company during these first few years, he starts to codify some retail management philosophies. He famously canonizes these as FedMart’s four priority order principles. He teaches every new employee throughout the whole company about this.

(1) First priority, provide the best possible value to customers. (2) Second priority, pay good wages to employees and provide good benefits, including health insurance. This is in the 50s. This is progressive stuff. (3) Maintain honest business practices. (4) The last one, make money for investors. If you’re a Costco nerd out there, and there are probably many Costco investor nerds listening right now, those all probably sound very familiar to Costco’s priority order values.

Ben: Right. Not the same, but rhymes. Put a pin in it. When it comes to Costco, we’ll bring those up and go into each of them in depth.

David: You might be listening and saying, yeah, that sounds good. Maybe I go to Walmart today, or I walk into Target, and I see some similar things written on the walls there, isn’t this all the same? If you really mean them? No. There are some very, very clear trade-offs that Sol is going to make with FedMart that Costco makes today that are very different from what their competitors do.

Like do you sell loss leaders in the store, loss leaders being when you mark down items below your cost in order to attract people into the store with sales? If you’re those other retailers, yeah, of course, this is a time-honored tactic and retailing. Of course, you’re going to use this.

Ben: Sam Walton bragged about it in Made in America about, we could get this incredible number of, I don’t even remember what the thing was, but build a pyramid of them in the parking lot, blow them out to get people to come, and participate in the spectacle.

David: If you’re Sol and Costco today, you’re absolutely not going to do this stuff.

Ben: No, they won’t sell something unless they can make money on it.

David: The flip side of doing loss leaders is that you have to make up for it somewhere. You got to markup other goods in the store to fat margins to make it worth doing the loss leader for you. Basically, it means you’re treating your customers like they’re stupid.

Ben: Totally. That’s exactly my read on this, too. I feel like Acquired number one tenet: treat the audience like they’re smart. If you’re going to ever do loss leaders, you’re violating that tenet and saying like, we’re going to get one over on our customers.

David: Totally. This is anathema to Sol. He passes that down to Jim Sinegal. It’s anathema to Jim. That’s one trade-off.

Here’s another really big one. What do you pay your employees? In 2006, Harvard Business Review published a really great piece called The High Cost of Low Wages, where they very directly compare Costco and Walmart employee salaries and benefits.

Ben: For our listeners, if you want those numbers today, Costco’s average hourly wage is $26 and Walmart’s is $19.50. Huge, huge difference if you are going to go get an equivalent job at one or the other. On top of that, at Costco today, you also are eligible for a 401(k) with a match and very, very good healthcare, shockingly good health care, even for hourly workers. If you’re going to go work at one or the other today, you’d be very lucky to go work at Costco.

David: Obviously, the trade-off of this is for FedMart at the time and straight through to Costco today. This creates meaningfully higher per employee labor costs for the company.

Ben: Totally but what are the benefits? This is where we get this beautifully interlinked set of trade-offs that play well together. What do you get? You get low employee turnover. When I say low, I mean very low. After the first year, Costco today has only a 7% attrition rate among their workforce.

David: This is for hourly labor.

Ben: Yes, typical retail is 20%. It is a meaningfully lower cost to onboard and train new employees. You normally have to spend a lot of your money ramping people to get them up to speed. Costco, Price Club, FedMart doesn’t have to do any of that because they’re really rewarding their employees.

Employee loyalty also reinforces the idea that people shouldn’t steal. They feel grateful for this job. They’re excited to be in it. The shrinkage or the unaccounted-for merchandise at Costco today is astonishingly low. It is 0.15% of sales.

David: That’s crazy.

Ben: Merchandise does not walk out the door. Their strong bias also is to promote internally. If you look at Costco today, 36% of US employees have over 10 years of service.**


  • Costco’s principles serve as constraints which guide their operations and tradeoffs
    • e.g. they always make a margin on everything they sell, and never use loss-leaders as a result of the principle to always make a margin on everything they sell
    • e.g. they pay some of the highest salaries in the sector $26 /hr vs Walmart’s $17/hr. This is a corollary of their principle “pay good wages and benefits to employees”, and is an upfront cost: however, this results in a longer-term savings, as they do not need to recruit or train new hires due to lower attrition & increased loyalty.


  • How did Sol Price discover these four principles?
  • How does this apply outside of Costco/FedMart?
    • Perhaps the point about tradeoffs, and the subsequent recursive benefits/costs e.g. with higher salaries, is that the real benefit actually comes later in time, downstream & after the nth iteration (when your competitors need to pay to hire and train)
    • This might mean losing out in the shorter term, but just being focused on the longer-term.

2. Sometimes, the most precious pot of gold is sitting right under your nose. Superior economics allow for concentration & efficiency

David: Yup. Sol and Robert are sitting around in their new office, brainstorming what’s their angle of attack here. They keep coming back to one part of the FedMart business that they felt was underappreciated and they didn’t really exploit enough while they were at FedMart. That is the division that Jim Sinegal ran, the centralized warehousing operations.

The two of them I(sic) like, if we zoom out, there really is a different and orthogonal way to think about the FedMart business. You really could say that Jim ran our warehouse operations like its own business. They were supplying the individual FedMart stores, which were smaller businesses. When you look at it that way, almost all of the margin that we made at the company was at the warehouse level. The stores themselves were not particularly profitable and pretty hard to compete with the competition out there.

Ben: I didn’t realize that they thought to slice the margin up into those two, almost like places in the value chain.

David: Yeah. They’re like, well, is there a way that we could take Jim’s operation, recreate it, and make that the core business instead? The business plan that they come up with is literally that. Create warehouses for other individual small businesses, other retailers. They’re envisioning gas stations, restaurants, small variety stores in the independent chains, that they can come and shop to stock their own shelves at the centralized warehouse that we’re going to operate.

Ben: Just business owners can be members.

David: Just business owners. They’re like, man, if we did that, I think that would be providing a huge service to these small businesses, because one of their big problems that we know from operating the FedMart stores is actually how you manage your inventory, like physically where you put it. You need a centralized warehouse to hold your inventory. If you’re a small gas station, you don’t have your own warehouse. We can be your warehouse.

Ben: Right. To put a finer point on it, the reason why it’s awesome to just run warehouse operations is because the logistics are simple. You are taking pallets of stuff, and you are moving it to a location in a warehouse, and then the customer comes and takes a huge amount of it off your hands. You don’t really have to turn and make sure the labels are facing out. You don’t have to deal with little one-offs. We’ve only sold 16 units, but there are actually 127 units on this thing.

Everything is nice, easy, big quantities, and doesn’t require a lot of attention from your staff. Being in the wholesale business is good if you can get it, but their inclination at this time is well, the only people who would be willing to shop and buy in that way are business owners. This would never work as a consumer concept.

David: Yup. All of that, totally true and amazing parts of the Costco model. There’s one piece in particular that really, really makes this a crown jewel. It’s the reason why they were so enamored of what Jim was doing. If you’re operating a wholesale warehouse, you don’t have to operate any logistics. The manufacturers deliver the product right into your warehouse. You don’t need to run trucks, you don’t need to operate other warehouses, you don’t need to move stuff around the country.

Ben: Right, and the business owners just come to you and pick it up right from the warehouse where it was delivered right from the manufacturer.

David: Totally. Because of all this, because this new business, this Costco going to be called Price Club, is providing such a valuable service to the small businesses that are shopping there and managing all these logistics for them. I shouldn’t say managing because Price Club doesn’t manage it either, the manufacturers do. They’re like, we can actually go back to that original Fedco membership idea. Instead of having it just be like a way to skirt around the law, we can charge real money for this membership because we’re providing real value out of this to the businesses.

Ben: Let’s just follow the cash flow cycle. They deliver to the warehouse. The moment they drop off that pallet is when they invoice Price Club. Invoices tend to be about net 30, that means the pallet gets dropped off and you have 30 days to pay the supplier.

David: But the minute that the pallet gets dropped off in the warehouse, those goods are for sale.

Ben: Right. No more internal supply chain, no more unpacking, no more shelving. It’s just available to buy now.

David: In many, if not close to all cases with Price Club and then with Costco today, those goods are sold before Price Club has to pay the invoice to the supplier. It’s amazing. … Ben: All right, here’s how it all works today. Costco actually turns their inventory 12.4 times per year. Just for comparison, Walmart turns their inventory eight times per year, Home Depot is more like five times per year. At this number north of 12 times a year, David, exactly what you’re saying, it means Costco can sell through its inventory faster and more often than every 30 days. To be specific, they’re on about a 26-, 27-day sale.

David: This is amazing.

Ben: With typical payment terms being net 30, it means they literally have $0 tied up in inventory. In fact, they’re able, to your point, to make a few dollars on the float. This is, of course, an average. There are some things that will sell in a week or two, other big ticket items might sit for a month or two. Sometimes Costco can even turn things two or three times before they have to pay a supplier for it. This is called a negative cash conversion cycle, where vendors effectively finance Costco’s inventory for them.

Ben: There are two unique things that enable them to do it. One is this warehouse model, where things are instantly available for sale, customers come right to the place where they were dropped off. Not quite anymore, and we’ll get to that later. But at Price Club, that’s definitely what it was, and grab stuff right off the pallet.

The other thing that makes it all work is to this day, Costco has kept their SKU count very low, SKU being a unique item that a store has for sale. I think, David, you mentioned before, about 3000 at Price Club is what they had available for sale. If you look at a Walmart today, they have something like 100,000–250,000 different SKUs that they sell.

David: Super Centers, indeed.

Ben: Costco, in the last 10 years, was around 4500, and then they looked and said, can we bring it down? It went to 4000. Today, they’re sitting at 3800. This number is still going down, not up. If you do the math and you start thinking, geez, if you’re not selling a lot of SKUs, but you have a lot of customers coming through your stores, what does that mean? It means that any given item is going to turn faster. It’s this magical unlock, in addition to the instantly available for sale in the warehouse thing. It is the low SKU count that directly gives you the ability to turn your inventory over quickly.


  • The most valuable part of the FedMart model was actually Jim Sinegal’s warehouse operations, which had the highest margins. But this fact was obscured by the costs from the other parts of FM’s business, which prevented the FedMart management from really thinking about it until later.
  • The simplicity of logistics combined with a number of advantages:
    • you don’t need to deal with the logistics:manufacturers deliver it to your warehouse, while your customers appear to pick it up themselves.
  • These advantages combined well with the membership model.
  • The negative cash-cycle also allows Costco to focus on reducing their SKU, thus to focus & improve their efficiency (later there’s a learning point about how their buyers are able to get the best deals because they have focus on their products)


  • Sometimes it’s worthwhile to re-examine what’s underneath you, buried beneath the details.
  • If you are in a sweet spot, both your suppliers & customers will want you, and that could drive an arrangement that is cash-flow positive for you, and allow you to build more interlocking advantages.

3. Find a partner who complements your interests: you can provide value to their members, but they don’t want to do so.

It turns out it’s a lot harder to sell and recruit businesses to convey your customers than it is just putting out a shingle and attracting consumers.

Ben: There’s not a viral word of mouth necessarily among these business owners. They’re not just encountering each other everywhere all the time.

David: Exactly. They’re worried after a couple of months that this thing might not work. They might need to shut it down. And then they have the greatest stroke of luck. They’re going around San Diego trying to sell memberships to businesses. They get a meeting with the San Diego City Credit Union.

The credit union management are like, we’re a credit union, we’re not a retailer. We don’t really buy much stuff, we’re not interested in this. But you know what? Our members, if we could find a way to get them access to what you’re doing here, that might be a really good benefit that we could offer of like, oh, you can get wholesale prices on goods.

Giles, the wunderkind, young CFO, goes over to the credit union and hammers out a deal whereby any credit union member can qualify for a new “group membership plan” at Price Club, and be allowed to shop there just at slightly higher prices than the business members. It turns out that this does two things. This unlocks the gusher of consumers into Price Club.


  • see title.


  • find a potential partner who doesn’t want to do the “schlep” work, but who is interested in the value you might bring.

4. Viral growth relies on word-of-mouth: even a B2B business needs consumers to tell other consumers

Ben: Which allows for not only volume but word of mouth. These are the seeds that are sown of Costco today doesn’t really advertise. This is the first moment that they realize, oh, my gosh, consumers are going to tell each other about this thing.

David: Exactly, and it’s even better than that. Because not only do consumers tell other consumers, it turns out that a lot of small business owners are also consumers. It also drives small business owner membership. Because the business members get slightly better pricing on things, all of a sudden, all these consumers are running around and be like, oh, hey, I think my aunt owns a nail salon or something like that. Let me get her to go sign up and get a membership, and then I can use her card and get better prices.


  • B2B growth tends not to be viral: Sol Price struggled with the initial version of Price Club, until they hit the credit union which allowed them to ride the consumer word-of-mouth bandwagon.
  • That, in turn, drove their small business business (adjacent market segment?)
  • Important detail, though, is that PriceClub has a better deal for small businesses than consumers. i.e. there is differentiation between the different segments.


  • To target the small biz segments, maybe it’s worthwhile to figure out if there is a way to reach to consumers.
  • Pro-sumers market i.e. targeting professionals + consumers might be a good digital equivalent.

5. If you offer great value for money, experience-be-damned

…There is this interesting question that has now been answered, which is, there’s this horrible way of shopping, where I need to go buy in bulk directly from the warehouse. No good retail experience. Are consumers actually going to do that?

This whole thing was intended for business owners. There are all these benefits that come from selling to business owners. Again, you don’t need a separate retail area and wholesale area, the logistics are all much easier, you don’t have to ever have your own logistics to move stuff from your warehouse to a different store to sell it, but are consumers going to do this? They learned immediately, yes. It’s this shocking thing where it’s like, whoa, consumers are willing to just go to a warehouse and buy stuff right off the pallet. That’s a pretty unexpected thing that happened.

David: It turns out that there is really one pretty sure thing, at least in America, probably the whole world, that if you sell something at lower prices than anywhere else, you’re going to sell a lot of it, no matter what hoops people have to jump through.

‘Nuff said.

6. Membership + buying in bulk/upfront payments selects for wealthier, better-doing customers

Ben: One that we haven’t talked about is the economics of membership. There are the obvious ones that everyone realizes. Today, the base level membership is $60. As a consumer, I assume I’m getting some good deal by paying $60. Even before learning too much about Costco, I’m aware that that $60 is something I’m paying up front to get the benefit of some low prices later. Let’s analyze some of the second order effects of membership, which I think are potentially even more interesting than the obvious ones.

David: There’s a lot of psychology happening here.

Ben: Yes. The first one is that it actually selects for wealthy customers.

David: Yes, this is amazing.

Ben: As does buying in bulk. The items that you’re buying are literally cheaper per unit. You’re saving money, but you need to buy a lot of it upfront, just like you need to pay a membership fee upfront, which means that they tend to get members who are not sensitive to cash flow. They also tend to get members who have space to store stuff at home.

I looked into some of the data on this to try and put some numbers to it. There was an independent research firm that found that the typical Costco consumer makes about $125,000 a year in household income and has a four-year degree. Walmart, by comparison, has a median income of about $80,000. Keep in mind, the median US income is $71,000, so Costco shoppers have a 70% higher income than the US median.

David: This is one of the most surprising things about Costco. They have the lowest prices, but they have the wealthiest consumers of any major retailer.


  • Interestingly, Costco selects for the wealthiest segments who are still looking for a good deal and also quality (later point). Because they are targeting lower per-unit costs, the absolute costs will be higher, which then filters for the wealthy.
  • Also, only the wealthier will be able to pay upfront


  • What is the equivalent of lower per-unit cost filter, which selects for the wealthier segments, in different markets?
  • What is the equivalent of pay-upfront filter, which selects for the wealthier segments in different markets?
  • This might not work for all industries e.g. in luxury, this would destroy brand value.

7. Membership - greater chance of members actually using the membership due to Endowment effect

Ben: It’s totally fascinating, and very smart consumers. People who can look at the deal and go, actually, I know I’m coming out ahead on this.

Another interesting psychology around this is when you pay $60 up front, it encourages you to come and use the membership. You are more likely to shop because you’ve prepaid some of your margin dollars.

David: I think this is called The Endowment Effect, if I remember, back to my psychology classes.

Ben: Yes. You just assume that you’re getting some good deal by pre-paying for a membership upfront, so you want to go maximize the margin dollars that you’re able to get on their discounts, which is totally fascinating.


  • If people pay a membership, they are much more willing to use it.


  • Create your own cult, and make the cult members pay for it.

8. Membership creates a feeling of part of an “in” club means less shrinkage/theft/antisocial behaviour

Another one is that membership further decreases shrinkage. We already talked about the fact that employee retention is great for making sure people don’t steal things. This membership makes it so members don’t want to lose their membership. You feel like you’re part of some club.


  • An “in” club creates pro-social behaviours, which reduce costs by increasing trust (assuming not gamed)


  • Create your own cult!

9. Provide insane value to your customers by curbing your own greed(and focusing on quality), and your customers will stick with you

Ben: This is super interesting. Costco basically wants to provide insane value to consumers. They want you to get a better deal as a member than you could possibly get by shopping anywhere else. How do they go about doing this? They have enforced a strict cap on the margin that they are willing to make on any product. They have decided internally that they are not allowed to markup anything more than 14% above what the suppliers sell it to them for.

I’ll tell you, they are tough but fair with their suppliers and making sure that they get a great price for their members. Costco decides, we will only markup anything a maximum of 14%. They actually do mark other things up less than that because things like electronics, they actually can only mark up 6%, 7%, 8%. Maximum is 14%. The only exception to this is Kirkland Signature, where they cheat a little bit and let themselves go up to 15%. Quite indulgent.

How does this compare? I think that’s the interesting thing here. A common practice at department stores is literally 100% markup. Someone gets a good for $50, they sell it for $100. Even at Walmart, a “discount” marks up 25%, which is almost twice as much as Costco’s margin.

Jim Sinegal has a great quote on this. He was asked about it, and his response was, “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.”

There’s this great anecdote. I heard one, but there are 50 examples of this that you can find in various Tegus calls or talking with people who are suppliers to the company, where Costco buyers always ask why when a supplier tries to increase the price. That part’s not that novel. I imagine a Walmart buyer also tries to ask why.

The buyers are very deep. They actually know the commodity prices of ingredients from suppliers. Let’s take a chocolate company, for example, that sells a chocolate product. If the chocolate company said, hey, the chocolate cost more now, the Costco buyer would say, I know the price of cocoa, I’ve been watching the commodities market, I understand milk, sugar, butter, why is it more expensive, just give me feedback on that.

A lot of the times, it is like the commodity price has gone up, or they use labor in a certain area that’s gone up, or maybe they have a long-dated contract with a supplier of their own that has an artificially high price for some reason until the contract expires.

The Costco buyers will write all of this down, and will keep track of it. Because they manage so few accounts, they actually can keep track of it. Each buyer is only really adding 3, 5, 10, maybe 15 new SKUs a year, but you’ve managed a very tight set of relationships. They’ll just call a supplier back and say, hey, the last time we talked, you’d mentioned that cocoa prices were high, I’ve noticed they’ve gone down, are you lowering the prices so that we can lower it for our members? It’s this really amazing side benefit of having the low SKU count. They can be tough but fair with suppliers and really stick to it.

David: So awesome.

Ben: And because of Costco’s gross margins always being targeted at 11% capped at 14%, this means that for every dollar that Costco gets a supplier to reduce the price on something—again, tough but fair—the customer actually sees most 89% of the benefit. Costco really does just get to pass whenever they get a benefit, 89% of that benefit goes to the member.

The way I look at this is some companies always look for ways to make more margin. Costco specifically does the opposite. They look for ways to provide more value to members, retain them for members as longer, and get them to get their friends to be members. They try hard across the board to get lower overhead costs through cleverness and efficiency, not through squeezing, underpaying, or anything like that.

David: There’s a really fun Acquired canon, Acquired cinematic universe story related to this, which is the famous as chronicled by Brad Stone in The Everything Store, Coffee Date between Jim Sinegal and Jeff Bezos in 2001, which occurs at the Starbucks inside of the Bellevue Barnes & Noble, of all places. It’s so perfect.

At the time—this is 2001—Amazon stock was in the dumps. They were under pressure from Wall Street. Jeff and the organization were embarking on a campaign of raising prices on amazon.com to get profitable. They just started this rolling out. It was super important.

Jeff has this coffee with Jim. Jim explains this philosophy to Jeff. Jeff comes back to Amazon HQ the next day. He’s like, I’m reversing the policy and says exactly what you just said. There are two types of companies in this world, companies that work hard to charge their customers more and companies that work hard to charge their customers less. Henceforth, as of today, Amazon is a company that works hard to charge its customers less, and that is directly from Jim Sinegal.

Ben: Wow. That’s awesome. On this point number four of suppliers, here’s some quick math that illustrates why they do have to be so careful and why they do wield such an enormously large stick. Walmart’s revenue today is about three times Costco in the US. But since Costco sells so few items, they are a massive customer for any given supplier. They always have this super lopsided relationship. The average revenue per product because of the SKU count at Costco is about 10 times Walmart.

David: Wow.

Ben: Anytime they’re in a negotiation, almost every time, the person sitting across the table is looking at Costco like, you are my largest customer.

David: You’re 50% of my business.

Ben: It sounds so generic. I didn’t even put it together when I first moved to Seattle 12 years ago, that the Kirkland over there was of Kirkland Signature, because Kirkland just meant nothing to me. What’s the whole foods version, the 365? Interestingly, over time, Kirkland Signature has come to mean something, and that is a certain level of quality.

Nobody is attesting that this Kirkland signature sweatshirt is a Lululemon sweatshirt that has fancy materials and the most cutting edge technology in it, but it is of a certain bar of quality that is sufficient for Costco members. That is the ethos that Costco has around Kirkland Signature, that we’re only going to put something out there if we feel that we can create value for you, that it’s going to be a lower price than what you could get otherwise, or the flip side of that, that we can make a better product than you could get from any of these branded products that we were either previously stocking or evaluating stocking.

David: At the same time, too, as they’re spinning up Kirkland Signature in the mid to late 90s, they also start expanding internationally. First, they go to the UK, then they go to Korea, to Taiwan, to Japan, ultimately China, which is now a big initiative for them.

What’s interesting is I think at the time, I suspect there were very few other Western style, globally aspiring retailers that were entering Asian markets, because it’s not exactly obvious that a huge warehouse with bulk packaging would work in cultures like (say) Japan, where people live in tightly packed, dense urban environments, much smaller houses and apartments than in America. This is not the land of SUVs and suburbs, but it works great.

Ben: Yeah. At the end of the day, people really like value. High quality products at a great value is a super compelling value proposition for anyone in the entire world.

Costco essentially has its entire buying team’s ethos shopping for you. They’re pre-selecting the best one or two items in every category. Consumers, because they do all that work ahead of time, are basically just okay, sacrificing selection entirely and saying, yeah, as long as you give us good value on great stuff, we’re totally okay with that.

That’s an important unlock. You can’t just have low selection and be like, well, it’s all cheap stuff. It has to be high quality in its category and the best deal on the market in order for people to be okay with low selection, which drives low SKU count, which drives all the amazing things we’ve talked about so far.


  • Costco caps their own margins, and sticks to that to be able to pass value to their customers. This is a stark contrast from their industry peers, who frequently earn the extra dollar.
  • At the same time, they obsess about quality, making sure that their buyers know their stuff, and are able to provide high quality products
  • This integrity creates a win-win-win across Costco, their members & their suppliers, which builds long term trust across all parties.


  • Creating customer value is an evergreen.
  • If you keep creating value for your customers, they will keep coming back.

10. If your values and operations take care of your ecosystem, in the long run, your ecosystem will flourish for you and your owners

Ben: Yup. Okay, I was going to save this for later, but we got to do it now. The Costco code of ethics. As it exists today, largely inspired by the FedMart values from 40–50 years before are in order. (1) First and foremost, obey the law. We will save that for a moment. I’ve got a fun story of how that came to be. (2) Take care of our members.

Listeners, when you’re listening through these, the order is important, the subject of each statement is important, and the phrasing of each statement is important. (1) Obey the law. (2) Take care of our members. (3) Take care of our employees. (4) Respect our suppliers. I find it fascinating that they use the word respect, because they have a posture of tough but fair.

Ben: Notoriously missing from these four is the notion of a shareholder. Jim Sinegal articulates, if we do these four things throughout our organization, and again, those four things are obey the law, take care of our members, take care of our employees, respect our suppliers in that order, then we will achieve our ultimate goal, which is to reward our shareholders.

The company was fortunate to realize at very early days, how much it would pay off to be truly above reproach. No matter how tempting anything was, they had to build a culture that was completely obsessed with this code of ethics.

You just see it everywhere. The wages, the way they treat suppliers, the fierce fix cap on markups, the discipline not to raise memberships constantly. I think it’s been six years between the last two times they raised the membership, even $5. It’s a ludicrously squeaky clean and long-term–oriented mindset.


  • Costco’s timescale is also long term. They think long-term and behave respectfully towards long-term partnerships, hence they and their ecossytem still flourish.
  • Notably missing from Costco’s equation is a focus on the ultimate result: they are focused on the causes & drivers of great shareholder returns, not on great shareholder returns per se. They are not resulting, but are instead focusing on the drivers of results in the long term
  • Interestingly, Costco’s policies are also sustainable in the short term i.e. they don’t make any loss-leaders.


  • Thinking long-term and focus on building up your drivers of success is more important than focusing on results alone.

11. Intelligent loss of sales

David: Yeah. This isn’t necessarily the number of brands in terms of the selection out there. This is about product sizes. Today, Costco has taken this to the extreme of like, you can only buy the 2½ pound jar of nuts. There’s no eight ounce jar of nuts.

Ben: You can buy a whole bunch of little packs of afternoon packs of nuts.

David: Either way, you’re walking out with a lot of nuts. But other retailers and everybody back in the FedMart days had all sorts of different sizes of products. The idea was that, by having different sizes, you would maximize the surface area of customers in-market that you could reach. Sol uses the example in the book of household lubricating oil, like WD-40 type stuff.

He’s like, we only carried the eight ounce can, even though there was a three ounce can out there. We lost some sales from customers that only needed one or two ounces, and thus would only buy a three ounce can, and they just didn’t buy the eight ounce can. But it was worth it to us to forgo that, because by only having the eight ounce can, we could reduce the number of SKUs that we had and get all these benefits that you’re talking about, Ben.

Ben: Right. This stuff is all about the trade offs you were willing to make and just daisy chaining them together such that the benefit of each trade-off plays into the benefit of another trade-off that you are making in a way that’s aligned.


  • This is really about focus: focusing on what really matters to you, rather than chasing after every little bit of consumer surplus.
    • Losing sales because they didn’t have that sales format also meant they could benefit from having fewer SKUs. They have higher cost-benefit, because they are willing to forego the cost of having that marginal sales/margin, in order to focus.
  • Customers are more sensitive to price than to selection.


  • What marginal customer segment or need can you drop?

12. Creating a Strategic Flywheel from economies of scale, to give back to customers

The first segment that we’re going to do in our analysis here is power, which is adapted from Hamilton Helmer’s Seven Powers book, which is an amazing framework for business strategy. The question here is, what is it that enables the business to achieve persistent differential returns? Or put it another way, how can a business be way more profitable than their closest competitor and do so sustainably?

The seven options are counter positioning, scale economies, switching costs, network economies, process power, branding, and cornered resource. There’s one here that is so painfully obvious that has been observed over and over again over the years. The original credit goes to an investor, Nick Sleep. The power is scale economies. It’s Hamilton Helmer’s notion that Costco has the ability to leverage their scale to compete for items that their competitors can’t get, or perhaps get a better price from suppliers than any of their competitors.

Nick Sleep has this phrase that I think is possibly **the best way to describe Costco. Scale economies shared with customers. The flywheel looks like this. Costco has enormous volume. What they do with that volume is they go to the supplier and they say, what is your absolute lowest price where you’re still making an honest margin on this, but you’re willing to sell it to us?

Costco makes sure of that, they do their research, they come to a price, and they say, great. Then Costco looks at their own business and they say, how can we have the lowest possible overhead? What is the smallest amount of dollars we can spend at our head office, turning the lights on at facilities? What is literally the leanest we could possibly run and still breakeven or generate a small profit? That’s how they come up with this 11% target gross margin number.

What they do then is they mark up the goods, literally the smallest amount that they can in order to share the most value with their shoppers, with their members. And then the cycle repeats. They get more members, they get better deals from suppliers. To be honest, this scale economies that they then share with customers, I don’t know how anyone could ever catch them in this moat that they’ve built from that**.

“Costco will never generate excess margin because of their brand, but their brand earns them something. People become members and trust them, and that leads to something. I assume it leads to volume, it leads to willingness to buy, which leads to volume, or it leads to retention. This is the second episode, where it’s not branding power under Hamilton’s definition. Its latent branding power.

David: Yup, just like the big one was scaled economies here.

Ben: In a lot of ways, I think what Costco is doing is, they realize that they have latent branding power and latent scale economies. They choose not to recognize short-term profits from those. I think it’s all this super long-term game, where this is why the market is willing to pay a much higher multiple for Costco than any of their competitors. There are a lot of ways that if Costco wanted to, they could make more money today than they currently do, but they’ve decided not to.


  • Costco’s main competitive edge is from economies of scale.
  • The other secret ingredient is that they generously share the savings and deals with their customers, which draws more customers, which gives them more leverage to negotiate better deals, which draws more customers, etc.
  • This builds up a very strong latent branding power for Costco. Which they do not exploit, as they focus on giving their customers value.


  • If you are able to create a strategic flywheel which will always provide more value to your customers, and your customers know it, and you do not betray that trust, then you’ll grow rich.

13. Use your existing advantages to find adjacent advantages in a new space

Credit cards

Ben: If you get the Costco-issued Citi Visa card, you renew at an even higher rate. They have these layers of letting you opt into loyalty. All of this, David, as you mentioned earlier, is on top of a high renewal rate anyway. Ninety-three percent of members in the US renew every single year.

David: Amazing. You can really see the fingerprints of this DNA in Amazon Prime. Obviously, the whole thing is inspired by the Costco membership writ large. But the same dynamics definitely play out for Prime members at Amazon of order more frequently, much more likely to renew, access a whole suite of services.

Ben: It keeps you in the Amazon ecosystem, and it makes sure that you’re buying more stuff. Amazon makes money on the stuff, Costco makes money on the membership, but at the end of the day, it is nice to retain a loyal customer. To contextualize the 93% member retention, again, that’s just all members. That’s not even the executive members or the credit card owners.

Subscriptions to streaming services renew half of their customers every year. Consumer subscriptions retaining at 93%-plus is nuts. That’s the monthly retention of most streaming services. It’s crazy. On top of all of this, I’m pretty sure that this has never been disclosed, and I haven’t asked anyone about it. But if you read trade publications, people seem pretty convinced that Costco is making money, which of course they are, on the deal that they caught with Citi and Visa, in order to have the Costco card be the Citi Visa card.

Most of the time, when you are processing payments, you owe 2%–3% of each transaction to the issuer of the card. I think the dynamics are actually the opposite way with Costco, where Costco gets to hold an auction and say, we have an enormous amount of payment volume with enormously good customers with good credit. Would you like to do business with us? And who would like to pay us for the privilege of being the Costco card rails?

David: I imagine there are not a lot of defaults in the Costco customer segment base. There’s also some fun history to all this, too. That deal, as you may know, Ben, used to be with American Express. And then they essentially held an auction as you say. I think the origins of this though start all the way back with the original Price Club business plan. Not to offer credit, but specifically not to offer credit.

Another one of the big benefits of moving to this business wholesale model was they could get out of the credit card game that they had to play at FedMart. When they were only selling to businesses, when that was the plan, it was like, hey, cash or check? That’s it. No credit card exchange fees that we’re going to have to bear. When they opened to consumers in the group model, they kept that. For a long, long, long time, you couldn’t use credit cards at all in Price Club Costcos.

**Ben: That’s the importance of doing the hard thing first. By proving that they could exist and set customer expectations around where only cash and check, it meant that they never had some scary moment, where if credit card companies were putting the screws to him, they had a bunch of fear around, well, customers not shop here. They were, just from the very beginning, getting 100% of the dollars rolling in.

They knew the counterfactual. They knew customers are going to shop with us no matter what. Credit card companies, if you want to work with us, you’re welcome to, but we do not need to pay for the privilege, because we know that our customers are not going to leave us for a fact.**

David: Yup. You’ll be happy to have our business, not the other way around.

Ben: It’s crazy. Of course, with Costco’s margin structure, they literally couldn’t. Speaking of trade-offs, they literally couldn’t ever accept credit. How with an 11% gross margin are you going to go give three percentage points of that 11% to a Visa? It actually would flip the business upside down. We talked about it a minute ago. They make $7½ billion of operating income on $230 billion of sales. The credit card companies eat all your profitability if you let them in the door. It’s a pretty incredible position, toughing it out and doing the hard thing first, and then being able to flip to the other side of the table.


  • Costco has a card deal where Citibank Visa is their membership card.
  • Rumor has it that Costco made money on this deal.
  • Main reason is because Costco initially didn’t have credit cards, but they built up their customer brand anyway: they did this hard thing first.Their customers also have very low defaults (due to the economic segment they belong to). So by the time Costco negotiated with Visa and Citibank, they knew the counterfactuals to the deal, and were probably able to walk away if needed.


  • Costco was able to leverage their membership base & successful model to negotiate into a new business


Ben: Yup, it’s exactly right. I do think this is an interesting area for Costco and ecommerce. The second one is costconext.com. Do you know what this is, David?

David: No, I didn’t find this.

Ben: It allows you to shop directly on other websites, put in your Costco number, and get a discount.

David: That’s awesome.

Ben: Costco cuts a deal with those companies to say, we’re going to send you traffic as long as the traffic we send you once you verify it, you give those people a discount.

David: This is literally like Ebates or Rakuten for Costco.

Ben: Yes. Costco looks at it like, oh, great, we get to give yet another value to our members without having to take on the ecommerce logistics that they hate that complicates their business, that changes people’s impression of what Costco is.

David: Fascinating.

Ben: It’s the obvious way for them to play this market for anyone who’s willing to partner with them.

David: Which again, to the supplier dynamics, it’s the same thing here. On the surface, if you’re XYZ ecommerce player, that’d be crazy. But then you think about it and you’re like, well, we could get a lot of very high value traffic. Maybe we should do this.

Ben: It’s like selling through Costco without having to sell through Costco, without having to physically drop stuff at their warehouse. It’s the Internet way to sell through Costco.

David: Amazing.


  • Costconext allows you to shop directly on other websites, key in Costco’s number, and get a discount.
  • This allows Costco to provide value to their customers, selling through Costco, without having to take on the ecommerce logistics cost, while retaining the brand identity they already have with their members.


  • This is only possible with the membership and brand they already have.
  • What is stopping Singapore from doing something similar, with regard to investments in the region?

#costco #acquired #business #lessons #strategy

Started on 11 Apr 24 at 1806hrs.
Finished on 28 Apr 24 at 1606hrs.