Costco Porter's Five Forces


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Taking a look at Costco through the lens of Porter's Five Forces.

Published in: Retail, Technology, Business

Costco Porter's Five Forces

  1. 1. Costco NASDAQ: COST Porter’s Five Forces 1
  2. 2.  Porter’s Five Forces is a model named after Michael E. Porter that takes into consideration five market forces that play out on any given company or industry. The five forces are: power of buyers; power of suppliers; threat of substitutes; threat of new entrants; and industry jockeying.  This model examines these forces thereby helping to determine a given company’s strengths and weaknesses.  Porter’s Five Forces is also a way to view the potential risks to which any given company may be exposed.  Porter’s is a valuable yet somewhat subjective tool. It is a starting point meant to encourage further discussion. 2 What is Porter’s Five Forces?
  3. 3.  Please note there is no official method to score the model. This method is simply a way to further categorize companies.  Each market force is scored on a scale of 1 – 5 with 1 representing the lowest threat and 5 representing the highest threat.  All five forces are totaled for a final score. The lowest possible score is 5 and the highest possible score is 25. implies a lower threat rating. implies a medium threat rating. implies a higher threat rating. 3 Scoring
  4. 4. Power of Buyers  The buyers are consumers like you and me.  There are no real switching costs involved. The company will refund the membership fee “in full at any time if you are dissatisfied.”  Costco’s commitment is to its members which is why it runs on razor-thin margins (TTM net margin is 1.8%).  Customers reciprocate via loyalty (Q32014 worldwide renewals were 87.3%)  Customers shop at Costco because of low prices and wide selection. But it’s not the only warehouse in town.  In most retail, customers call the shots.  Score – 4 4
  5. 5. Power of Suppliers  Suppliers provide the commodities and materials for what COST sells.  Generally speaking, COST sells its goods before it has to pay suppliers. As this continues, COST finances more inventory via payment terms versus working capital.  COST is not reliant on any one supplier, has never experienced difficulty obtaining inventory and has many alternate sources due to suppliers own risks.  Given the scale of COST’s business and rapid inventory turnover it would appear that suppliers enjoy the relationship.  Score – 2 5
  6. 6. Threat of Substitutes  Substitutes include Sam’s Club and BJ’s on the warehouse side.  Sam’s Club brought in about $57.1 billion in sales for FY2014.  The graph to the right shows COST (red line) vs. Sam’s (blue line) sales back to 2004.  The longer this goes on, the lower the threat of substitutes becomes as it demonstrates that COST has its customers as its number one priority.  Online sales for 2013 COST was ~3% of consolidated net sales; about $3.2 billion.  Don’t forget about  Score – 3 6
  7. 7. Threat of New Entrants  Barriers to entry at this point in the lifecycle are very significant. Economic barriers, tech barriers, logistical barriers, get off your butt and do it barriers. Is it worth it?  Competitors in the space have built up such a large presence that it would be a very tall order for another concept to just open up shop and dethrone any of these main players.  Loyal customer base, inventory control, product variety, scale, distribution, even parking are all factors that work against new entrants into the space.  Start-up costs are quite prohibitive.  Score – 1 7
  8. 8. Industry Jockeying  According to IBISWorld COST plus Walmart Supercenters and Sam’s Club control more than 80% of the overall “warehouse club” market.  Even if we exclude the Supercenters it’s still Sam’s Club and COST. Everyone else is fighting for a little piece of the pie.  Lest we forget about ecommerce, this is the new frontier in retail and is blazing the trail. Prime is becoming more powerful.  COST and WMT are also investing in online. COST online sales in 2013 were ~$3.2B, Sam’s ~$1.3B, AMZN $78B.  Score – 3 8
  9. 9.  Power of Buyers – 4  Power of Suppliers – 2  Threat of Substitutes – 3  Threat of New Entrants – 1  Industry Jockeying – 3 9 Score