Costco will survive the apocalypse

or why actually caring about people generates alpha

This is a macro piece (I post daily to TikTok). I publish these once a week (beta phase), as well as single stock pieces (1-3x a month) and weekly market updates. I also publish on TikTok, Youtube, and Twitter!

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  • Costco in most financial analysis: Inelastic membership warehouses

  • Costco in reality: The Epitome of the Consumer

One thing I’ve been thinking a lot about is the ~Recession~. When the market collapsed inwards on Monday, it made sense that Costco was one of the only stocks to stay green (along with NVIDIA).

Costco is the heart of the American consumer.

And a lot of people tweet about the “American Eater” winning again.

I believe that Costco’s business model not only encapsulates the American Eater - but also the American Treasure Hunter, the American Car Fanatic, and the American Pizza Fan - in totality, the Consumer - but in a great way. They care about people- and that makes people their business model.

The *Massive* Business Model

Costco’s entire business model is efficient - 800 warehouses across 12 countries, ~$180bn in sales.

  • They have no bags at checkout and operate through bulk product sales.

  • The products are shipped in on pallets, which they remain on until they are sold to reduce transport and labor costs.

They basically serve MASSIVE quantities of good at discounted prices and promise nothing sparkly - just what you *need* (as well as what you *discover* at their stores, which you ultimately end up *needing*). They have a wide variety of goods, including jewelry, clothing, furniture, and home supplies.

  • Their most common item sold is toilet paper.

  • Largest wine seller in the U.S.

  • 2nd largest auto dealer through the Costco Auto Program

  • 5th largest optical company

  • 14th largest pizza chain

As evidenced by their leading market share in several core businesses outside of groceries (food), Costco is well-diversified.

  • That allows the company to support their main model of retail sales.

  • It also allows them to vary their revenue stream (diversification is the only free lunch in investing!) and get exposure to a variety of industries.

The Private Label

Another important aspect is the products that they are offering - Kirkland, their private label brand (which contributes 25% to their sales) - standalone “would probably be the largest consumer packaged goods business in America”.

A lot of big brands are hidden behind Kirkland - Starbucks makes their coffee, Jelly Belly makes their Jelly Beans, Stearns & Foster makes their mattresses, and more.

So Costco’s private label brand (which is really a bunch of very good brands in “disguise”) - and isn’t optimized for profitability or distribution - would be the largest CPG brand in America. And for good reason - suppliers have to create Kirkland lines at least "1% better" than the supplier's premium product based on an identifiable metric - Costco demands GOOD PRODUCTS.

  • Costco demands the best - and suppliers love it because they have 1) their product and 2) their product with the Kirkland branding (at a “slightly worse margin”)

    • They also treat their suppliers really well. They don’t squeeze every dollar out of them like W*lmart - quite the opposite.

  • Costco keep margins as low as possible - by intention.

    • They have a “shared scale economy” model where they intentionally keep prices low - for the good of the consumer. You might get 5lbs of tuna cans - but it’s a deal you *CAN* not miss heh

      • Also these bulk sales model allows total cart sales to be bigger too - leading to high sales per square foot in those big ol warehouses

  • This gives it pricing authority - you know it’s gonna be a good price because its Costco

The Growth

But how does Costco drive this growth?

Costco does not rely on pure product sales to grow.

  • Membership: They have an >90% membership renewal rate - and with 55 million members paying $60/year, that is extremely strong.

  • Big Money: Memberships are most of the profit that they make.

That’s important - the consumer subscription model is incredibly powerful. If you can be loyal to your customers, they will be loyal to you - and Costco has achieved that.

The Supply Chain

Costco also has a vertically integrated supply chain, including buying products directly from the manufacturers and using their Business Delivery Fleet to get the products to their depots located across the country. These are their key variables of efficiency:

  • Cross-docking: gets the shipments to the stores with as little storage time as possible.

  • Just-in-time inventory: they take into account both lead time and a sales cushion to find the best reorder inventory point, at which the product is immediately replaced - turning goods over quickly and efficiently

  • Fully vertical meat production: Breaking up the Tyson and Perdue chicken monopoly!!!

    • Costco currently sells 60M rotisserie chickens each year!! This vertical integration gives Costco control over 40% of it’s chicken supply, at a fixed price of $4.99 per chicken.

  • Managing produce: Fruit and vegetable waste is one of the biggest costs for grocers. Costco uses a tool called ZestFresh that basically helps them reduce waste and maximize shelf price - this ensures their fresh produce doesn’t go to waste, which will help them to operate more efficiently, and reduce the overall cost of goods sold.

Overall, Costco’s Supply Chain Management can be summarized in three words: “Minimize the Fingerprints”.

  • The warehouses are usually big stores (at least near) the middle of nowhere (cheap rent!!!)

  • They purchase goods directly from manufacturers - preventing that gnarly middle-man interference - and ship them to Costco depots, which then get shipped to Costco stores, all in under 24 hours (Amazon WHO?!?).

  • A Costco employee touches it for the first time at the cash register.

At traditional retailers, there are at least 5 different touch points, and even more if there is a middle man in the equation. Touch points add ~0.25 cents in cost to each product, which is why Costco is so operationally efficient. They have large warehouses, an integrated supply chain, and have made the process from manufacturer to consumer as simple as possible.

Costco has a similar business model to dollar stores, which I wrote about last week. They carry ~4,000 SKUs (whereas Walmart is much, much more) which is normally a mix of staples (toilet paper) and “treasure hunt” items (think: jacuzzi).

The Founder

This is what Bezos said after meeting Jim Sinegal, the founder of Costco:

Jim was solely focused on the customer. And the employees. He never had an exit plan with Costco, and that is one of the reasons that they are so successful. They actually got in trouble with Wall Street in the beginning because the banks didn’t think that they were taking good care of the shareholders *lol*.

Chris Bloomstran had a great point on Jim:

The profound long-term ability to think about what really matters in a business and it ain't quarterly profits. It is not getting rich in a hurry. It's getting rich long-term side-by-side with your shareholders, letting the entire universe that surrounds you win. Let your employees win, let your customers win, let your suppliers win to a point.

The story of the hot dog is most well known - the Costco hot dog is the most recession proof item in the world, with it’s price remaining $1.50 since inception. When asked if they could raise the price of the hot dog Jim said “I will kill you” if they did. That underscores how important the customers are to the Costco model - they are the model.

Final Thoughts

Costco is built different.

That’s mostly due to their values - they treat their employees, customers, shareholders, and suppliers really well, and that shows up in their operational efficiency. They carry carefully selected products, with the goal of providing the consumer the best possible option. They make money on groceries and goods - but they make PROFIT on their membership model.

People are the lifeblood of an organization. If you have unhappy employees - everyone will be unhappy. Costco was always building to truly succeed - for customers, shareholders, and the employees.

And the best part - customers love going to Costco - it’s this weird idea of togetherness, it’s this weird warehouse in an industrial park that somehow feels like a theme park and a journey all in one. It’s just one big adult theme park.

This is an evergreen business model - take care of your people, and the rest of it will work itself out (mostly) over time.

Disclaimer: This is not financial advice or recommendation for any investment. The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.