Costco

Executive Summary

Costco limits what it earns on the goods it sells. Its buyers may mark a branded product up by no more than 14 per cent, and are expected to stay well below that, so selling goods covers little more than the cost of the warehouses and the people who work in them. For most of Costco's history its profit came from the annual fee that members pay to shop there. In the year to August 2009, for example, the fees came to $1.53 billion, about 86 per cent of Costco's operating profit of $1.78 billion [1].

The cap is a ceiling, and Costco's managers decide how far below it to go. When Costco cuts a cost, by buying at scale or by paying a card company less, the saving can lower its prices, pay its staff more or become profit for its shareholders. Sol Price, who invented the warehouse club and taught Costco's co-founder Jim Sinegal the trade, held that savings belong to the customer. Since 2003, the year of two profit warnings, Wall Street analysts have complained that Costco serves its members and employees better than its shareholders.

In the year to August 2026 Costco sold a record $297 billion of goods and made a net profit of $9.2 billion [2]. The boost from its last fee increase, in September 2024, has worn off, membership is growing more slowly and Costco holds $20 billion of cash. Investors pay about 45 times its earnings for its shares, so they expect profit to keep rising. Costco has to decide once more how to divide what it makes.

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Cash or Cheque Only, 1954-1985

At ten o'clock on the morning of 15 September 1983 a warehouse opened its doors at 4401 Fourth Avenue South, in the industrial flats south of downtown Seattle. The building had been put up for Western Marine Supply, a seller of equipment for ships, and it looked like what it was: cement floors, an open-beam ceiling, steel racks and forklifts moving between them [3][4]. The advertisement in the previous day's paper promised "No Frills!" and warned that the store took only cash or cheques [5]. Its first customers were the owners of small businesses, whom the company had invited to a trade show in the warehouse that day [4]. Jim Sinegal, who ran the company, later said the crowds "weren't overwhelming" [4].

The company was Costco. Six months earlier Sinegal and his co-founder, Jeffrey Brotman, had sold 300 stakes of $25,000 each in a limited partnership, The Cost Club, raising $7.5 million [6]. Their plan called for about 12 warehouses, mostly in the Northwest, each selling perhaps $80 million a year [4].

The idea came from Sol Price, a San Diego lawyer who in 1954 had opened FedMart, a discount store for government employees that charged each family $2 a year to shop there. In 1975 Price sold control of FedMart to Hugo Mann, a German retailer. In 1976 the new owners fired Price, then 60, and he found himself locked out of his office [7]. On 12 July 1976 he and his son Robert opened Price Club in a converted aircraft hangar on Morena Boulevard in San Diego, with $2.5 million raised from friends and family [8]. It sold only to businesses, which paid $25 a year to join, and it marked most goods up by less than 10 per cent [9].

Price Club lost $750,000 in its first year [8]. "We almost went off the cliff for about the first seven months," Price later said [10]. A customer suggested letting in employees of governments, hospitals, banks and utilities, "the type of customers who were unlikely to bounce checks" [10]. With these members added, Price Club made $1 million in 1979 [8], and by 1985 the Price Company, which ran Price Club, had 20 warehouses and almost $2 billion of sales [9]. In 2003 Price told Fortune the rule he had worked by.

You are the fiduciary of the customer. You've got to give before you get. If you get something for a lower price, you pass on the savings.

Sol Price, founder of Price Club, to Fortune, November 2003 [11]

Sinegal had learned the trade from Price. He started at FedMart in 1954 as a bagger while studying at San Diego City College and rose to executive vice-president. He held the same post at the Price Company in 1978-79 and then ran a business that sold food to retailers on behalf of manufacturers [12]. Brotman, a Seattle lawyer whose family owned clothing shops, had admired the hypermarkets he saw on a trip to France, and his father encouraged him to look at Price Club [13]. Brotman asked retail contacts who could run such a business. "Jim was on most lists," he said; he cold-called Sinegal and flew to California to meet him [4]. In 1982 the two men drew up their plan [8], and they chose the name Costco over beers at a restaurant in south Seattle [14]. Brotman later explained why he thought the Northwest was the place to start.

I was very sure on one thing, that the retail environment in the Northwest was completely noncompetitive. I was absolutely certain that anybody who came into this market and offered high-quality products at low, good values would succeed.

Jeffrey Brotman, co-founder of Costco, to the Seattle Times, 1997 [15]

Costco copied Price's model closely. Business members paid $25 a year [16]. Individuals who belonged to an approved group, such as a credit union, paid no fee but paid 5 per cent more than business members at the till [6]. Costco stocked few items and bought each in such volume that it could sell close to cost. A decade later its warehouses carried only about 3,500 to 4,000 products, where a discount department store carried 40,000 to 60,000 [17].

Profits took time. Costco had seven warehouses by the end of its first full year, to August 1984, and lost $3.3 million on sales of $101 million. In the following year it opened eight more, including its first in California and its first in Canada, at Burnaby, near Vancouver, and lost $5.7 million on $366 million [6]. In the quarter to November 1985 it made its first profit, $38,000, and on 5 December it sold shares to the public at $10 each, raising $35.2 million [6]. In 1985 it also put a hot dog cart in front of the Seattle store, selling a hot dog and a soda for $1.50 [8], a price it has not changed since.

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Sam's Next Door, 1986-1993

Costco was not the only company copying Price. On 7 April 1983, five months before Costco opened, Walmart opened the first Sam's Club in Midwest City, Oklahoma [18]. Sam Walton, Walmart's founder, made no secret of where the idea came from.

I guess I've stolen—I actually prefer the word "borrowed"—as many ideas from Sol Price as from anybody else in the business.

Sam Walton, founder of Walmart, in his memoir Made in America (1992), as quoted by Fortune [11]

For a few years the market grew fast enough for all three. In 1987 Costco had 39 warehouses, Sam's 49 and Price 35 [9]. Costco's sales passed $1 billion in its fourth year, reaching $1.37 billion in the year to August 1987 [19]. Not every market worked. On 1 May 1988 Costco closed its three warehouses in Minneapolis and Milwaukee and took a $4 million charge [20]. But it kept opening elsewhere, and in the year to August 1992 it sold $6.5 billion of goods and made a net profit of $113.3 million. By December 1992 it had 100 warehouses [19].

The scramble to open warehouses left little room for anyone else. By 1992 Price, Costco, Sam's and Pace, a chain owned by Kmart, operated 91 per cent of America's membership warehouses [21]. Sam's had more than 250 warehouses and could draw on Walmart's money [21]. The warehouses had also begun to take sales from each other, Costco's own included. In the first half of Costco's 1992 financial year, sales at warehouses open for more than a year, the measure retailers call comparable sales, grew at an annual rate of 15 per cent. In the third quarter they grew at 12 per cent and in the fourth at 5 per cent. In their letter to shareholders in December 1992, Brotman and Sinegal blamed new Costcos taking sales from old ones, "increased competition in our industry" and a weak economy [19].

Investors had already grown worried. On 1 September 1992, three months before that letter, Costco cut the starting wage of new employees during their first three months by 15 per cent, to as little as $7 an hour; the average hourly wage was $12. The Seattle Times reported that the company had been under "pressure from Wall Street" as that growth slowed [22]. Sinegal played the cut down.

It only affects the first three months. We've maintained the same wage structure after that.

Jim Sinegal, chief executive of Costco, to the Seattle Times, November 1992 [22]

The Price Company was in worse shape. Under Robert Price, who had succeeded his father as chairman in 1988 [9], it had stayed almost entirely on the West Coast, and in July 1993 BusinessWeek wrote that it had left "the rest of the country wide open for more aggressive competitors" [9]. It also owned shopping centres and other property, and in 1992 its profit fell for the first time since it had gone public in 1980 [9].

The two companies had already tried to merge. According to the International Directory of Company Histories, the threat of a takeover by Sam's led Price to open merger negotiations with Costco in 1992, and the talks broke down because the two sides could not agree on who would run the combined company [9]. Sam's had looked into buying Price or Costco, and so had Kmart [23].

By the spring of 1993 Price had 94 warehouses in eight states and 8 million members. Costco had 102 warehouses in 15 states and western Canada and 6 million members [21].

Sinegal and Brotman could try again with Price. A merged company would buy goods for almost 200 warehouses instead of about 100, and analysts quoted by the Seattle Times said it would have more money to fight Sam's [21]. Against that, the 1992 talks had failed over who would be in charge, and the two companies did not want the same things: Price had built a property business that Costco did not have, and Price had chosen not to expand east, where Costco wanted to grow. Costco could instead stay independent and keep to its plan of opening 20 or more warehouses a year, paid for in part with the $300 million it had raised in June 1992 by selling bonds that could be turned into shares [19]. Or Costco's shareholders could accept that the industry was consolidating and sell the company to a larger rival, such as Kmart, while its shares still fetched a good sum.

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