Costco - Culture and Competitive Advantage

An enduring competitive advantage is a must in any would-be investment.  Generally, there are just a few kinds of "moats" including a low-cost position, high switching costs, high barriers to entry and network effects.  In rare cases, a corporate culture can be included on this list.  Part of the reason investors ought to be wary of investing in a company based on its culture is because it's inherently difficult to measure, particularly for outsiders.  Nearly all companies insist in public that they have a one-of-a-kind culture, and the loyal, motivated staff that goes with it, but usually it's not true.  In addition, while a winning culture only exists if it has spread throughout an entire organization, it takes just one imperious, foolish or unethical CEO to destroy it, so even if it exists today, it may be gone tomorrow.

A recent BusinessWeek article makes a compelling case that Costco belongs to the very short list of companies with a culture so favorable to employees that it gives the company a competitive advantage, and is so ingrained that it's almost certain to endure over many decades.  In general, and unlike many of its competitors, Costco sees workers as an asset to invest in, rather than a cost that must be reduced.  (Costco's unique culture also includes a genuinely customer-friendly approach, and a commitment to keeping costs low that’s double-stitched into the company's DNA, but this particular article focuses on employee relations.)

In the US, Costco pays workers an average of nearly $21 per hour, almost three times the minimum wage and about twice what most notable competitors pay.  In addition, the company's health care package is far more attractive than what rivals typically offer.  In fact, many competitors are cutting workers' hours to below 30 per week, the threshold at which Obamacare would force them to offer coverage.  The company insists that its generosity isn't charity, but is motivated by bottom-line results.  Not only does a generous approach lower turnover and training costs, the company notes, it increases loyalty and productivity.  There's much truth to this claim.  Turnover is a mere 5% for workers who've been with Costco over a year, and a vanishingly small 1% for executives.  These saving indeed hit the bottom line: net income was $1.7 billion in the year ended 2012, up 33% from 2008, despite a stagnant economy.  

However, it's clear that there's a moral element to Costco's approach.    The CFO acknowledges that the company could make more money if wages were lower by a few dollars an hour, but says simply "We're not going to do it."  In short, the company simply believes that it's the right way to behave.  Jim Sinegal, Costco's long-time CEO and head culture-maker, recently retired.  This represented a rare occasion where, if handled poorly, the company's principles could have been undermined.  It didn't happen.  The new CEO believes the same things as his predecessor.  It doesn't hurt that the board includes Berkshire Hathaway's Charlie Munger, who, along with Warren Buffett, has been instrumental in building one of the business world's most unique and impressive corporate cultures.

While its culture is likely to give Costco an ongoing edge over its brick-and-mortar rivals, a long-term competitive threat exists online.  Amazon and similar firms have largely cut out workers, since they've cut out the physical retail channel altogether, and sales over the internet are growing significantly faster than in-store buys.  However, the faster growth is happening from a very small base, and Costco's large scale will allow it to offer low-priced wares online just as it does in the physical world.  In summary, Costco has a wide, shark-infested "moat" that's likely to ensure stellar long-term performance.  Currently, the stock is trading at a designer price, not at a discount, but Costco possesses all of the other elements of a superb investment.  

Source:  www.businessweek.com/articles/2013-06-06/costco-ceo-craig-jelinek-leads-the-cheapest-happiest-company-in-the-world

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

A Summary of James Surowiecki's "Boom or Bubble"

Warren Buffett has noted that two highly important data points have a gravity-like effect on the stock market: the price/yield of bonds, and the ratio of corporate profits to GDP.  He remains bullish on stocks, explaining that they are attractive compared to bonds.  In the past, Buffett would likely be cautious about the second number, though, given that corporate profits now stand at over 10% of GDP, far higher than the 6% it has averaged in the past.  Yet he remains upbeat on the value of stocks, and James Surowiecki explains why.

In "Boom or Bubble," Surowiecki explains that three secular shifts have boosted corporate profits, and why those inflated earnings are here to stay.  First, the average corporation paid a tax rate of nearly 50% in 1951, over 30% in 1965, but now pay only 20% or so.  As corporate tax rates have fallen almost everywhere in the past few decades, any movement from here will almost certainly continue in a downward direction.

Second, the denominator - US GDP - is no longer as relevant as it was in the past.  Due to globalization, a third of corporate profits now come from abroad, compared no almost nothing a few decades ago.  Moreover, the mature US economy will grow at a significantly slower pace than the economies of the developing world, so the non-US portion of profits is sure to grow over time.

Third, the decline of unions combined with a sluggish job market has led to a much diminished labor force.  For years wages have risen slowly, if at all, and every dollar not spent on salaries and benefits boosts a firm’s bottom line.  Even as the labor market strengthens, Surowiecki suggests, increased sales will likely counteract any pressure from squeezed margins.

Anticipating the predictable response - that people always claim that "This time is different" as bubbles inflate - Surowiecki argues convincingly that this time is indeed different.  Wary investors should step off the sideline and into the game, because US stock markets are likely to keep setting records for years to come.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.