By  on January 30, 2012

Quiet and humble Costco Wholesale Corp. has big expansion plans.

The Issaquah, Wash.-based warehouse chain has earmarked $1.4 billion to $1.6 billion for capital expenditures. Co-founder Jim Sinegal, 76, who retired as chief executive officer Jan. 1 but is staying on in an advisory role for one year and maintains a seat on the board, said increases from this level are expected in fiscal years 2013 and 2014. “We would expect increased expansion activity as we’ve got more in the pipeline as well as an ongoing increase proportionally of some of the overseas expansion, which tends to be a little more expensive in some of these very densely populated major cities.”

While Costco is continuing to open stores in the U.S. — 20 are on tap for 2012 — it’s delving deeper into international markets. Costco operates units in the U.K., Mexico, Australia, Korea, Japan and Taiwan. In addition, Craig Jelinek, 59, the 28-year Costco veteran who was most recently president and chief operating officer and is succeeding Sinegal, has said that the company is eyeing major European cities, including Paris and Madrid.

“We’re looking at those markets, but there’s no formal announcement,” said Jeff Elliott, assistant vice president of financial planning and investor relations. “We have somebody there kicking the dirt around for us.”

“It’s been staggering how productive their [international] locations have been,” said R.J. Hottovy, a retail analyst at Morningstar. “One of Costco’s few hardships is finding real estate options for such large box sizes.”

“I do believe that the membership model run by Costco will prove successful in Europe,” said Sean Naughton, a retail analyst at Piper Jaffray. “While it will not be easy, the company’s limited assortment and sophisticated supply chain will help make it successful on continental Europe. The membership model has resonated well in Asia, Canada and Mexico and I believe Costco’s model will prove successful in continental Europe given the company’s limited assortment of high-quality merchandise.”

Part of the company’s success can be attributed to the demeanor of its executives. Jelinek is said to have the same trait, humility, as his mentor, Sinegal. In a speech to students at Seattle University last year, Jelinek said he puts his pants on “one leg at a time, like everyone else.” That lack of pretension is a hallmark of Costco executives, who shun the media spotlight, politely declining interviews. The company doesn’t have a public relations department. “We’re in a competitive business and don’t want to compromise any supplier relationships or divulge anything that might be considered proprietary from a competitive perspective,” said Elliott.

While Wal-Mart and Target have worried about being perceived as either too upscale or too bare bones — depending on the direction of the prevailing economic winds — Costco has perennially managed to straddle both ends of the spectrum.

The retailer satisfies budget-conscious shoppers and small business owners and caters to consumers who are discriminating to a fault. Costco’s business model — intentionally low margins coupled with high inventory turnover — has been a key to the membership club’s success. The retailer, which operates 596 clubs worldwide, puts a 14 percent cap on its profit margin for all products except its Kirkland private label brand, which earns 15 percent. By comparison, supermarkets typically have a 25 percent profit margin and department stores mark up their inventory by as much as 50 percent.

Costco’s warehouse club concept is built on keeping a low number of stockkeeping units in stock and constantly rotating them to match consumer preferences. Retail analysts said Costco sells about 4,000 stockkeeping units. Its major competitor, Sam’s Club, had annual sales just shy of $50 billion in 2011 and operates 660 stores. “Costco focuses on higher price point and quality items, which appeals to its core affluent customer,” said Naughton.

“We look at them as being one of the most disruptive forces in retail other than Amazon,” said Hottovy. “[Costco] gets the same kind of price power typically reserved for Wal-Mart and Kroger. Its merchandising team, we consider to be one of the strongest in retail. The proof is in Costco’s consistently excellent financial performance.”

Costco’s net sales for 2011 rose 14 percent to $87 billion from $76.3 billion the year before. Excluding sales from the company’s joint partnership in Mexico, the increase would have been 11 percent. Net sales for the first quarter of fiscal 2012 increased 13 percent to $21.18 billion from $18.82 billion during the first quarter of 2011. Comparable sales for the period ending Nov. 20 were up 10 percent in the U.S. and 11 percent internationally. Net income for the first quarter was $320 million, or 73 cents a diluted share, compared with $312 million, or 71 cents, in the previous year.

“Costco has a very long-term view” when it comes to low prices, slim margins, and the way it treats employees — and the company’s track record validates its approach, Jelinek said at Washington University last year.

The warehouse club sells office supplies, food, consumables and cleaning materials in bulk. Its range also includes furniture, pharmacy, health and beauty, electronics, even caskets — Universal’s Edward model is $2,999.99.

One category that has helped earn the retailer its upscale reputation is grocery and pantry, where oversize canisters of Starbucks house blend coffee sell for $45.69, Fini limited edition balsamic vinegar from Modena is $34.99 for 8.5 oz., and six 12-oz. D’Artagnan Kobe American Wagu-style strip steaks are $279.99. Costco is the largest wine retailer in the U.S. and offers all the accoutrements, including 450-bottle Vinotemp wine cellars for $2,199.99 and Apex custom wine cellar cooling systems. Food samplers wearing aprons offer nibbles. “Try some kettle corn,” said a worker on a recent morning. “It’s salty and sweet and tastes really fresh.”

A greeter-receipt checker commented on a package of ravioli in a customer’s shopping cart. “That looks really good,” he said. “Can I have some?”

The enthusiasm of the company’s (largely) hourly workforce is hard to find in other stores.

“Costco compensates employees very well, well above [the industry] in terms of wages and benefits,” said Hottovy. “When retailers are cutting health benefits, Costco employees really don’t have to worry about that. It’s a trademark of Sinegal, and will continue with Jelinek. The happiness and morale of employees goes a long way and it’s often overlooked in retail. Costco has one of the lowest turnovers in the industry and generates $530,000 in sales per employee.”

Costco’s ability to retain and entice its members to stay and spend more — even during the downturn in 2008 — is a testament to its merchandising prowess, Hottovy said. The club’s renewal rate is in the 89-plus percent range in the U.S. and Canada and 86 percent worldwide. Consumers with higher-priced memberships spend $200 a trip and up. Members at the “business” level have a renewal rate of 93.3 percent and for “gold star” members, it’s 88.1 percent. Membership increases of $5 to $10 a year went into effect in November, but members’ reactions remain to be seen.

Apparel occupies a prime piece of real estate smack in the center of the store. Costco doesn’t seem to consider apparel a priority. “We’re really in the basics business, not the fashion business,” Elliott said. However, last year it ventured into the bridal arena with Costcouture, sold in Costco’s California stores. The gowns, priced from $650 to $1,400, are designed by Kirstie Kelly, known for her work for Disney Bridal. Kelly has been making appearances at stores.

While Costco hasn’t disclosed volume for apparel, in a fiscal 2011 presentation, the company listed the sales for categories such as cameras, $466 million; wine, $1.3 billion, and televisions, $1.9 billion. A photo of a bin of men’s shirts was not accompanied by sales information. On display recently were Calvin Klein trenchcoats for $43.99; Kenneth Cole women’s dress pants, $14.99; CK Calvin Klein five-pocket flair jeans, $24.99; Polo jeans ruffle T-shirts, $12.97, and Cole Haan wool coats, $64.99. Labels such as Speedo, Gloria Vanderbilt, Adidas and DKNY Jeans were also in evidence. The house label Kirkland appeared on cashmere sweaters at $59.97.

Like Sam’s Club, Costco is trying to make a mark with diamonds. Inside the sleek display cases next to the flat-screen TVs are diamond engagement rings ranging in price from $999 to $50,000 — while prices online run as high as $479,999.99 for a 4.25-carat round solitaire. There’s also gold jewelry, colored stones and pearls. Watch brands include Gucci, Movado, Raymond Weil, Michele and Cartier.

“We have Docker pants, underwear, socks and athleticwear in anticipation of spring and summer,” said a spokesman. “We always try to service the big brands. There’s always certain brands we go in and out of from time to time. We call it the treasure hunt. We do it for the ‘wow’ factor.”

It might not elicit “wows,” but Jelinek plans to keep the lowly hot dog on Costco’s menu. He shares his fondness for the $1.50 hot dogs with Sinegal and his enthusiasm for selling them is another sign of Costco executives’ lack of pretention and the retailer’s skill at balancing high and low.

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