HBS Case Study 2:
Costco Wholesale Corporation
Financial Statement Analysis (A)
MMS 185: Managerial Finance
September 27, 2007
It is important for stockholders to continuously re-evaluate their investments. Although some investors do this more frequently and thoroughly than others, the majority of shareholders do so at least once each year. Therefore,Torres’ desire to update her analysis in order to determine whether Costco was still operating efficiently makes perfect sense. After thorough examination, my analysis proves that Costco remains one of the industry’s leading competitors and there seems to be no reason for Torres to sell her shares as long as she wishes to retain holdings of a retail wholesale club in her portfolio.
Thecommon-size financial statements evaluating the period 1997-2001 (exhibit 9) reveal valuable information regarding Costco. Torres noticed that there were two revenue lines: net sale of goods and membership fees. She decided to use net sales of goods as the point of comparison and express other line items, including membership fees, as a percentage of net sales in order to allow for a clearerreflection of gross and operating margins. This format enabled her to analyze the profit and asset structures of Costco over time.
To begin, Margarita Torres’ common-size financial statements for Costco demonstrate a rise in membership fees and other sources of revenue from 1.82% in 1997 to 1.93% in 2001. This is supported by Costco’s trend to increase membership fees over time and also gain newmembers. For example fees cost $25 in 1986 and rose as high as $45 in 2002. But why were customers willing to pay a fee to shop at Costco when they could go to discount stores for free? Costco created value for the customer by only purchasing a handful of SKUs from its vendors, by selling goods at such a low per unit cost due to bulk packaging, by expanding its selection of name-brand products, byadding ancillary services, and by refusing to mark up products more than 14% over the distributor’s price. Also, because of its target market composed of wealthier clientele of small business owners and middle class shoppers, small increases in membership fees didn’t seem to be heavily resisted. This may have been very different if Margarita was analyzing membership fee increases at Sam’s club whotraditionally cater to a lower income customer. Thus, the more savings Costco passed on to its customers, the more it was able to increase its membership fee and the more members it attracted.
Moving onto operating expenses, merchandise costs experienced a slight decrease from 89.9% of net sales in 1997 to 89.63% in 2001. This signifies Costco’s ongoing attempt to provide customers with the lowestper unit cost possible and demonstrates the increase in purchasing power obtained through expansion. Another interesting trend under the operating expenses section relates to the rise in SG&A (selling, general and administrative expenses) from 8.74% of net sales in 1997 to 9.17% in 2001. Examination of this figure as a percentage of sales gives some idea of management’s efficiency of cash flowexpenditure, showing that it is optimally keep under tight watch. The increase in this figure is most likely attributed to an increase in general and administrative expenses including salaries of non-sales personnel, rent, heat and lights due to store expansion rather than due to poor management. Exhibit 4 demonstrates how Costco grew from 274 stores in 1997 to 365 stores in 2001, an increase of 91stores. In general, total operating expenses experienced a decrease from 2001 to 1997 due to Costco’s culture of cost-cutting. Examples of cost-minimization methods include running stores in “no-frills” warehouses which reduced capital expenditures, loading goods with forklifts to minimize human labor, and utilizing cross-docking to reduce transportation costs and speed up inventory turnover....
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