• The Genius of Simplicity

    Costco profits by taking great pains to keep it simple and embracing the ‘intelligent loss of sales’

     

    By Margaret C. Roth

     


    Army AL&T Magazine interviews Mr. Richard Galanti, executive vice president and chief financial officer of Costco Wholesale Corp. to offer a perspective outside of the Department of Defense on issues faced by the Army AL&T community.

    Galanti, who is also a member of Costco’s board of directors, began his retail career in 1964 at the age of 8, bagging groceries at his father’s grocery store in Canton, GA. He went on to earn a B.S. in economics from the Wharton School of the University of Pennsylvania and an M.B.A. from Stanford Graduate School of Business. Galanti joined Costco in 1984 as vice president, finance. Previously he worked on Wall Street as an investment banker with Donaldson, Lufkin & Jenrette Securities Corp., where he provided a variety of financial services to both public and private corporate clients, including Costco in its infancy.

    He is currently serving a three-year term on the board of directors of the Federal Reserve Bank of San Francisco and recently joined the advisory board of the University of Washington’s Michael G. Foster School of Business.

    Costco buys most of its merchandise directly from manufacturers, routing it to one of its depots or directly to its warehouses. Last year, Costco retained the No. 1 spot among warehouse stores with a 46.5 percent market share, compared with 38.4 percent for Sam’s Club, a unit of Wal-Mart Stores Inc.

    With 69.1 million cardholders including individuals, families and businesses, Costco is the second-largest retailer in the United States and the seventh-largest in the world. It operates 622 warehouses in eight countries, employing a total of 160,292 full- and part-time employees. Costco’s $99.1 billion in revenues for its FY12 represents more than 2 million transactions a day including 113,000 carats’ worth of diamonds, 62 million rotisserie chickens, 36 million prescriptions filled, 3 billion gallons of gas, 16,500 mortgage loans totaling $4 billion, 160,940 vacation packages, and 1.5 million pumpkin pies during Thanksgiving week.

    Q. One of the ways that the Department of Defense and the Army want to make affordability a fundamental requirement for acquisition investments is to do more market research before choosing vendors. What drives Costco’s research into the products you decide to buy? What are you looking for?

    A. In terms of the types of products that we want to sell to our members, it starts with the 80-20 rule: What are the 20 percent of items that represent 80 percent of the sales? Then, how can we choose from that limited set of items and provide the best-quality merchandise at the lowest possible price to our members? At Costco, you’ll find fewer than 4,000 active SKUs (stock keeping units). That might compare to a supermarket with 40,000 to 50,000 items and a supercenter with 100,000-plus items.

    The total number of items is a little less than 4,000, but the breadth of the items is enormous, from tires to mayonnaise, to fresh foods, to furniture, to jewelry, to certain services. So it’s a wide selection of items but not a lot of depth within each category. That is very deliberate. If you think about the fact that a supermarket generally marks up its goods 20 to 25 percent or more, and home improvement centers 30-plus percent, and the mall stores 50 to in excess of 100 percent sometimes, and we’ll mark our goods up about 11 percent on average, you’ve got to bring great efficiencies—not just buying in large volumes, but efficiencies throughout the system.

    Take something as basic as a can of peaches. If you go into a supermarket, you’d expect to find three or four brand names plus perhaps a private label. You’d then find four or five different sizes for each of those brands. Then you’d find sliced and diced and halves, and then you’d have heavy syrup and light syrup. In the end, you might have 40 different choices just of canned peaches.

    LITTLE DETAILS, BIG BUSINESS
    No detail of Costco’s operations is too small to be examined carefully for possible efficiencies, including the impact of packaging on the entire supply chain, from receipt of deliveries to time spent at the cash register. (Photos courtesy of Costco Wholesale Corp.)

    Part of our ability to sell at such low markups is to identify those fast-selling items that not only provide great quality but also the very lowest price—not just the purchase price but also the lowest cost in terms of logistics: shipping and handling by both the manufacturer and the employees at Costco, including stocking and ringing up the goods through the cash register. We probably underemphasize the word “research”; ultimately everything that we’re doing is research, whether it’s our buyers visiting competition and looking at what else is being sold, talking to manufacturers, going to trade shows. You’re not going to come into Costco and have a lot of selling help on the floor. You’re not going to have a lot of choices to make. Hopefully we’ve pre-chosen those items that are both great in quality and value, that our members are going to want to buy. This requires a tremendous amount of discipline, because human nature is just to want to offer a customer more: more variety, more selection, more sizes.

    At Costco, we’re going to sell what’s referred to in the business as a No. 10 can, which would be for a restaurant, commissary or day-care center, as well as a six-pack of one of the leading national brands. Maybe it’s sliced, maybe it’s diced, but it’s going to be the regular consumer-size can. Unless your 8- or 10-year-old is having a birthday party and you need the peach halves so you can put whipped cream and a cherry on top, nine times out of 10, the person buying that can of peaches is going to bring it home, open it up and put it on the table for dinner with the family. And you’re generally indifferent whether it’s one of those three leading brands or the private label, as long as you know it’s going to be high-quality.

    So what we’ve done is say, Okay, we’re not going to have 40 different choices of canned peaches. One, we don’t have to make 40 different buying decisions every week. Two, in a supermarket chain, the distribution center would have ample qualities of each of those 40 SKUs of peaches; then each store clerk orders one case of this and two cases of that, and then it’s put on a truck and delivered to each retail store and put in the back room, and then brought out, and then each case is cut open and put on the shelf.

    Getting back to the buying side, one of those leading brands probably overproduced one of those sizes last month. And so they’re giving everybody, whether it’s Costco, Walmart, Safeway, Kroger or Albertson’s, they’re giving us all a better value on that because they want to clear out that excess inventory on that one SKU.

    Part of our genius, if you will, is our simplicity. It’s a lot easier to be smarter on fewer things. We’re a very lean company.

    Well, each of those retailers is probably going to buy some extra of that item, maybe an extra two- or three-week supply. However, at Costco that’s all we’re going to buy that month, because it’s a leading national brand. And then we’re going to tell them, “You know what? Don’t put it in single cans, and 24 cans to a case, 100 cases on a pallet, where the stock clerk has to cut open each case and neatly stack every one of those 24 cans by hand so that all the peaches look pretty up front on the shelf, and then the cashier has to ring up every single can. Put them in six-packs, like you do soda, and don’t even put them in corrugated boxes; put them on a pallet and build the pallet basically in six-packs and shrink-wrap it. And let’s take 2,400 cans, or 100 cases of 24.”

    At Costco, that entire pallet of that one SKU, in order to stock those 2,400 cans, there’s a forklift operator putting it on the selling floor and cutting off the shrink wrap. And then you, the customer, are willing to buy six cans at a time instead of four, three, two or one because it’s such a great value. And then at the register, you’re only ringing up once for those six cans and not six hand strokes.

    So again, it gets back to that intelligent loss of sales: If we happen to have sliced peaches that month and you needed halves because you’re having a party with the whipped cream and the cherry on top, we’re going to lose that sale. But think about how many more cans we’re going to sell, and at such a lower price. We’re looking at selling what’s hot, and also what will save the customer money in terms of the quality and the value that we provide.

    Q. In the area of cost control, the Army is striving to eliminate redundancy within its “portfolios” of equipment: aviation, clothing, ground vehicles etc. How does Costco manage redundancy in its vendors and products?

    A. The whole mantra at Costco is limited selection, so we’ve eliminated a lot of the redundancy in the business. Redundancy, of course, means different things in different areas. Outside the product area, we have some redundancies built in. Certainly we have them in some aspects of energy management. Needless to say, we’re not going to be able to sell you goods unless our facilities, our retail warehouses, are open and running and ready for business. What we’ve chosen, and we looked at this over time, is that we’re not prepared to have full redundant energy systems in every location, with backup generators that can back up everything on location. However, on a regional basis, we do have mobile generators that can accommodate some aspect of that, unless it’s something as big as when Hurricane Sandy hit, and of course we had 18 or 20 locations closed for a few days. That’s the risk and reward of what we’re prepared to do.

    We do have redundancies within the warehouse. While we may not have full generators at every location, when the power does go out, we have the ability to run the registers to get customers out. We don’t have redundant energy systems in every location to power all the refrigerators and freezers, because unless we’re going to be out for a few days, which would be an issue, that’s something that we’re prepared to live with.

    In terms of disaster recovery, agencies like the big banks and the big credit card companies have tremendous redundancy; that’s the backbone of what they do. We have limited redundancy; we have a disaster recovery site that’s outside of the Seattle market, but not mimicking everything. We also have certain redundancies built in so we can continue to accept merchandise that’s already been ordered in the system, and receive it and deliver it. But again, if we get past a few days, then we haven’t chosen to have such full redundancies.

    A GOOD LIVING
    Costco was founded on a philosophy of providing a good living wage and affordable health care benefits, to attract employees who want to stick with the company and work hard. On average, Costco’s 160,292 full- and part-time employees, 90 percent of whom are hourly, earn more than $21 an hour, with a starting wage of $11. By comparison, across big retail, the average hourly rate ranges from $13 to $15 an hour.

    Q. How long are you committed to that one vendor whose peaches you chose to sell?

    A. We’re committed to high-quality items with which we can save the consumer money and sell a lot. We’re still merchants; we still want to sell a lot of merchandise and services, and sometimes it might be seasonal items. So we’re committed to providing great items. Our members have learned over time that part of the requirement of these great savings is that sometimes we might even be out of an item, or we might choose not to sell an item.

    One of the things we do is to recognize that, given our purchasing power, much like the Army’s or even bigger than the Army’s perhaps, we generally don’t like to represent more than 20 percent of a given supplier’s sales, because one day we may choose not to sell that item, whether the product stopped selling well or there’s something better or hotter out there. If we choose to delete it, we don’t want to destroy that supplier. It may not be anything that they’ve done. So we have a process in place, standards to help ensure that once a supplier has been with us for a certain period of time, typically at least one or two years, a decision to terminate that relationship must be vetted at the highest level of management.

    If they’ve done something dishonest, if a vendor did something wrong, they’re out. If the proverbial manufacturer of butter cookies took a little butter out of the cookie because butter prices went up, changed the quality without telling us, that’s fatal. You have to be upfront and honest with us. At the same time, if the price of something has changed dramatically, come to us and talk to us about it, and we’ll work with you. The message throughout the organization is that we want our buyers to be tough but fair with our suppliers. We want the best quality at a great price, and they won the business based on that. But ultimately we recognize that they’ve got to make money, too. We just want us and them to make a little money, a lot of times.

    Q. There’s a lot of discussion in the military about the 80 percent solution. And that is, when you look at the portfolio, what you may want, ideally, may not be what you get because of pricing and because of affordability, availability, logistics, whatnot. From that point of view, to get back to the peach example, how does Costco choose which peaches it’s going to get, other than through oversupply and the possibility of a discount?

    A. Somebody has to prioritize all those requirements: What must you live with, and what can you live without? Generally speaking, when a consumer goes into a supermarket and looks at the top three or four leading national brands of canned fruits and vegetables, whether it’s Green Giant, S&W, Libby’s, Del Monte, in most people’s minds they’re all good and high-quality. So we’ve started with the premise that you, the customer, will generally be happy with any one of the three or four high-quality brands. And we’ve also started with the premise that most cans of peaches are not bought to present them on a party tray in a particular way, in other words sliced vs. diced vs. halves.

    Now that doesn’t carry through to every item; everything is different. We’re going to sell only the best-quality fresh meat, USDA Choice and above, even though we might be able to save you money if we sold processed, Good or Select, which is certainly healthy and fine to buy, but it’s not the cut that we’re prepared to sell our members. In the case of peaches, many of those brands are fine, but there’s probably an institutional-grade can of peaches that we’re not prepared to sell, even though we could save the customer a little more money, that’s a little lower than our quality standard that we want to provide to our customer. Not that there’s anything wrong with it; it’s our choice.

    It’s the difference between perfection and excellence. It’s going to cost you a lot more money to get to perfect, but excellent is going to cost you less. You’ve still got to put a lot of effort into it. It’s the same thing with the 80-20 rule: We’re going to sell the 20 percent of items that represent 80 percent of the sales. We’re going to spend all of our time focusing on the things that can accomplish 80 percent of what we do and recognizing that those last little incremental improvements sometimes are inefficient.

    We go the other way in terms of safety in the warehouse. We have merchandise on pallets 20 feet up in the air. We spend many millions of dollars on “floor walkers,” just making sure pallets are up there right. 80-20 doesn’t govern everything. When we talk about safety in the warehouse, we have over 2 million front-end transactions a day at our warehouses, which means nearly 4 million people, so something like 3,400 customers coming in each Costco, seven days a week. Our policy is, ideally, we never want to have a forklift out on the floor during open hours because they’re dangerous, right? Now, sometimes you have to. When you do, it requires three employees: one in front, one driving and one in back. When they have to go down one of the aisles to take a pallet of merchandise off the top, you have to cordon off two aisles.

    We don’t want to close off an aisle for even five minutes, but we have to because of safety, and we want to because of safety. We try to have enough merchandise on the floor so that it does not require us to replenish during the day. But we make the procedures safe, even if it takes three people to get that pallet out and close down some aisles for five or so minutes, because God forbid we have a pallet fall off the steel shelf.

    It’s the difference between perfection and excellence. It’s going to cost you a lot more money to get to perfect, but excellent is going to cost you less.

    I think we go to a great extreme, an appropriate extreme, on food safety. We’re never going to be perfect, but we’re going to be darn near as best we can. At our own meat processing plant in California, which serves our own needs for ground beef, hamburger and meatball items, we do an inordinate amount of extra testing for everything from E. coli to Listeria. It doesn’t say we’re going to be perfect, but it says we’re going to be as good as we can get. Then, when there is any type of issue, fortunately, because we know what every member bought, we’re able to communicate with them almost immediately, even though the items may have been purchased three to five months ago.

    Q. Getting back to the vendors, a follow-on question: How do you encourage cost efficiencies, productivity and innovation in your vendors? Do you have any sorts of incentives?

    A. There’s no incentive, like, if you save us this much more, you’ll get a piece of the action. But when you get back to the limited selection, what always amazes people when they hear from our buyers is first, the degree of knowledge that they have, not only on the quality—if it’s apparel, the thread count; or if it’s food, commodity pricing—and the cost of the tin cans and packaging, and the freight costs. When we’re trying to manage 3,800 items in a location, the buyer’s trying to buy those 3,800 items compared to buyers managing 150,000 to 250,000 different items.

    Part of our genius, if you will, is our simplicity. It’s a lot easier to be smarter on fewer things. We’re a very lean company. We don’t have any research and development department. All of our employees are the research and development department.

    Another aspect is being transparent with our vendors. If you’re a small, regional company doing $4 million in sales, we’re not going to be able to accommodate you because our appetite is so large; we never want you to double your business just for us, in case we ever decide not to use you. But by the same token, the key is coming in and understanding our quality, understanding that we’re not necessarily as interested in what’s the hottest-selling item in the department store today, but understanding the entire cost structure and the supply chain costs, and how we can work together to lower those costs, increase the quality of the merchandise and ultimately lower the price to our members.

    It’s also recognizing that we’re not looking to sell at a price point. A lot of manufacturers will say, we can sell you this item at $11, and with shipping $12.50, and you can sell it at $19.99 to make a 50 percent markup. First of all, we’re not interested in a 50 percent markup. If everybody else is selling it for $24.99, and you’re trying to get us to sell it for $19.99, we want to figure out how to do a two-pack for $14.99. And we’ll make our 10 or 12 percent, thank you very much. We want to figure out all the costs so that we’ll both be successful, Costco and the vendor, if it sells a lot. And if it sells a lot and we may end up making more money, let’s figure out how to take that item and improve it and lower the price even further and drive more business. We’re not typical retail.

    Q. What’s the primary incentive, then, for a vendor to want to sell to Costco, since you’re looking to pay them a lower price?

    A. The primary incentive is volume, and volume not in 27 different versions of the item. If you think about it, using the simple example of toilet paper, well, first of all there’s only three or four big suppliers out there that can accommodate our volume. Recognizing that if they can turn on that machine at that plant and not have to worry about the different color dyes and embossed and two-ply and one-ply and different packaging quantities, and basically come in in January and turn the machine on and just keep making it for us 24/7 for the rest of the year, it creates a lot of efficiencies for them, too. A lot of times, if we can be 5, or 10, or 20 percent of one of their facility’s production capacity, it eliminates a big hurdle for them in getting to efficient capacity utilization.

    And we talk to our vendors, I’m sure that some will say we’re a pain in the behind. But what I hear time and again, whether it’s Procter and Gamble, one of our largest suppliers across the board, to the small and medium-size suppliers, the one thing is that the message throughout Costco is consistent and straightforward. If we tell them what they need to do and we expect quality, then they know that’s what they need to do. They don’t need to try to sell us six other things.

    Q. Looking at it from an entirely different perspective, what kinds of incentives could Costco offer its employees to encourage efficiencies?

    A. We don’t have commissions anywhere in the company. Sometimes people ask in the warehouse, what about your membership desks? They’re selling upgrades to the executive membership, or getting someone to do the triple play: signing up as a member, the upgrade to the membership and the co-branded American Express card. We have contests, and basically it’s a job well done. A lot of the incentives are growing through promotion and merit, being promoted to the next-level position, whether you start off as an hourly inventory control specialist in merchandise, which is making sure the product is flowing through the system, to the assistant buyer, to the buyer, to the assistant merchandise manager, to the general merchandise manager, which is typically at the VP level.

    At Costco, it’s one message: We all work hard. I think part of it is that we start by recognizing that 90 percent of our employees are hourly. Of the 300 people employed in an average warehouse, with a warehouse manager, 20 are salaried; the rest are hourly. The philosophy of our founders was, and still is, to provide a good living wage and affordable health care benefits. So in an hourly environment where many part-time hourly employees at other retailers don’t even get health care, all of our employees do; they have to be there for three to six months to qualify, depending on whether they’re full- or part-time.

    With most employer-sponsored plans across industry, employees pay anywhere from 20 to 30 percent of their health care premium through payroll deduction. At Costco it’s about 10 percent. Our average hourly wage in the U.S., for example, is a little over $21 an hour. By comparison, across big retail, whether it’s Home Depot, Walmart, Target, Best Buy, the supermarket chains, the averages range anywhere from $13 to $15 an hour. That’s the average, whether you started yesterday or 20 years ago.

    Our starting hourly wage is $11. If you’re full-time, working 38 to 40 hours a week, in your fifth year of service you’ll get to the top of the scale. After an employee has worked for the company for about 10 years, there are some added increases every five years besides the usual annual cost-of-living increase, up to the 25-year mark. But you’ll get up to the top of the scale, which is $21.50 right now, in four to five years instead of over a lifetime.

    So if we’re paying such a higher premium, darn near 40 to 50 percent higher, we’d better be hiring better people to start with, who want to stick with us and work hard. Pay is the first priority, needless to say, a livable wage and affordable health care. Beyond that, we have our open-door policy, hopefully providing opportunities for everybody, and we have to work at that.

    We looked at our inventory shrinkage numbers, which are very low. Part of it is, nobody’s stealing toilet paper. In big-box retail, there are certain things you have to do. We don’t use electronic sensor tags. We do have only one way in and one way out, and you have to go through the cashier and then the security person; and that definitely helps. Additionally, experts suggest that one-half or more of pilferage is internal—your own employee. At Costco, many times when we catch an employee doing something wrong, it’s because a fellow employee has turned that person in, and we’ve got to believe that’s because our employees believe in us and trust us, and that’s something we work on every day of the year; that’s set up in our policy, that’s paying our people well, that’s promoting from within.

    We don’t hire M.B.A.s into guaranteed management positions. Part of that’s the philosophy of the founders; it’s kind of like the old philosophy of doctors, I worked 100 hours a week when I was doing my residency, and so will you. Seventy percent of managers in warehouses today started by pushing carts and stocking shelves. They know what it’s like to sweep the floors. As our employees grow and become supervisors and then managers, it’s the responsibility of each and every one of them to teach and develop the next generation of supervisors and managers.

    We highlight examples of what we should be doing, not just what we shouldn’t be doing: There are plenty of things, and Costco Today, which goes out monthly, highlights efficiencies, simple things in the warehouse. I think of a silly example, years ago, of kids pushing carts in the parking lot. We have the little rope that attaches to the cart, whereby you can push eight carts at a time now. You can maneuver, and it’s not like you’re going to run into a car or something. It’s those simple things: What’s somebody doing out there? Who’s going to have our best ideas? People out there. And when we promote those ideas and present them to the rest of the workforce, they look at that and they come up with ideas. So no idea’s too small.

    One of our challenges is to provide growth opportunities to all, even when our employee turnover is so low; we’re growing our workforce at 4 or 5 percent a year. So we move people around between functions, even if they’re physical functions, such as stocking shelves or folding, or working the membership desk.

    Q. What kinds of processes does Costco consider unproductive? How do you define bureaucracy in its worst sense?

    STREAMLINING DISTRIBUTION
    Outbound shipping is an area where Costco is making a concerted effort to find efficiencies in packaging, as well over half of its depot operating costs are for outbound freight. The company is looking to achieve full use of pallets and full use of outbound trailers by eliminating oddly sized or undersized items that make pallets harder to stack.

    A. Bureaucracy, in its worst sense, is setting up procedures, committees, inefficiencies in decision-making that take longer and make it more costly to get things done, recognizing that we’re a different company today than we were when we were 50 people in a central office 28 years ago with four locations. As Jim Sinegal, our co-founder and recently retired CEO, said, if he could do everything himself, there would be nobody else employed here. But you have to have organization.

    We pride ourselves on being efficient, and we have to constantly revisit what we’re doing and question everything we do. Let’s take a look at everything we’re doing and what we shouldn’t be doing anymore, even though we’re doing it well.

    Not everything’s printed nowadays, but management information tools and reports can take on a life of their own. Even within buying, within the 30 or so subdepartments, everyone wants to look at information differently: “We turn our inventory 13 or more times a year, not four to eight times a year, so we’ve got to look at things differently.” Maybe so, and sometimes yes. So, on a regular basis, we go back and look at every management information tool that we prepare. What’s funny is that you find, a few years later, that something that was created on behalf of a particular user group, they’re not using it anymore, perhaps because something else came about that they’re using and don’t need it anymore, which is great.

    Q. In choosing vendors, the Army is focusing more and more on “what” it wants them to produce and less on the nitty-gritty details of “how” to produce it. How does Costco ensure it gets the quality that customers want without creating overly prescriptive requirements for vendors that could prove onerous and counterproductive? How do you develop your house-brand products?

    A. It’s a two-edged sword. On the one hand, we demand whatever spec we want. Whether it’s a patio umbrella, for which we want a certain number of threads per inch and the quality of the turning mechanism and the diameter of the umbrella. Now, we’re not going to tell them where to go buy their thread necessarily, other than that there’s the vendor code of conduct that it can’t be child labor, and you now have to provide your source of work; you now have to trace your work for a lot of food items. And they’re going to determine the spec of what we want, and they’re going to bid it based on that spec.

    We have eight regional buying offices in the U.S., two in Canada and one in each other country. Needless to say, the manufacturer wants to accommodate the buyer in each region. And shame on us if we’ve got four different buyers wanting four different packaging and sizes because that buyer’s decided that something will sell better in that region. From the Costco side, we have to turn them down and say, “Guys, think of the inefficiencies that we’re creating, the efficiencies that we’re losing.”

    Q. Small businesses are a significant element in the Army’s strategy to promote effective competition, representing 26 percent of all contract dollars awarded, because they are thought to be more innovative and quicker to respond to changing needs than larger companies. What competitive value do small businesses bring to Costco’s goods and services?

    A. On the one hand, I did say that because of our appetite and our size, our quantity needs, sometimes a small vendor can’t supply us. On a regional basis, we will bring in small vendors to do things, and sometimes that will create exciting opportunities for us, new items. So we can’t lose sight of that innovation. We don’t have some of the limits that the government does—we don’t have to have X percentage for small businesses and X percentage for minority-owned small businesses. We probably can be more pragmatic on that than the Army, but we will have small business trade shows, if you will, to advise small vendors. We sometimes can turn them on to manufacturers that use small vendors, or tell them how to sell to a company like Costco. Sometimes we can turn a regional item into a national item.

    Thirteen times a year, senior managers across functions come to Issequah, WA, where we’re headquartered, for a day-and-a-half budget meeting. In those meetings, there are eight heads of regional merchandising. One of the things they do, in addition to how did we do versus our budget and how can we improve the next budget, is what’s hot in that area. And sometimes the other regions will look at that and say, I’ll give that a shot. Sometimes the CEO says, “Why haven’t you given that a shot?” I think it’s been a good forum for us to cross-fertilize ideas from one region to the next.

    One of the reasons we went from one buying office 20 years ago to two, one on the East Coast and one on the West Coast for the time difference, to eight about 10, 12 years ago was that regional flair. On a national basis, we want to be working with Procter & Gamble, or Bounty paper towels, to achieve national efficiencies. But on the food side, we’ve found some great items over the years that have become co-branded Kirkland Signature items. One of my current favorites is a peanut butter-filled pretzel, a Kirkland Signature item by H.K. Anderson. That was a strong smaller regional item. It continued to succeed, and we developed it with them.

    I think small businesses bring innovation and unique regional tastes. As much as we’re an international, cement-floor, big-box retailer, we’re also a merchandiser. And part of merchandising is offering exciting merchandise, and sometimes exciting merchandise can be found at the regional level. There may be a particular item that is unique to a particular region that we never would have found out about if we only worried about big national brands. It’s a treasure hunt.

    We get the question more than once a week about why we don’t have signage as to where merchandise is located. Well, first of all, we bring in and out a lot of seasonal items, and while the layout of the warehouse is pretty much the same—you have electronics in the front, and in the middle or lower area you have some books and CDs, seasonal items, apparel tables, for the most part, we want you to shop through the whole place. We want you to look around.

    Q. Improving the professionalism of the workforce is the newest area of focus for Army Acquisition. What sort of culture does Costco strive to instill in its workforce? If you had to describe this in three sentences to a new employee, what would you say?

    A. We’re trying to instill in them, first of all, that our mission at Costco is to provide the best-quality goods and services at the lowest possible prices to our members, and doing it in an honest way. And where there are promotional opportunities for you the individual, it’s an open-door policy. Finally, that we deal with things with a high degree of honesty and integrity, and everybody gets a fair chance.

    When we talk about quality, it’s not just quality of merchandise; it’s how often the bathrooms are cleaned; it’s the 10-foot-wide parking spaces instead of 8-foot-wide. And we get great grades for quality, even though it’s just a no-frills warehouse. We get high marks for customer service, even though in our case the best service is self-service sometimes. Our returns policy is great; we get compliments all the time. Hopefully we’ve hired the right people, and we’ve been able to hire better employees because we pay well, and if they see growth in our company and we provide opportunities, then so much the better. The message from the very beginning is that we’re about gaining the trust and loyalty of our members, and certainly gaining the trust and loyalty of our employees, and to be the best retailer out there, providing great goods and services.

    The other thing is, how do we deal with adversity? And that’s something that our CEO has talked to our managers about at the managers meeting: You deal with it head-on. Years ago, we were written up in the Northeast about a rodent problem at one of our New York City locations. Now, if you sell food, whether you’re a restaurant or a convenience store or a retail supermarket, at some point you’re going to have a rodent issue. It must have been a slow news day, but it was on one of the national programs. They asked Jim, our CEO at the time, and he said, “I’ll meet you at the warehouse and we’ll walk it.”

    I remember in the office the next day, asking him, “How did it go?” And he said, “Well, I was standing in the middle of the produce section, taking the interviewer’s questions, and I was responding to one of the questions, and he said, ‘Let’s take that again. You sounded a little defensive.’ ” And this is an investigative reporter. He saw that we weren’t trying to hide anything. We didn’t write him a letter from our lawyer saying, “If you have any questions, send them to us. And no, you can’t go near our warehouse.” So I think how someone deals with adversity, whether it’s an E. coli recall or a problem at a hotel through Costco Travel, the best way we can deal with things is to deal with them straight-on, and if we have made a mistake, we don’t throw a bunch of lawyers at it. We make it right with the customer.


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