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CostcoNASDAQ: COSTPorter’s Five Forces

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Porter’s Five Forces is a model named after Michael E. Porter that takes into consideration five market forces that play out on any given company or industry. The five forces are: power of buyers; power of suppliers; threat of substitutes; threat of new entrants; and industry jockeying.

This model examines these forces thereby helping to determine a given company’s strengths and weaknesses.

Porter’s Five Forces is also a way to view the potential risks to which any given company may be exposed.

Porter’s is a valuable yet somewhat subjective tool. It is a starting point meant to encourage further discussion.

What is Porter’s Five Forces?

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Please note there is no official method to score the model. This method is simply a way to further categorize companies.

Each market force is scored on a scale of 1 – 5 with 1 representing the lowest threat and 5 representing the highest threat.

All five forces are totaled for a final score. The lowest possible score is 5 and the highest possible score is 25.

5 – 11 implies a lower threat rating.12 – 19 implies a medium threat rating.20 – 25 implies a higher threat rating.

Scoring

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Power of Buyers The buyers are consumers like you and me. There are no real switching costs involved.

The company will refund the membership fee “in full at any time if you are dissatisfied.”

Costco’s commitment is to its members which is why it runs on razor-thin margins (TTM net margin is 1.8%).

Customers reciprocate via loyalty (Q32014 worldwide renewals were 87.3%)

Customers shop at Costco because of low prices and wide selection. But it’s not the only warehouse in town.

In most retail, customers call the shots. Score – 4

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Power of Suppliers Suppliers provide the commodities and

materials for what COST sells. Generally speaking, COST sells its goods

before it has to pay suppliers. As this continues, COST finances more inventory via payment terms versus working capital.

COST is not reliant on any one supplier, has never experienced difficulty obtaining inventory and has many alternate sources due to suppliers own risks.

Given the scale of COST’s business and rapid inventory turnover it would appear that suppliers enjoy the relationship.

Score – 2

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Threat of Substitutes Substitutes include Sam’s Club and BJ’s on the

warehouse side. Sam’s Club brought in about $57.1 billion in

sales for FY2014. The graph to the right shows COST (red line)

vs. Sam’s (blue line) sales back to 2004. The longer this goes on, the lower the threat

of substitutes becomes as it demonstrates that COST has its customers as its number one priority.

Online sales for 2013 COST was ~3% of consolidated net sales; about $3.2 billion.

Don’t forget about Amazon.com. Score – 3

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Threat of New Entrants Barriers to entry at this point in the lifecycle

are very significant. Economic barriers, tech barriers, logistical barriers, get off your butt and do it barriers. Is it worth it?

Competitors in the space have built up such a large presence that it would be a very tall order for another concept to just open up shop and dethrone any of these main players.

Loyal customer base, inventory control, product variety, scale, distribution, even parking are all factors that work against new entrants into the space.

Start-up costs are quite prohibitive. Score – 1

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Industry Jockeying According to IBISWorld COST plus Walmart

Supercenters and Sam’s Club control more than 80% of the overall “warehouse club” market.

Even if we exclude the Supercenters it’s still Sam’s Club and COST. Everyone else is fighting for a little piece of the pie.

Lest we forget about ecommerce, this is the new frontier in retail and Amazon.com is blazing the trail. Prime is becoming more powerful.

COST and WMT are also investing in online. COST online sales in 2013 were ~$3.2B, Sam’s ~$1.3B, AMZN $78B.

Score – 3

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Power of Buyers – 4 Power of Suppliers – 2 Threat of Substitutes – 3 Threat of New Entrants – 1 Industry Jockeying – 3

TOTAL – 13

Score