Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

{audio:0:00:21} How did you end joining Costco in the early 90s?

{audio:0:00:28} I started in 1991 when Costco and Price Club were two separate entities. Costco had the West Coast of Canada and Price Club had the East. I was on the East Coast in Montreal, which was where the Price Club head office was. I started there with only eight locations at that time, and it grew like a bad weed. Within six months, we reached a dozen locations and the following year we opened eight more. In 1993 the merger started being talked about and by the end of that year it was called PriceCostco. It was combined but still ran separately. 

{audio:0:01:13} In 1995, it basically became Costco and, in the US, they only had one buying office in Seattle, whereas Canada still had two; one in Vancouver for the Western Canada buildings, and one in Montreal for the East. That stayed that way for several years, even though there were more synergies with common goals and buying principles. It took until 2001 for the Ottawa office to become the Canadian head office. In the early days, we were bitter rivals as Price Club was trying to expand in Eastern Canada, looking to the West, and the Western Canada guys were thinking about coming East and had actually made an offer to purchase land and backed out at the last minute. It became very much an East-West rivalry and stayed that way for a while, until finally things came together.

{audio:0:02:25} How would you compare Costco and Price Club before they merged?

{audio:0:02:29} Price Club was a loose cannon and would try anything to see if it would work. Costco Wholesale was more structured and specifically went after wholesale business. Price Club was getting many private members because if you worked for any Federal or Provincial agency, you qualified as a member. Even though the formats were large and they certainly wanted and had some small businesses, most of the East side membership was individuals who qualified to be members, whereas Western Canada had way more business members.

{audio:0:03:18} Why was Costco more structured than Price Club?

{audio:0:03:21} That came from the top, and Sol Price started Price Club, whereas Jim Sinegal and Jeff Brotman the real estate guy, started Costco. Jeff would negotiate properties and land and Jim was the merch guy. I got to know Jim over the years but I didn't know Sol very well as I only met him several times. I got to know Jim as well as you can for someone who only sees him several times a year, and there was no gray with Jim. It was black and white; we're doing what's best for the member. Their shareholders will be rewarded if the company does well, and so will the employees. 

{audio:0:04:04} Sol was the kind of guy where the first building was an old airport hangar in San Diego. It was a terrible looking building but he took a chance on it because it was cheap and no frills. It was bare bones and nothing like what a Costco looks today. The shelving was terrible and the packaging was non-existent, it was all brown boxes. Sol threw everything against the wall, and what stuck, worked and what didn't, they didn't continue. It got more refined than that, but that's the way it started. It was totally novel in 1986 when the very first building opened in Quebec. It was totally out of the box, never been seen before, nobody had any idea what it was. It evolved quite a bit, but that was the biggest philosophical difference between Costco and Price Club back then.

{audio:0:05:03} Why did Costco grow quicker in those early days?

{audio:0:05:21} There were several reasons, but geography was the first one. Western Canada was called the Wild West as it was growing like crazy. Oil was through the roof and Alberta is based on oil production. They opened several Calgary and Edmonton buildings which did well, then they expanded in Alberta as fast as they possibly could. The reason they grew quicker was that they had a bigger commercial or business base than Price Club did, so it was easier to get big volume out of that commercial base. C-Stores and mom-and-pop shops only spent $300 a week whereas businesses spent $3,000 or $30,000 a week, which gave them exponential growth. Price Club grew slower and didn't expand as quickly as their first 10 locations in Eastern Canada were all in Quebec. They finally ventured into Ontario when we opened the first Ottawa building which was my first opening, then started ramping up in Ontario and there was a lot of growth there, so that was probably a big factor.

{audio:0:06:42} The member mix was more wholesale focus for Costco than a mix for Club?

{audio:0:06:51} Yes, and even the merchandise mix was different in the early days. When we flew to Vancouver we would go into a Costco and find a much more industrial type, similar to a Costco Business Center today, whereas Price Club was geared more towards the consumer. Some of the quantities were more reasonable and there were more brand name electronics and small electrical appliances. Western Canada carried those but took whatever they could get their hands on. Back then, many companies did not want to sell to Price Club or Costco.

{audio:0:07:39} How was the pricing different?

{audio:0:07:40} The pricing was fairly similar because the model was similar. Western Canada was prepared to work with lower mark up because of their business clientele, and some of those categories are lower margin categories. If you sold tobacco, C-Store products and cleaning supplies, your margins were lower there. You would make a lot more money on clothing. That was part of their strategy which obviously worked. It was the same philosophy but with a slightly different direction and mix between the two.

{audio:0:08:21} Can you paint the story around the merger? What was the context behind how they got together to what eventually became Costco?

{audio:0:08:34} As an employee, we didn't know all the inner workings of what was going on. In Montreal, we believed that the trigger to merge rather than compete, was when they came to our head office in Laval, Montreal, and started scouting out some property. They quickly realized that Quebec was a different animal compared to the other provinces. It was mostly French speaking with quite restrictive language laws and a different way of doing business. They didn't have the expertise to set it up, unless they raided our office for a few key people. That's when the talks started and it was the same thing in the US. Costco were strong where they started which was in California, which was where they did a lot their expansion. Costco was strong on the Seattle side and were starting to infringe. They each wanted to get into another market where the other one wasn't, and it made more sense to merge. 

{audio:0:09:49} Sol Price was well into his 70s and wanted to relinquish some of the business to his sons. Robert Price drove that when he saw the opportunity and realize merging was a better scenario for the future. What often happened in Canada is that if we carried the same product, we beat each other against the wall until we were making no money, because we always felt that either Costco or Price Club had to be the best price. That never stopped and I believe that was the big trigger. They realized this was not a formula that would work out well. Jim Sinegal saw the potential for some of the markets they weren't in at that time, both in the US and Canada, and said they could do it better together. The first steps were in 1993 but it solidified in 1995 when the Price Club hierarchy was either eased out or left because they were not agreeing with everything.

{audio:0:11:32} Why was Jim Sinegal the one to take over and run the merged entity?

{audio:0:11:39} He had the experience at FedMart and some of the executives in the Costco Seattle office had also worked there, so they had good knowledge of the US market and good confidence level with the Canadian side because it had been run well and it was profitable. They felt they could do a good job of taking over the Price Club business and growing it, while also expanding the Costco side and becoming one company. Jim had a vision from the start and he put that in place. The six main tenets that we hear repeatedly, respect your vendors, respect your employees, deliver the lowest price to the member, that was ingrained in everybody's mind for sure, up at the top level. It worked top level down, which is why they are still successful today. Not many people from outside the Costco family get hired. That happens rarely because people are promoted from within.

{audio:0:13:08} How do you compare Craig's style to Jim's?

{audio:0:13:11} Craig is definitely Jim number two and followed right along that line. I was there for the last five years of Craig being in charge and you could see it happening. When we did warehouse tours, Jim would fly to Canada, especially for an opening, and we would do many building visits. Craig was always right there by his side, and you would watch him, as Jim would put out the same message, philosophy and basic principles. Craig took over seamlessly. I have been out of the office for almost five years but I am regularly in the stores and I have not seen a bit of difference. Jim did a great job getting everything in place, so all Craig needed to do was keep the boat afloat, instead of reinventing the wheel. Why mess with a formula which works?

{audio:0:14:09} What were the role and responsibilities of your Assistant General Merchandising manager (AGM) position?

{audio:0:14:15} An AGM is a bit of a hybrid because you are very involved on the buying side. Buyers and assistant buyers report to you but you also have the responsibility of reporting to your GM VP who is in charge of whatever division you run. You have a fair amount of people so you have to wear the HR hat. Depending on what business you are in charge of, you can also be involved with operations. When I was doing the optical department, pharmacy, tire shop and photo centers, those were very operational departments so you had more than one boss. The buying and operations sides go together so there are several roles within that. Obviously, ensuring your staff have everything they need; they come to you for advice and approvals. You are also a buffer which is sometimes needed for the AGM to take the message from the top and apply it to their particular situation. 

{audio:0:15:33} Sometimes you get a broad direction which is what a top-level manager needs to do, but to get that message to the people who are living it day to day, if you give them that broad message, it may wind up being misinterpreted or not even that applicable to their particular business. A clothing or tire buyer are night and day, so part of the job is to manage the expectations and communication levels so each individual buyer understands what that message means for their area, because it varies greatly. The AGM position also involves dealing with major vendors and even some of the smaller ones. I used to attend all the trade shows that buyers went to and most of the top end meetings. Buyers never went into a meeting on their own; they always had support.

{audio:0:16:58} How would you compare Costco's buying/merchandising team structure versus Sam's or BJ’s?

{audio:0:17:14} I'm not as familiar with BJ’s because we didn't have that much contact with them. Costco buyers could make their own decisions quicker, few levels are required to get approval. It was also pretty lean with few staff in each department. They had the right amount of people but it made it very busy. You were not sitting around trying to find something to do; you were trying to squeeze an extra hour because it's always busy. Marketing was another big thing, and buyers work with the marketing team on advertising and promotions. Buyers negotiate that with their vendors which differs from most other retailers. Everybody wears a few hats. A Costco buyer doesn't simply pick product, negotiate a price then let it hit the floor and hope it sells. Every step of the way, they ensure the product on the floor sells successfully.

{audio:0:19:11} Is there no marketing team or promotions person at Costco that's going to the supplier and organizing the pricing and marketing of the vendor's products?

{audio:0:19:25} There is a marketing team who supply all the materials for warehouse signage. They publish the Costco Connection, and have writers who do the articles. They are in charge of that area, but when it comes to a vendor placing an advertisement in the Connection Catalog, the buyer negotiated that. All they would do is sign the contract and forward it off to marketing, who ensured everything was in place at the warehouse level for coupons, signage or promotions.

{audio:0:20:17} How do you negotiate with a large vendor like Nestlé or Mars, who want to improve or at least sustain their margins?

{audio:0:20:35} A big selling point for corporations who have large market share in their industry, is that we're not putting fliers out every week discounting their product. There are some promotions but, by and large, it's an everyday low price, and volume. We only buy full truck loads from them as opposed to them shipping two pallets to different buildings. If it's the kind of product a building can sustain a full truck load of on its own, it will go right to the store. If not, it will go through the distribution centers and get split up from there. To be able to ship truck loads is a huge cost savings for both parties.

{audio:0:21:31} Inflation is 9% or 10% today so I assume vendors will increase their pricing due to raw material costs. How does Costco negotiate with large vendors today?

{audio:0:21:47} That's a tough negotiation because the goal is to keep prices as low and the same as much as possible. As a buyer, I have been through these times during my 26 year career, and we generally try to maximize every potential way to reduce costs. We understood that if a raw cost went up 5%, the cost to us would have to go up at least initially, but we work with smaller and medium vendors to get some efficiency out of freight or packaging, which worked well. 

{audio:0:22:35} Often vendors would ship pallets to the store from a different factory or the same warehouse on their end, so we were able to consolidate a lot of that product and get it all into one place. We would maintain the price by finding efficiencies to either buy, ship or even package the product. The best story was the nut category where they came in round containers, which meant they had to be inserted in boxes to be able to be stacked on a pallet to ship out. Our buyer went to them to figure out a way to maximize freight, and the easiest way was to get your vendor to switch to square containers, saving 10% to 12%. You are able to stack and nest them together which means you can put more product on a pallet making it more efficient to ship. That's what they did years ago and today every container is square for that reason.

{audio:0:24:00} Are there limitations to that given today's freight prices and inflation?

{audio:0:24:10} In these extreme conditions, you need to consolidate more business with a vendor. If you're carrying four SKUs of Mars and three of Hershey, you can ask them both what it would be worth to them if we carry seven of yours and none of the competitors. For them that's big because now they can ship more product and get more market share and get a big competitor out of the way in a large retailer. That strategy often worked but today you have inflation, container prices and raw costs all going the wrong way, so you have to be willing to pull anything out of your bag of tricks to figure out a way to at least reduce the increase. If you only put your price up 2% and everybody else has to go up 6% or 8%, that is a big win.

{audio:0:25:14} You might keep your margin the same if Hershey gets 100% through Costco.

{audio:0:25:24} In good times, when you didn't have these issues, you could substantially reduce costs because you would sign an exclusivity deal which wasn't totally exclusive, but it would give a vendor a good parameter of what we would buy from them and how many SKUs and the volume they could expect, which would make a big difference in pricing. In bad times like we are currently going through, it would probably maintain the price in most cases.

{audio:0:26:05} Is there a historical example of high inflation where you reduced the SKU count in categories to maintain your margin?

{audio:0:26:13} Yes, there were some areas where there might have been a selection of eight SKUs from three vendors and suddenly, in a difficult situation, the buyer would cut out one vendor which would result in better sales and prices. If you had 3,500 SKUs from 3,000 vendors, that would be a nightmare to manage, whereas if you can do those same 3,500 SKUs using 1,000 vendors, you're getting more efficiency from freight, better pricing from the vendor and it's much easier to control. Your only downside there is if that vendor has huge production problems, you might be out of some SKUs, but that's the risk you have to take, and these days, that could happen anyway.

{audio:0:27:38} Are there other tricks you can pull out of the hat during inflationary times?

{audio:0:27:44} Sometimes you could see that things were going to go a different way, and you could negotiate with bigger vendors to do a buy in, which they would support in many cases. They were also trying to get in as much product as they could before costs would go up, so we would tell them if we bought 10 truckloads from them instead of the usual two, they had to maintain the price, and they would absolutely do it. Sometimes we would buy in and hold the product ourselves, because every depot had a buy in section where you could keep some product for a short amount of time. In the commodity business, it is a big plus to be able to do that. Buyers today try to figure out with their best vendors what are ways to keep it as low as they can. They realize they may get an increase but how can they minimize that increase to the bare minimum, to keep it as low as possible.

{audio:0:29:01} Do you simply buy up front then store it in your own distribution centers and distribute to stores when the sales come through?

{audio:0:29:07} Yes, and sometimes the vendors would also do that, if they were big enough. They would say, if we committed to this many truckloads, they would allow us to draw 10 a week for four weeks, which was a big help because it comes down to how much space you have. Obviously, smaller vendors couldn't do that, but the larger corporations definitely could. Today has to be one of the more challenging times for buyers.

{audio:0:29:35} We are seeing crazy inflation in energy and fuel which leads through to the freight. Target reported yesterday that their freight costs increased by $1 billion this year. When that happened before, what was Jim's philosophy on keeping a gross margin target of 14%?

{audio:0:30:09} The philosophy was that you had to find ways to keep it as low as possible. During difficult times, more people come to the locations. Costco was looked at as a haven for fighting high prices and inflation, so in some years we would do even better than normal when times were tough, due to increased membership. Existing members bought and you got new ones. The membership base is what makes the wheel turn so you cannot afford to lose members.

{audio:0:31:18} Between 2006 and 2009 gross margins were consistently 12.3% to 12.7%, which is incredible during a crisis; annual sales grew, apart from the 2009 drop of 2%.

{audio:0:31:40} That's one of the reasons why margins remain stable. Jim's philosophy from the very beginning was that if you continue to maintain and grow your membership, you can afford to sell product at lower prices. When your costs increase you can hold prices for longer than any other retailer because your membership revenue ensures you will not be affected. Obviously, in these times that's slightly different because there are so many factors including raw costs, freight and fuel, but it still holds in the respect that you don't think Costco's top line changed much. The biggest cure for anything was sales. If you could sell more product than you sold before, your percentage might drop but you still bring in the same amount of money.

{audio:0:32:50} Target's earnings report highlighted challenges in having too much stock of bulkier items, which had to be marked down and hit their gross margin by 4%. How does Costco ensure they maintain turns and not end up marking down their products?

{audio:0:33:23} The nice thing with the Costco model is that there is not a lot of turnover in SKUs. There is certainly seasonality where you have garden and lawn furniture coming in and out. They bring in a fair amount of home furnishings twice a year. We ensured every buyer maintained a level of inventory which was almost like an open to buy but it was a dollar figure. As we got more refined and got better software for freight purposes and cube, we analyzed how much each department had in the system in terms of cube, rather than dollars, because dollars fluctuate. The average inventory in dollars goes up when everything is more expensive, but that does not mean you have more product in the building. 

{audio:0:34:37} If I have 50 TVs that cost $200 each, I don't have a whole lot of inventory, but if they cost $2,000 each, I have a fair amount of dollars but it's still 50 TVs and I haven't increased my inventory in units. We started doing the cube analysis to say, our department takes up this amount of cube in the building, which gave you a better handle on stock levels. It is not easy, especially during these times.

{audio:0:35:18} Would buyers abide to a target unit per cubic meter in a certain category?

{audio:0:35:27} Yes, there were for us, because 95% of products were on pallets. As an example, if you had one item of 40 cubic feet, that's pretty much a pallet, so you knew if you had 240 cube on one item, you were carrying four pallets, and the dollar value was a consideration and there was a target there, but that was more of a moving target as it fluctuated.

{audio:0:36:23} Would a home furnishings buyer know how many products per cubic feet they had in their category and when to replenish them to be efficient?

{audio:0:36:42} Yes, and to minimize your cube and inventory, you would work with US vendors who could ship often and quickly. When you start getting into container loads, which furniture is a prime candidate, a lot of the product comes from overseas in containers, which makes it even more difficult to manage. When the container hits the water, it's coming and you cannot turn that ship around. The big advantage was that our inventory control system was superior to most of the others out there because you could see absolutely everything in real time. You knew exactly what you had on hand, what you were selling per day and what was coming in. You could see that something was coming in in two weeks so you could push that off a week, or if you needed it quicker, you could advance it. 

{audio:0:38:00} Being flexible allows you to get a good handle of your situation for every item with every vendor. I know other retailers have good systems, but when I was there, I would talk to many vendors in different categories who couldn't believe how fast we were at knowing if a product was doing well or not. They could tell right away which they didn't get from most of the people they dealt with. That was a big part of it.

{audio:0:38:33} What about that system would enable that?

{audio:0:38:36} The biggest difference was the sophistication in being able to visualize absolutely everything in every location; what's already coming into your distribution center and what is future or has not been shipped yet and is still at the vendor's facility or not yet on a container. We got reports from our freight department which listed the contents of every container, broken down by department, then by item, so we could drill down and see the status for every item when it came to on hand or incoming inventory. You could even get hourly sales for a product which came in that day, if you wanted to check how well it was doing. A big advantage there is, after several days or even a week, if you saw the velocity of an item was good but not what you thought it would be, you could manage future orders which not everybody could do.

{audio:0:39:49} If Costco reported a quarter of mark downs which hurt gross margins, what do you think could cause that?

{audio:0:40:09} Sometimes an item didn't sell and you had to do a drastic mark down to move it, but by and large, mark downs were well-controlled. You had a budget you could massage and you would try to stay within that, but sometimes you couldn't if the item had to get out. Another option was to work with the vendor to make a commitment to take it back later or for next season, rather than marking it down drastically, but not if you had a small amount left. If you had an unusual summer which wasn't sunny or it rained like crazy and never got warm, you could have a ton of patio furniture and other products geared to that time of year which did not sell. We would rarely mark that down because buyers would negotiate a way to either send it back to the vendor with the commitment of taking it back the following season, or you would take care of your existing inventory and they would take care of everything coming in. Those were the kinds of negotiations that went on, especially in those unpredictable areas.

{audio:0:41:33} That is the benefit of having fewer SKUs and deeper relationships.

{audio:0:41:40} Absolutely; the traffic count at Costco is always high no matter the time of year. You always have an opportunity to do more sales than you think you might, and you also get new members which although hard to predict, is actually a plus. If you are in an unsaturated market in a building which has only been there two years, you still sign up new members so many people are seeing products for the first time, so you have an opportunity to still sell. One of the big principles is early in, early out. People always asked me why they brought out snow suits at the end of June. People will buy snow suits for their kids no matter what time you bring it in, as long as the price is good. If you bring them in early and are out before the first snowfall, you are no longer dependent on the weather because you already sold them all. That works in many categories.

{audio:0:42:48} How do you limit the extent of mark downs for unique seasonal products? Would you buy at a certain volume to minimize taking a huge inventory risk?

{audio:0:43:14} Yes, that's one way, especially for items which have a certain life to it. It might be there for three months and then planned to be out, and furniture is a good example of that. Most of the furniture you see at Costco doesn't stay there all year, especially outdoor bulky sofas and chairs, so you have to be careful. Many of the early items are test items, where you buy limited product and only stock them in specific locations. If it does well in the first year, then you make the bigger commitment the following year, so you are willing to give up some sales to get a read on what it will actually do. That was one way to minimize the mark downs. 

{audio:0:44:09} There were other aspects where we knew that when we would ask a vendor for help, they would help us out with a financial contribution to that mark down. They would probably put money in reserve knowing that it could happen. They might have left some money on the table when negotiating the price, but you don't know that for sure. Most vendors know that at some point, a retailer will ask them for help. It might be financial, to store product or to participate in marketing. That was definitely another way of lessening the blow. If we needed to mark something down, we could do 50% and the vendor would cover 50%, that worked.

{audio:0:45:13} Given the market over the past year, what is the biggest risk for Costco?

{audio:0:45:23} There are so many locations in the US, Canada and other countries that the risk of over buying a product is high. The way things are going right now, the price you sell at today could dramatically change in a month, and if it does, your volume could take a real kick, and if that happens, it's a domino effect. You projected so many truck loads per week or month, now your price has gone way up, through no fault of anybody; it's pure inflation. Suddenly less people are buying it, you have more product in stores and you can't handle what's coming in. That is a real domino effect which can result in a serious situation. They cannot simply buy on a weekly basis as most vendors need a projection of how many boxes weekly or monthly. We need to work out a shipping schedule, because with over 100 locations in Canada and many more in the US and other countries, you have to give vendors indications and commitments on what you will buy.

{audio:0:47:02} What is the lead time to get the product to market? Months or weeks?

{audio:0:47:12} Domestic or foreign vendors usually ask three months out, knowing you will buy weekly or sometimes monthly, but they want a three month projection to be able to build, because some of these places do not carry a lot of inventory. They get an order and build whatever you buy, and don't have finished product sitting in their warehouse ready to ship. Car batteries are made as you order because if you pre-make them, you diminish their life because the acid is in the case. That is an extreme example but other items are risky when it comes to forecasting that far, and if things turn completely around; it's a pretty risky business.

{audio:0:48:27} What percentage of revenue is at risk from managing supply, demand and inventory?

{audio:0:48:35} The risk on the food side is low because you deal mostly with domestic vendors and it is usually a product which everybody needs or carries.

{audio:0:48:56} Do you buy food weekly or daily?

{audio:0:48:58} In some cases you buy daily, especially for bulky items like toilet paper and paper towel which take up a ton of space. When it comes to exposure to inflation, higher pricing, fuel costs and freight, I would say it is anywhere from 25% to 40%.

{audio:0:49:39} Is it harder to match supply and demand lead time in a changing market?

{audio:0:49:46} Exactly, because a cereal manufacturer based in Canada has a lead time of days, whereas any of the hard-line categories, be it small electrical, electronics or hardware, most of that product is coming from overseas. It will either come directly in a container to a Costco depot, or to the vendor's location as a container and then get shipped out. So you are at the mercy of container shipping and are looking at 21 to 30 days minimum, possibly longer.

{audio:0:50:26} If 25% to 40% products are longer lead time and at risk and a buyer has been ordering X amount of volume expecting existing stock to be sold, if that doesn't sell, this other shipment could lead to being over stocked in higher risk categories?

{audio:0:51:00} Depots have 20% of their floor space dedicated to buy in; we would use that for bulky items for a certain amount of time – not months – which was very helpful. The other plus Costco has, which is only matched by Sam's and BJ’s, is the amount of storage space you have in the steel above the product. There is a ton of storage in every aisle above products where you store a lot of over stock. You don't want to have that overflowing by any means, but you do have that extra storage space and it's substantial and most other retailers don't have that. Sam's and BJ’s do but many retailers cannot afford it and might only have a small back area where they can put some inventory, but not enough to sustain an over stock situation. That is probably the biggest challenge from a buyer's perspective. You can never be right as the buyer; either you have too much or not enough. You are never perfect, ever.

{audio:0:52:38} How would you compare Costco Canada with Costco in the US?

{audio:0:52:48} The big advantage of Costco Canada is that BJ’s never opened a store in Canada. Sam's only opened eight locations in Toronto and were relatively unknown. Many people don't know Sam's is part of Walmart, so they saw Sam's warehouse club trying to rival Costco, who were established and people had already bought memberships. Sam's tried to draw people in with free memberships to get people interested in the concept. I was in quite a few of them and it didn't look that different to a Costco. It was quite similar and it would have to be; they were buying the same products from the same vendors. They simply weren't successful. 

{audio:0:53:47} They stayed in Canada for several years then they shut it down, so that is a huge advantage for Canada versus the US. The other difference in Eastern Canada is that Price Club was almost a cult, it was a big deal when somebody would pull out their Price Club membership card and say this is where I shop. It became so much of a destination in Canada whereas in the US, it’s so much bigger and there are many other retailers you can shop with. There is no Target in Canada, who also tried to establish themselves when Zellers went out of business, but failed.

{audio:0:54:42} Loyalty is a big business in Canada. People who have been to a US Target expect a similar thing in Canada, which is not easy to do because some vendors don't sell into Canada, or by the time they get their product into Canada, it's way more expensive due to tariffs and local laws which increase costs. The packaging has to be bilingual and some vendors wouldn't ship to Canada. Those with English/Spanish packaging wouldn't retool to put French on there, so they wouldn't sell product. You cannot compare Target in the US to Canada, because there is no way they can reproduce the same product mix they had in the States, and Costco isn't that different. A Canadian Costco and a US Costco definitely look very familiar, but the product mix is not. We buy a lot of local product in Canada, and a lot of it cannot cross borders without either increasing costs or being extremely difficult logistically.

{audio:0:56:11} Is the mix between food and non-food in Canada similar to the US?

{audio:0:56:21} Are the extra SKUs the only difference?

{audio:0:56:23} The product mix is not very different. There are some slight differences due to preference or volume. When we started our fresh at the back end of the building, one of the biggest draws was rotisserie chicken, which started in Canada. The US were extremely successful with hot dogs and the pop and pizza and hadn't gone with rotisserie chicken, so they wound up adopting the equipment and some of the same vendors and is probably one of the biggest success stories on the fresh side, but that was a big difference at the time. You don't see that much now, and other than regional preferences, they have a pretty similar mix.

{audio:0:57:16} Why hasn't BJ’s entered Canada?

{audio:0:57:21} We were never able to figure that out, other than the population is not big enough. Perhaps when they saw Sam's come in and fail, they might have said if they can't do it, why would we? I don't know if that's the case, but that could have been a big part of it for sure. The Canadian cities of Toronto, Montreal, Calgary, Ottawa and Vancouver have 80% of the locations and the outlying areas. There are five in Edmonton, six in Calgary, 10 in Montreal and 15 in Toronto, so they can only go so far, unless they are willing to branch out into some of the outlying areas.

{audio:0:58:22} How many Sam's stores are there in Canada today?

{audio:0:58:26} There are none; they pulled out of the market.

{audio:0:58:28} Who is their biggest competitor?

{audio:0:58:30} Walmart would probably be the biggest competitor for Costco. They carry some of the same mix and are definitely everyday low price and they offer good promotions. Canadian Tire is very strong on the hardware, automotive, seasonal side of product, and are entrenched. They have many stores across the country; some big, some small. Those are the two biggest non-grocery competitors. For grocery, Loblaws is the biggest food retailer in Canada, with many solid secondary ones like Metro and IGA. On the food side there is a lot of competition.

{audio:0:59:27} Is there no wholesale club format in Canada that competes with Costco?

{audio:0:59:33} No; the last one that made a decent try of it was Sam's, and that was 15 years ago. They only ran for a year and a half and then they pulled the plug.

{audio:0:59:51} So your theory that Costco owned the market and had too many members per store which made it difficult for any new entrant to get to scale?

{audio:0:59:57} I think so. Toronto has a huge cosmopolitan population base and looks like a huge city and it is, but then you start breaking it down into the suburbs, which is mostly where the Costco buildings are, or break it down into the regions of the city like Scarborough which is an industrial and busy area. There might be 300,000 people in that area and the Costco there has 60,000 members, so the penetration is huge. The last number I saw years ago when the population base in Canada was 34 million people, 6 or 7 million people had a Costco card, which is phenomenal when you think of how many areas don't have a Costco. Half of the population base doesn't have one, so it was incredible, and I'm sure it's gone up since then.

{audio:1:01:04} From Costco's SEC filings, you can compare the US and Canada, and Canada's operating margin is 1% higher than the US. Why do you think that is?

{audio:1:01:26} The membership base per building is very high in Canada. The renewal rate is well over 90% which is similar to the US. The Price Club consumer membership had many people who were executive members who pay double the fee of the regular membership.

{audio:1:02:04} That was my original view, but you can look at the sales per square foot and the size of their stores are very similar, roughly 140,000 square foot in both. The sales per store for Canada was similar to the US, so is there any reason why there will be difference in the cost base of running Canadian stores versus US?

{audio:1:02:57} Yes, some of the locations which drive sales are in areas with cheaper real estate than the US. Examples are the provinces of New Brunswick, Nova Scotia and Newfoundland. They are not big provinces but their cost per square foot is half the price of Montreal. The stores may not be in the perfect spot, but they may be only 10km away from the ideal spot, and because the Costco is such a draw, the same amount of people go but the costs are less. When we moved to merge the office, it was the same scenario. You had an office in Montreal and in Vancouver and the logical place to merge to which most people thought was Toronto, but we didn't and the reason being is Ottawa is a smaller city so it was less money for land.

26 years at Costco Canada

Former Assistant General Merchandise Manager, Costco Canada

inpractise.com/articles/26-years-at-costco-canada

Why is this interview interesting?

26 years at Costco Canada(June 8, 2022)

Peter Malizia

Former Assistant General Merchandise Manager, Costco Canada

Interview Transcript

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Audio

26 years at Costco Canada(June 8, 2022)

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