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:0:00:01} Can you share some context to your role when you first moved into the buying team at Costco?

{audio:0:00:08} I was with Costco for 30 years and, about a year and a half into it, I decided that I wanted to make a career there. I went and spoke to my operations manager and let him know that I was interested in moving into buying, which meant relocating. He orchestrated some meet ups with that personnel and leadership, for me to tour the warehouses. Shortly after some of those meet ups, I was invited to fly to Washington, to interview for a couple of positions and I landed one of the two positions and started my career in buying.

{audio:0:00:57} What made you realize that you wanted to build a career at Costco, in those early days?

{audio:0:01:05} My friend was working at Costco and he said, there’s this new company in town. It pays really well; it’s a super cool environment and is like nothing you’ve ever experienced before. I went to see the manager. I walked in, all dressed up in the newest fashion, not realizing the exact environment, because I had never seen it before. They hired me on the spot. It was only temporary, to fill in, until I finished school. But I fell in love with the culture; it was amazing.

{audio:0:02:31} The camaraderie, everyone having each other’s backs. Super supportive and really a joyful place to work. I realized I wanted to make my career there but knew I didn’t want to make my career in the operations division. I wanted an office job; something that would exercise my brain more than my body.

{audio:0:02:52} What was it about Costco that fostered that culture of camaraderie and everyone having each other’s back?

{audio:0:03:04} There was a great sense of appreciation for everybody’s contributions, every day. I remember clocking out from my shift, high fiving my team mates and having my manager thank every single one of us, as we left the building, for our contributions for the day. I had never experienced that before.

{audio:0:03:41} It almost sounds so simple. 

{audio:0:03:43} Yes; it’s super simple. But it just isn’t prevalent. It didn’t feel transactional. It didn’t feel like and employer employee transactional relationship. It felt meaningful.

{audio:0:04:06} Why do you think Costco is unique in having that culture?

{audio:0:04:12} Jim Sinegal. He’s the Grand Poobah. He had one simple slide, every presentation he ever gave. He had multiple slides but one simple slide existed in every presentation; teach, teach, teach. If you don’t get that 98% of your job is teaching, then you don’t get your job.

{audio:0:04:46} Everything; all of your knowledge. Anything you learn, you share, you teach, you propagate. We’re stronger together than we are individually. It fosters camaraderie and teamwork and breaks down the building of fiefdoms. Knowledge is power and he did not want power struggles, when he was trying to build a corporation.

{audio:0:05:13} What was so unique about Jim specifically, that really enabled everyone to believe in or follow him?

{audio:0:05:28} When I first moved to buying, from the warehouse to Seattle, it was the time it was in Kirkland, and it was a two-story building. The bottom floor was accounting and IT and there was a café and atrium. There was then a staircase that was open, down to the atrium, with offices around it. There was a landing above it, on one side, which was the entry to the building and that’s where the receptionists were. You walked around to the left and there were the stairs down and a bit further down, on a landing area, he decided that open area, where everybody had to walk by, to either to the stairs to go downstairs, to get to the café, or go to their respective area in the company, that was his desk. He sat right in the center of that. 

{audio:0:06:29} He was approachable, said hello to people and was ever present. He went downstairs and got his own lunch and mingled with everybody. He made it a rigid rule that he visited every warehouse, at least once a year, and listened to the employees in the warehouses, to hear what they needed and how they were doing, so he always knew the talent pool and they always knew there was an open-door policy. That open-door policy is written in the handbook, to this day. The walls were down; none of the executives have doors on their offices. Some of the high-ranking executives have conference rooms next to their offices, if they need to have private conversations. It’s a hot commodity to be able to find a conference room to go to because the whole thought is, it’s open concept, so everyone can overhear one another’s conversations. It’s an environment of teaching and gleaning, all the time.

{audio:0:07:40} How did you see the culture change, over the years, as Jim moved on?

{audio:0:07:47} It has changed, for sure. Jim would never acquiesce to the shareholders, which were called the Street. He would get a ton of pressure, from the Street, to reduce wages or not give as high wage increases. He would get a lot of pressure to reduce benefits and that the benefits were just too lucrative; it was unnecessary to offer such magnanimous benefits to the employees. He would also get a lot of pressure from the Street to raise margins because the marketplace would buoy sales because the slope for value, for the shopper, would still exist if he took two, three or four more points, and he would be able to deliver greater shareholder value. 

{audio:0:08:49} He wouldn’t do it. He would take his beatings, let the stock be beat to the ground, before he took it out of the backs of the employees or out of the baskets of the members. He would send memos out, talking about the pressure he was under and saying, I’m not doing it; you’re going to hear about it and the stock is going to suffer and I want everyone to know it’s the right thing to do for the long term. This is a decision that is part of our moral compass and it is a decision that the company is making, so we’re going this way. Nobody was afraid when the stock got pummeled.

{audio:0:09:32} What’s different now is that the current CEO believes, and professes, his first boss is the shareholders. 

{audio:0:09:45} Jim put the employees above the shareholders.

{audio:0:09:51} That’s the mission statement. The tenets of the company are, obey the law, take care of your members, take care of your employees and, ultimately, you will reward your shareholders. 

{audio:0:10:19} What makes you believe that the culture has now changed to put the shareholders above the employees?

{audio:0:10:28} I lived the [culture] transition. I felt it, because I started 30+ years ago, with Jim being my CEO and having a tremendous amount of access to him. I also had a very strong and good relationship with Craig. After he took over the CEO position, we met to discuss some concerns. He said, I have a boss too; do you know who my boss is? He said, the shareholders are my boss. Jim would never have said that in a million years.

{audio:0:11:19} What did Craig not understand about how Jim ran the business, that makes him feel like that?

{audio:0:11:27} I think, perhaps he remained silent through some periods and went along and supported Jim’s efforts. But that doesn’t translate into you necessarily believing in them.

{audio:0:11:45} Also, it’s maybe just too tempting, in terms of serving the shareholders and trying to boost the stock price and getting caught up in that Street game?

{audio:0:11:59} In 2008, the economy was in a perilous condition; the government was bailing out car manufacturers and banks. At that time, Jim was so concerned about the members and the employees, that he reduced prices. It was a very small amount, at first, on key items such as butter, milk and chicken breasts; what are the items that people need to feed their families? We are a solvent company because we are fiscally conservative and we can weather this. We can afford to invest in margin and give it to our members. Our employees shop with us too, because everyone who works there gets a free membership.

{audio:0:12:54} When everyone started realizing this was a longer situation than originally thought, after about 90 days, he came back and said, I know we’ve done 10 items and then 20 items; I want 300 items. Granted, we are a limited SKU environment with 3,000 items. He wanted 10% of the items cut down to 5% margin or less. Before, it was reduced by 5%. Some of the items made 12% or 13% margin but, for that period, nothing could be over 5%. Some of them even went down to 2%.

{audio:0:13:37} It got to the point where he wanted some of them to be at cost and he wanted us calling our vendors, to find out about their solvency to see if they can lower their prices to us, so we can lower them even more. He wanted everybody working on this; it was our main mission, at that point, because the people needed it. He said that we owed it to our loyal members and employees, to be able to deliver these savings to them, because everybody was getting stretched thin and there was a lot of fear. People’s 401ks were collapsing. 

{audio:0:14:12} Fast forward; he retires and Craig takes over. Fast forward again and the pandemic hits in 2020, 2021. No prices were reduced. If you read the reports during the pandemic periods – I know the work that was done because I was there for a portion of the pandemic and it was very difficult for the supply chain – no prices were reduced. Craig was very late to let employees work from home, even though there was no travel happening. Everybody was perfectly capable of working from home, doing well, being productive, feeling safer and reducing fear, stress and anxiety; all those things that have diminishing returns on people’s performance and their health and well-being. But he didn’t reduce any prices for the members.

{audio:0:15:32} He expanded some hours and made some shopping concessions, but there was no value given and people were losing their jobs. Many people went on unemployment, which meant significant reduction in salaries. There was no concern for people’s fiscal well-being. 

{audio:0:15:55} Read the earnings reports for Costco; there were some of the highest sales and highest margin – not just margin dollars, but margin percent – delivered to the company, over that period of time. The stock was on fire. The employees were stressed out. Eventually, he let people in the office work from home, especially in certain divisions. When he started having them come back to the office, which he did, everyone was quitting.

{audio:0:16:39} Post-Covid, it was 100% work in the office?

{audio:0:16:46} Yes; he called them back and they’ve been back nine months.

{audio:0:16:50} Yes. He called them back nine months ago or more.

{audio:0:16:59} Because he wanted to be equal to the warehouse personnel who needed to go the warehouse, to interface with the members, so they could have operations open. In my mind – this is my opinion and my perspective – you put everybody at risk because you want to make sure that those that need to be at risk feel as if everybody is in it together. I believe we could have sent out a very different message.

{audio:0:17:37} What was Craig’s rationale in not changing pricing during Covid when, as you said, sales were exploding?

{audio:0:17:54} He owed it to the shareholders to ensure the solvency of the company. There were so many unknowns that it would have been too high risk for his appetite to reduce prices. Also, part of the perspective was that Costco’s members are above the mean point where people were losing their jobs. They’re not the impacted people.

{audio:0:18:40} Which, I guess, is also true, from the numbers they report?

{audio:0:18:49} More people became Costco members during the pandemic. There was an increase in memberships because people were looking for goods and the grocery stores were out. So why not capitalize on that?

{audio:0:19:12} You’re saying more of the average earning demographic came into Costco because of the lack of supplies elsewhere and they want cheaper goods. Therefore, you represent more of the overall demographic anyway, so he should have decreased the prices, like Jim did?

{audio:0:19:37} I would say so; comparatively speaking, yes.

{audio:0:19:44} How does he communicate, versus Jim? Given that it is a different philosophy, how does he rationalize or communicate that to the employees?

{audio:0:19:57} He doesn’t. There is an absence of communication. He doesn’t owe that explanation to the employees.

{audio:0:20:07} Where did Jim even get this philosophy from? 

{audio:0:20:25} I think it was his moral compass. He worked for Sol Price for a long time and he loved Sol’s business idea, but he didn't like the way Sol treated people. He wanted that business idea with the antithesis of Sol’s behaviors. He knew that Sol meant well, but he knew that you didn’t have to get results out of people by berating them. He knew you could get results out of people by respecting their humanity and he wanted to be able to do that. 

{audio:0:21:04} He became CEO by meeting Jeff Brotman and Jeff liked the business idea. They got a bunch of people together, to get money, to open their first and only warehouse in Seattle, with the office on top. They thought, if we do 10 or 15 warehouses, we’re going to call it a huge success. Between all these people, there was a decision as to who was going to be CEO. Jim got two votes because someone voted for him and he voted for himself. It was important to him that the philosophy he had in mind became the moral compass of the company. It was fundamentally important to him.

{audio:0:22:08} He was a Christian and Jeff was a Jew; they both had strong moral compasses. It was just important to them that they spread more love, grace and loyalty than a transactional business relationship.

{audio:0:22:35} What do you think Jim saw in Craig?

{audio:0:22:40} Business acumen, for sure. He thought that there were enough people that had been taught the core values of the company, that would be perpetuated and taught, that Craig had what was needed to ensure the solvency and strength of the company for the future. He thought that his moral compass wasn’t so bad that he would destroy the company or do something egregious to tarnish it and there were enough leaders and rank and file that embodied what Jim had taught. There was enough equity there to ensure that it would be perpetuated.

{audio:0:23:39} Do you think he would look at that in a different way today?

{audio:0:23:45} I think that Craig spends Jim’s equity. I like Craig, as a person. I had an extraordinarily strong relationship with him. He is just not Jim. Nobody is Jim but he just doesn’t embody the same moral compass that Jim did. Once he got into significant power, it very much started to show up. 

{audio:0:27:14} How would you compare the way the executive team was structured and behaved around Jim versus Craig, today?

{audio:0:27:41} Jim was so loyal and so extraordinarily smart, but not intellectually smart in a superior way, where it was a condescending presence. Everybody sought to stop and listen to what he might say. He always presented it in a very gentle way. I can remember, one time, him being irritated with me, in a room. Because I spent so much time with him, it was not damaging. But I remember his gentleness was that he stopped reading what he was reading, because I was presenting him something, and I said something a little bit off-color. He stopped and he didn’t even move his head up. He looked over his glasses at me and looked at me right in the eyes. 

{audio:0:29:04} I always felt like he was very fatherly to me, because I was so young when I started at the company. I felt as if my formative years were really under Jim’s leadership. I reflect on that and think, I am the person I am today and I am the person who raised the children I raised, because of the effects of Jim’s leadership in my life. They were so shaping. I feel so grateful that I fell backwards into this pile of goodness, to be able to be led by him for so many years.

{audio:0:29:36} My point being, he didn’t have to say a word to me. He just made it clear that he expected more from me than that by just looking in my eyes over his glasses. But then later, he would come up to me and put his arm around me. There was no shame. It was just always the sense of, I expect so much from you. If your parent gets mad at you or you disappoint them, what’s worse? He was really good at showing you he was not mad at you but, boy, that’s sure disappointing.

{audio:0:30:30} There are also incredible stories of him, about raising prices of the hot dog for example. Do you have any other instances that really stick out in your mind, of your interactions with Jim, that just define him, his culture and his philosophy?

{audio:0:30:48} People would say, why don’t your buyers raise the prices on this particular item; there is such a huge gap from the marketplace. He said, yes; my buyers could make $15 more on these jeans, and we’d still have a huge value. Fortunately, they know the rule about only making this much margin and they are dogged about always getting lower and lower costs, so they can have lower sell prices, so they can continue to have smashing authority in the marketplace. 

{audio:0:31:32} If my buyer ever came to me and said, I can make this much more and we have this much margin and I can deliver this much more to the company, he said, I would look at them as if they had two heads and think, you’re working for the wrong company and how did we ever promote you to be a buyer. At the shareholder meetings, he would stand up and tell stories like that, because the shareholders wanted Costco to make more margin. He said, that is not what we do.

{audio:0:32:04} Back to this question about culture and its evolution at Costco, how have you seen Craig’s approach change around pricing, for example, and that gross margin target?

{audio:0:32:17} For instance, the Kirkland Signature water, the buyer, the AGM and the assistant buyer worked tirelessly, with the vendor, on this item, which goes in 98% of the carts, in the 16.9oz bottle of Kirkland Signature water that is in the 40 pack. They worked tirelessly to get to $2.99. This became the Holy Grail because $2.99 is unheard of. But the vendor wanted to make more margin and Craig let them take a 20-cent price increase – which is a huge percentage of $2.99.

{audio:0:33:30} When you are building Kirkland Signature is all cost plus and there is visibility. Jim would have got involved and asked for update after update of how much of this is real and asked the vendor to give some and make less margin, because they were still getting rich. He would have had Costco make less margin because he wouldn’t have broken that price point and he wouldn’t have allowed the vendor to take that large of a price increase nor Costco to take that large of a price increase.

{audio:0:34:13} In addition, every item, in every region, in every geographic area stands on its own; that’s how Costco functions. Some regions make 12% on an item and some regions might make 8% and some might make 13%, depending on the distance from manufacturing. Craig let one of his SVPs, an executive of a division, talk him into weighting the average of the margin – not the cost, not the sell – to reach, say, 13% on an item if it showed a significant value in the marketplace. That meant some regions might make 10%, depending on their volume and some regions might make 16% or 17%, which is outside the bounds of the philosophy of the company that has been in force for over 40 years.

{audio:0:35:34} It created so much confusion for the executives in the regions, the buying teams in the regions as well as the executives and buying teams at corporate, that there is now this huge deviation from the guiding principle of the company, that used to be talked about as a Holy Grail and that a buyer wouldn’t even belong in the system if they did something like that. 

{audio:0:36:05} This was all to be able to deliver margin, where the company always delivered value. They were a topline company in sales, so delivering value drives sales. But if you can take a little for yourself, it’s a huge deviation from the philosophy, the bedrock, the foundation.

{audio:0:36:40} Shareholder value. Some regions were being penalized on some high-volume item because of their geographic distance to manufacturing versus others. In order to benefit that region’s P&L – although they operated under those expectations, they had all their goals based on historical data, which means they weren’t challenged to make more margin; they were always challenged to drive more sales – let’s deviate from a philosophy that is a driving principle of the company.

{audio:0:37:21} For all these other managers that have been at Costco for 20 or 30 years, or longer, what do they think about these big things that are happening?

{audio:0:37:38} Some of them were like, so we’re doing that now? What am I going to tell my people? This is something that we have told them forever. We have legacy buyers that have been buyers for 25 or 30 years. Now I have to train my people that this is okay. At what point do we stop negotiating with our vendors, to get better pricing and deliver it in more sophisticated way to the market, to shave pennies out of the cost, to get a little more out of our margin, instead of marking goods up, in a price opportunistic price change period, so that we can have an amalgamated average margin and that region can have more money?

{audio:0:38:37} Did he only do that for water or were there other products that rolled out to?

{audio:0:38:44} There are enough manufacturing sites for water. The point on water was taking a price increase and breaking a critical price point, such as the $1.50 hot dog. The $2.99 water was a Holy Grail, like the $1.50 hot dog.

{audio:0:39:00} In your mind, with this weighted average pricing, there could be a risk that this is rolled out to many categories or many SKUs, across Costco?

{audio:0:39:11} Yes; it’s an erosion of philosophy.

{audio:0:40:17} How does the buying team structure working with the merchandising team at Costco, historically? How does that fit together?

{audio:0:40:25} At Costco, merchandising is buying. Operations is the warehouses and merchandising is the buying division.

{audio:0:40:44} Merchandising is buying, so assistant merchandise manager is the manager over the buyers and their teams. I was a buyer, for some time, and then I got promoted to be over the buyers and their teams. I travelled with them, all over the world. I travelled all over the world and taught in all of our international regional offices. I would teach buying tenets. I was a foremost merchandiser for the company, to be honest.

{audio:0:41:52} What are those core principles that you learned about, buying under Costco?

{audio:0:41:57} Quality, plus cost, equals value, which is not the same measurement of value for a lot of companies. That means that you should always be using a more sophisticated thought process and to be making the supply chain more efficient, so you can strip pennies out. Pennies matter and they add up, over time. You need to be in the manufacturing sites, with your manufacturers, looking at how they can become more efficient, because they should also share in those efficiencies. If you are able to find five pennies, through that portion of the supply chain, maybe the manufacturer keeps three and gives two to Costco; or maybe vice versa.

{audio:0:42:51} Always looking at, is this the best way to transport the goods to the marketplace? Transportation is very expensive and a really heavy load on the cost of goods. Never compromise on quality to get to those lower costs. It is always about creating efficiencies. It is always about a more sophisticated way of looking at things.

{audio:0:43:20} You don’t strip out quality to get to a lower cost. Ever.

{audio:0:43:24} How do you measure quality? 

{audio:0:43:27} You would measure quality compared to like items in the industry. There is a full-scope lab, on site, at the corporate headquarters. They would in the Kirkland Signature item, or the brand item, and then other similar items in the category and makes sure that all of the claims were accurate and check the efficacy of anything that was supposed to be deliverable and effective in and product, to ensure that it did, in fact, meet or exceed those metrics.

{audio:0:44:04} Let’s say I’m a big branded supplier, such as Nestlé – someone in the snack or chocolate goods category – obviously, I’m a huge brand and have power. How would you approach a negotiation with me, in terms of sourcing product?

{audio:0:44:33} It depends on what the category captain was, from Nestlé, because they are across many categories. Let’s just talk about chocolate; say it’s a Nestlé Crunch Bar. That is maybe the category captain for them. You would do a competitive shop, across the marketplace and find out what the retails and deal times were. When you had them in to talk to them, you would talk about Costco’s volume and what kind of efficiencies that would drive for their system. You would talk about what kind of a gap could be created to reward Costco for those efficiencies in getting those goods to market, versus other outlets, where they are delivering goods in significantly less efficient ways and, probably, lower volume.

{audio:0:45:35} You would lever all of the benefits that your business provides to that supplier, against what any other one of their customers provides.

{audio:0:45:50} If I’m Nestlé, I would have a SKU or a packaging or product size for the grocery channel and for the club channel, and the club channel would be Costco and Sam’s. How would you look to position Costco, in the club channel, versus Sam’s?

{audio:0:46:09} There’s a law – called Robinson-Patman – and it’s channel specific. You have to demonstrate that you have key metrics that create efficiencies, that drive cost decreases, in order to get those, versus any one of your competitors in your same channel. You can also put your channel of trade against other channels of trade, demonstrating the same differences. If you have metrics that measure to your benefit, and you can demonstrate that, then legally, you can get a better cost.

{audio:0:46:58} More efficient packaging; more efficiencies in getting it to market; more efficient volume. For instance, if you are just going to run one SKU for Costco, and you’re running 15 SKUs for a grocery store, and their volume on those 15 SKUs doesn’t even match your one SKU for Costco, you’ve got 10 hurdles right there, that you’ve just crossed. Each one of those hurdles can have a value of X.

{audio:0:47:34} How much does the packaging and getting it to market actually really matter, versus just the volume being so much better because it’s only one or two SKUs, versus 10 or 20?

{audio:0:47:47} Package is a really big load on the cost of goods. As a percentage of the goods, it’s significant. You’ve got the outer wrap and, usually, you would have some sort of cellophane. Then you may have some sort of a box and then each individually wrapped piece that the person was going to eat, which usually had two wrappers on it. For instance, say you have a 12 count that is going to the grocery store and you are going to sell it to Costco and you have a 36 count, you just cut your tertiary packaging costs by one third, because you are spreading it over three times as many candy bars.

{audio:0:48:33} Instead of putting it in boxes that need to be broken open and put on the display, you’re going to palletize it, which means you reduced the additional tertiary packaging, the costs associated with it and all of the handling costs associated with putting in on the line and putting it in one more package; who knows what other packaging it might go into. 

{audio:0:48:59} Often, these stores don’t buy full pallets; they buy six cases. Costco is going to buy a finished pallet, in a full truckload, to one destination and then they will distribute it themselves. Costco distributes only in pallet quantities. They display in pallet quantities; they sell goods off pallets. Very efficient.

{audio:0:50:09} At Costco, do you have certain KPIs, as a buyer, that you have to meet, per SKU?

Costco Wholesale: Management, Philosophy, & Culture

Former Senior Manager at Costco

inpractise.com/articles/costco-wholesale-management-philosophy-and-culture

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