South-Westerns' Economic News Summaries
Costco's business model proves successful
Subject Costco increases sales by treating customers and workers well
Topic Profit maximization and the firm; labor markets; elasticity
Key Words

Costco, Wal-Mart, Sam's Club, revenue, costs

News Story

Costco is the largest warehouse retailer, with almost 50% of the market, compared with Sam's Club 40% market share. Costco's profit last year was $882 million, up 22% from the previous year. How does it do it and keep its profitability going?

Costco treats its customers well by selling quality goods very cheaply and relentlessly trying to reduce price. It sells fewer items--about 4,000 per warehouse--compared with about 100,000 at Sam's Club, allowing it to get deeper discounts from its fewer suppliers. Costco doesn't advertise, saving more money. Its CEO earns a salary of just $350,000, about 10% of the norm.

It also treats its employees well. Its workers average $17 per hour, about 42% higher than the industry average, and pay only 8% of their health care premium. It has also allowed workers to unionize. Teamsters represent about 14,000 of the 113,000 Costco workers. Costco contributes to its employees' 401(k) plans, up to 9% of their salaries. Workers enjoy being there, based on survey comments such as, "I want to retire here."

Not everyone likes the model, however. Wall Street analysts complain that shareholders are treated worse than employees are. They argue that Costco could raise prices and force employees to shoulder a higher share of health care costs, and thereby increase profits further.

What is the result? Costco now has 457 stores in the US and five other countries. Its average client has a household income of $74,000, and a third of its clientele has an income over $100,000. It receives deep discounts from suppliers to pass on cost reduction to customers. Its worker retention is very high, and employee theft rates at the company are very low.

Questions
1.

Costco workers are paid much higher wages than at other retailers, analogous to the "efficiency wage theory." Why would Costco want to pay higher wages than their competitors pay?

2. Based on how Costco treats its employees, would you describe its labor supply as elastic or inelastic? Why?
3. Would you describe labor demand at Costco as elastic or inelastic? Why?
Source Steven Greenhouse. "How Costco became the anti-Wal-Mart." The New York Times, 17 July 2005.

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