Progress Report 3

Meghan Fischer Elisa Santamaria Kara Fanty

Kaitie Thomas Matthew Murphy

Internal Audit Current Situation: The Path to Costco Wholesale Corporation: A History 1976: Sol & Robert Price open Price Club on July 12, the first warehouse club for business shoppers in San Diego, California. 1980 -1989: The Price Company offers public stock on July 12th, 1980. In 1982, Jeff Brotman and Jim Sinegal meet and draw up plans to start a new wholesale club business. A year later the first Costco warehouse opens in September in Seattle, Washington. Costco’s public stock is available on December 5th, 1985. Price Club is named the Forbes Magazine's "Best Managed Company" 10 years after its open. In 1989 Costco begins the year with 46 warehouses in operation. The Price Company is the third most profitable company in the United States. 1990 - 1999: Costco celebrates its 10th anniversary in September of 1993 while shareholders approve the merger of Price Company and Costco, forming PriceCostco. Kirkland Signature, Costco's exclusive private label, is introduced in 1995. Two years later, the company officially changes its name from PriceCostco to Costco Companies, and the Executive Membership is introduced. 1997, Costco launches its E-Commerce site at Costco.com to bring Costco prices and services to the internet. Before the turn of the millennium the average annual sales per warehouse reaches $100 million. The Company changes its name to Costco Wholesale Corporation on August 30th. 2000 – Present: The 2% reward program is initiated, increasing Executive Member value. In July of 2001, Costco celebrates its 25th anniversary. Costco finishes the 2002 fiscal year with 40.5 million cardholders and 98,000 employees worldwide. Costco.com generated sales of $226 million in 2003 while average annual sales per warehouse were $105 million. In 2004, Costco is the 5th largest retailer in the U.S. and 11th largest in the world. Fortune Magazine lists Costco 29th on the Fortune 500. Over 57,000 vacation packages were booked through Costco Travel in 2005. In 2006, Costco was named one of the "most admired" companies by Fortune magazine while approximately 30 million rotisserie chickens were sold company wide. * Source: “Historical Highlights” Costco.com Costco’s Words to Live by: Mission & Keyword Analysis To continually provide our members with quality goods and services at the lowest possible prices. In order to achieve our mission we will conduct our business with the following Code of Ethics in mind: Our Code of Ethics • Obey the law. • Take care of our members. 2

• •

Take care of our employees. Respect our suppliers.

•

Reward our shareholders.

If we do these four things throughout our organization, then we will achieve our ultimate goal, which is to:

(See Appendix) *Source: “Code of Ethics”: Costco.com Current Long-term Objectives: (with in last 2-3 years) • To increase sales • To acquire increasing numbers of memberships each year o Costco currently ( as of 2/2007) has 49 million cardholders broken down into:  26.7 million households  18 million Gold Star  5.3 million Business  3.4 million Business Add-Ons *Source: Costco 10K 2006 p.16-7, Costco.com Current Corporate Strategies (within last 2-3 yrs) Growth- Intensive: Market Penetration • Expand business in new markets by attaining a greater overall market share. Costco seeks to continually offer quality products at significant savings to members. It is their philosophy to keep costs down and pass the savings on to members. Costco also offers a unique “treasure hunt” experience while shopping in their warehouses, making shopping exciting and fun. Market Extension • Opened new stores in new markets (US and abroad) o Projected Openings FY 2007: 29-31 o Projected Openings FY 2008: 35-41 Product Development • Martha Stewart plans to bring her own line of fresh, refrigerated, and frozen foods to Costco called Kirkland Signature by Martha Stewart in 2008. Stabilization: Enhancement • To continually meet and exceed the high standards for energy efficiency placed by California law in all of our warehouses in the United States o Use of solar panel in warehouses – 2006 o Testing of hybrid trucks for distribution – Spring 2007 • To increase interaction with our members to fit current customer trends. o Sampling

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o To spend approximately $1.4 – 1.6 billion for warehousing, clubs, related operations: o Real estate o Construction o Remodeling o Equipment *Source: Costco 10K 2006, Costco 2006 Annual Report, Costco.com, Barbaro

Functional Analysis: Management: Costco is committed to promoting from within the company. The majority of our current home and regional office team members are "home grown." This means that they started in our warehouses, depots and business centers, learned the business and moved up within the company. This philosophy also ensures promotional opportunities for motivated individuals. Costco has one of the most competitive benefits packages in the industry. Not only do we provide our employees with a full spectrum of benefits, but employees also may elect coverage for their spouses, children and domestic partners. The company pays a larger percentage of the premiums than do most other retailers and employee-paid premiums are withheld pre-tax, which means you get to keep more of your hard-earned money. Merchandising is the lifeblood of Costco, and our business is centered on our warehouse operations. (See Appendix) *Source Costco.com Costco vs. Wal-Mart Facts: o 44% of Wal-Mart employees leave after the first year. o 6% of Costco employees leave after the first year. o Sell more because well-treated and motivated, which accounts for $16,550 of operating income in 2004. Wal-Mart employees only contributed $12,800. *Source: Greenhouse, DiCarlo, Costco.com Analysis: As a corporation, Costco cares about their employees. They provide a stable work environment, higher work salaries than the industry average and great benefits. They view their employees as more than an asset. This is evident because many of the people in the top management positions once worked as an employee of Costco. Costco has the ability to furnish their employees with higher salaries because of the way they run their warehouses. The warehouses are designed with a simple structure in mind. They are not ostentatious or made to look expensive. This allows for there to be little overhead cost for each warehouse. Aside from benefiting employees, Costco’s operations also benefit the customers 4

because it allows Costco to lower the retail price of their products. Lastly, the hours of operations for Costco warehouses are shorter on the weekends, which help employees achieve a better work – life balance. In comparison to Wal-Mart, Costco has a significantly smaller employee turnover, meaning their investments into employees are lasting and ultimately lead to a higher contribution. In addition to employee benefits and store setup, Costco is a logistically sound company. They stream light their distribution into a single-step channel they lower costs without cutting quality. Marketing: Costco figures that it saves a good two percent a year in costs because it rarely shells out money for mass-media advertising. It does, however, effectively target small-business owners as its primary target market. Operating largely under the radar of the general public, Costco has cadres of marketing representatives who are attached to each store and whose continual task it is to network with business owners. There was a 13.7% increase in net sales from 2005-2006, driven by an 8% increase in comparable store sales and opening of 25 new warehouses in 2006. Also, there was a 10.0% increase in net sales from 2004 to 2005, driven by a 7% increase in comparable store sales and the opening of 16 new warehouses in 2005. (See Appendix) Total Sales: Revenue $60,151,227

% Increase 13.70%

200 6 200 $52,952,226 10.10% 5 200 $48,109,907 13.10% 4 *Source: Costco 10K 2006

Net Income $1,103,215.0 0 $1,063,092.0 0 $882,393.00

% Increase 4%

Net Profit Margin $0.018

% Increase -9%

20%

$0.02

9%

22%

$0.018

8%

Analysis: Net sales in fiscal 2006 increased 13.7% over fiscal 2005, primarily because of an increase in comparable sales of 8% and the opening of 25 new warehouses. Membership fees for fiscal 2006 increased 10.7% to $1.2 billion, representing new member sign-ups at new warehouses opened during the fiscal year, increased penetration of the Executive Membership program, and continued strong member renewal rates. As shown above, the profit margin decreased as a percentage. We believe that this decrease is primarily due to increased penetration of the Executive Membership two-percent reward program. Comparable warehouse sales, which are broken down and shown in Costco’s 10K, are also a 5

major factor in overall net sales for Costco. Retailers see the percent increases or decreases of the amount of warehouse sales, both in the United States and internationally, and react to what they observe. They react by determining where to focus most of their distribution of products because whichever warehouses are selling more are the areas the retailers want more of their products to be shipped to. Marketing Mix Products: Our merchandising strategy is to provide our members with a broad range of high quality merchandise at prices consistently lower than could be obtained through traditional wholesalers, mass merchandisers, supermarkets and supercenters. An important element of this strategy is to carry only those products on which we can provide our members significant cost savings. The following table indicates the approximate percentage of net sales accounted for by major category of items: Segments

2004 Sales % of Sales 2005 Sales % of Sales 2006 Sales % of Sales

Sundries

12,027,476

25%

13,238,055

25%

14,436,269

24%

Hard Lines

9,621,981

20%

10,590,444

20%

12,030,245

20%

Food

9,621,981

20%

10,060,922

19%

11,428,733

19%

Soft Lines

6,254,287

13%

6,354,266

12%

7,218,147

12%

Fresh Foods

5,292,089

11%

5,824,744

11%

6,616,634

11%

Ancillary/ Other Total

5,292,089

11%

6,883,788

13%

8,421,171

14%

48,109,907

100%

52,952,223

100%

60,151,227

100%

Members can also shop for private label Kirkland Signature products, designed to be of equal or better quality than national brands, including juice, cookies, coffee, tires, housewares, luggage, appliances, clothing and detergent. The Company also operates self-service gasoline stations at a number of its U.S. and Canadian locations. Additionally, Costco Wholesale Industries, a division of the Company, operates manufacturing businesses, including special food packaging, optical laboratories, and meat processing and jewelry distribution. These businesses have a common goal of providing members with high quality products at substantially lower prices. Price:

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The main objective for Costco is to allow the customers to get more for less because they are buying in bulk. This allows the company to receive a high industry turnover as well. (See Appendix) Place: Our typical warehouse format averages approximately 140,000 square feet. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise and the control of inventory. Because shoppers are attracted principally by the availability of low prices, our warehouses need not be located on prime commercial real estate sites or have elaborate facilities. (See Appendix) Promotion: We generally limit marketing and promotional activities to new warehouse openings, occasional direct mail marketing to prospective new members and direct marketing programs (such as the Costco Connection) to existing members promoting selected merchandise. These practices result in lower marketing expenses as compared to typical retailers, discount retailers and supermarkets. (See Appendix) Customer Profiles Costco is open only to members and offers three types of membership: Business, Gold Star (individual) and the Executive membership.. Business members qualify by owning or operating a business, and pay an annual fee ($50 in the U.S.) to shop for resale, business and personal use. This fee includes a spouse card. Business members may purchase up to six additional membership cards ($40 each) for partners or associates in the business. Gold Star members pay a $50 annual fee (in the U.S.), and is available to those individuals that do not own a business. This fee includes a free spouse membership. Costco targets individuals who have a medium to large disposable income and/or are affiliated with a small to medium sized business. Both target markets patron Costco because of the unique product sizes and varieties combined with competitive prices. The Costco member differs from the average Wal-Mart shopper. While both target markets are looking for valuable products and services at low prices, the Costco shopper could perhaps afford to spend more because he/she has a larger disposable income than the Wal-Mart shopper. Also, while the Costco member enjoys the low-pricing structure offered, the “Treasure Hunts” that offer high-price products such as designer apparel, are very appealing. (See Appendix) Analysis:

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Costco does little to no advertising. Since Costco does not do formal advertising, they run the risk of not being able to reach their full customer potential. However, their main form of advertising relies on customer word–of–mouth and direct marketing. Pertaining to word–of– mouth advertising, Costco feels that the best way to get customers to their warehouses are positive feedback from current customers. Costco also receives word–of–mouth publicity from celebrity clients, such as Oprah Winfrey, who name drop the company. The company also attracts purchases through sampling, which is direct marketing for the specific product and, overall, the company. Sampling involves tables and/or displays of different products being strategically placed throughout the warehouses. These displays help to entice customers to buy the products they are advertising. *Source: Robes, Hazel, Costco.com, Costco 10K 2006 Financial Performance Costco: Sales Net income Total Assets Equity Current Assets Current Liability Inventory Debt Receivables Fixed Assets COGS Earnings Before Interest & Taxes Day Sales ROS (in %) Total Asset Turnover ROA (in %) Financial Leverage- Equity multiplier ROE (in %) Current Ratio Quick Ratio Debt to equity Inventory Turnover Receivable Turnover Fixed Asset Turnover Gross Profit Margin Operating Profit Margin Day Sales Outstanding

2004 47,148,627 882,393 15,092,548 7,624,810 7,269,099 6,170,550 3,643,585 993,746 335,175 7,219,829 42,092,016

2005 51,879,070 1,063,092 16,665,205 8,881,109 8,238,001 6,760,537 4,014,699 713,900 529,150 7,790,192 46,346,961

2006 58,963,180 1,103,215 17,495,070 9,143,439 8,232,082 7,819,191 4,568,723 523,892 565,373 8,564,295 52,745,497

1,400,624 129174.32 2004 1.87% 3.1240 5.85%

1,548,962 142134.44 2005 2.05% 3.1130 6.38%

1,751,417 161542.96 2006 1.87% 3.3703 6.31%

1.9794 11.57% 1.1780 0.5876 0.1303 12.9402 140.6687 6.5304 0.1072 0.0297 2.5947

1.8765 11.97% 1.2185 0.6247 0.0804 12.9223 98.0423 6.6595 0.1066 0.0299 3.7229

1.9134 12.07% 1.0528 0.4685 0.0573 12.9058 104.2908 6.8848 0.1055 0.0297 3.4998

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BJ’s: Total Asset Turnover ROA (in %) Financial Leverage- Equity multiplier ROE (in %) Current Ratio Quick Ratio Inventory Turnover Receivable Turnover Gross Profit Margin (in %) Operating Profit Margin (in %)

2004 3.81 0.06 2.0139 0.12 1.1933 0.26206 9.239 83.043 8.17 1.6

2005 3.89 0.065 1.9585 0.13 1.986 1.1885 9.708 65.286 10.3 1.7

2006 4.17 0.036 1.9539 0.07 2.043 0.355 9.774 62.994 10.4 0.9

Costco is in stable financial condition, this is evident in nearly all of their financial ratios. Inventory turnover is particularly strong, with Costco turning over inventory approximately once every month. Return on Sales and Return on Assets are also consistent from 2004-2006. Costco’s current ratio is also greater than one meaning that the company is fairly liquid and able to pay their debts as they become due. Also, Costco’s Accounts Receivable ratios show that, aside from a slight decrease in 2005, Costco has approximately 104 days to be paid by their creditors. Comparing Costco to its competitor, BJ’s, the company is superior to BJ’s. This is evident in several ratios such as Inventory Turnover, Gross Profit Margin and Operating Profit Margin. In these, Costco excelled, such as having a greater ability to turnover inventory, which was about once a month, and to turn more sales into profits, giving Costco a better GPM. However, in Asset Turnover, BJ’s was better than Costco. Overall, Costco and BJ’s are stable companies on their own, with Costco’s dominating BJ’s in most ratios. (See Appendix) *Source: Hoover’s Costco 10K 2006 *Source: BJ’s 10K 2006 Production/Operations Costco Wholesale operates stores in 37 US states and Puerto Rico. The company also operates stores in nine Canadian provinces, Japan, South Korea, Taiwan, and the UK. Costco also operates 29 outlets in Mexico via a joint venture. Because of our high sales volume and rapid inventory turnover, we generally have the opportunity to sell and be paid for inventory before we are required to pay many of our merchandise vendors. As sales increase and inventory turnover becomes more rapid, a greater percentage of the inventory is financed through payment terms provided by vendors rather than by our working capital. Our typical warehouse format averages approximately 140,000 square feet. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise and 9

the control of inventory. Our warehouses generally operate on a seven-day, 69-hour week. Generally, warehouses are open weekdays between 10:00 a.m. and 8:30 p.m., with earlier closing hours on the weekend. (See Appendix) *Source: Costco.com, Costco 10K 2006 *Source: Standard & Poor’s 2007 Analysis Costco is very effective in tapping into global markets in addition to their domestic ones. Their operations hours lower production costs and are appealing to employees. Information Systems The Internet Systems Division of Costco consists of four groups: 1.) AS/400 Application Development - designs and maintains programs for the different business applications within the company. For example, there are teams to maintain and enhance accounting, inventory, payroll, membership, and payroll applications. 2.) Customer Service and System Support - is divided into several groups that provide focused, daily support of all IS functions for users of all levels throughout the company. 3.) Client/Server and Internet Technologies – is divided into three groups (Network Security, ECommerce Administration, and BackOffice Administration), each with a separate function. 4.) e-Commerce Application Development - supports Costco's corporate efforts in the Internet, obtains the web technology needed to streamline internal systems, and implements major phases and daily maintenance. (See Appendix) *Source: Costco.com, Costco 10K 2006 Analysis: While Costco is effective with their significant participation in many international markets, the company has yet to bring this strength to their websites. By only allowing shipping to Canada and the United States through their website, they are potentially cutting off and not tapping in to a huge segment of their online market. However, the company does offer websites in the official languages of the countries they are in. The website layout is over-whelming due to the clutter of the opening page. The tabs are not the same size, the pictures are cluttered, and there is no distinct focal point of the page. As a result, the navigation of the website is a little confusing, because it conveys a sensory overload. Though the main page is problematic, the department pages give a simplistic way of navigating

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the different products within each department. A more simplistic way of designing the layout of the website would help parallel the message of the warehouse layouts, which are simple with a lot of products. In an effort to hedge against the confusing setup, the website does have a business tab that helps remind the small business customers to check out the different products for companies. The graphics of the website showcase the quality of the products because of their high-resolution and clarity. Browsers are also able to enlarge the pictures. Also, some products can be viewed in many different angles, allowing the customer to glean more information about the products.

Global External Audit: Macro Environment Audit: Economic Forces The United States: The US has the largest and most technologically powerful economy in the world with a $40,100 per capita purchasing power according to 2004 statistics. They have the fastest growing GDP and one of the lowest unemployment rates showing a healthy and prosperous economy for Costco to be in. These factors affect demand for products and services or require a change in the mix of products they sell which adversely affects profitability. There inflation rate is however, the highest of the three countries which causes Costco to face high cost of sales and operating, selling, general and administrative expenses, and otherwise adversely affecting operations and results. US as compared with Japan has more flexibility to expand capital plant, to lay off surplus workers, and to develop new products. At the same time, the US faces higher barriers to enter their rivals' home markets than foreign firms face entering US markets. Canada: Canada resembles the US in its market-oriented economic system, pattern of production, and affluent living standards. While the GDP growth rate is not as prominent as the United States it is still increasing by 2.4 percent. The GDP purchasing power is also slightly less then the United States but above that of Japan with $31,500 per capita. The unemployment is the highest at 7 percent which could affect Costco by having a huge segment of the population out of work and unable to purchase, slowing down the economy. Their inflation rate is lower then the United States, which presents an opportunity for Costco to have lower cost of sales and operating expenses. Costco is highly dependent on both Canada and the US, which represent 94 percent of their total net sales. A prosperous economy is necessary for to ensue financial success for Costco. Japan: Government-industry cooperation, a strong work ethic, mastery of high technology, and a comparatively small defense allocation (1% of GDP) helped Japan advance to the rank of second most technologically powerful economy in the world after the US and the third-largest economy in the world after the US and China. Their GDP growth rate is 2.9 percent which is above that of Canada and their GDP per capita is $29,400. Their unemployment rate is the lowest of the three

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countries at 4.7 percent which has a high potential for Costco to profit. One notable characteristic of the economy is how manufacturers, suppliers, and distributors work together in closely-knit groups called keiretsu. A second basic feature has been the guarantee of lifetime employment for a substantial portion of the urban labor force. This results in a stable economy that is able to purchase Costco’s products. United States Canada Japan GDP Real Growth 4.4% (2004 est.) 2.4% (2004 est.) 2.9% (2004 est.) Rate GDP Per Capita purchasing power purchasing power purchasing power parity - $40,100 (2004 parity - $31,500 (2004 parity - $29,400 (2004 est.) est.) est.) Unemployment Rate 5.5% (2004 est.) 7% (2004) 4.7% (2004 est.) Inflation Rate 2.5% (2004 est.) 1.9% (2004 est.) -0.1% (2004 est.) Population Below 12% (2004 est.) 15.9% (2003) NA Poverty Line Demographic/Sociocultural Forces The United States: The United States is the most culturally diverse country of the three. They also have the highest population and fastest growth rate. Majority of the spoken language is English but there is still prominent speaking of Spanish and Asian languages. Costco must adapt to the diverse cultures that are present in the US but also to the US’ own culture. The largest population age range is 67 percent between the ages of 15-64, which is a great segment for Costco to target to. Canada: Canada has a fairly diverse ethnic population with 28 percent British Isles, 23 percent French, 15 percent European and 2 percent American. Even though the country is diverse its population maintains strong ties to their cultural background. It is important for Costco to understand and adapt to the different cultural products and languages when doing business in Canada. They have the lowest population of the three countries with around 32,000,000 and a growth rate .9 percent. Japan: Japan’s population is second to the United States with around 127,000,000 which averages out to around 327 persons per square kilometer. Such a dense population has help to promote extremely high land prices. They also maintain a strong pride in their culture do to the fact that 99 percent of the population is Japanese and it is the only spoken language. This forces Costco to adapt to their language and culture to fully break into their market. The population growth is the smallest out of the three countries and their biggest age range is 66 percent between the ages of 15-64. United States Canada Japan Ethnic Groups white 81.7%, black British Isles origin Japanese 99%, others 12.9%, Asian 4.2%, 28%, French origin 1% (Korean 511,262, Amerindian and 23%, other European Chinese 244,241, Alaska native 1%, 15%, Amerindian 2%, Brazilian 182,232, native Hawaiian and other, mostly Asian, Filipino 89,851, other

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Languages

Population Population Growth Age Structure

Literacy Rate

other Pacific islander 0.2% (2003 est.) note: a separate listing for Hispanic is not included because the US Census Bureau considers Hispanic to mean a person of Latin American descent (including persons of Cuban, Mexican, or Puerto Rican origin) living in the US who may be of any race or ethnic group (white, black, Asian, etc.) English 82.1%, Spanish 10.7%, other Indo-European 3.8%, Asian and Pacific island 2.7%, other 0.7% (2000 census) 295,734,134 (July 2005 est.) 0.92% (2005 est.) 0-14 years: 20.6% (male 31,095,725/female 29,703,997) 15-64 years: 67% (male 98,914,382/female 99,324,126) 65 years and over: 12.4% (male 15,298,676/female 21,397,228) (2005 est.) definition: age 15 and over can read and write total population: 97% male: 97% female: 97% (1999

African, Arab 6%, mixed background 26%

237,914) note: up to 230,000 Brazilians of Japanese origin migrated to Japan in the 1990s to work in industries; some have returned to Brazil (2004)

English (official) 59.3%, French (official) 23.2%, other 17.5%

Japanese

32,805,041 (July 2005 est.) 0.9% (2005 est.) 0-14 years: 17.9% (male 3,016,032/female 2,869,244) 15-64 years: 68.9% (male 11,357,425/female 11,244,356) 65 years and over: 13.2% (male 1,842,496/female 2,475,488) (2005 est.)

127,417,244 (July 2005 est.) 0.05% (2005 est.) 0-14 years: 14.3% (male 9,328,584/female 8,866,772) 15-64 years: 66.2% (male 42,462,533/female 41,942,835) 65 years and over: 19.5% (male 10,435,284/female 14,381,236) (2005 est.) definition: age 15 and over can read and write total population: 99% male: 99% female: 99% (2002)

definition: age 15 and over can read and write total population: 97% (1986 est.) male: NA% female: NA%

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est.) Political/Legal: Government Type

Legal System

Budget

United States Constitution-based federal republic; strong democratic tradition

Canada a constitutional monarchy that is also a parliamentary democracy and a federation based on English common law, except in Quebec, where civil law system based on French law prevails; accepts compulsory ICJ jurisdiction, with reservations

federal court system based on English common law; each state has its own unique legal system, of which all but one (Louisiana's) is based on English common law; judicial review of legislative acts; accepts compulsory ICJ jurisdiction with reservations revenues: $1.862 trillion expenditures: $2.338 trillion, including capital expenditures of NA (2004 est.)

Japan constitutional monarchy with a parliamentary government modeled after European civil law system with EnglishAmerican influence; judicial review of legislative acts in the Supreme Court; accepts compulsory ICJ jurisdiction with reservations

revenues: $151 billion revenues: $1.401 trillion expenditures: $144 expenditures: $1.748 billion, including trillion, including capital expenditures capital expenditures of NA (2004 est.) (public works only) of about $71 billion (2004 est.)

Technological: Telephones-Main Lines Telephones- Cellular Phones Internet Users

United States 181,599,900 (2003) 158.722 million (2003) 159 million (2002)

(See Appendix) *Source: Costco 10K 2006 *Source: CIA World Factbook Industry Audit:

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Canada 19,950,900 (2003) 13,221,800 (2003)

Japan 71.149 million (2002) 86,658,600 (2003)

16.11 million (2002)

57.2 million (2002)

Costco is identified as a major player in the Warehouse Clubs & Supercenter industry along with Sam’s Club and BJ’s Wholesale. According to NAICS, this industry specified with code 452910, “comprises establishments known as warehouse clubs, superstores or supercenters primarily engaged in retailing a general line of groceries in combination with general lines of new merchandise, such as apparel, furniture, and appliances..” Breakdown of Warehouse Club and Supercenter Industry from the parent industry of Retail Trade is as follows: Industry NAICS Detail

# of

Code 44-45 452 4529 45291 452910

Description Retail Trade General Merchandise Stores Other General Merchandise Stores Warehouse Clubs & Supercenters Warehouse Clubs & Supercenters

% of Estab .

% Sale s

% Estab.

% Sales

GM

GM

Estab.

Sales

1,114,63 7 40,723

3,056,421,99 7 445,224,985

3.7%

14.6%

31,368

224,482,103

2.8%

7.3%

77.0%

50%

2,912

191,252,396

0.3%

6.3%

7.2%

43%

2,912

191,252,396

Although Warehouse Clubs & Supercenters (WC&S) only make up .3% of the retail trade industry in terms of number of establishments, this industry earns only 1% less than other general merchandise stores in terms of sales. If the WC&S industry is compared to General Merchandise Stores, it pulls in 43% of the industry’s sales with only 7.2% of the industries establishments running with a WC&S classification. According to Hoover’s Online, warehouse clubs are seeing customer membership at an all-time high. While annual membership fees range from $40-100, Costco’s offers its memberships from $45-60. The supermarket industry lost market share to such warehouse clubs and supercenters. Currently in North America, supercenter Wal-Mart has achieved the number one spot of top 10 Mass Market Retailers, with Costco coming in at number 3. On the global scale, Costco is the seventh largest food retailer. In regard to the warehouse industry, Costco rivals both Sam’s Club and BJ’s for the number 1 spot. (See Appendix) *Source: US Census Bureau. – Industry Statistics Sampler *Source: Hoover's, Inc. *Source: Supermarket News 2006 *Source: Mass Market Retailers, August 2006 *Source Mintel Oxygen: Warehouse Club Buying, 2005 Financial Performance:

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The industry has a steadily growing return on revenues and return on assets. Return on equity, throughout the industry, varies from year to year. This is mainly because the amount of debt the different companies take on during specific years. The debt to capital ratio has a wide range due to the amount of financial leverage the different companies choose to incur. The net income is a mixed stream throughout the industry due to the increase of sales of the varying companies. The forecast of the industry appears to be positive, with strong financial activity ratios. (See Appendix) *Source: Standard & Poor’s Porter’s Model: Threat of Entry Absolute Cost Advantage - High Economies of Scale - High Brand Identity - High Access to Distribution – High Switching Costs - High Government Policy - Mod Bargaining Power Of Suppliers – Supplier Concentration - High # of Buyers - High Switching Costs – Mod. Substitute Raw Materials - High Threat of Forward Integration - Low

Degree of Rivalry Number of Competitors – Low Industry Growth – Moderate Asset Intensity – High Product Differentiation – High Exit Barriers - Low

Threat of Substitution Functional Similarity - Low Price/Performance Trend - Mod Product Identity - High

* Source Mintel Oxygen: Warehouse Club Buying, 2005 *Source: Costco.com *Source: Standard & Poor’s

16

Bargaining Power Of Buyers Buyer Concentration - High #of Buyers - High Switching Costs - Low Substitute Products Low Threat of Backward Integration – Mod.

Competitor Analysis: BJ’s Wholesale Club has several current objectives. There objectives of BJ’s are to be dedicated to providing its members with high-quality, brand name merchandise at prices that are significantly lower than the prices found at supermarkets, supercenters, department stores, drug stores and specialty retail stores. BJ’s bottom line; to have high sales with rapid inventory turnover. BJ’s current strategies are to offer a narrow assortment of food and general merchandise items within a wide range of product categories. The warehouse clubs sell a diversified selection of product categories; they attract customers from a wide range of other wholesale and retail distribution channels, such as supermarkets, supercenters, department stores, drug stores, discount stores, office supply stores, consumer electronics stores and automotive stores. BJ’s also targets small businesses and households. In addition, BJ’s places added focus on the individual consumer. Inner Circle members are offered merchandising strategies that emphasize a customer-friendly shopping experience. Second, by clustering our clubs, they achieve the benefit of name recognition and maximize the efficiencies of their management support, distribution and marketing activities. Finally, BJ’s seeks to establish and maintain the first or second industry leading position in each major market where they operate. For the convenience of their members they maintain longer hours of operation than their warehouse club competitors. While all wholesale clubs sell merchandise in bulk, BJ’s also offers smaller package sizes that are easier to carry home and store, including sizes that are comparable to those offered in supermarkets. BJ’s future plans are to open 8 to 10 new clubs in 2007, all of which are expected to be in existing markets. In each case, they will replace an older club with a new prototype. Also, BJ’s wants to retain new members, be more competitive with prices and offer new assortments and presentation of products. Lastly, BJ’s, financially, does not do as well as Costco, but they are still a financially stable company. (See Appendix) *Source: BJ’s 10K 2006 SWOT Analysis: Management

Strengths Majority of top management officials are “home grown”. Only 6% of Costco employees leave after the first year, compared to 44% of Wal-Mart’s. Section B-1

17

Weaknesses Simple layout may detract from luxury items offered in store. Section B-1

Marketing

Increase in comparable store sales 20042005 (8%) and 2005-2006(7%). “Treasure Hunt” aspect makes shopping fun again; Costco’s philosophy is to keep overhead costs low and pass those savings on to customers in the form of low prices.

Accounting / Finance

Section B-2 Costco turns over its inventory nearly once a month, which is more frequent than its competitor BJ’s. Costco has consistent Return on Sales and Return on Assets.

Production & Operations

Section B-3 Costco operates stores in the US, Canada, Mexico, UK, Japan, South Korea, and Taiwan.

Costco does little to no formal advertising except in the instance of a store opening, so they may not be reaching their full membership potential. Section B-2

BJ’s has a stronger Asset Turnover than Costco. Costco’s gross profit margin has declined from 2004-2006, while BJ’s has increased. Section B-3 Costco has not yet opened stores in all regions of the globe. Section B-4

Because of Costco’s high inventory turnover we generally have the opportunity to sell and be paid for inventory before we are required to pay many of our merchandise vendors. Information Systems

Section B-4 Costco has a separate website for stores in each of its international reasons. Costco offers special online deals each week dubbed “This Week’s Treasure Hunt”. Costco’s website showcases the quality of the products it offers and lets the customer view products from various different angles. Section B-5

18

Costco only offers an online retail outlet to customers in Canada and the US. Costco’s homepage is overwhelming due to the conglomeration of graphics. Section B-5

Opportunities Costco operates stores in countries with high GDP per capita and targets customers with high disposable income. US- $40,100 Canada-$31,500 Japan- $29,400

Economic

Demographic / Sociocultural

Political / Legal

Technological

Inflation Rates are relatively low: US- 2.5% Canada-1.9% Japan- -0.1% Approximately 67% of the population in the US, Japan, and Canada are between the ages of 15-64 and will fall in Costco’s target market.

Threats 12% of the US population is below the poverty line and 15.9% of Canada’s population is below the poverty line. These people will not be able to afford a Costco membership and are not in Costco’s target market.

Costco will have to expend energy and resources for translation of company materials and websites as all of the regions we operate in have a different primary language. Different laws and legal systems exist in each area, so Japanese workers will be subject to different restrictions than American workers or Canadian workers and vice versa.

Constitution based democracy in the US and a constitutional monarchy in Canada and Japan are good types of government for retail competition. Governments should not impose any restrictions unless the possibility of a monarchy arises. 159 million internet users in America 57.2 million Internet users do not and 16.11 million in Canada have access have access to online purchases in to Costco’s website and can make Japan. purchases online.

Strategic Issues: o Costco is a global company, but only operates in seven countries, so the company has a great potential to expand. o BJ’s is becoming more successful in areas where Costco is losing ground. o Costco’s website does not offer different languages or online purchasing opportunities in all the countries in operates in.

Strategy Analysis: Revised Mission Statement: To continually provide our members with a unique product mix of quality brand name and private label merchandise, as well as everyday services, at the lowest possible prices in order to be an industry leader competing in a global market. In order to achieve our mission we will conduct our business with the following Code of Ethics in mind: Our Code of Ethics 19

• • • • •

Obey the law. Take care of our members. Take care of our employees. Respect our suppliers. Be environmentally aware.

•

Reward our shareholders.

If we do these four things throughout our organization, then we will achieve our ultimate goal, which is to:

Long Term Objectives: o Increase sales by 14% annually for the next 5 years. o Increase total asset turnover to 4.5% in the next 5 years. o Increase membership sales by !!!! o For Costco to increase number of stores globally by 15%, or 78 stores, in 3 years. o Focus expansion in other markets of the world, specifically in Asia, Australia and Ireland. o Make the website fully functional by: o Create a universal website that provides one standard opening page that allows the viewer to click on any of the countries Costco operates in and view the Costco website that is specific to that country. o Enable the online shopping application and be able to ship from one country to any other Costco operates in. o Achieve this in 3 – 5 years to keep in accordance with the timing of the opening stores. Possible Corporate Strategies: TOWS Matrix Model:

Opportunities – O

Strengths – S Weaknesses – W 1.) An increase in 1.) Costco only offers an comparable store sales online retail outlet to from 2004 to 2005 of customers in Canada 8% and from 2005 to and the United States. 2006 of 7%. 2.) Costco does little to no 2.) High inventory formal advertising. turnover rate (nearly 3.) Costco has not yet once a month). expanded into every 3.) Costco has a consistent region of the globe. ROS and ROA. 4.) Costco puts so much 4.) Costco keeps overhead emphasis on being cost low and pass those simple (layout of savings on to warehouses) that is customers in the form may translate to of low prices. customers that no quality products could be bought there. Strength – Opportunity Weakness – Opportunity

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1.) Canada, Japan and United States have high GDP per capita SO1: and low inflation rates. 2.) Potential to compete in SO2: exploding global markets. SO3: 3.) There are 59 million Internet users in the United States and 16.11 million in Canada. 4.) The ability to sell and be paid for inventory before the merchandise vendor is paid. 5.) An online website that ships to the United States and Canada. Threats – T 1.) 57.2 million Internet users do not have access to online purchases in Japan. 2.) BJ’s has a stronger asset turnover ratio than Costco. 3.) Different legal laws and restrictions exist in the different countries, which creates a challenge. 4.) Diversity of the languages in the global regions cause for energy and resources to be expended for translation for company materials and the website.

Strategy:

Strategy: WO1: Costco will overcome its lack of stores in the global market by opening new stores in the exploding global markets. WO2: Develop promotions online to display the quality goods Costco offers, which would deter customers from thinking Costco does not sell quality goods.

Strengths – Threats Strategy: ST1: Costco has a good ROA that will make sure our investments in other countries grow and they can then have the resources to expend on translations for company materials and websites. ST2:

WO3: Increase advertising expenditures for online advertising for the 59 million Internet users in the United States and the 16.11 million in Canada. Weakness – Threats Strategy: WT1: Costco does little to no formal advertising, which means they would have to expend less on translations. WT2: Increasing advertising in other countries will inform those customers that Costco is making attempts to appeal to their cultural needs.

ST3: WT3:

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Appendix Internal Audit: Current Mission: To continually provide our members with quality goods and services at the lowest possible prices. In order to achieve our mission we will conduct our business with the following Code of Ethics in mind: Our Code of Ethics • Obey the law. • Take care of our members. • Take care of our employees. • Respect our suppliers.

If we do these four things throughout our organization, then we will achieve our ultimate goal, which is to:

•

Reward our shareholders.

Value Creation Principal products or services

Quality goods and services, lowest possible prices, members, employees, suppliers, shareholders n/a

Geographic scope

n/a

22

Philosophies (basic values)

Obey the law, Ethics

Self-image (distinctive competencies)

n/a

Public image (social responsibility)

Ethics

Revised Mission: To continually provide our members with a unique product mix of quality brand name and private label merchandise, as well as everyday services, at the lowest possible prices in order to be an industry leader competing in a global market. In order to achieve our mission we will conduct our business with the following Code of Ethics in mind: Our Code of Ethics • Obey the law. • Take care of our members. • Take care of our employees. • Respect our suppliers. • Be environmentally aware.

If we do these four things throughout our organization, then we will achieve our ultimate goal, which is to:

•

Reward our shareholders.

Value Creation

Geographic scope

Quality goods and services, lowest possible prices, members, employees, suppliers, shareholders. A unique product mix of quality brand name and private label merchandise and everyday services. Global

Philosophies (basic values)

Obey the law, Ethics

Self-image (distinctive competencies)

Be our industry leader.

Public image (social responsibility)

Be environmentally aware.

Principal products or services

Long-term Objectives: FISCAL YEAR 2006 Opening Date Location First Qtr ‘06 9/17/2005 San Luis Obispo, CA 10/14/2005 Pembroke Pines, FL 10/21/2005 Kalispell, MT (relocation)

10/26/2005 10/27/2005 11/7/2005 11/10/2005 11/11/2005 11/16/2005 23

La Habra, CA Centennial, NV Milton Keynes, UK Veracruz, MX Phoenix, AZ (Cave Creek) Kanata, ON

11/17/2005 Hillsboro, OR Second Qtr ‘06 11/22/2005 W. Bountiful, UT 12/1/2005 Chandler, AZ 3/28/2006 Gatineau, QC (relocation) 3/29/2006 Sherwood Park, AB 3/30/2006 NW Calgary, AB 4/26/2006 SW Bakersfield, CA 5/3/2006 Mall of Georgia, GA 5/4/2006 SE Gilbert, AZ 5/5/2006 Lake Elsinore, CA Third Qtr ‘06 03/28/06 Gatineau, QC (NRL) 03/29/06 Sherwood Park, AB 03/30/06 NW. Calgary, AB 04/26/06 Bakersfield II, CA 05/03/06 Mall of Georgia, GA 05/04/06 SE Gilbert, AZ 05/05/06 Lake Elsinore, CA Fourth Qtr ‘06 06/01/06 S. Austin, TX 06/02/06 Juarez, MX 06/29/06 Sheffield, UK 07/18/06 Lacey, WA 07/27/06 E. Bayamon, PR 07/28/06 Wilmington, NC 08/09/06 Duncanville, TX 08/17/06 Sequim, WA (NRL) 08/23/06 Nampa, ID 08/24/06 Lehi, UT 08/25/06 Sparks, NV

09/21/06 Marysville, WA 10/17/06 Kauai, HI 10/20/06 Gypsum Eagle Co., CO 10/25/06 Raleigh, NC 10/26/06 Louisville, KY 10/27/06 Maple Grove, MN 11/10/06 Vancouver, BC 11/14/06 W. Nashville, TN 11/15/06 Cumberland Mall, GA 11/16/06 Toluca, MX 11/17/06 Fontana, CA 11/21/06 Boisbriand, QC 11/22/06 La Quinta, CA Second Qtr ‘07 11/28/06 Helena, MT 11/29/06 Columbus, OH 11/30/06 Orland Park, IL 12/02/06 Chester UK Third Qtr ‘07 02/21/07 Thornton, CO 03/08/07 W. Homestead, PA 03/30/07 E. Markham, ON 04/12/07 Estero, FL 04/13/07 Royal Palm Beach, FL 05/05/07 Potomac Mills, VA Fourth Qtr ‘07 06/07/07 Tustin II, CA 07/12/07 Kawasaki, JP 08/03/07 West Valley, UT 08/15/07 Spartanburg, SC 08/16/07 Greenville, SC 08/23/07 NE San Jose, CA 08/29/07 Toledo, OH 08/30/07 Grafton, WI

FISCAL YEAR 2007 Opening Date Location First Qtr ‘07

Management: Some of the benefits that management provides to their employees are: o Health Care o Dental Care

24

o o o o o o o o o o o

WorkLife Program Voluntary Short Term Disability Pharmacy Program Long Term Disability Vision Program Life Insurance o 401(k) Plan Employee Stock Purchase Plan Health Care Reimbursement Account Long-Term Care Insurance Dependent Care Reimbursement Account Employee Assistance Program

With the average age of the top management being 66 years old and having an average span with the company for twenty-one years, they are more likely to continue with the current way the company is being run. This has been successful for the company over the years Usually it means that one to two people are working the phones all day calling prospective members and setting up appointments, and others are out calling on businesses," says Wanklin. "They work leads that they get from business lists and networking. They go through unions, credit unions, church affiliations and more." At the same time, while competitor Wal-Mart is being attacked more and more for its lowcompensation policies, Costco is emerging as an exemplar of how to treat employees right. In turn, this highly motivated staff of internal marketers is a powerful force for building Costco's sales. .

25

Marketing: Breakdown of Revenue 2005

Breakdown of Revenue 2006

2%

2% 14%

20%

12%

Food

30%

12%

Sundries

12%

16%

Hardlines

24%

29%

Other

Membership

Membership

2%

16%

Sundries Hardlines

Other

Breakdown of Revenue 2004

11%

Food

Softlines

Softlines

13%

31%

31% 29%

Food Sundries Hardlines Softlines Other Membership

26

Membership Breakdown: Gold Star Business Total primary cardholders Add-on cardholders Total cardholders

17,338 5,214 22,552 25,127 47,679

Increase in Comparable Warehouse Sales: United States International Total

2006 7% 11% 8%

2005 6% 11% 7%

2004 9% 14% 10%

2003 4% 10% 5%

2002 7% 2% 6%

Products: Items that members may request but that cannot be purchased at prices low enough to pass along meaningful cost savings are often not carried. We seek to limit specific items in each product line to fast-selling models, sizes and colors. Therefore, we carry an average of approximately 4,000 active stock keeping units (SKUs) per warehouse in our core warehouse business, as opposed to discount retailers and supermarkets that normally stock 40,000 to 60,000 SKUs or more. Selected Products and Services • • • • • • • • • • • • • • • • •

Alcoholic beverages Apparel Appliances Automotive insurance products (tires, batteries) Automobile sales Baby products Books Cameras, film, and photofinishing Candy Caskets CDs Floral arrangements Gasoline Gifts Glasses and contact lenses Groceries and institutionally packaged foods Hardware

27

• • • • • • • • • • •

Checks and form printing Cleaning and institutional supplies Collectibles Computer hardware and software Computer training services Copying and printing services Credit card processing DVDs Electronics Eye exams Flooring

• • • • • • • • • • • • • • • • • • • • • • •

Health and beauty aids Hearing aids Home insurance Housewares Insurance (automobile, small-business health, home) Jewelry Lighting supplies Mortgage service Office equipment and supplies Outdoor living products Payroll processing Pet supplies Pharmaceuticals Plumbing supplies Real estate services Snack foods Soft drinks Sporting goods Tobacco Tools Toys Travel packages and other travel services Video games and system

Private Label o Kirkland Signature Price: Costco’s products are priced lower than their competitors. This is due to the fact that they have a loyalty to the customers not to mark up their prices. They maintain this strategy by combining the wholesaler and retailer parts of the distribution channel into one. This saves Costco money, which they then can then cut from the prices of their products. Also, by maintaining a simplistic warehouse layout and cutting labor costs by avoiding the hassle of breaking down many products, Costco is able to ultimately offer lower prices for the customer. Business members qualify by owning or operating a business, and pay an annual fee ($50 in the U.S.) to shop for resale, business and personal use. This fee includes a spouse card. Business members may purchase up to six additional membership cards ($40 each) for partners or associates in the business. Gold Star members pay a $50 annual fee (in the U.S.), and is available to those individuals that do not own a business. This fee includes a free spouse membership. The 28

Company also has a third membership level, called the Executive Membership. In addition to offering all of the usual benefits, it allows members to purchase a variety of discounted consumer services (auto and homeowner insurance, real estate and mortgage services, long-distance telephone services, auto buying, personal check printing, financial planning) and/or discounted business services (merchant credit card processing, health insurance, business lending, payroll processing, communication solutions, check and forms printing) at substantially reduced rates. Executive Members also receive a 2% annual reward (up to $500) on most of their warehouse purchases. Executive Members pay an annual fee of $100. Membership Data: 49.0 million cardholders 26.7 million Households 18.9 million Gold star 5.3 million Business 3.4 million Business ad ons Place: Costco’s warehouses are not only domestic, but global as well. They maintain the mentality that it is not a necessity to spend excessive amounts of money on prime real estate. Instead, the company buys large areas of land for their stores. This results in many of their stores being in suburban or secluded areas. These suburbs are targeted by Costco because they have the correct customer profile. Many of the residents here have the option to shop in higher priced stores, but shop at Costco because they have good quality products for a discounted price. Also, the warehouses are built very large as to hold all the many different products Costco offers. Number of warehouses: Locations:

518 as of (8/30/07) 383 locations in 39 U.S. States & Puerto Rico; 71 locations in nine Canadian provinces; 19 locations in the United Kingdom; 4 locations in Taiwan; 5 locations in Korea; 6 locations in Japan; 30 locations in 18 Mexican states

Warehouse Information:

29

Warehouses in Operations (2)

2006

2005

2004

2003

2002

Beginning of the Year

433

417

397

374

345

Opened (3)

28

21

20

29

35

Closed (3)

(3)

(5)

--

(6)

(6)

End of Year

458

433

417

397

374

Promotion: In connection with new warehouse openings, our marketing teams personally contact businesses in the area that are potential wholesale members. These contacts are supported by direct mailings during the period immediately prior to opening. Potential Gold Star (individual) members are contacted by direct mail or by providing membership offerings to be distributed through employee associations and other entities. After a membership base is established in an area, most new memberships result from word-of-mouth advertising, follow-up messages distributed through regular payroll or other organizational communications to employee groups and ongoing direct solicitations to prospective Business and Gold Star members. Customer Profiles: Costco’s marketing mix is unique to the company and their industry. They have a large range of products that are offered in bulk and for competitive prices. They have their own signature product label, Kirkland, along with other big name brands. Costco also changes their offerings every so often to give their customers the feeling of a “treasure hunt.” This form of surprise makes a sense of excitement for the customers. Their products are in bulk packaging, which are variety packs a lot of the time. This allows for the customers to have variety; not a large amount of the same thing. o Customers: o Small to medium size businesses o Individuals  The typical Costco customer is both a business owner with a family who heads to Costco to shop for both. They are homeowners with higher education levels and annual household incomes of more than $100,000 yearly. A customer shops there about 20-50 times a year, depending on whether or not he/she carries an annual Gold membership or the pricier Executive membership. o Averages: o Medium age: 51.8 years (well above U.S. mediums of 35.6) o Medium Income: $85,000 yearly (well above the U.S. mediums of $ 41,000 yearly. o 42% of Costco’s customers earn over $100,000 yearly.

30

Membership Fees: Fiscal 2006 $1,188,047 10.7% 2.02% 47,679

Membership fees Membership fees increase Membership fees as a percent of net sales Total cardholders

Fiscal 2005 $1,073,156 11.6% 2.07% 45,258

Fiscal 2004 $961,280 12.7% 2.04% 42,416

2006 vs. 2005 Membership fees increased 10.7% to $1.19 billion, or 2.02% of net sales, in fiscal 2006 from $1.07 billion, or 2.07% of net sales, in fiscal 2005. This increase was primarily due to additional membership sign-ups at the 25 new warehouses opened in fiscal 2006, increased penetration of the Executive Membership program, and high overall member renewal rates consistent with recent years, currently 86.5%. In April 2006, we announced plans to increase annual membership fees by $5 for our U.S. and Canada Gold Star (individual), Business, and Business Add-on Members, effective May 1, 2006 for new members and July 1, 2006 for renewals. Approximately 15 million members will be affected by this increase. Membership fees are accounted for on a deferred basis, whereby membership fee revenue is recognized ratably over the one-year term of the membership, which will have the effect of spreading the full realization of the increase over the next two fiscal years. 2005 vs. 2004 Membership fees increased 11.6% to $1.07 billion, or 2.07% of net sales, in fiscal 2005 from $961 million, or 2.04% of net sales, in fiscal 2004. This increase was primarily due to additional membership 22 sign-ups at the 16 new warehouses opened in fiscal 2005, increased penetration of our Executive Membership program and a high overall member renewal rate of 86%. Financial Performance: Selling, general and administrative expenses consist primarily of salaries, benefits and workers’ compensation costs for warehouse employees, other than depots, fresh foods and certain ancillary businesses, as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include utilities, bank charges and substantially all building and equipment depreciation, as well as other operating costs incurred to support warehouse operations.

Selling, General and Administrative Expense Selling, General and Administrative Expense as a Percent of Net Sales

Fiscal 2004 $4,600,792

Fiscal 2005 $5,061,339

Fiscal 2006 $5,732,141

9.76%

9.76%

9.72%

2006 vs. 2005 Selling, general and administrative (SG&A) expenses were $5.73 billion, or 9.72% of net sales in fiscal 2006, compared to $5.06 billion, or 9.76% of net sales in fiscal 2005. Improved warehouse and central operating costs positively impacted SG&A by approximately nine basis points,

31

primarily due to increased expense leverage of warehouse payroll, which was positively impacted by strong comparable warehouse sales and a lower rate of increase in workers’ compensation costs. This improvement was partially offset by an increase in stock-based compensation cost of approximately five basis points in fiscal 2006. 2005 vs. 2004 SG&A expenses were $5.06 billion, or 9.76% of net sales, in fiscal 2005 compared to $4.60 billion, or 9.76% of net sales, in fiscal 2004. Had EITF 03-10 been in effect for all of fiscal 2004, SG&A expenses as a percent of net sales would have shown improvement of four basis points as a percent of net sales in fiscal 2005. For fiscal 2005, warehouse and central operating costs positively impacted SG&A comparisons year-over-year by approximately ten basis points, primarily due to improved payroll utilization at the warehouse level, including increased leverage from increased comparable sales and cost control measures employed in employee benefits, primarily health care. This improvement was offset by the implementation of EITF 0310, which negatively impacted SG&A as a percentage of net sales by five basis points, and an increase in stock-based compensation costs approximating six basis points year-over-year. The Company considers as cash and cash equivalents all highly liquid investments with a maturity of three months or less at the date of purchase and proceeds due from credit and debit card transactions with settlement terms of less than five days. Of the total cash and cash equivalents of $1,510,939 at September 3, 2006 and $2,062,585 at August 28, 2005, credit and debit card receivables were $593,645 and $521,634, respectively. In general, short-term investments have a maturity of three months to five years at the date of purchase. Investments with maturities beyond five years may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. Short-term investments classified as available-forsale are recorded at market value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income until realized. The estimate of fair value is based on publicly available market information or other estimates determined by management. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis. Receivables consist primarily of vendor rebates and promotional allowances, receivables from government tax authorities, reinsurance receivables held by the Company’s wholly-owned captive insurance subsidiary and other miscellaneous amounts due to the Company. Amounts are recorded net of an allowance for doubtful accounts of $2,423 at September 3, 2006 and $1,416 at August 28, 2005. Management determines the allowance for doubtful accounts based on historical experience and application of the specific identification method. Cash Flows: (in thousands) Operating Activities Investing Activities Financing Activities

2004 2,096,265 (1,045,963) 209,569

32

2005 1,775,961 (2,051,513) (518,651)

2006 1,827,290 (1,153,560) (1,233,227)

Net Income in Cash & Equivalents Cash & Equivalents at Beginning of Year Cash & Equivalents at End of Year

(551,646) 1,545,439 2,823,135

(760,550) 2,823,135 2,062,585

(1,277,696) 2,062,585 1,510,939

Costco’s Cash Flows show that the company is stable and growing somewhat. They are investing, which means they are repurchasing stock and are paying their dividends. Also, over the years Costco’s Net Income in Cash & Equivalents and Cash & Equivalents have grown which shows the company is growing and prosperous. Costco is also financing more, which means they are able to pay off debt. One downside is that the company did increase investing from 2004 to 2005, but from 2005 to 2006 they decreased investing, which shows they were not growing at a steady rate. Common Stock: Price – Close High Low

10/12/07 68.00 70.55 51.52

2006 52.87 57.94 46.00

2005 49.47 51.21 39.48

2004 48.41 50.46 35.05

2003 37.18 39.02 27.00

Our common stock is traded on the National Market tier of the NASDAQ Stock Market LLC (“NASDAQ”) under the symbol “COST.” On October 31, 2006 we had 8,172 stockholders of record. Payment of future dividends is subject to declaration by the Board of Directors. Factors considered in determining the size of the dividends are our profitability and expected capital needs. Subject to qualifications stated above, we presently expect to pay dividends on a quarterly basis. Share repurchases are not displayed separately as treasury stock on the consolidated balance sheets or consolidated statements of stockholders’ equity in accordance with the Washington Business Corporation Act, which requires the retirement of repurchased shares. The par value of repurchased shares is deducted from common stock and the remaining excess repurchase price over par value is deducted from additional paid-in capital and retained earnings. See Note 5 for additional information. Ownership Breakdown: Shares Outstanding (in millions) Institutional Ownership (%) Number of Shareholders

437,940 82 8,100

Costco is not a closely held company. The majority of the company is held by outside shareholders, as well as having a large percent of the company held by employees. Cost of Goods Sold: (in thousands)

2004

33

2005

2006

Cost of goods sold or Cost of sales Total Sales or Total Revenue

42,092,01 6 48,109,90 7 .875

Common Size (cost of goods sold divided by total sales)

46,346,961

52,745,497

52,952,226

60,151,227

.875

.877

Costco’s COGS have remained relatively consistent. Cost of Sales have risen from 2004 to 2005 to 2006, but that is due to the increase of sales from new warehouses. Common Size has remained almost exact. Operations: Costco buys the majority of their merchandise directly from manufacturers and route it to a cross-docking consolidation point (“depot”) or directly to our warehouses. This maximizes freight volume and handling efficiencies, thereby lowering our receiving costs by eliminating many of the costs associated with multiple step distribution channels. Our depots receive container-based shipments from manufacturers and reallocate these goods for combined shipment to our individual warehouses, generally in less than twenty-four hours. Because shoppers are attracted principally by the availability of low prices, our warehouses need not be located on prime commercial real estate sites or have elaborate facilities. By strictly controlling the entrances and exits of our warehouses and using a membership format, we have limited inventory losses to less than two-tenths of one percent of net sales in each of the last three fiscal years—well below those of typical discount retail operations. Gasoline operations generally have extended hours. Because the hours of operation are shorter than those of traditional retailers, discount retailers and supermarkets and due to other operational efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities of each item, thereby reducing labor required for handling and stocking. Preopening Expenses Preopening Expenses as a Percent of Net Sales Warehouse Openings Relocations

Fiscal 2004 $30,451 0.07%

Fiscal 2005 $53,230 0.10%

Fiscal 2006 $42,504 0.07%

20 20

21 16

28 25

2006 vs. 2005 Preopening expenses totaled $42.5 million, or 0.07% of net sales, during fiscal 2006 compared to $53.2 million, or 0.10% of net sales, during fiscal 2005. During fiscal 2005, in response to the February 7, 2005 letter of the Securities and Exchange Commission (SEC) concerning accounting standards related to leases, we adjusted our method of accounting for leases (entered into over the previous twenty years), primarily related to

34

ground leases at certain owned warehouse locations that did not require rental payments during the period of construction. We recorded a cumulative pre-tax, non-cash charge of $16.0 million to preopening expense in the second quarter of fiscal 2005. Twenty-eight warehouses (including three relocations) were opened in fiscal 2006 compared to the opening of 19 Source: COSTCO WHOLESALE COR, 10-K, November 17, 2006 twenty-one warehouses (including five relocations) in fiscal 2005. Preopening expenses also include costs related to remodels and expanded ancillary operations at existing warehouses. 2005 vs. 2004 Preopening expenses totaled $53.2 million, or 0.10% of net sales, during fiscal 2005 compared to $30.5 million, or 0.07% of net sales, during fiscal 2004. As discussed above, fiscal 2005 included a cumulative pre-tax, non-cash charge of $16.0 million to preopening expense related to an adjustment to the method of accounting for leases. Twenty-one warehouses (including five relocations) were opened in fiscal 2005 compared to the opening of 20 warehouses in fiscal 2004. Preopening expenses also include costs related to remodels and expanded ancillary operations at existing warehouses. “We operate membership warehouses based on the concept that offering our members very low prices on a limited selection of nationally branded and selected private label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. This rapid inventory turnover, when combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, selfservice warehouse facilities, enables us to operate profitably at significantly lower gross margins than traditional wholesalers, mass merchandisers, supermarkets and supercenters.” “These practices are consistent with our membership policies of satisfying both the business and personal shopping needs of our wholesale members, thereby encouraging high volume shopping. Many consumable products are offered for sale in case, carton or multiple-pack quantities only. Appliances, equipment and tools often feature commercial and professional models. In keeping with our policy of member satisfaction, our policy is to accept returns of merchandise.” Information Systems: 1.) Most of our applications are developed in house, using a mixture of RPG III and RPG IV. Costco also utilizes third-party applications, such as Lawson for payroll, Order Power for fulfillment, and Infinium's (Software 200) Fixed Asset system. For candidates with experience in these areas, Costco offers challenging and rewarding opportunities to use and expand their skills. 2.) Individual groups supply and maintain workstations and software installations, and provide around-the-clock on-call support for users of all AS/400 and microsystem applications. Other groups develop and maintain multimedia training and printed user manuals, and provide personto-person training on AS/400 applications. Another group ensures the efficient operation of the AS/400s and other systems in our 24-hour computer room.

35

For candidates with AS/400 operations, hardware, training, multimedia, technical writing, or other support experience, Costco offers many fast-paced and rewarding opportunities to use and expand their skills. o 3.) Network Security designs and supports all Firewall, Internet, extra-net, and VPN access. This group is also responsible for supporting the UNIX environment and Network Management system. o E-Commerce Administration is responsible for over 30 servers and 20 applications on our e-commerce site (Costco.Com), as well as the resources necessary to support our company-wide intranet. o BackOffice Administration is responsible for an infrastructure of 90 servers that supports various applications available to our company's 4000 users. Costco utilizes NT and UNIX, SQL and Oracle databases. We administer and support other third-party applications, such as Exchange as our email platform, and anti-virus applications to protect our network. Via distributed servers, Costco exchanges information with our regional and international data centers. Current efforts include preparation for Windows 2000, implementing a software management solution, improving our backups (via SAN or fiber backup solution), automating the collection of performance data, and standardizing the data center design. For candidates with experience in NT system administration, IIS, SQL Database, messaging technology, network security, or network management, Costco offers challenging and rewarding opportunities to use and expand their skills. 4.) This group utilizes Microsoft technology for hardware, software, coding standards, and project management. In some cases, third-party applications are utilized for specific functions, such as tax, shipping, and address verification, and out-of-the-box technology is modified to meet the specific needs of the online warehouse. In development, Costco uses a mixture of ASP, COM, SQL, and VB, programming languages which are handled through the Visual Interdev/Visual Source Safe environment. Development teams work on individual NT server stations ("sandboxes"), and work closely with server administration, hardware support, and testing groups as projects pass through a common development system for testing and movement through the build process. For candidates with programming and ISS software experience in any of these applications, Costco offers challenging and rewarding opportunities to use and expand their skills. Internet Page: o Gives information and financials of Costco, while also functions as an online shopping resource. o Costco’s website: o Costco has an American, European and Canadian website 36

o The language of Costco’s websites depend on the native language of the country  Canada is in both French and English because they are both national languages o Websites still require Costco membership o Offers shipping to the United States and Canada o Very busy opening site page o Displays current products and/or products that are on sale Macro Environment: We also intend to open warehouses in new markets. The risks associated with entering a new market include difficulties in attracting members due to a lack of familiarity with us, our lack of familiarity with local member preferences and seasonal differences in the market. In addition, entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. While we have a track record of profitable growth, in new markets we cannot ensure that our new warehouses will be profitably deployed; as a result, our future profitability may be materially adversely affected. Any inability to open new warehouses on schedule could hurt our financial performance. We expect to increase our presence in existing markets and enter new markets. Our opening of new warehouses, domestically and internationally, will depend on our ability to: identify and secure suitable locations; negotiate leases or real estate purchase agreements on acceptable terms; attract and train qualified employees; and manage preopening expenses, including construction costs. We compete with other retailers and businesses for suitable locations for our warehouses. Our ability to open new warehouses also is affected by environmental regulations, local zoning issues and other laws related to land use. Failure to effectively manage these and other similar factors will affect our ability to open warehouses on schedule, which could adversely affect our financial performance. We are highly dependent on the financial performance of our United States and Canada operations. Our financial performance is highly dependent on our United States and Canada operations, which comprised 94% of consolidated net sales in both fiscal 2006 and 2005. Within the United States, we are highly dependent on our California operations, which comprised 31% and 30% of consolidated net sales in fiscal 2006 and 2005, respectively. Any substantial or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our United States and Canada operations could arise from, among other things: failing to meet annual targets for warehouse openings; declines in actual or estimated comparable warehouse sales growth rates and expectations; negative trends in operating expenses, including increased labor costs; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets; and failing consistently to provide high quality products and innovative new products to retain our existing member base and attract new members.

37

Risks associated with the suppliers from whom our products are sourced could adversely affect our financial performance. The products we sell are sourced from a wide variety of domestic and international suppliers. Effective global sourcing of many of the products we sell is an important factor in our financial performance. Our ability to find qualified suppliers who meet our standards, and to access products in a timely and efficient manner is a significant challenge, especially with respect to suppliers located and goods sourced outside the United States. Political and economic instability in the countries in which foreign suppliers are located, the financial instability of suppliers, suppliers’ failure to meet our standards, labor problems experienced by our suppliers, the availability of raw materials to suppliers, merchandise quality issues, currency exchange rates, transport availability and cost, inflation, and other factors relating to the suppliers and the countries in which they are located are beyond our control. In addition, the United States’ foreign trade policies, tariffs and other impositions on imported goods, trade sanctions imposed on certain countries, the limitation on the importation of certain types of goods or of goods containing certain materials from other countries and other factors relating to foreign trade are beyond our control. We may also face changes in the cost to us of accepting various payment methods and changes in the rate of utilization of these payment methods by our members. We may not timely identify or effectively respond to consumer trends, which could adversely affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services our members will demand. The success of our business depends in part on our ability to identify and respond to evolving trends in demographics and consumer preferences. Failure to timely identify or effectively respond to changing consumer tastes, preferences and spending patterns could adversely affect our relationship with our members, the demand for our products and services and our market share. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial results. Generally accepted accounting principles and related accounting pronouncements, implementation guidelines and interpretations with regard to a wide range of matters that are relevant to our business, such as revenue recognition, impairment of long-lived assets and warehouse closing costs, inventories, self insurance, stock-based compensation, income taxes, unclaimed property laws and litigation, are highly complex and involve many subjective assumptions, estimates and judgments by our management. Changes in these rules or their interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance. Our international operations subject us to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate, which could adversely affect our financial performance. Our international operations could form a larger portion of our net sales in future years. Future operating results internationally could be negatively affected by a variety of factors, many beyond our control. These factors include political conditions, economic conditions, regulatory constraints, currency regulations and exchange rates, and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade, monetary and fiscal policies both of the United States and of other countries, laws

38

and regulations of foreign governments, agencies and similar organizations, and risks associated with having major facilities located in countries which have been historically less stable than the United States. Implementation of technology initiatives could disrupt our operations in the near term and fail to provide the anticipated benefits. We have made and will continue to make significant technology investments both in our warehouses and in our administrative functions. The cost and potential problems and interruptions associated with the implementation of technology initiatives could disrupt or reduce the efficiency of our operations in the near term. In addition, new or upgraded technology might not provide the anticipated benefits; it might take longer than expected to realize the anticipated benefits or the technology might fail. Market expectations for our financial performance is high. We believe that the price of our stock reflects high market expectations for our future operating results. Any failure to meet these expectations for our comparable warehouse sales growth rates, earnings per share and new warehouse openings could cause the market price of our stock to drop. Cost related to natural disasters could adversely affect our financial performance. The occurrence of one or more natural disasters, such as hurricanes or earthquakes particularly in California where over 30% of our net sales are generated) could adversely affect our operations and financial performance. Such events could result in physical damage to one or more of our properties, the temporary closure of one or more warehouses or depots, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some local and overseas suppliers, the temporary disruption in the transport of goods from overseas, delay in the delivery of goods to our depots or warehouses within a country in which we are operating and the temporary reduction in the availability of products in our warehouses. We are subject to a wide variety of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge, and disposal of hazardous materials and hazardous and non-hazardous wastes, and other environmental matters. While we believe that our operations are currently in material compliance with all environmental laws, any failure to comply with these laws could result in costs to satisfy environmental compliance, remediation requirements, or the imposition of severe penalties or restrictions on operations by government agencies or courts that could adversely affect our operations. We are involved in a number of legal proceedings, and while we cannot predict the outcomes of such proceedings and other contingencies with certainty, some of these outcomes may adversely affect our operations or increase our costs. We are involved in a number of legal proceedings, including consumer, employment, tort and other litigation. We cannot predict with certainty the outcomes of these legal proceedings and other contingencies, including environmental remediation and other proceedings commenced by government authorities. The outcome of some of these legal proceedings and other contingencies could require us to take, or refrain from taking, actions which could adversely affect our operations or could require us to pay substantial amounts of money. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management’s attention and resources. Our business requires compliance with a great variety of laws and

39

regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines and penalties. Failure of our internal control over financial reporting could harm our business and financial results. Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes: maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of the financial statements; providing reasonable assurance that our receipts and expenditures of our assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report our financial results accurately and timely or to detect and prevent fraud. Industry Audit: By offering a convenient, low cost shopping environment to consumers, warehouse clubs provide a value to consumers that is not replicated in other channels. As such, across the three main competitors, consumer satisfaction and member retention are high. Mintel’s exclusive consumer research indicate that 80% of warehouse club respondent shoppers agree that clubs provide an enjoyable shopping experience, while 60% of warehouse club respondent shoppers agree that these retailers provide the most time efficient way to shop. Furthermore, by rapidly turning inventory, expanding selections, and stocking new items quickly, warehouse clubs are among the most responsive merchandising channels, which attracts consumers because there is always something new. This ability will remain one of the key features to differentiate warehouse clubs from other retail channels. The online retail channel is one of the most rapidly expanding markets. The following figure details retail ecommerce sale sin the U.S. from 1999 through 2004. Because of the vast differences in the number of SKUs carried, warehouse clubs typically limit selection to items that are brand name leaders within their respective category or to staple products in which private label brands can compete. Consumers have different expectations when shopping at warehouse clubs, thereby creating a unique experience which separates these retailers from competitors in other channels. Warehouse clubs appeal to consumers’ sense of value and the convenience of stocking up on certain items. A typical supermarket will stock 30,000-52,000 SKUs. Supercenters normally stock up to 125,000 SKUs. Warehouse clubs by contrast typically carry 4,000 SKUs.

40

Even though they carry fewer SKUs, the large number of product categories covered means that warehouse clubs face a wide array of competitors ranging from drug stores to florists. Tracking of same store sales shows that growth in the market is varied from month to month and does not display a consistent trend. In December 2004, sales increased a combined 7.3%, however, earlier growth in April 2004 was much higher. In that month, Costco, BJ’s Wholesale and SAM’S CLUB posted 16%, 12.1% and 11.8% gains respectively. Overall, membership revenues—which are excluded in market size data—represent only a small share of total revenue, approximately 2-3% on average. Over the review period, Costco’s membership fees as a share of net sales were 1.9-2.0%. Similarly, SAM’S CLUB’s ranged from 2.5-2.7%. This indicates that membership revenues are driven, in large part, by new store openings and by same store sales increases, to lesser degree. In terms of warehouse club locations, the market has grown 32% over the review period. Overall, 41 new warehouse clubs were added in the U.S. in 2004, following growth by 50 stores in 2003. Note that warehouse club locations is computed as the net value of store opening minus store closings over the year. However, store closings in the U.S. are relatively infrequent with only a few closings among the three industry leaders in recent years. Despite the companies’ similarities, there is a great deal of differentiation among the top three warehouse clubs, both in terms of performance and strategic execution. This differentiation exists in multiple areas, including SKU assortment, customer segments targeted, distribution capabilities and manufacturers partnered with. Top 10 Mass Market Retailers (North America) (Annual Sales) 1. 2. 3. 4. 5.

Wal-Mart Kroger Costco Wholesale Target Walgreen

6. CVS/Caremark 7. Albertsons 8. Safeway 9. Ahold USA 10. Loblaw

Top 10 Worldwide Food Retailers (Annual Sales) 1. 2. 3. 4. 5.

Wal-Mart Carrefour Tesco METRO AG Kroger

6. Royal Ahold 7. Costco Wholesale 8. REWE-Zentral 9. Lidl 10. ALDI

Top 5 US Warehouse Clubs (Annual Sales) 1. Costco Wholesale

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2. 3. 4. 5.

SAM'S CLUB BJ's Wholesale Club Smart & Final PriceSmart

Financial Performance: Return on Revenues (%)

Ticker

Yr. En d

Company

200 8

200 7

200 6

200 5

200 4

200 3

200 2

HYPERMARKETS & SUPER CENTERS‡ BJ

†

BJ'S WHOLESALE CLUB INC

COST

* *

WMT

1.0

1.1

1.1

1.6

1.6

1.6

2.5

COSTCO WHOLESALE CORP

JAN AU G

1.8

1.9

1.8

2.0

1.8

1.7

1.8

WAL-MART STORES INC

JAN

3.5

3.6

3.5

3.6

3.6

3.4

3.3

Return on Assets (%)

Ticker

Yr. En d

Company

200 8

200 7

200 6

200 5

200 4

200 3

200 2

4.6

4.6

4.7

6.6

6.5

6.5

10.0

6.6

6.5

6.5

6.7

6.2

5.8

6.4

8.6

8.5

8.4

8.7

9.1

8.9

9.0

HYPERMARKETS & SUPER CENTERS‡ BJ

†

BJ'S WHOLESALE CLUB INC

COST

* *

COSTCO WHOLESALE CORP

JAN AU G

WAL-MART STORES INC

JAN

WMT

Return on Equity (%)

Ticker

Yr. En d

Company

200 8

200 7

200 6

200 5

200 4

200 3

200 2

HYPERMARKETS & SUPER CENTERS‡ BJ

†

BJ'S WHOLESALE CLUB INC

COST

* *

WMT

8.8

8.9

9.1

13.2

13.0

13.2

20.4

COSTCO WHOLESALE CORP

JAN AU G

12.5

12.4

12.2

12.9

12.4

11.8

13.2

WAL-MART STORES INC

JAN

21.4

21.3

21.2

21.9

22.1

21.4

21.6

Current Ratio Yr. Ticker

Company

End

200 8

42

200 7

200 6

200 5

200 4

200 3

2002

BJ'S WHOLESALE CLUB INC

#

COSTCO WHOLESALE CORP WAL-MART STORES INC

#

JAN

1.2

1.1

1.2

1.3

1.3

1.2

1.2

AUG

1.2

1.1

1.1

1.2

1.2

1.1

1.0

JAN

1.0

0.9

0.9

0.9

0.9

0.9

0.9

Debt / Capital Ratio (%) Yr. Ticker

Company

End

200 8

200 7

200 6

200 5

200 4

200 3

200 2

HYPERMARKETS & SUPER CENTERS‡ BJ

BJ'S WHOLESALE CLUB INC

COST

COSTCO WHOLESALE CORP

WMT

WAL-MART STORES INC

#

#

JAN

0.2

0.2

0.2

0.3

0.3

0.4

0.0

AUG

2.0

2.1

2.2

7.2

11.2

15.8

16.9

JAN

32.7

32.6

32.5

35.6

31.8

30.8

32.5

Debt as a % of Net Working Capital Yr. Ticker

Company

End

200 8

200 7

200 6

200 5

200 4

200 3

200 2

HYPERMARKETS & SUPER CENTERS‡ BJ

BJ'S WHOLESALE CLUB INC

COST

COSTCO WHOLESALE CORP

WMT

WAL-MART STORES INC

#

#

JAN

1.0

1.1

1.1

1.1

1.5

2.5

0.0

AUG

61.7

55.3

52.2

48.1

90.5

184.1

669.6

JAN

NM

NM

NM

NM

NM

NM

NM

Net Income Yr. Ticker

2008

2007

2006

2005

2003

2002

116.6

104.8

145.8

1,063.1

882.4

721.0

700.0

11,231.0

10,267.0

8,861.0

8,039.0

Company

End

#

JAN

87.6

89.4

92.9

128.8

AUG

1,697.2 15,653. 3

1,438.3

1,103.2

13,743.4

12,178.0

2004

HYPERMARKETS & SUPER CENTERS‡ BJ

BJ'S WHOLESALE CLUB INC

COST

COSTCO WHOLESALE CORP

WMT

WAL-MART STORES INC

#

JAN

Porter’s Model: Threat of Entry o Absolute Cost Advantage o Economies of Scale – High  The three players in the industry have extremely large stores.  A unique experience, high sales with lower SKUs than traditional Supermarkets.  Rapid inventory turnover.  Low labor costs.

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Consumers have different expectations when shopping at warehouse clubs, thereby creating a unique experience which separates these retailers from competitors in other channels. Warehouse clubs appeal to consumers’ sense of value and the convenience of stocking up on certain items. A typical supermarket will stock 30,000-52,000 SKUs. Supercenters normally stock up to 125,000 SKUs. Warehouse clubs by contrast typically carry 4,000 SKUs. Brand Identity – High o Membership increases each year o Wide array of products offered Even though they carry fewer SKUs, the large number of product categories covered means that warehouse clubs face a wide array of competitors ranging from drug stores to florists. o Access to Distribution o Switching Costs o Government Policy Degree of Rivalry o Number of competitors – Low  There are three main players in this industry: Costco, Sam’s Club and BJ’s o Industry Growth - Moderate  Industry growth of 7.3% is below Market Median of 11.35  Same store growth does not show consistency  Location growth has risen to 32%  Store closings is rare Tracking of same store sales shows that growth in the market is varied from month to month and does not display a consistent trend. In December 2004, sales increased a combined 7.3%, however, earlier growth in April 2004 was much higher. In that month, Costco, BJ’s Wholesale and SAM’S CLUB posted 16%, 12.1% and 11.8% gains respectively. Overall, membership revenues—which are excluded in market size data—represent only a small share of total revenue, approximately 2-3% on average. Over the review period, Costco’s membership fees as a share of net sales were 1.9-2.0%. Similarly, SAM’S CLUB’s ranged from 2.5-2.7%. This indicates that membership revenues are driven, in large part, by new store openings and by same store sales increases, to lesser degree. In terms of warehouse club locations, the market has grown 32% over the review period. Overall, 41 new warehouse clubs were added in the U.S. in 2004, following growth by 50 stores in 2003. Note that warehouse club locations is computed as the net value of store opening minus store closings over the year. However, store closings in the U.S. are relatively infrequent with only a few closings among the three industry leaders in recent years.

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Asset Intensity - High o Industry ROA of 4.7% exceeds the Market Median of 1.5% Product Differentiation - High o Warehouse Clubs offer high value to customers in unique bulk sizes. o High appeal for small businesses. o Differentiation exists between the three players Despite the companies’ similarities, there is a great deal of differentiation among the top three warehouse clubs, both in terms of performance and strategic execution. This differentiation exists in multiple areas, including SKU assortment, customer segments targeted, distribution capabilities and manufacturers partnered with. Exit Barriers – Low o The retail industry can easily apply inventory to other locations or liquidate. Threat of Substitution o Functional Similarity – Low o Warehouse clubs are hard to replicate because of the low cost shopping experience for customers coupled with high value. o 60% of warehouse club customers agree that channel is the most time efficient. o New products are common – exciting for customers o Increased use of ecommerce By offering a convenient, low cost shopping environment to consumers, warehouse clubs provide a value to consumers that is not replicated in other channels. As such, across the three main competitors, consumer satisfaction and member retention are high. Mintel’s exclusive consumer research indicate that 80% of warehouse club respondent shoppers agree that clubs provide an enjoyable shopping experience, while 60% of warehouse club respondent shoppers agree that these retailers provide the most time efficient way to shop. Furthermore, by rapidly turning inventory, expanding selections, and stocking new items quickly, warehouse clubs are among the most responsive merchandising channels, which attracts consumers because there is always something new. This ability will remain one of the key features to differentiate warehouse clubs from other retail channels. The online retail channel is one of the most rapidly expanding markets. The following figure details retail ecommerce sale sin the U.S. from 1999 through 2004. Price/Performance Trend - Product Identity – High o 65% of BJ’s sales came from their private label in 2004. o Private label brand items are heavily featured because of the undulating SKUs carried

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Because of the vast differences in the number of SKUs carried, warehouse clubs typically limit selection to items that are brand name leaders within their respective category or to staple products in which private label brands can compete. Bargaining Power of Suppliers o Supplier Concentration – High o # of Buyers – High o Switching Costs – Mod. o Substitute Raw Materials – High o Threat of Forward Integration – Low Bargaining Power of Buyers o Buyer Concentration – High o #of Buyers – High o Switching Costs – Low o Substitute Products – Low o Threat of Backward o Integration – Mod. Competitor Analysis: Competitor: BJ’s o As of 2007 Annual Report: 172 stores in US in 16 states o New England in 1984 o Ticker: BJ o 287th on Fortune 500 largest public corps. o Smaller package sizes can be found in fresh food categories, including dairy, meat, bakery, fish and produce. o Limit the items offered in each product line to fast selling styles, sizes and colors, carrying an average of approximately 7,500 active stockkeeping units (SKU’s). By contrast, supermarkets normally stock from 30,000 to 52,000 SKU’s, and supercenters typically stock up to 125,000 SKU’s. o Food accounted for approximately 60% of BJ’s total food and general merchandise sales in 2006. The remaining 40% consisted of a wide variety of general merchandise items. o Paid membership is an essential part of the warehouse club concept. In addition to providing a source of revenue which permits us to offer low prices, membership reinforces customer loyalty. They have two types of members:  Inner Circle members • Most of our Inner Circle members are likely to be home owners whose incomes are above the average for the Company’s trading areas.

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•

o o o o

o o

Generally charge $45 per year for a primary Inner Circle membership that includes one free supplemental membership.  Business members • A significant percentage of business members also shops BJ’s for their personal needs. • A business membership also costs $45 per year and includes one free supplemental membership. • Additional supplemental business memberships cost $20 each. Have approximately 8.7 million BJ’s members (including supplemental cardholders) at February 3, 2007. Members in the same household may purchase additional supplemental memberships for $20 each. BJ’s Rewards Membership program, which is geared to high frequency, high volume members, offers a 2% rebate, capped at $500 per year, on generally all inclub purchases. The annual fee for a BJ’s Rewards Membership is $80. At the end of 2006, Rewards Members accounted for approximately 5% of their primary members and approximately 13% of our food and general merchandise sales during the year. As of January 28, 2006, approximately 21,200 full-time and part-time employees (“team members”). None of their team members is represented by a union.

BJ’s Financials: Total Asset Turnover ROA (in %) Financial Leverage- Equity multiplier ROE (in %) Current Ratio Quick Ratio Inventory Turnover Receivable Turnover Gross Profit Margin (in %) Operating Profit Margin (in %)

2004 3.81 0.06 2.0139 0.12 1.1933 0.26206 9.239 83.043 8.17 1.6

o Stockholders Equity: 1,019,887 o Net Income: $72,016 as of Feb 2007 o Net Sales 2006: $8,303,500

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2005 3.89 0.065 1.9585 0.13 1.986 1.1885 9.708 65.286 10.3 1.7

2006 4.17 0.036 1.9539 0.07 2.043 0.355 9.774 62.994 10.4 0.9

Works Cited Barbaro, Michael. "Next Venture From Stewart: Costco Food." The New York Times. 4 May 2007. 11 Sept. 2007. . "Code of Ethics." Costco.com. 2004. Costco. 11 Sep 2007 .

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"Company Profile." Costco.com. 2004. Costco. 11 Sep 2007 . Costco Wholesale Corporation (2006). “Form 10-K” Edgar Search. Online database. Mergent Online. 9 Sept. 2007. < http://www.mergentonline.com/compsearch.asp?type=edgar>. DiCarlo, Lisa. "Costco Rings Up Results." Forbes 07 Dec 2004 11 Sept. 2007 . Greenhouse, Steven. "How Costco Became the Anti-Wal-Mart." The New York Times 17 Jul 2005 11 Sept. 2007 . Hazel, Debra. "Costco Taking Anchor Spots." International Council of Shopping Centers. Jul. 2003. 13 Sept. 2007. . "Historical Highlights." Costco.com. 2004. Costco. 11 Sept. 2007. . Hoover's. (2007). Costco Wholesale Corporation. 11 Sept. 2007. . Robes, Karen. "Costco will reshape Lakewood Center." Presstelegram.com 17 Sept. 2007 17 Sept. 2007 . NEW Source: CIA World Factbook: http://geography.about.com/library/cia/blcindex.htm http://www.bjsinvestor.com/profile.cfm

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