DECEMBER 2007 :: COVER STORY : INTERVIEW

Leader of the Club

Costco's CEO Talks About Prices, Paychecks and Prospects for Expansion

BY KRIS HUDSON
The Wall Street Journal

Costco Wholesale'sproduct mix and customer-friendly policies have created fiercely loyal shoppers. But some investors think Costco should focus more on profit and have been pressuring CEO Jim Sinegal to squeeze customers a little harder.

Costco is the largest U.S. retailer of its type, with an anticipated $65 billion in sales this year from its 514 warehouse clubsworld-wide. Along the way, Mr. Sinegal has proved himself to be a master merchandiser, honing Costco's retail model with a success that outstrips competitors, including its chief rival, Wal-Mart Stores' Sam's Club.

Costco charges its patrons annual membership fees of $50 to$100 for access to warehouses loaded with bulk goods priced at no more than 15%above its wholesale costs. For pizzazz, Costco uses the "treasure hunt" approach, peppering its stores with unexpected, limited-availability items-ranging from designer jeans to $80,000 diamond rings-that keep shoppers coming back.
Investors, for the most part, have endorsed Costco's strategy. But some have begun to worry that Costco could slip if it doesn't show more profit growth.

Mr. Sinegal recently sat down for an interview with The Wall Street Journal to discuss topics ranging from competitive pricing to expansion. Here are excerpts:

WSJ: You are constantly balancing the needs of customers, employees and shareholders. Some on Wall Street complain that shareholders seem to come third in that equation. Do they?

MR. SINEGAL: That's not the case. Wewant to obey the law, take care of our customers, take care of our people and respect our suppliers. And we think if we do those four things pretty much in that order, that we're going to reward shareholders.

WSJ: Giving customers a great deal can sometimes mean taking a hit on profits. Is it worth it?

MR. SINEGAL: There are all sorts of opportunities where you can try to sneak in a little more margin here and a little more profitability there, but that's not what we're about. When you start suggesting that it's not important to save the customer money on this because they'll never know the difference, you start to fool yourself. The customer trusts us. You don't want to give up on that type of reputation.

WSJ: You've revoked at least one popular policy: unlimited returns of big electronics. Why did you decide to initiate a 90-day time limit on returns of flat-panel TVs earlier this year?

MR. SINEGAL: We were spending an enormous amount of dollars by taking these things back and [selling them to a salvage company] for 30 to 40 cents on the dollar. Most of the reason for the TVs coming back was that customers couldn't understand what to do with them. We said, "We're going to help you get this thing hooked up. We're going to give you two years of warranty. We're going to make sure, even if we have to send somebody out to your house, that it works." We think we came up with a great solution.

WSJ: Why has the treasure-hunt technique worked so well for you in attracting customers?

MR. SINEGAL: We try to create an attitude that, if you see it, you ought to buy it because chances are it isn't going to be there next time. You're going to come in and find that maybe we have some Lucky jeans that we're selling. You come in the next time and we don't have those jeans but we have some Coach handbags. That's the treasure-hunt aspect. We constantly buy that stuff and intentionally run out of it from time to time.

WSJ: What was one of the most successful treasure-hunt items at Costco?

MR. SINEGAL: We wound up finding a place where we could get several million pairs of Calvin Klein jeans, and we bought them at a great price. Every department store was selling them for $50. We easily could have said, "Well, we're selling every pair that we get ... Why not sell these for$29.99?" But we didn't. We sold them for $22.99 because we made such a great buy.

WSJ: Can you recall one of your bigger treasure-hunt disappointments?

MR. SINEGAL: One year, we bought an IBM computer that we were going to sell for, I think, $1,000.We bought thousands of them, and it bombed. We had to lower the price. Several times.

WSJ: Costco offers better wages and benefits than most of its rivals. Why is that?

MR. SINEGAL: We think that you get what you pay for. If you hire good people, pay them good wages and provide good jobs and careers, good things will happen in your business. We think that has proven true in our case. We are the low-cost provider of merchandise, and yet we pay the highest wages. Wouldn't that suggest that we're getting better productivity?

WSJ: Costco plans to open about30 new stores in the U.S. this year, pushing your total past 400. Sam's Club plans to open 10 or 20. Are you concerned about over-reaching?

MR. SINEGAL: There are a lot of markets that we can go to. If we perform well, and if those new units get off the ground, we'll feel pretty confident about continuing to grow at that pace and maybe even stepping it up a little bit beyond that.

WSJ: Municipal laws banning development of large-format stores have gained momentum, especially in California, where Costco has quite a few stores. Will that limit you?

MR. SINEGAL: It doesn't apply to us in many instances. But we don't think that legislating in that fashion to limit competition is a good idea. Generally speaking, it's difficult to ban something like our business when we pay the wages and we provide the types of jobs that we do. We're a desirable business in the community.

WSJ: How does the recent concern over tainted goods from China affect Costco's sourcing of merchandise?

MR. SINEGAL: That type of tainted product doesn't just come from one country. It can come from any number of countries, including our own country. It's going to make us better buyers in terms of looking at every single thing that we buy and testing things much more carefully.

WSJ: You've already expanded to several countries abroad, such as Japan and Mexico. Where next? China? India?

MR. SINEGAL: We would have to have been living on Mars not to recognize that those are two up-and-coming markets. India at the moment has laws that restrict our ability to do business there. We think probably that will change eventually. China has got lots of possibilities as well, but we don't think there's any big rush to go to China. We're going to take our time and make sure we know what we're doing.