What does the world’s second-largest retail chain operation look like on-site? 52,000 paying members visit the warehouse hall in the middle of the Omaha fields every week, and they pay an annual membership fee of $60-120 for this privilege. Why? We decided to find out.
On Thursday, May 4, 2023, enthusiastic investors gathered at Helsinki-Vantaa Airport. The goal was not to return home by evening but to embark on a journey to the American Midwest, the location of Berkshire Hathaway’s annual shareholder meeting, where Warren Buffett, the Oracle of Omaha, shares his wisdom yearly.
During the same trip, we intended to get firsthand experience of the operations of Costco, one of Sifter’s significant investments. What impressions did we take away from the journey?
The U.S. consumer market – no signs of a recession
We stayed at a small motel located 25 kilometers outside downtown Omaha. The location was deliberately chosen close to Costco’s giant store, where we had scheduled a meeting with the store manager on Friday.
Our first observation was that the highways were filled with trucks, and the transfer of goods was still significant.
The vehicle fleet was also new, which was to be expected. After all, the car is still considered the holy cow of the American consumer. However, electric cars were noticeably absent in Omaha.
The other observation was that there is room for improvement in the Midwest’s infrastructure. The roads, bridges, power grids, and buildings were in dire need of repairs. This has also caught the attention of the White House, and it remains to be seen when funds will start flowing into these repairs. It could be an option to invest in infrastructure builders in the United States; there should be plenty of work available.
Inflation has left its mark. The price level was surprisingly high for a European visitor.
Hamburgers cost $7-9, and roadside diners ask over $20 for lunch.
Nevertheless, consumption has not declined at first glance. We had discussions with customers, store managers, and taxi drivers in Costco and other stores, and consumption has remained despite the high prices caused by inflation. The American consumer heavily relies on leverage, as the anticipation of the future is always optimistic.
The American consumer can still afford to choose their jobs and request pay raises. Even truck drivers’ annual earnings could reach up to $100,000.
Although an economic downturn is considered almost inevitable in the United States, it is not yet evident on the streets. How this super-dynamic and work-oriented society will move forward remains to be seen.
As long as the U.S. dollar remains the world’s reserve currency, living on debt can continue in the United States.
Warren Buffett expressed concerns about the U.S. debt ceiling in his presentation at the Annual meeting. Despite worries, Mr. Buffett did not see better alternatives for the world’s reserve currency than the U.S. dollar.
A Visit to Costco’s warehouse store
We had reserved a two-hour meeting at Costco in Omaha, where we met with the store manager, Dale. Sifter invested in Costco in 2020, and we have conducted extensive research and written about it. Now it was time to experience the store in person.
Costco’s warehouse, over 14,000 square meters in Omaha, is only six years old and already generates $250 million in annual revenue.
Over 90 percent of Costco’s profits come from the annual membership fees of $60-120. New members continue to join, and existing members are highly loyal. And why wouldn’t they be? They can buy quality goods, services, and food at discounted prices in exchange for the membership fee.
The quality exceeded our expectations
The 14,000 square meter store in the middle of a field may appear dull on the outside. But as we entered the store, a consumer’s paradise unfolded before us. Home electronics were stacked in huge boxes from floor to ceiling, yet very neatly organized. The atmosphere exuded quality.
The range of services was broader than we expected
Store manager Dale guided us through various departments and answered our questions. We arrived at the food section, which featured a long wine shelf. To our surprise, we noticed high-quality French wines were under Costco’s private-label brand, Kirkland. We learned that Costco’s Kirkland brand accounts for about 30% of its sales. It is highly profitable for Costco.
We continued our journey until the air filled with the aroma of baked bread. Dale introduced us to a massive bakery selling fresh bread; customers could even design their celebration cakes. The fruits, vegetables, and meats all appeared to be good quality at Costco.
There was no feeling of a warehouse store; a delicate atmosphere prevailed.
We continued our tour, moving from section to section—tires, diapers, detergents—until we stumbled upon the pharmacy and the hearing/eye care section. These were new services for Costco, but they generated several million dollars in revenue each.
Through these new services, Costco attracts new members into its realm (membership fee model). There is a Costco gas station in the parking lot, and customers can even change their tires while shopping. The restaurant was under renovation, but the famous $1.50 hot dog and soda offer is always available after a rigorous shopping spree.
Membership is growing and for good reason
We concluded our tour at the membership desk, where two cheerful women explained how they acquired new members. Costco, the money-making machine, generates over 90% of its profit from membership fees.
This warehouse has 52,000 paying members, growing at 10% per year. The loyalty of existing members is at 99%, meaning almost every customer renews their membership annually. It is a highly predictable revenue stream.
The store manager said the membership count could reach 75,000-80,000.
However, they can only increase members at certain limits without compromising the customer experience. I, too, would have become a member, but a 15-hour plane ride distance is too much.
Employee and customer experience was positive
As shareholders, we were pleased to see the staff appear openly cheerful. Employees approached the store manager to chat; he knew them all by name. Store manager Dale spoke respectfully about his team.
Even if we were to remove the American superficiality from the equation, the atmosphere felt genuine.
Costco customers also recognized the store manager and approached him to have conversations during our tour. Many expressed their satisfaction, and it was evident from their shopping carts. In true American fashion, the vast carts were overflowing with goods.
In summary
Although our visit to just one Costco store was only a glimpse, it gave a strong impression of a well-managed business model.
First and foremost, the customer benefit is genuine – quality and price. The number of customers, who pay the annual membership fee, is increasing, and they are highly loyal.
Additionally, this business model does not need to spend money on ads because the members do their job. The saved advertising costs translate into lower prices or better profits.
Costco’s centralized purchasing acquires high-quality goods in large quantities and distributes them to over 800 giant stores worldwide. Overall, the revenue stream is highly predictable and profitable.
Sifter Fund has been a Costco shareholder since 2020. Warren Buffett’s investment company, Berkshire Hathaway, sold its stake in Costco in 2020, but Charlie Munger is still on the company’s board.
On Saturday, the Sifter team attended the Berkshire Hathaway annual meeting, which was a true Warren & Charlie fan event. T-shirts and mugs with Buffett’s images were sold in large quantities.
Read more about the event: Berkshire Hathaway 2023 Annual Meeting – 10 Lessons from Warren Buffett for Investors.
Santeri Korpinen
CEO, Sifter Capital
