One of the things that many long-term investors like to do is to find companies with strong and lasting economic moats. The term “economic moat” was popularised by Warren Buffett and he uses it to refer to the characteristics a company has that protects its profits from competitors.
I recently published This is Berkshire Hathaway’s Simple But Unreplicable Competitive Advantage In The Insurance Industry. In it, I discussed the unique mindset that Buffett has that gives Berkshire (he’s the leader of the company) an unassailable edge over its insurance industry peers:
“What we’ve had going for us is a managerial mindset that most insurers find impossible to replicate.” This is the simple but unreplicable competitive advantage that Buffett and Berkshire has in the insurance industry. It is simple. You just have to be willing to tolerate a huge decline in business volume – potentially for a long time – if the pricing for business does not make sense. But it is unreplicable because it goes directly against our natural human tendency to be greedy for more.
If we spot similar simple but unreplicable competitive advantages in companies, it could lead us to fantastic long-term investment opportunities.“
After reading my article, a friend prompted me to also discuss Costco (NASDAQ: COST). The US-based warehouse retailer happens to also have a simple but unreplicable competitive advantage: A fanatical focus on lowering costs for customers, even at the expense of its short-term gain. Below are four few telling examples of the unique mindset that Costco’s leaders have
Uncommon
1. Inc. published an article in August 2019 about Costco and it said (emphases are mine):
“Unlike the typical 25 to 50 percent or more markups at most retailers, Costco caps its mark-ups at 14 percent for outside brands and 15 percent for Kirkland (in-house) brands.
But in many cases the markup is significantly lower, which is why the average mark-up across all Costco products is 11 percent.”
2. According to a June 2019 article from The Hustle (emphasis is mine):
“Not long ago, Costco was selling Calvin Klein jeans for $29 a pop — already $20 less than almost anywhere else — when a change in its purchasing deal meant Costco could get them for even less from the vendor. Instead of keeping the extra profit from the improved deal, it lowered the jeans’ price to $22.”
3. From the same article from The Hustle (emphases are mine):
“In the 2012 CNBC doc “Costco Craze,” a Costco buyer related one tale about a toy he found that retailed for $100. The company had the option of buying the unit for $50 wholesale and selling it for around $60 — but this wasn’t good enough.
Over a period of months, Costco ended up working with the vendor and its factory to redesign the toy from the ground up, analyzing every part of the process for ways to cut costs. In the end, Costco got the vendor to reduce the price by 50%, and sold it for $30.
The profit margin Costco made from the toy at $30 was the same it would’ve made at $60: The time and resources the company invested to lower the price were strictly for the benefit of their shoppers.”
4. Here’s an excerpt from a 2007 Wall Street Journal article (emphasis is mine):
“When the company signed a new contract in 2005 with a supplier for Brooks Brothers-style men’s cotton, button-down shirts, and got a significant price reduction for a massive two-year order, it immediately cut the price of the shirts to $12.99 from $17.99, notes Richard Galanti, Costco’s chief financial officer. Other retailers might have phased in the reduction and captured added profits, but that’s not the Costco way. The shirts now cost $14.99 because they are made with better-quality cotton.”
A market beater
So Costco has been relentless at lowering costs for its customers, often at the expense of its own short-term benefit. How has Costco’s business and share price done over time? Here’s a chart showing the growth in the company’s share price, earnings per share (EPS), and revenue since the start of 2007 – I chose 2007 as the start to remove the “rebound-effects” from the bottom of the Great Financial Crisis of 08/09.
Turns out, there has been solid growth in all three metrics! Costco’s management could have easily juiced the company’s revenues in the short run. But they held off, thinking that the long-term gains are even better. They have been right.
The table below shows Costco’s revenue and EPS from its fiscal year ended August (FY2007) to FY2019. It also shows the same numbers for Walmart (NYSE: WMT) over roughly the same period – for Walmart, it is the fiscal year ended January 2008 (WFY2008) to WFY2020. It’s definitely not an apples-to-apples comparison, but I think it’s instructive to compare Costco’s results with those of Walmart. That’s because Walmart is also a US-based bricks-and-mortar retailer – and one of the largest retailers in the world.
Costco has grown at a much faster pace than Walmart over a similar time period. Again, it’s not apples-to-apples. Walmart is much bigger than Costco, and size does create a drag on growth. But I can’t help but think that Costco’s faster growth over Walmart – in the face of the rise of online retail too, I need to add – is partly a result of the unique mindset that its leaders have.
A simple secret
In This is Berkshire Hathaway’s Simple But Unreplicable Competitive Advantage In The Insurance Industry, I wrote:
“Competitive advantages need not be complex. They can be simple. And sometimes the really simple ones end up being the hardest, or impossible, to copy. And that’s a beautiful thing for long-term investors.”
I want to expand on that. Costco is an example of a simple secret to long-term investing: A lasting competitive advantage can come from simply doing what others are unable or unwilling to do. Costco is willing to voluntarily lower the prices of its products to give customers the best deals. And it does this consistently. How many retailers are willing to do what Costco does? Not many, is my guess. And this is what gives Costco a lasting competitive advantage.
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