Costco

I don't think I have ever been more in love with a company in a business model.

Ben Gilbert opens the episode with open admiration for Costco. David Rosenthal jokes that he sounds like Charlie Munger. Ben says Costco is unusual because "the deeper you dig, the more good things you find". He calls that the opposite of what usually happens, and the opposite of life as an early stage venture capitalist.

Ben's opening describes Costco as one roof covering a wide range of goods and services: a 2½ pound container of cashews, prescription eyeglasses, gas, tires, 96 rolls of toilet paper, a refrigerator, an outdoor shed, a 10 carat diamond ring, fresh sushi and fine wine. The list ends with the hot dog and soda, with a free refill, for $1.50. Ben says the price has been the same for 40 years, and David corrects him to 47 years.

Ben's central claim is that the model only looks simple. Selling in bulk makes good deals possible. What makes it work, he argues, is about 50 "clever innovations" refined over the years that work together "like an orchestra that's been rehearsing for decades." He says nothing is accidental, from the extra-wide parking spaces to the whole rotisserie chickens. He sets up the episode as a walk through the specific decisions and trade-offs Costco made to deliver three things: extreme value, high quality products and the lowest possible prices.

David shows how much Munger likes the company with a Warren Buffett joke that he says was told at a Berkshire annual meeting and is on YouTube. In the joke, hijackers grant Buffett and Munger one last wish each. Munger asks to give his speech on the virtues of Costco one more time. Buffett replies, "shoot me first." Ben adds that Munger sits on Costco's board.

Statistics the hosts cite for Costco's scale and performance: - Revenue has grown right about 10% a year for over 30 years in a row. - Revenue per square foot of its warehouses, Ben says, belongs more in a conversation with Tiffany than with Walmart. - The company appears to have a lot of room to expand both internationally and in North America. - Its store brand, Kirkland Signature, sells about $52 billion a year on its own. Ben says that beats all of Nike by about a billion dollars, and the figure doesn't include Kirkland Signature gas.

The hosts frame Kirkland's ranking differently. David says it "might be" the largest brand in the world by revenue. Ben narrows that to the largest consumer packaged brand in the world. David pushes back that the label is a misnomer because Kirkland sells everything, while most other brands "only sell shoes." The hosts also state that the show is not investment advice and that they may hold investments in the companies they discuss.

David gives the official origin: retail veterans Jim Sinegal and Jeffrey Brotman founded Costco in Seattle in 1983. Brotman came from a long line of Seattle retailers, including his father and brother, and was one of the first investors and board members of Starbucks.

The hosts argue that the real history goes much further back, to Sol Price, whom they discussed at length in their Walmart episode. Today's Costco is the result of a merger between Costco and its predecessor, Price Club. Price Club grew out of Sol's earlier company, FedMart, which in turn grew out of Fedco in the 1940s. Ben describes all of these as effectively one company, because each is a set of stacked learnings from Sol Price and "his various brain children" over the years.

Sol Price was born in January 1916 in the Bronx. His parents were Jewish immigrants from Belarus who had arrived at Ellis Island as teenagers a couple of years earlier, with no English and no money. Like many Jewish immigrants in New York at the time, they worked in garment factories on the Lower East Side, where conditions were terrible.

David uses the 1911 Triangle Shirtwaist Factory fire as context. The owners had locked the doors to keep workers from stealing, and when the fire broke out, 146 people were killed, mostly women and young girls. David calls it the start of the American labor movement and says the Communist and Socialist parties emerged in America partly in reaction to it. Sol's parents didn't work at Triangle, but they worked in factories like it. David's point is that one of the most influential American retail capitalists came out of that world of labor activism, communism and socialism.

Ben ranks Sol among the top two or three American retailers, alongside Sam Walton. David backs up the case for Sol's influence with two claims. First, Walton wrote in Made in America that he stole more ideas from Sol than from anyone else in his career. Second, Jim Sinegal tells a story about a reporter who asked whether he had learned a lot from Sol.

I didn't learn a lot, I learned everything. Absolutely everything I know, I learned from Sol.

Much of the hosts' detail comes from a rare, out-of-print, self-published biography of Sol written by his son, Robert. David says he knows of no other source that lays out in such detail how Costco and its predecessors work. Ben adds that Robert appears to have signed every copy, since both of their copies were signed. The hosts mention that Blinkist, a sponsor, made a summary of the book.

In the New York Jewish community at the time, there was no such thing as Republicans. The Socialists were the Conservatives and the Communists were the radicals.

Ben says this quote shows where Sol's political ideology comes from. David adds a personal detail. As a young child, Sol developed an eye defect that made his left eye droop, and he was self-conscious about it. David says Sol channeled that insecurity into overachieving at school, where he skipped two grades. In the middle of high school, his family moved to San Diego.

David stresses how small San Diego was then: about 150,000 people, no Qualcomm or Illumina, and only the beginnings of the Navy and defense industry. He draws a parallel with Sam Walton. Sol met his future wife, Helen Moskowitz, in high school. Like Walton's wife, also named Helen, she came from one of the wealthiest families in town, and she and her family would be influential on him.

Helen's family ran a scrap metal business. David says that was about as well-positioned as a business could be in 1930s San Diego, because World War II turned the city into the principal base of the Navy's Pacific Fleet, with booming shipbuilding and metal work. After the war, many sailors and GIs who had passed through decided to settle there. David says San Diego is now the eighth largest city in America, larger than both Seattle and San Francisco.

Before the boom, Sol earned a law degree at USC and returned to practice law in San Diego. David says the timing could not have been better. Drawing on his own parents' experience as small-town lawyers, he explains that such a lawyer acts as a consigliere, advising clients on business, real estate, negotiations, divorces, trusts and estates.

After the war, Sol advised entrepreneurs launching new retail concepts in San Diego. One was The Seven C's Locker Club, where Navy sailors could store their uniforms while on leave, or their personal effects while at sea. David calls the lockers a "Trojan horse" to get customers in the door. Once inside, they were offered laundry, dry cleaning, clothing, jewelry, food and haircuts. David notes that this may sound familiar.

Another client, Four Star Jewelers, also sold jewelry wholesale to other retailers. Most of that wholesale business went to a single account: Fedco, a retail operation in Los Angeles. Ben describes the natural reaction of finding out how one customer could move so much volume.

Fedco was a nonprofit membership club and customer collective that was only open to federal employees, mainly postal workers. After the war, about 800 postal workers in the Los Angeles area pooled their buying power to get better prices. Fedco charged dues, but as a nonprofit it didn't really make money on memberships: a lifetime membership cost $5, once.

Ben compares it to REI today. He says that, adjusted for inflation, a one-time fee of roughly $85 builds affinity with the store rather than serving as a meaningful revenue source. David calls the analogy perfect. Fedco grew popular enough that customers drove from across Southern California, including San Diego, sometimes hundreds of miles round trip, to do most of their shopping there.

Ben notes that Fedco, as a nonprofit, had no interest in expanding. Sol and the jewelers saw the demand and wanted a Fedco in San Diego. Helen's family owned an empty 21,000 square foot warehouse in the city's industrial district, and the three of them decided it could house one.

David presents what happened next as a way Sol differed from Sam Walton, and he connects it, tentatively, to Sol's New York upbringing. Instead of simply cloning Fedco, Sol first proposed a joint venture: Sol's side would supply the building and run the store. When Fedco's board declined, Sol offered to let Fedco own the whole business, with San Diego as a franchise that would give Fedco all the upside and enterprise value. The board turned that down too.

Ben says this can be read two ways: as a lack of business savvy, or as being "ridiculously principled." David argues for the second reading. Sol was a good businessman who was also highly principled, and David says that trait flows directly into Costco. To show Sol's humor about his legacy, David recalls that, when asked late in life about being the father of modern American retailing, Sol laughed and said maybe he should have worn a condom.

After the second rejection, Sol and his partners opened their own store in the warehouse in November 1954. They couldn't use the Fedco name, so they called it FedMart to borrow Fedco's brand recognition. Ben calls it "An equally bad name," and David adds that it was one "that would have historic impact." David says the name explains why Walmart and Kmart are called what they are. In his account, Walton wrote in Made in America that FedMart was already known and expanding nationally when Walmart started, so he deliberately drafted off the FedMart brand. Kmart did the same.

David argues that FedMart was the first scaled, quasi-national discounter, and that Sol created the industry later occupied by Walmart, Kmart and Target. Ben clarifies that FedMart was not yet the wholesale model Costco uses today, with pallets of huge quantities. It worked more like a Walmart, with individual items on shelves. It did combine packaged food and general merchandise under one roof.

The key difference from Fedco, David says, is that FedMart was a for-profit company and therefore had the drive to expand. It was still restricted to federal employees and still required a membership. David says he thinks the lifetime price may have dropped to $2 to undercut Fedco, but he isn't certain. Either way, he says, the business was not about the membership fee.

David explains why the membership structure mattered legally. US laws at the time let manufacturers set a minimum retail price, and selling below it to the general public was illegal. "Discounting" originally meant selling below that minimum. Sol discovered that a membership club is not open to the general public, so it could legally sell below the manufacturer's minimum price. David says this is why no other discounters had scaled before.

David says this is the basis for his claim that Sol is "the GOAT" of American capitalist retailers. Sol first invented the discounter, which Sam Walton, Kresge with Kmart and Dayton with Target copied into America's dominant retail format. He later invented the wholesale club through Price Club, which led to Costco. David calls these two separate inventions by the same person.

The first FedMart was an immediate success. The founders' most optimistic target for 1954 was $1 million in sales, and the store did $3 million in its first year. Asked why it worked, David says it was a "no risk bet," because Fedco had already proven the model in Los Angeles. A year later, FedMart opened in Phoenix, where David says lines half a mile long stretched to the parking lot. Stores in San Antonio, Houston and Dallas followed, and all were huge successes.

David highlights two developments that would shape both FedMart and Costco. Sol left law to become FedMart's full-time president. FedMart also hired Jim Sinegal, a student at San Diego City College, as a part-time bagger at the San Diego store. Sinegal worked directly for Sol at FedMart for 22 years and eventually ran its distribution and centralized warehousing operations. David notes that this is where the Costco picture starts coming together.

FedMart went public in 1959 and raised $2 million. It used the money to open more stores and to widen the range of goods and services, echoing the Seven C's Locker Club. One addition was gasoline, which David calls the origin of the Costco gas line. FedMart priced gas a few cents below local stations, which mattered when gas cost 25¢. Unlike a gas station, FedMart earned money from shoppers inside the store, so it could sell gas at cost to drive traffic.

FedMart also added a pharmacy, the predecessor of Costco Pharmacy. David tells how the person who set up the division received death threats from people in the industry and had a rock thrown through his window, because FedMart was undercutting pharmacy counters' fat margins. That person's protégé later took over FedMart's pharmacy division and then started and ran Costco's.

David says the most important step for the Costco story was FedMart's house brand for popular products, which carried the FM label. Ben and David point to old photos and newspaper references to products such as FM Cola.

Sol formalized his management philosophy as FedMart's four principles, in priority order, and taught them to every new employee.

FedMart's four priority-order principles, as David describes them: 1. Provide the best possible value to customers. 2. Pay employees good wages and provide good benefits, including health insurance. David calls this progressive for the 1950s. 3. Maintain honest business practices. 4. Make money for investors.

David says these will sound familiar to anyone who knows Costco's values. Ben adds that they are "Not the same, but rhymes," and plans to return to them when discussing Costco. David expects the objection that Walmart or Target post similar words on their walls. His answer is that what matters is whether a company truly means them. Sol made clear trade-offs at FedMart that Costco still makes, and its competitors don't.

The first trade-off is refusing to use loss leaders, meaning items priced below cost to draw shoppers. David calls the tactic time-honored in retail. Ben recalls Walton bragging in Made in America about stacking a huge quantity of an item into a pyramid in the parking lot and selling it off to create a spectacle. Ben says Costco won't sell something unless it can make money on it. David argues that loss leaders have to be paid for with fat margins elsewhere in the store, which amounts to treating customers "like they're stupid."