Why Is Costco Winning but Wal-Mart Losing?

From the beginning of 2015 to the end, Wal-Mart Stores Inc. (NYSE: WMT) lost more than 36% of its market cap. Across the same period, Costco Wholesale Corporation (NASDAQ: COST) logged a 20% gain. Wal-Mart is far bigger than Costco from a revenues perspective. It generates half a trillion dollars annually, versus the $120 million or so of Costco, and there is no shortage of U.S. and global consumers looking for deep discount purchases. So why the disparity in performance from the two retailing giants?

Essentially, it comes down to business model, and the impact that model has on customer satisfaction. The cost of an annual Costco membership comes in at $55 for the base membership, and $110 for the executive. Customers pay for the right to shop there. Wal-Mart is, of course, free to shop in. Why is this important? It means that Costco is not reliant on sales margins for its revenues.

The vast majority of Costco’s earnings derives from its membership fees, which allows it to sell products at little to no, or even negative, margin. Wal-Mart relies on product sales for its revenues. Of course, Wal-Mart has a huge amount of leverage on supplier pricing, based purely on the volume of products it purchases for resale, but in the deep discount retail environment, even the narrowest of margins can make a big difference.

Where does customer satisfaction come in? Anecdotal reports suggest the retailing experience Costco offers its customers is far superior to what Wal-Mart brings to the table. The fact that shoppers are willing to pay to shop in a store backs this up, and it is quantified in the annual American Customer Satisfaction index report, in which Costco regularly tops the list and Wal-Mart generally comes in last place.
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This distinction likely resides in the way both companies treat their employees. Costco pays its workers far more than Wal-Mart does (close to double), and is renowned for a strong benefits program. A happy workforce translates to improved customer service and a better retail experience.

What can we expect for 2016? The trend of Costco outperforming Wal-Mart looks set to continue going forward. Costco is set to open 22 new domestic stores throughout the year and continue its aggressive international expansion strategy with 10 new overseas locations before the end of the year. Wal-Mart expects to close 269 stores throughout the year, and with mounting pressure from chain grocery retailers for its grocery revenues, which account for a little over 55% of total revenues, could suffer a weakened bottom line going forward.

By Matt Winkler