Hacker News Reader

Did you notice the data point in the article that Costco makes $2 billion in membership revenue and yet makes $1.7 billion in profit, which means they effectively lose money on their sales?

In fact, a little known feature of Costco's business model is their ability to sell all their stock well before their suppliers require payment for goods (Net 30)? This means they have an effectively _negative_ cash conversion cycle, or in other words, their suppliers are paying to stock their products.

Everything about Costco's business model is backwards.

> Did you notice the data point in the article that Costco makes $2 billion in membership revenue and yet makes $1.7 billion in profit, which means they effectively lose money on their sales?

That $1.7 billion is net income, which is after subtracting out the income tax. You have to compare to pre-tax income, which in the case of Costco is essentially just operating income.

75% of Costco's income came from membership fees in the last fiscal year, and similar or higher percentages in other recent years.

From Costco's FY 2012 annual report, page 25 (in millions of dollars):

         Membership   Operating income
  2008      1,506          1,969
  2009      1,533          1,777
  2010      1,691          2,077
  2011      1,867          2,439
  2012      2,075          2,759

PDF file: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9M...

The membership fee, of course, serves another purpose. It reduces patronage by lower-income shoppers, and therefore helps to reduce shoplifting. The receipt-check is another deterrent. Since Costco has such a tight margin on its merchandise, it cannot tolerate industrywide shrinkage rates.

The receipt check is generally there to catch crooked cashiers not crooked customers. Without it a cashier could fake scan items and their accomplices walk out undetected. The check means at least two employees have to collaborate to steal.

>>Did you notice the data point in the article that Costco makes $2 billion in membership revenue and yet makes $1.7 billion in profit, which means they effectively lose money on their sales?

I'm pretty sure the revenue isn't net. It would mean they have absurd retail margins on their members and negative ones on every other product sold; which doesn't make a lot of sense.

>>In fact, a little known feature of Costco's business model is their ability to sell all their stock well before their suppliers require payment for goods (Net 30)? This means they have an effectively _negative_ cash conversion cycle, or in other words, their suppliers are paying to stock their products.

That could just be their way of handling stocking fees. They handle a lot of merchandise they can't afford to stick into inventory.

No, they make money on their products, but the costs of workers/rent/etc. is what costs them more than the profit on the goods

This argument only makes sense if you consider 100% of membership revenue to be profit with absolutely no associated costs. However, clearly Costco's customers would not be willing to pay $60 annual dues if there were no benefits.

In fact, a little known feature of Costco's business model is their ability to sell all their stock well before their suppliers require payment for goods (Net 30)? This means they have an effectively _negative_ cash conversion cycle, or in other words, their suppliers are paying to stock their products.

AFAIK most supermarkets run this model; when I was in school in Ireland in the 90s, this model was explained to me with reference to the main Irish chains. They end up with a big chunk of free cash that they invest.

Is the $2 billion in membership figured into the net? It seemed like it was separate in the article's table.

It includes all the revenues, including sales, membership fees, and interest income. Minus all the expenses, including cost of goods, sales and marketing, corporate overhead, debt service, and taxes.

Net income is literally the "bottom line" number on the accounting statement. It's the number that coes out after accounting for everything in the business.

Cool, thanks. I wasn't sure if the author was trying to separate the concerns to make some kind of a point about the different types of revenue. The membership revenues were also listed after the net, iirc, which I thought was strange. That makes sense, though.

This seems to be the same model as most gaming consoles.

The opposite model as Xbox and Playstation.

The console is the up-front purchase, which equates to Costco's membership fee. But Xbox and Playstation lose money up-front.

Instead, Costco operates on the Wii or the iPhone model, where you take most of your profit up-front and then operate the rest at a much smaller profit. (Though still positive.)

Walmart spends a great deal more on cost of goods sold than selling expenses, which is where the retail wages are counted. http://investing.businessweek.com/research/stocks/financials...

According to the data in the article, Walmart would have the same profit margin as Costco if they spent $3,500 more per employee annually. Ignoring part-time workers, salary-exempt, benefits etc., this is an hourly wage increase of about $1.75, still well under what Costco pays.

80% of Costco's profits comes from membership fees (source: http://www.businessweek.com/articles/2013-06-06/costco-ceo-c... ), so Costco is less dependent on changes in buying patterns, and sells pretty much at cost. Unless consumers start canceling their memberships en masse, Costco won't be in deep trouble.

Wal-Mart's profits, I'd imagine, are entirely from markups, and a slight change in consumer behavior (higher prices on gas, higher unemployment numbers, smaller paychecks) makes them a volatile player.

I used to work in a supermarket and in a department store.

Those people you see shooting the shit and slacking off are necessary. The reason why they're there is because if the store suddenly gets packed, they will be split up and given tasks. They're insurance. You can't not have them there, or you'll get customer complaints when they can't find someone to help them, there's too few lanes, etc.

And that's just during the day in front-end customer facing situations. They're constantly called back to inventory to do warehouse-type jobs, even if they're cashiers.

> You can't not have them there, or you'll get customer complaints when they can't find someone to help them, there's too few lanes, etc.

Aldi (in Germany) operates on a system were they don't have that insurance, and trained the customer to accept it. But that low level of customer service would only ever fly in Germany.

This. I used to work in a supermarket. Courtesy clerks (baggers) and even cashiers could be given bizarre tasks during slowdowns, but the crowds would always pick up during their shifts and they'd need to be called back to their posts. Seemed like this was usually at the top and bottom of the hour and various rush points of the workday. If the overflow labor wasn't there, lines would back up into the aisles and customers wouldn't just complain, they'd go bonkers.

Yeah, I don't mean to bash on them. And goodness knows I'm sure Walmart knows what it's doing with it's staffing levels. That's why I just added it as a random anecdotal PS.

Given that labor costs are the single largest expense for these types of business it's not unreasonable to reach the conclusion of those she's rebutting with this article.

Whaaaa? The largest expense, by far, is most certainly cost of goods sold.

I wouldn't really consider them an expense in the same way as labour costs. Maybe in terms of the costs of distribution and storage for things that aren't moving. Things that are moving though with a profit margin aren't really a cost center.

In bookkeeping, no, but in looking for opportunities for efficiencies, it's pretty relevant.

Say, you've got a single employee on a $60k salary moving goods worth $10mm, but at a razor thin margin, so your profit on the goods is $100k, and your net profit is $40k. If you want to increase your net profit, it would probably be easier and yield a bigger return to see if you can do something about your $9.9mm product expense than your $60k salary expense.

Oh, but you still have to pay interest on that tied up capital. (I.e. the faster you move your inventory, the cheaper it gets.)

It's a good point, Walmart is doing better in both volume and margins. That might imply Walmart has poorly allocated some of its returns.

There's a floor, though, where that argument isn't as compelling. It's not like we're talking of dropping from 20% to 10% margins, here, Costco's 1.7% margins might not be sustainable, or might only be sustainable for a business with less fixed capital.

I mean, maybe you're right, maybe 1.7% isn't that floor yet, I'd just need more information.

But the last piece focused more on the fact that Walmart is in business relationships with more poor people than just its employees. So even if Walmart has poorly allocated its returns, I'd rather see those margins distributed to customers or foreign suppliers first, because my hunch is that the humanitarian impact would be greater on these groups, who I see as larger, poorer, and having fewer substitutes.

So even if Walmart has poorly allocated its returns, I'd rather see those margins distributed to customers or foreign suppliers first, because my hunch is that the humanitarian impact would be greater on these groups, who I see as larger, poorer, and having fewer substitutes.

Exactly. The basic argument is that Walmart should engage in charity by paying above-market wages to its employees. But there are much more effective ways to be charitable; mosquito nets in Africa and anti-aging research comes immediately to mind.

Also interesting is that Walmart gets bashed for relatively low wages, but doesn't get credit for employing lots and lots of people. Imagine the reaction if they announced that they were doubling salaries and laying off half their workforce.

> there are much more effective ways to be charitable; mosquito nets in Africa and anti-aging research comes immediately to mind.

You are crazy if you think those are more effective use for WalMart's money, especially the anti-aging research.

Anti-aging research I have to agree.

But according to Givewell (http://www.givewell.org/) who do research into cost effective use of charity money, mosquito nets are very effective. Their #1 recommendation is the Against Malaria Foundation who "provides long-lasting insecticide-treated nets (for protection against malaria) in bulk to other organizations, which then distribute them in developing countries."

"AMF is a recommended organization because of its:

- focus on a program with a strong track record and excellent cost-effectiveness (more). - standout transparency and accountability - it publishes photographs and reports from each of its distributions and requires that organizations that distribute its nets monitor the usage and condition of nets in the years following the distribution and track and provide monthly malaria case rate data (more). - room for more funding - AMF has told us that it can use additional funding to expand its core program and has committed to reporting on how additional funds are used and what results are achieved."

Even if you don't accept Givewell's research, I think there is enough evidence here to doubt the statement that you wouldn't be "crazy" to think their were more effective use of money than mosquito nets.

Just silly examples. If you want some more conventional, donate to Doctors Without Borders.

If paying your employees is 'charity' what the hell do you call stock dividends?

Capitalism.

Stock dividends are a return on the investment made by investors. Many of us in the startup space would be unemployed if it weren't for that pesky thing called capitalism. VCs and investors aren't charities. They risk money for a return. Granted most VCs and angels are after capital appreciation, but for larger companies, especially those with a shelf life beyond the duration of the latest tech trend, dividends are a significant reason to invest in a particular stock.

The retirement funds of a large percentage of people absolutely depend on dividend-earning stocks. Let's not forget that those shareholders aren't Wall Street "fat cats." They are pension funds, teacher retirement funds and granny's retirement savings. So if you raise wages, you lower dividends (or raise prices, which lower demand) and THAT hurts the people that can least afford it -- those retirees that don't have the option to go find a higher paying job.

Let's look at it this way -- no one is forced to work at Walmart. If Walmart employees think they are worth more, then they can quit and sell their services to someone willing to pay more. If someone isn't willing to pay more, then obviously they aren't worth more. There's an argument that the government should simply require companies to pay more. That's fine and dandy, except now what happens to the cost of goods? It necessarily has to rise. So that means that everyone has to effectively subsidize workers' wages. Yet how is it fair that we have to pay more for goods (or higher taxes) to subsidize others?

In 2006-2007 I lived for several months in my car, ate Ramen almost every day for 6 months when I didn't have a job. I lost my apartment and eventually my car because I made some dumb mistakes both financially and personally. Yet during that time, I didn't ask for the government or any of you to give me some of your paycheck. I chose not to get married or have children until I could afford it. I didn't demand that you pay $2 more for a Big Mac so I could make more money. Eventually, moved to Korea, then China to English, then taught myself software development and now I'm doing ok.

These "sad" stories about people who work for 10 years at McDonalds for 7 bucks an hour don't move me one bit. If after 10 years you can't improve your lot in life, you're either stupid, lack ambition or you're a star in a Charles Dickens novel. There are plenty of stories about the single mom who worked minimum wage while earning a degree in night school and then going on to greater things. It can be done, it's up to the person. If we incentivize working shitty jobs, what's going to drive innovation and aspiration?

I refuse to subsidize wages in the name of "fairness." What's unfair is that I pay 30% of my income in taxes, plus sales taxes, property taxes, gas taxes, cell phone "universal service fee" taxes, and my telephone bill STILL has an excise tax on it that was supposed to fund the Spanish-American war! And what do I get for those taxes? I still have to pay $82 to get more pages added to a passport at the US Consulate. I still have to pay $25 at the DMV for a drivers license. I still have to pay yearly auto registration and inspections. I still have to pay tolls for bridges (and tunnels) that were built with taxpayer money (I'm looking at you Lincoln Tunnel with your $13 one-way toll!)

I have to pay almost 50% in taxes and fees for airline tickets and still have to deal with crappy infrastructure, a manically inept TSA, shitty transportation systems and public schools that I wouldn't send a dog to. Yet somehow certain groups of people get free cell phones, free medical care (I pay $1300 a month for a family of 4,) subsidized housing (there's public housing in Chelsea, NYC!) food stamp cards on which you can buy lobster and organic peaches and educational grants and subsidized loans for people to go to school.

I'm not arguing for or against any of those government programs, but if you're asking me to pay a buck more for a box of Kraft Macaroni & Cheese, you're out of your g'damned mind.

you think Walmart's customers are poorer than walmart's employees?? seriously? Walmart states that it's target demographic, which it also finds contains the majority of their customers, makes $30,000-$60,000 per year. Walmart's employees make $16,000 a year. So, the typical Walmart customer makes 2-4x as much as their employees. This stuff isn't hard to research, and should be blindingly obvious if you ever shopped at walmart in a rural area. The people who shop at Walmart are very clearly middle class in those regions, not the poor.

> Walmart is in business relationships with more poor people than just its employees

"more" here refers to "a greater number than", not "poorer than"

For comparison purposes, Apple and Google make 6-7 times higher net margins than Walmart.

And Netflix's DVD side of the business (the one Reed Hastings wants to kill somehow) is turning in 50% margins.

http://techcrunch.com/2012/01/25/netflixs-streaming-dvd-marg...

(That's old, they've dropped precipitously since then to something like 48%...)

> And Netflix's DVD side of the business (the one Reed Hastings wants to kill somehow) is turning in 50% margins.

DVD rental is a high-margin but stagnating market, while streaming is a low-margin but growing market.

The stock market believes that it's better to expand profitlessly than to remain small but profitable. See Amazon's P/E ratio.

Besides, Reed Hastings is a tech guy. He cut his teeth on the Purify memory leak detector. He claims that he always wanted to do streaming -- it's just that the broadband infrastructure wasn't well-developed In 1997, whereas DVDs were just then starting to take off. (And they happened to weigh under an ounce, which made them cheaply mailable.)

Stagnating at 50% returns is a strange kind of problem. Even Reed has admitted streaming will never get there. And it's stagnating because Netflix has no interest in growing that side of the business. They don't advertise it, they bury the sign up option on their page, they've tried to split it off, they've arbitrarily raised its prices... I mean, easy, drop to 30% margins and buy an ad, you'll get growth again.

Some people think that being a tech guy is exactly what's blinding Reed to the fact that the licensing problem is a far bigger problem than the shipping costs..

"I am struck by just how many people there are working there on the floor. There seem to be too many whenever I'm there."

Maybe that's more more of a load problem? They are probably there for the peak rush periods, and I would imagine forecasting those accurately is almost impossible, so you operate with a buffer. Lower wages enable them to be more flexible in handling these peak loads.

In terms of your point about the financial impact, a quick look at the SG&A of Walmart (20%) shows a big difference vs. Costco's (~9%). I don't have the breakout of employee wages, but it does seem like it's definitely a more labor intensive model. Then again, they probably could afford to pay higher wages, but the problem is that customers haven't given them a financial incentive to do so. I feel like the point the author was trying to make was a good one...many people that write about these issues should acknowledge the different business models instead of just quickly pointing at Costco and saying the model works with higher wages.