Motley Fool Hidden Gems Investing - Costco's Winning Formula

Episode Date: September 4, 2015

Costco has racked up big profits for shareholders. In this special episode of Motley Fool Money, Costco co-founder Jim Sinegal shares some secrets to Costco's success. Learn more about your ad choices. Visit megaphone.fm/adchoices

Chris Hill, and this week, it's our Labor Day weekend special. We hope you're enjoying a little bit of R&R. We are. So if there's any big news in the world of business, we I promise we'll get to it next week. But this week, we're talking Costco, one of the world's most successful retailers and a market-beating stock. Earlier this year at our Motley Fool One event in Seattle, Motley Fool CEO Tom Gardner sat down with Costco co-founder and longtime CEO Jim Sinegal in front of a live audience. Even though Sinegal stepped down as CEO a few years ago, he's still very involved in the business. And the conversation began with Senegal talking about his very first job in retail, working at FedMart when he was just 18

years old. You know, I was a student at San Diego Junior College and a sophomore and was invited, a friend of mine, it was between Christmas and New Year's, and a new company called FedMart had just started in business in San Diego. And I had a job at that time. I used to get out into the harbor and pick up the laundry early in the morning before school. So I'd work for about three or four hours early in the morning and then go to college. And they got a load of mattresses in at this new business. And a friend, a buddy of mine that I went to school with was working there. They'd only been open for about four weeks. And they needed some help putting away the mattresses. And so I went down. There was a dollar and a quarter

an hour and we put the mattresses away and at the end of the day the guy who was the boss said you better come back tomorrow. So I came back the next day and they still didn't pay me and I wound up staying there 23 years. So it became was my introduction to the retail business I thought I wanted to be an attorney. I had even selected the law school I was going to go to they had not selected me at that point but I had selected them and I fell in love with the business and that's how and I've been in the business ever since then and so you started I mean I would I would guess that most people would have expected that you started Costco at some point in maybe your late 20s or early 30s but no you started Costco when you were 47 years old that's

correct and what what preceded that how did you get connected with Saul Price and what did you learn from Saul that planted some of the seeds for your thinking in developing Costco well how do I describe Saul price I mean just you know he was fantastic he was the smartest man I ever knew in my life it's also one of the toughest people I ever knew and I was you know how lucky was I to have him as a mentor over the years. He was fantastic, a great influence in my life. I remained friends with him. There was a period of time when I was a competitor that we weren't friends for about seven or eight years, maybe longer. But we remained friends until he died.

I had dinner with him just a couple of evenings before he died. So a lifelong relationship. And as I say, how lucky was I to have had that relationship? So what was the catalyst to strike out on your own and start Costco? Well, you know, I suppose when you're a business person, you always think, gee, could I do something myself? You know, do I have the courage to do something myself? Do I have the ability to do something myself? And so that spirit of being an entrepreneur, I think, probably exists in most of us who are in business. And it was just a matter of time, I think, before it happened

and before I got involved in doing that myself. And it was scary. It was meaning giving up some things. And as an example, it meant moving from San Diego or the San Diego-Southern California area to Seattle, which seemed grim at that time. but you know when you look at a day like today it's not so grim is it so it was you know it's wonderful a lot of a lot of us get locked into things in life that we shouldn't get locked into

and obviously it was a wonderful experience for me and I was lucky that it happened and worked out the way it did but I think I'd been preparing myself for this all the time that I was working Did you have anywhere in your mind the idea that Costco could grow to the size and scope of the business today? I mean, well, we, you know, clearly we thought, Tom, that we were going to be successful. We hoped it that we were going to be successful. But our original business plan showed that we could eventually grow to 12 Costco's. And that if we averaged about $80 million, a unit that would do about a billion dollars and make a nice return for our customers. And we're going to be a Northwest company.

So that was the way we described the business plan. So people ask me all the time, did you ever have any idea that the company would be as big and successful? And of course, I haven't been able to find all those original business plans and destroy them. so I have to admit that we had much more modest goals my partner Jeff always said that he knew all along it was just my lack of vision that day so with an initial goal of 12 locations in a billion in sales how many Costco locations are there today and what's the revenue of the company there are 678 eight Costco's around the world about 200 of them in other countries and the

revenues are for the year that ended last August were a hundred and ten billion dollars so you're just off by a rounding we have we missed we missed the original plan so one of the one of the principles of your leadership was to visit the locations, all of the locations, all of the locations within a single year? Well, that was the image I tried to create. Because, you know, you want everybody to think you're going to get around there. You certainly want your managers to think you're going to get around there. And to tell you the truth, we loved doing it. But we tried to get around as much as we possibly could. Today, that's no longer possible because they're so spread out. And

And, you know, if you want to go to Anchorage, Alaska, as an example, where there are two Costco's, you've got to figure that it's going to take you a day and a half to two days to get up there and get back. So it's much more difficult, but we still go out and visit them. Craig Jelnik, who's the CEO, is traveling as much or more than I did when I was the CEO, and he's continuing. And we don't make any money at the home office. the money's made out there at the Costco's and we enjoy seeing them can

you explain to us what a store visit how it would go for you well to begin with when you drive on the parking lot you hope you're not the only car there you know you're looking around and you know use we drive around the building you look at the landscaping you look at the cleanliness of the facility obviously you're much more pleased if there are a lot of cars out there but you go inside the building and you generally get a pretty clear picture and I've always said that within the first hundred feet or so inside that building I could tell whether or not I was going to enjoy the visit there and I think the manager

probably got a pretty clear picture about that first hundred feet also and And so Craig is the same way. I mean, you know, he does exactly that same thing. We go into the buildings. We continually are checking them out. We are looking for all the things that you might imagine. Do we have the right stuff out that is going to please the customer? How appealing is it from a shopping standpoint?

We're looking at the safety and the housekeeping and cleanliness of the building. And we're happy to see the employees. And you get a feeling when you enter the building as to whether or not the morale is good in the building. Because when the morale is good, the employees want to come up and say hello. They want to talk to you. That's a very good feeling. And generally speaking, when we're traveling, whether I'm in a Dallas warehouse or Chicago or Philadelphia or New York, San Francisco, somewhere in the building a customer will recognize me

and come over and say something and their comment would be, I love Costco and then they'll say, I've got to tell you almost like an aside, I've been to a lot of Costco's but this is the best Costco in the company and then they always say and you have the most wonderful people here they are just fantastic

and clearly you understand that the best Costco can't be in Dallas and in Chicago and in Los Angeles and San Francisco, that there has to be a consistency. And so you're proud of the people that are taking care of our customers. And I'm not kidding you, that story that I told you is almost scripted from customers who come up and talk to me and to Craig relative to our visits, that they're always pleased with our people. Is it true that Costco has the lowest employee turnover of any large retailer in the world? Let's say north of 5 billion in sales for a retailer. You know, I don't know if it's the lowest. I can tell you that it's very low. I can tell you that after an employee's been with us

for a year, that turnover drops somewhere to about 5%. That's even considering the seasonal help that we have in the building. So it's a very low turnover compared to other retailers. I don't know if it's a world's record but if you can find out for me let me know okay we but we take pride in that we take pride in having a very low turnover and do you get the sense that competitors are starting to recognize that they haven't done what they should for the people that are coming to work for the business and therefore there there may be a little bit more of a challenge in recruiting and developing people at costco because there will be a battle to retain talent more effectively than they have in the past.

There's an article on Walmart recently trying to make some changes on that front. Do you see that impacting Costco at all, or do you think it's a good thing? Well, as you know, there's been kind of a grassroots movement across the country to raise the minimum wage. And so now you have major cities. Seattle was the first city to raise it to $15.

And you see Los Angeles is following suit. I think Chicago and New York and San Francisco all have provisions to raise the minimum wage. I think there are some 26 states that have a minimum wage that's higher than the federal minimum wage. So I think you're going to see more and more of that. You know, yes, if you study your business, you recognize that it's a people business. you might be surprised Tom to know that 70 cents of every dollar that we spend to run our business 70 cents of every dollar is spent on people well clearly that makes it the most important ratio that you have in the conduct of your business and control of your business so if you can do

something well you better do that well because that's where all the meat is that's where all the savings and where you can be most effective. And so it's an extraordinarily important thing for us. Coming up, more of Tom's conversation with Costco co-founder Jim Senegal. You're listening to Motley Fool Money. Welcome back to Motley Fool Money. I'm Chris Hill. Let's get back to Motley Fool CEO Tom Gardner's conversation with Costco co-founder Jim Senegal. Here's one of your quotes, the Motley Fool that we love among many. Wall Street is in the business of making money between now and next

Tuesday. We're in the business of building an organization, an institution that we hope will be here 50 years from now. Do you feel that you were able to convince Wall Street to change its perception about Costco? Or did you just punt on that

and decide those who understand our game we're going to communicate and hang out with them and grow our business together with them and those that don't we're just going to do our best to do the minimum amount that we have to cover it but we're not going to obsess over trying to please Wall Street there's always over the years

there's been this feeling that there's an antagonism between Costco and Wall Street nothing could be further from the truth I mean, we're not knocking the system. The system's been very good to us. But, again, you have to recognize what our goals are. Our goals are to try to build an institution that we want to be here for a long time.

We think all of the people who are associated with our company have the right to expect us to do that. And so that includes our employees and our customers and our communities and our suppliers that we're going to be here for a long period of time and that we're going to run our business in that fashion. And so, you know, Wall Street rewards performance. It's a good system. I mean, it works very efficiently. If you run your business well, everything will take care of itself. but that's an important caveat you have to run your business well

but to refer back to your quote you don't have to run your business well with an overemphasis on what's happening between now and next Tuesday you know we have we have said all along one of the things that we have determined about our business

is that we have four things to do as a company We have to obey the law, take care of our customers, take care of our people, respect our suppliers. Pretty much in that order. Obey the law, take care of your customers, your people, and respect your suppliers. We think that it's possible to reward your shareholders short time by not paying attention to those four things. But long-term, you're going to trip up pretty badly, and you're going to stub your toe if you're not paying attention to those four things.

So we think that we've rewarded our shareholders, that those four things ultimately get you to the goal that you have to do, which is to take care of your shareholders. I'm wondering if you think there's a reason that so many great businesses have congregated in Seattle. I mean, you've got Amazon, Microsoft, Starbucks. Nordstrom. Nordstrom. Smaller company like Zillow that we'll be talking to later today. Costco. Why has that happened, or is there a reason?

You know, I have no idea. It must be the weather. Well, you know, it's very interesting. Every year, Fortune magazine prints the 50 most admired companies in the world. And for the past five or six years, five of those companies, 50 in the world, and five of them, 10% of them, are in a small little geographic area in the northwest part of the country. And it's always Microsoft and Amazon and Nordstrom and Starbucks and Costco that are there. As a matter of fact, I think this year all five were in the top 20. Now, I don't know how objective that analysis is on the most admired companies,

but you continue to mention it. There's a congregation of some very good companies here, and Boeing still has a very big presence in this community, as you know, even though their headquarters are in Chicago. They still have a very significant presence in this community. Nice people in the community, and maybe that has something to do with them. I'd love to hear just a sentence or two, your reflections on the different founders of those companies. So what are your thoughts about Jeff Bezos?

He's a brilliant guy. I mean, he's incredible. What he's accomplished is unbelievable. He's made that one of the most customer-centric companies in the world and very clever. And he's a competitor, and so I'm not so crazy about him. And he's probably not so crazy about us. How about Bill Gates? Well, again, brilliant.

I mean, this was incredible what happened. I mean, what happened with the whole thing with computers and software, it's like another industrial revolution. It changed the world. It wasn't so long ago in the 80s when everyone was saying the century of America is over and that the U.S. was never going to be on top again. And then you turn around and everything you looked at had Intel and Microsoft inside and changed the entire world.

Coming up, Jim Senegal weighs in on the competition. Stay right here. You're listening to Motley Fool Money. welcome back to motley fool money i'm chris hill this week we're sharing tom gardner's recent interview with costco co-founder jim senegal how about howard schultz well you know if you were to do think about this they started in about 83 or about the same time as costco as when howard got involved with it If you were to ask a hundred people in this audience to do a word association test and you said Costco, or excuse me, and you said coffee, what do you think the first word might be?

I bet you about 85 of them or more would say Starbucks. What a branding story, an incredible branding story that I don't know how many, how many of you here stopped and got a coffee at Costco or at Starbucks this morning? That's the way to build the Costco coffee brand right there. Or how many of you are going to stop and get a hot dog at Costco? That's a better... But the Starbucks is just a wonderful branding story, amazing branding story to have happened in such a short period of time. And it's a worldwide branding story.

You mentioned the competition or the competitor that is Amazon, which so many companies can say, yeah, they compete with us too. But what do you see as the primary competitive threats to Costco now? Mostly they're about internal and running the company. If you keep doing what you're doing, you should be successful, or there's a big technology shift that's happening, and Costco's going to have to figure that out. You have to be watching competition continually.

Competition makes you better. You don't like it so much when it's happening, but in truth, it makes you better. And I have often said over the years that if Sears and Roebuck had had tougher competition in the 50s and 60s, they would be a much better company today than they have turned out to be. And I hate to knock Sears because nobody's here to defend them, but clearly we see what has happened to a company that was an icon in our country. And they eventually didn't have any real tough competition.

and you turn around and they've reached a point where you wonder whether or not they're relevant any longer. So competition will keep you on your toes. There is hardly a week when we aren't going in and seeing our competitors and looking at them every time we travel someplace. One of the things that disappointed me when we merged with the Price Club

was that I could no longer go in and shop them and get good ideas you know I'm not kidding I'm not kidding that was a very important thing because we we were not hesitant at all to steal every good idea that we could see from the price club or any other competitor that we have and and so didn't Sam Walton say a similar thing about Costco I think he said something like I've stolen most of my great ideas from actually I'd like to use the word borrow. Yeah. He was talking about my old boss, Saul Price. He said, I've stolen more ideas from Saul Price. And then he amends and say, I guess I should use the word borrowed from Saul Price than any man I've ever known. And that was high praise. One of my factors as an investor is

to look very close at who's leading the business. And a moment when I consider selling a stock is, which I do very infrequently is succession and if I look at let's say the story of Starbucks the five or six or seven years that Howard Schultz was not running Starbucks were not particularly good ones for the company when I look at Walmart it hasn't necessarily been a great performing business to be a shareholder of past Sam Walton's term as leader of that business so what do you think you all have gotten right at Costco with Craig and the process that you followed that other businesses might learn from and you think I'm overrating succession is an issue when looking at companies in retail or across the board in terms of

investing in them for the long term no I don't think you're overrating succession it's it's very important now one of the things that you recognize is that a founder of the business gets a little bit of a pass not criticized as roundly people are and the street is more readily accepting decisions that are being made with each succession and each succeeding generation of management that goes away a little bit so it's a little tougher for this third and fourth and fifth generation of management to get away with the same things that Sam Walton did and when I say get away I don't know that's probably partially

mean that they they're given a longer leash and therefore a longer time horizon the opportunity I know one of another one of your quotes that we love is I try never to make the same mistake five times and so so presumably the next round of leadership is they're going we probably make the same mistake four times then it gets down to three then two where am I at how many of us succession planning is very important everything it's the key if if you if you don't recognize that one of the dilemmas that I went through as a as a founder when I was going to retire is understanding that it was not about me

as much as I wanted it to be about me it was not about me it was about the company and having the right people in there to make sure that the company could be sustained and that all of the stakeholders were going to be protected and that the company would be around as I suggested 50 years from now and what What has gone particularly well in the period since you stepped down from CEO, and what are some new challenges that the company is facing that you see? I think things have gone very well. I think the numbers reflect that.

The business has been very successful. You're never going to find two people who are going to agree 100% on every item, but I got to say that 99% of the time I agree with everything that Craig is doing. I think he's done a great job, and that's not just frivolous talk. I think he's just done a wonderful job, but he's a lifer. He's been with Costco for 30 years. He understands the business, and it's part of his heart and soul. Before I ask you a little bit about your retirement, one more question about Costco.

You have stated that the goal is to promote 100% from within at Costco. Can you talk about what that means? how what's the impact of that and to what extent is it really a hundred percent or have you hired some people to run an entire Costco location who had not worked at Costco before but excelled at another retail business well it's not a hundred percent but it's very close our you know our policy when we started was that we were going to try to promote 85% of the time in our company it's turned out that it's probably more like 95% of the time that we promote from

within. And, you know, we have always had the feeling that if you go out and hire good people and provide good jobs and good wages and good career opportunities, that good things will happen in your business. And there's always the danger when you're promoting so much from within the company that you become internally focused. We concern ourselves about that. But we also think it's very important that the culture of our company be maintained and we think that the culture of our company is very difficult to instill in people who just come in from the outside we would never dream of hiring a warehouse manager to run one of our businesses from outside if we hired somebody even if they'd had a very substantial position someplace else that have to

work in our company for at least a year and a half two years before we put them in charge of Costco now maybe that's a little craziness on our side but but it's an important value that we have now also when you do that people have and you can sometimes raise expectations a little higher people feel if they didn't get the job it's because of favoritism and when those instances where we have rarely gone out and hired somebody. The rejection process sets in pretty clearly and fast so we have to guard against that as well. But we've been pretty successful at doing it and I think that you know Craig has continued

to do and improve over the last couple years. The company continues to be very innovative and the things that they're doing so I think we're getting the right results from the people. How's retirement? What is retirement for you? Oh, retirement is that where I used to go in the office about 7.30 in the morning. I don't go in now until about 8.30. I'm, you know, I'm not just kidding. I mean, that's a big deal. And, you know, I still have an office out at Costco because I still get a lot of mail. I'm still on the board of directors. I still visit a Costco every day, including Sundays, but that's a whole special brand of sickness. And, you know, I have, I've got a winery that

I own with one of my sons down in Napa Valley, and I speak at about 15 universities a year at business schools, and I'm on the board of a couple of business schools at Notre Dame and Seattle University and San Diego State University. So I've got a lot of things going on. We generally shy away from politics at The Motley Fool. We just leave that subject outside of the range of a lot of our investment out in our community. But you're a pretty diehard Democrat,

so I'm curious, what do you think about passionate Republicans who are Costco members? You know, obviously I have to evaluate their position because they're quite obviously very bright people. No, listen, in our own company, I mean, we've been associated as Democrats because Jeff and I are both Democrats and have personally made contributions.

But you might be surprised to know that we have never given a dime to a political candidate. Never a dime as a company. By the way, I would like to see how many Fortune 500 companies could make that statement, but never a single dime has gone to a political cause or a candidate.

We don't think it's our right to give the shareholders money away for political causes, and so we don't. But because we're associated as Democrats Everybody thinks that we're a democratic company. Let me tell you something. Jeff and I are in the minority in our own company. Most of the people in our company are Republicans. So it has nothing to do with politics.

Coming up, Jim Senegal talks about the two stocks that he owns. This is Motley Fool Money. You're Wendell shopping. Just Wendell shopping. Welcome back to Motley Fool Money. I'm Chris Hill. It's our Labor Day weekend special as we share Tom Gardner's recent interview with Costco co-founder Jim Sinegal. I know that your other son made a career change recently.

Can you talk a little bit about that? I was telling Mac the story earlier today. One of my sons, Michael, we sent him to Japan. He and his wife to Japan, and they lived there for 15 years, and they started our Costco business in Japan, and their two daughters were raised in that country. And as you might imagine, he became very fluent in the language. And so after about 15 years, I asked him if his wife, I thought,

had been a real trooper with the kids living there for that long. I said, would you guys like to go live in France? Because we're thinking of opening up in the continent, in Western Europe. And because he was fluent in French and Spanish, and he had done it before, we thought this would be a great opportunity. So he went over there, and he'd been over there for about a year. And he came to me, and he said, Pop, I've decided that I want to go back to school,

and I want to become a physicist. and I said how do you spell that what are you talking about clearly we have a wayward gene here and he hasn't been in school for 30 years so he's now gone and studying he's working on his master's degree in physics. At what age? Well he's 51 and I

I had two questions for him. I said, how am I going to see the report cards? Which, of course, is impossible to enforce, I'm not going to say. And what are you going to do with this? And he said that most probably teach. He said that by the time he gets through school, he'll probably be in his 60s. and and he knows and recognizes that in that field there's a bias that the really good work is done in research at the early ages and and so he said

teaching is be fine so he's on his way it's funny my father is 78 years old and he told me just in his non statistical evaluation of the lives of his classmates in high school in college that it is those who made a career change if they weren't if they didn't love what they were doing who made a career change around 50 in their early 50s at the latest that had the happiest next 25 years in his observation for example there was a partner at a law firm who left and started an ice cream business and his entire family was like what the hell are you thinking and the answer is I'm going for happiness I'm

going for I'm going for what I'm really interested in and I may I may not excel succeed reputationally to the degree that I am here at running a law firm but it sounds like maybe a similar thing has happened to your son he's found physics is is gonna is gonna be his joy well you know Tom all of us as parents and we all say this but I think most of us mean it too is we want our kids to be happy and we want them to be doing something that they're happy and I told you that I I speak at a lot of business schools, and generally speaking, when I talk to them, I leave them with two things. Number one, if you can find a mentor, do so.

It's going to be so very important in your life, and I tried to illustrate how important it was for me. And I tell them, you know, each of us in our lives have run across somebody that we truly admire and think could make an impact. Maybe it's a teacher or a coach or a parent or a family member, but take advantage of that. And the second thing, and I tell them also, guys like Saul Price are not a dime a dozen. You're not going to find them on every street corner, but all of us know somebody we admire. The other thing I tell them is if you find yourself involved in something that you don't truly love and feel passionate about, run don't walk to the fastest exit and get out of there and get yourself involved in something you truly can become passionate about because if you do that you'll never have to work another day

in your life how do you invest jim do you do you buy stocks do you have you invested in other retail companies um do you do you buy index funds and mutual funds what's your what's your approach I'd never buy another retailer. I only own two stocks. I own some Berkshire Hathaway and Costco. I don't own any other stocks. I'm not smart enough to be out there picking stocks. I have invested in some funds and some real estate and a winery

and some other things like that, property. You're mostly Costco. I'm mostly Costco, yes. Awesome. Later in the conversation, Jim Senegal talked about Costco's decision not to renew its deal with American Express. We had a long relationship with American Express, and the relationship is not contentious. I mean, we're still accepting American Express, and part of the negotiations that were established when we set up the contract was that it was necessary for American Express to recognize that they had obligations to the contract just as we did.

And one of those obligations is that they had to be competitive. And a lot of things have changed in the credit card business and in financing and in interest rates over the past 15 years. And that changed the relationship with American Express. We're still friends with them. We still like them. We admire the company. But we have an obligation. Doing business with Costco is not an annuity.

It is important that our suppliers be competitive on an ongoing basis. And we just found that there were deals that we could do that were better. The same thing applies with Coke and Pepsi. Both good companies. We've done business with all of them for a long period of time. But the relationship with Pepsi became important for us from a pragmatic viewpoint. Hebrew National was the same thing. I mean, we, you know, one of the things we have zealously tried to do is to make sure that we could keep the price of a hot dog and soda at $1.50.

And so that's involved a lot of creative thinking over the years, including opening up a factory where we produce our own hot dogs to keep that price at $1.50. Someone asked me, a reporter asked me here a couple years ago, they said, what will it mean if the price of the hot dog goes above $1.50? And I said, it'll probably mean that I'm dead. So the $1.50 hot dogs at Costco, don't worry, they're not going anywhere. That's going to do it for this week's edition of Motley Fool Money. Our engineer is Steve Broido. Our producer is Mac Greer. I'm Chris Hill. Thanks for listening. We'll see you next week.