PriceCostco, Inc.

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PriceCostco, Inc.

10809 120th Avenue N.E.
Kirkland, Washington 98033
U.S.A.
(206) 828-8100
Fax: (206) 828-8106

4649 Morena Blvd.
San Diego, California 92117
U.S.A.
(619) 581-4600
Fax: (619) 581-4773

Public Company
Incorporated: 1993
Employees: 40,000
Sales: $16 billion
Stock Exchanges: NASDAQ
SICs: 5141 Groceries, General Line; 5182 Wines & Distilled
Beverages

The merger of The Price Company and Costco Wholesale Corporation in 1993 created the nation’s second largest membership warehouse chain. With 240 Price Club and Costco Wholesale warehouse stores, including clubs in Canada, Mexico, England, and Korea, and sales of over $16 billion in 1995, PriceCostco, Inc. had become a giant in the relatively young warehouse retailing industry, challenging the leadership of the Sam’s Club chain owned by Wal-Mart, Inc. As of the mid-1990s, PriceCostco warehouse customers paid an annual fee in return for a low-cost, no-frills, limited selection of nationally branded and private label merchandise, including fresh foods and baked goods. Membership in PriceCostco clubs was limited to businesses, including individuals; members and employees of selected banks, credit unions, savings and loan and other associations; local, state, and federal government employees; and shareholders in the company. In exchange for the privilege of buying goods at prices only slightly higher than wholesale, business members paid a $30 annual fee and Gold Star (individual) members paid a $35 annual fee. With markups of 10 percent or less, PriceCostco clubs offset their low prices with a high inventory turnover rate, limited selection, no-frills self-service, volume purchasing, limited advertising, and other efficiency strategies, as well as with the annual fee charged to members.

The members-only warehouse club was the creation of Sol Price. In 1954, Price introduced the concept of one-stop shopping when he started Fedmart, a discount department store open to government employees, who paid a membership fee of $2 per family. Fedmart’s first year was highly successful; over the next 20 years Fedmart grew to include 45 stores in a chain that generated more than $300 million in annual sales. However, Price sold Fedmart Corp. after losing leadership of the company in 1976. Fedmart folded seven years later.

In the mid-1970s, small business owners had no options other than to buy their products and supplies from regional wholesalers or cash-and-carry operations. Price set out to offer an alternative. In 1976, with $800,000 of his own, $1 million raised among local California small business owners, and an additional $500,000 from former Fedmart employees, Price, along with his son Robert, formed the Price Company and opened the first Price Club store in San Diego. Price’s other son, Laurence, declined to join the new company.

Price Club represented a revolution in retailing. Its concept was simple: it would offer a small selection of products covering a broad range of goods and sell in bulk in order to keep prices low, usually at no more than a 10 percent markup over the wholesale cost. To maintain such discount prices, overhead was kept to a bare minimum. Products were stocked directly on the selling floor in minimally decorated warehouses built on cheap industrial land, sales help was almost nonexistent, and there would be no advertising, except to announce the opening of new stores. Selection was limited, offering the broad range but not the depth—and consequent inventory burden—of the typical department store. Products were bought in bulk directly from the manufacturers. Low margins were further offset by rapid inventory turnover, as high as 20 turns a year, allowing stores to pay suppliers quickly and achieve added early-payment discounts. Membership was initially limited to small business owners, whose fees would also offset overhead costs. Restricted membership reduced the risk of bad checks and shoplifting because members would be more financially secure than the general buying public. The store also refused to accept credit cards, in part to avoid the cost of their administration and credit card fees of as much as 1.5 percent.

Price’s first year went poorly, however, with losses of $750,000 on sales of $16 million. Price responded by broadening its membership base to include members of selected credit unions and savings and loan associations and government, utility, and hospital employees. Additional stock sold to friends generated enough capital to keep the company in business, and, by 1978, Price had recovered sufficiently to open its second warehouse in Phoenix, Arizona. In that year, Laurence Price borrowed money from the Price Company to open a tire-mounting and battery installation shop next to a Price Club store. The new shop leased its space from Price, servicing the tires and car batteries sold there.

The Price Company continued to expand, opening two more stores, in Arizona and California, and, when it went public in 1980, was already generating annual sales of $150 million. Business boomed among customers who appreciated the no-frills approach in exchange for low prices, and their word-of mouth remained the company’s most important—and only— advertisement.

The typical Price Club was a marked contrast to the department stores of the day. Located in industrial districts on a city’s outskirts, where land and building costs were low, a Price Club store was housed in little more than a large warehouse space, generally from 100,000 to 120,000 square feet. Goods, ranging from five-pound bags of rice and five-gallon jars of peanut butter to tires, televisions, and snowblowers, were loaded by forklift directly onto 18-foot-high shelves. Bulk packaging of smaller items appealed both to the small business owner and to families. Personnel and administration costs were also kept to a minimum by restricting store hours to a single-shift, eight-hour day. The stores had no expensive, trained sales staff, such as those found in department stores. In later years, the introduction of computerized scanning devices further reduced the need for personnel.

The rising inflation of the 1970s aided the success of the Price Club concept. Customers proved they were willing to travel to an out-of-the-way location for the best prices. Soon, Price began acquiring additional land and properties, forming a subsidiary, TPCR Corporation, to develop and operate land in excess of Price Club needs. Reasoning that increased traffic would offset increased competition, Price entered partnerships with developers, who would construct additional retail buildings, splitting rents with the Price Company. Price stepped up its expansion only slightly. By 1984 it had added 16 new stores, entering New Mexico and building two stores in Virginia. The East Coast proved a somewhat less accessible market, with suitably priced, commercially zoned land difficult to find. Consumers on the East Coast also faced heavier traffic when traveling to the stores’ typically remote locations. The company’s desire to own the land under stores they built themselves was another factor that kept the pace of its expansion slow. Nevertheless, Price moved into Maryland and formed a joint venture with Steinberg Corporation to operate Price Clubs in Canada. In 1985, Price posted profits of $45 million on sales of $1.9 billion.

By then, Sol Price’s warehouse concept had grown to a $4 billion per year industry. In 1983, Price was suddenly faced with new competitors who were successfully copying the Price Club idea. Wal-Mart’s Sam’s Clubs quickly became a giant in the young industry, with added competition from Kmart’s PACE Memberships Clubs, and from Costco, whose Seattle, Washington-based Costco Wholesale Clubs directly challenged Price’s hold on the West Coast market. At the same time, traditional retailers began introducing elements of the Price concept, including bulk goods and heavy discounting, providing additional competition.

James D. Sinegal, co-founder of Costco, had worked with Sol Price at Fedmart before joining him at the Price Company. Sinegal left Price, having reached the level of executive vice president, and in 1983 formed Costco Wholesale Corporation with Jeffrey H. Brotman, a former oil exploration company executive. The first Costco, based heavily on the Price Club concept, opened in that year in Seattle, Washington. In less than two years, Costco went public, expanded into Canada, and became one of Price’s fiercest competitors. Costco was also seen as the more creative merchandiser, becoming the first warehouser to extend its product line to encompass such fresh foods as baked goods, meats, seafood, and produce. As much as two-thirds of its sales were based on such recession-proof items, which became an important element to its success in the economic downturn of the late 1980s. In later years, Costco would also expand into the do-it-yourself market. By 1988, Costco had achieved sales of $2 billion, and by 1993 Costco was ranked third in the industry, with 103 stores.

Despite the increased competition, Price’s growth continued. In 1986 it posted earnings of $75 million on sales of $2.6 billion. The company’s stock reached its all-time high of $55.75 per share. Industry observers, however, began to predict a shakeout in an industry that was becoming increasingly crowded. By 1986, Sam’s Clubs had taken over the lead. Added trouble came in 1986 when, after a quarrel between Sol Price and Laurence Price, Price attempted to exercise its option to buy out Laurence Price’s tire-mounting and battery-installation chain, which by then had grown to 20 centers and over $5 million in sales. Laurence Price filed for arbitration, winning a $3.7 million settlement, then filed a $100 million lawsuit against Price Company.

Price’s conservative approach to expansion during this period was also criticized. “Instead of responding to the threat by pushing into and dominating new markets,” Business Week reported, “Price Co. remained almost exclusively on the West Coast... [leaving] the rest of the country wide open for more aggressive competitors.” Price’s focus on owning its own real estate had slowed its expansion. More than half of the Price properties also included shopping center and mall developments. Developing its property and building its own warehouses became a heavy financial burden for the company, during a time when its competitors were pursuing far more rapid expansion plans. Price also lagged behind in industry developments as well, as Costco and other competitors moved to provide fresh foods and other products, expanding the one-stop shopping experience. By 1987, Costco had 39 stores and Sam’s had 49 stores, passing Price’s 35.

Sol Price resigned as chairman of the Price Company in 1988 and was replaced by Robert Price. By then, Price had grown to $4 billion in sales, and earnings were growing steadily each year. In the next year, Price paid its first and only cash dividend of $1.50 per common share, for a total of $75 million. By then, Price Clubs had extended to New Jersey, Connecticut, New York, and Quebec. However, Price Club’s fortunes were beginning to fade. Attempts to venture into the home and office furniture market failed. In addition, despite a more aggressive expansion push in the early 1990s, many of the new Price Clubs were opened in California, adding, in 1991, 11 stores to the 29 already operating in that state. Staggered by a $630 million overhead burden, Price was also in effect cannibalizing its own stores. The following year, Price’s earnings dropped for the first time since it had gone public.

In just 17 years, the warehouse club industry had grown to a $39 billion industry. However, the rapid growth of the 1980s slowed drastically in the 1990s as the U.S. market became saturated with stores. The increasing numbers of warehouse-concept stores specializing in single markets, such as pet foods or office supplies, were adding to the competition. The warehouse clubs were beginning to cannibalize each others’ sales. Price moved into Mexico in a joint venture with Mexican retailer Controladora Comercial Mexicana in 1991, while adding stores in Colorado and British Columbia. But in order to finance its growth, Price was forced to spin off some $150 million of its real estate assets. Its expansion had come too late; competition from Sam’s and PACE closed down its newly opened stores in New York and Pennsylvania.

Threats of a Costco takeover by Sam’s Clubs, which by 1993 owned 434 stores and nearly half of the market, prompted Price to begin merger negotiations with Costco in 1992. Costco, too, was eager to avoid being swallowed up by Sam’s and was equally frightened by the prospect of Price selling out to Sam’s. Yet negotiations broke down when the parties could not decide on who would head the projected new company. When Price’s earnings continued to drop, however, down 40 percent in the second quarter of 1993, Price finally entered into a deal with Costco. Sinegal would take the CEO position and Robert Price was named as chairman of the board. Called a partial merger, the two companies would continue to operate their respective headquarters, with the bulk of domestic responsibility going to Costco and international business to be headed by Price. Price shareholders, including the 13 percent share of the Price family, would retain 48 percent of the new company to Costco’s 52 percent, the largest part of which, 24 percent, was controlled by the French Carrefour retailer. The merger allowed the two companies to consolidate their purchasing and shipping operations, share scanner and other technologies, and to dominate the West Coast market.

The new company, PriceCostco, Inc., continued Price’s international expansion, developing more stores in Mexico, opening two stores in England, and licensing a Price Club in South Korea. However, hopes that the merger would halt sales declines did not materialize, and by 1994 sales for stores open more than a year had fallen by 3 percent, with a corresponding drop in earnings. Despite the initial optimism that had greeted the merger, the two management sides had never reached agreement on many crucial issues. The company continued to operate out of both headquarters. Soon, arguments arose over which direction PriceCostco should take. Robert Price sought to continue his company’s real estate interests, whereas Sinegal pushed for further expansion of the warehouse chain. Disputes also arose over whether to continue funding the in-store Quest Electronic Catalogue, a computerized network that allowed customers to purchase products not stocked in the stores.

By the middle of 1994, the PriceCostco merger was being called premature. Disagreements between Sinegal and Robert Price finally resulted in a partial breakup announced in July 1994. PriceCostco’s commercial real estate properties, as well as other assets, were spun off as Price Enterprises, Inc., to be headed by Robert Price. Apart from its commercial real estate, Price Enterprises took with it four warehouse locations; a 51 percent interest in the Quest catalogue; 51 percent of PriceCostco’s Mexican partnership, which by then included nine stores; and 51 percent ownership of PriceCostco’s international development projects in Central America, Australia, and New Zealand. Together, these assets represented less than 10 percent of PriceCostco’s earnings. Sinegal remained as president and CEO of PriceCostco, while his long-time partner, Jeffrey Brotman, took over as chairman.

With PriceCostco’s focus now firmly fixed on increasing its warehouse operations, new PriceCostco clubs opened in San Francisco and in the New York metropolitan area. Plans were announced for as many as 29 new clubs to open through 1996. During the same period, PriceCostco expected to close several overlapping Price and Costco stores that had remained after the merger. Meanwhile, the company increasingly looked overseas for its growth, with plans for added stores in Korea and England and for entry into Taiwan and Latin America. Per-store profits were once again on the rise, and the total number of PriceCostco stores was expected to grow to 245 by the end of 1995. Yet competition seemed only certain to intensify as this very American industry spread worldwide.