Costco is a wholesale and retailing business that largely deals with fast moving consumer goods. Founded in 1983, the company has grown over the years in both size and revenue over the years. It has expanded and set up warehouses in many other countries outside the United States. The major strategy that the organization has adopted is the low pricing strategy. The business has capped its profit margin for most of its products at 14% (Thompson, 2017). Under this strategy, the company seeks to offer products to customers at the lowest possible price. The business gives customers an opportunity to become members by paying a stipulated membership fee. Once a customer becomes a member, he or she can shop at the lowest possible price. The pricing strategy is aimed at increasing the sales volume for the business. Moreover, it aims at increasing the stock turnover ratio for the business during any given accounting period. The logic behind this pricing strategy is that the increased sells volume will generate more income that can offset the financial effects of low pricing for the business.
While the pricing strategy is instrumental in increasing the sales volumes for the organization, it has several disadvantages. The strategy is not tenable in the end since competitors can equally choose to reduce their prices and equally adopt a similar pricing strategy. It will greatly reduce the company’s earnings in the end. Secondly, the tendency to cut operating costs to offer the lowest possible price may lead to a compromise on the quality of the products that the business is offering and the quality of customer service that the business can offer. It may be coupled with the transparency of the internet age, which enables customers to compare prices, and product quality will greatly reduce the sales volumes and business net revenue in the end.
Moreover, this strategy makes the business to be over-reliant on the membership fee. If the number of members is reduced, either due to a competitor offering a similar model or change in customer preference against a membership model of business, then the business will stand to make great losses. Therefore, there is a need for Costco to relook at its pricing strategy and offer a pricing model that is both customers friendly and sustainable in the end.
The business can adopt several alternatives that would offer a solution to the uncertainties and shortfalls of its pricing strategy. Firstly, the management could consider premium-pricing strategy. Under this strategy, the business can identify products that it considers premium within its product portfolio. The pricing of that product can them be increased considerably while holding the prices of other products low. The income from the premium product would them be able to offset any possible loss that could be incurred because of low pricing on other products. The second option would be a companion or captive product pricing. Under this strategy, related products are grouped and priced together. Group pricing helps to offset any low pricing that would have possibly occurred if the products were priced independently. Lastly, the business could adopt differential pricing by offering different prices to different customers in different locations.
With the available alternatives in solving the challenges of low pricing, differential pricing is the best alternative that the business can adopt. The strategy can be implemented by dividing the market into different segments and offering a higher price on products within markets where their demand is relatively high. It will help make a differential approach to pricing more effective.
Costco Case Study
Costco has prided itself as the business that offers the lowest and unbeatable prices in the market. The company’s business model is such that it offers customers an opportunity to gain membership in the business. The members can buy goods and services at the lowest possible prices. The strategy has been very instrumental in increasing the sales volume for the business and the overall stock turn over. The increased sales volume has equally played a critical role in increasing the company bottom-line. The pricing strategy was aimed at increasing the sales volume that would then offset the minimal profit margin that the business had set on its product pricing. It is interesting to note that the company has adopted a profit margin of 14%. Many of the competitors in the American retail market and the global market have set a profit margin of between 20% and 50% (Thompson, 2017). Consequently, Costco has been able to offer prices that are greatly reduced and hence greatly competitive in the market.
Costco’s pricing strategy has numerous disadvantages for the business both in the short run and in the end. For instance, this strategy is not restrictive since any business can adopt it. However, it would reduce the earnings of the company and lead to great loses. The company has predisposed itself to great losses should this strategy fail in the future. As such, it is important to review this pricing strategy and hence offer a strategy that is not only comprehensive but also sustainable in the end. The following discusses the shortfalls of the pricing strategy as adopted by Costco. It further discusses the available strategy options in pricing that can solve the challenges of the adopted strategy. The analysis suggests the most appropriate strategy and provides an implementation plan for the strategy.
Challenges of the Pricing Strategy
While this strategy has been greatly successful in the past, it predisposes the business to tremendous risks both in the short run and in the end. For instance, it predisposes the business to overreliance on the membership fee to operate profitably. The net revenue generated from the membership fee for the business in 2014, 2015 and 2016 were $2438 million, $2533 million, and $2646 million respectively. The net income for the business during the three years was $2058, $2377 and 2350 (Thompson, 2017). During these three years, the revenue generated from the membership fee supersedes the net revenue for the business. Therefore, the revenue generated from sales was insufficient to cover all the operating expenses and taxes for the business during the three years. As such, the overall revenue generated is largely from the membership fee. The business has largely over-relied on the membership fee to operate profitably. The overreliance on membership fee is risky since customers can change their preferences from membership purchasing and hence withdraw their membership (Westermann, 2016). The information age has predisposed customers to information that enables customers to compare prices, quantities, and qualities and make informed decisions on their purchasing behavior both in the short-term and over long-term commitments. As such, it is easy for them to withdraw their membership at any one given time. Such an action can adversely influence a business that over-relies on membership fee to remain profitable.
Secondly, this strategy is not a preserve for Costco. Many other companies can equally choose to adopt this strategy. In response to this strategy, competitors may equally choose to reduce the prices of the products (Westermann, 2016). Ideally, the pricing strategy is not a unique strategy that requires information that is unique to the company. As such, other businesses can equally adopt this strategy and hence reduce their prices. When this happens, it will lead to price wars between Costco and the competitors. Competitors may be willing to reduce prices until one of the businesses is out of the market. Such a scenario will negatively influence Costco that has heavily relied on the pricing strategy. The sales volumes will largely reduce due to competition. Moreover, it will no longer be economically viable for customers to gain membership to the company since they can purchase at equally lower prices from competitors without necessarily having to pay for membership. Therefore, this overreliance on the pricing strategy has predisposed the business to unhealthy competition that may lead to tremendous losses should the sales volumes decrease due to competition.
Thirdly, this low price denies the business opportunities for discounting. The business has greatly reduced its pricing model and consequently cut down its cost of operation to the minimal. The effect of this is that the business no longer can reduce prices further occasionally in promotional strategies. The principle of promotion using discounting is the occasional reduction of prices to attract more customers (Westermann, 2016). Given its pricing model, Costco cannot use discounting as a tool to attract more customers. In contrast, their competitors can reduce the cost further and hence offer to discount on their products. In the end, they get opportunities to attract more customers and increase their market share to the disadvantage of Costco.
Moreover, the perception of quality among customers is largely linked to pricing. Many customers associate the low prices of product with the low quality of products. Therefore, consistently low prices lead to low sales volumes due to the perception of poor quality. This quality perception associated with low pricing partly accounts because Costco has not been able to sell more unlike their major competitor Wal-Mart despite offering lower prices than Wal-Mart. During the years 2014, 2015 and 2016 Wal-Mart made net sales volumes worth $473 billion, $482 billion, and $478 billion respectively (Sueyoshi & Tadiparthi, 2017). The Wal-Mart sales volume for this period was relatively high compared Costco sales volume during the same period. During the same period, it made the sales volume worth $116,073 million $113,666 million $110,212 million for 2016, 2015 and 2014 respectively (Thompson, 2017). However, it reduced sales volume in comparison to competing companies can partly be attributed to customer perception that relates low pricing to poor quality.
Lastly, this consistent focus on reducing prices will greatly compromise the attention to quality both in product and customer service. With the low prices, the business will require being able to cut down on its cost of operations considerably. The quality of the product positively correlates with the cost of producing it (Westermann, 2016). Moreover, the enhanced customer experience is equally related to operational fees. Therefore, a bias towards cutting down the cost of operations compromises both quality and customer experience. Consequently, the customers may lose interest in gaining membership and hence the business is likely to experience reduced sales volumes in the long run.
The above challenges of the pricing strategy as adopted by Costco indicate that this pricing strategy is not sustainable in the end. Therefore, there is a need to consider other options for strategies that are sustainable in the long run and do not expose the business to the risks discussed above. The three options of solutions include a premium pricing strategy, companion or captive product pricing and differential pricing. Each of these possible solutions has merits and demerits. As such, it is important to consider each of the options carefully in determining the most suitable option.
Premium pricing is a model of pricing where premium products are priced higher in the market. In adopting a premium-pricing model, the business is required to identify the products that are considered by customers to be premium (Itkin, 2017). Such products are then priced high relative to other products. Premium products include expensive jewelry, Luxury electronics, and estates among others. Such products are associated with prestige and social class within the society. For such products, an increase in price leads to an increase in demand and consequently an increase in the sales volumes. On the contrary, a reduction of the prices of the premium product will greatly reduce the prestige associated with such products. Consequently, the demand for such products will greatly reduce and hence the sales volume from such product will equally reduce.
Costco will get various benefits if it adopts premium pricing. Firstly, premium pricing will help the business to offset the loss it incurs by the low pricing of other products. Identifying premium products and increasing their prices will help the business create more demand for such goods and equally generate more revenue from the sales of such products. Moreover, the increased profit margin on these products would translate into increased profits that would help to balance the low prices offered on other products and hence the increase of the total sales and the total sells revenue. The major disadvantage of this approach is that the volume of sales from the premium products is so insignificant compared to the overall sales volume of the business (Sueyoshi & Tadiparthi, 2017). Consequently, the business will not be able to obtain sufficient revenue necessary to offset the low effect pricing on other products. Therefore, this product will be ineffective in solving the problems that low pricing strategy possess to the business.
The second pricing strategy option is the companion or captive product pricing. Under this pricing strategy, related products can be grouped and priced together (Feurer, Schuhmacher & Kuester, 2018). For example, different utensils could be grouped together and hence priced together. The products are packaged together and priced as one unit. The prices of the package are often higher, unlike individual products. Costco can leverage on companion or captive product pricing to compensate for the effect of low pricing. As a result, it will obtain relatively higher prices compared to the current prices without necessarily rising customer concerns. The customers may not be automatically aware of the price differences if they are to purchase individual products. Secondly, the low prices of the product are offset by a collective higher price of the package (Itkin, 2017). The resultant pricing effect will be higher compared to the current pricing of single products. Consequently, the business will be able to raise its profit margin and reduce its overreliance on membership as a source of revenue for the business.
Despite the numerous advantages of a companion or captive product pricing discussed above, this strategy has numerous limitations in addressing the pricing challenge that the current pricing model predisposes Costco to failure. For instance, it does not offer a long-term solution because the strategy takes advantage of the consumer’s lack of knowledge on the pricing of individual products. Despite the lack of knowledge, the information is likely to get to consumers who would then prefer to purchase individual products. Consequently, the sales volume of such companion products will greatly reduce (Snelgrove, 2017). As such, this strategy will not be sustainable over the long run. Secondly, customers may feel frustrated by this approach. Some customers may feel that companion pricing has dubbed them. The customers will also withdraw from the business. This will lead to a reduction of the overall customer base and market share for the business. Consequently, the sales volume for the business will greatly reduce.
The last possible solution that could help the business in solving the risk that the low pricing has exposed the business to is differential pricing. This approach in pricing will be instrumental in solving the risks that the low price strategy has exposed the business to. Under the differential pricing strategy, the product is priced differently to different segments of the market and different geographical location (Feurer, Schuhmacher & Kuester, 2018). This pricing strategy takes into consideration the fact that lowering prices does not necessarily attract customers in all market segments. Higher prices mainly attract the high-end market segment since they are out of the rich of the majority of the customers and hence they are not likely to meet and mingle in such stores. Differential pricing will bring the effect of overpricing in certain market segments while maintaining the current low prices in other segments in a way that works for both segments of the market.
The major challenge in adopting the differential pricing strategy is in its implementation. The determination pricing strategy requires the business to undertake due diligence to understand the various purchasing power of the different segments of the market (Feurer, Schuhmacher & Kuester, 2018). An erroneous evaluation of this purchasing power may lead to wrong pricing in a given market segment. Consequently, the business stands to make tremendous losses from such miscalculations. Secondly, the adoption of this strategy will put the reputation of Costco at risk. Over the years, the business has worked to create the reputation of a low-cost outlet. As such, the differential pricing will compromise that reputation since such segments of the market will get higher prices over others.
The Recommended Solution
Given the challenges of low pricing strategy and the risks associated with this strategy, it is important for Costco’s management to a solution to this challenge. Of the three possible solutions discussed above, differential pricing is the most suitable solution. Several reasons make differential pricing a suitable alternative to the low pricing strategy particularly in the unique circumstances of Costco. First, differential marketing will help the business to rich different market segments with similar products but at different pricing point (Snelgrove, 2017). It is important to note that pricing plays a critical role in the 4Ps of marketing. Appropriate pricing to different market segments serves to market the business in those respective market segments. As such, this strategy will help the business to market and remain relevant among customers that prefer low prices and customers who value high prices.
Secondly, differential pricing will be critical in helping Costco to offset any potential loss or minimal profit margin occasioned by low pricing in some segments of the market. While some segments of the market will be able to access goods at services at a considerably low price, other segments of the market will access the same products at a considerably high price (Feurer, Schuhmacher & Kuester, 2018). Consequently, the loss occasioned by low pricing will be compensated by the high profits generated from the segment of the market that is overpriced. Therefore, the business will reduce its reliance on membership fee in remaining profitable but will obtain profits from its core business. The business will not be adversely affected if the membership is reduced.
Thirdly, differential pricing will help Costco to cover all costs associated with quality products and good customer experience. As already noted, the major challenge that this business has encountered through its price reduction strategy is the ability to cover the cost of providing high-quality products and enhancing the customer experience in all the company’s outlets. Consequently, setting up different pricing points will help generate more revenue that can cover such costs (Itkin, 2017). Therefore, the business will be able to offer high-quality products and enhance the customer experience in all its outlets. Moreover, the increased sales revenue occasioned by proper pricing in all market segments will equally help in generating enough revenue required to provide quality products, enhance customer experience, and ensure that the business runs profitably.
Lastly, differential marketing will help enhance efficiency in the supply chain management and inventory management because differential pricing is purely based on demand projection. For Costco to apply differential pricing appropriately, it will require to accurately forecast demand of the products among different market segments and geographical regions. This accuracy in demand forecasting will equally facilitate decisions on the quantity of inventory to stock in every segment of the market (Snelgrove, 2017). This will greatly enhance efficiency in inventory management and consequently, lead to a reduction in the storage costs. Such reduction in cost will further help to sustain low pricing strategy particularly within the market segment where it is applied.
The above-discussed aspects of differential pricing will be instrumental in dealing with the challenges of low pricing strategy that Costco business has adopted. The various advantages and specific features of this pricing strategy make it the most suitable solution option for the challenges of low pricing.
Implementing the differential pricing requires an appropriate strategy. This implementation of this strategy will be market segmentation. Market segmentation is the process of dividing the target market into different segments based on age, gender and level of income among other factors (Sueyoshi & Tadiparthi, 2017). In this particular implementation strategy, market segmentation will purely be based on the level of income and level of demand for specific products that the business stocks. The high-income earners will be under one segment while the low-income earners will be under another segment. Moreover, geographical regions where specific products have high demand will fall under one market segment while those regions with low demand will fall under the same market segment.
The second stage will involve surveying to establish the effect of low pricing on the entire market segments identified. It is important because the impact of pricing in marketing varies from one market segment to another. While low pricing may be appropriate to low income earning segment of the market, the high-income earners are interested with prestige associated with high prices. Therefore, this survey will identify market segments where low pricing can be appropriately applied and the market segments that would work well with relatively high pricing.
The third stage in this implementation strategy will be setting up the pricing points for all the market segments for the entire product portfolio. This price setting will be largely in line with the findings of the survey conducted (Sueyoshi & Tadiparthi, 2017). The market segments that can be priced low will be given low prices. Conversely, market segments that perform well under increased prices will equally be priced highly. The stage will involve setting up the differential pricing and equally implementing the strategy in the respective market segments.
The last stage will be an evaluation of the effectiveness of the differential pricing strategy adopted by the business. The evaluation will entail measuring the sales volumes in different market segments and comparing such volumes with the sales volumes in the same market segments before the implementation of the differential pricing strategy (Feurer, Schuhmacher & Kuester, 2018). An improvement in the sales volumes will indicate proper pricing for the respective market segments while those that do not show such improvement will be reviewed appropriately regarding pricing.
In summary, Costco’s business model is such that it heavily relies on the pricing strategy to attract customers. The business offers membership to customers willing to pay for such membership. The customers can them buy from the company’s outlets at a minimal price. While this strategy has been effective in increasing the company’s market share both in the United States and in other countries where the business operates, it has predisposed the business to possibilities of great financial losses in the future. Besides, the business has been over-reliant on the membership fee to remain profitable. The possible solutions to this challenge include a premium pricing strategy, companion or captive product pricing and differential pricing. However, differential pricing is the most suitable solution model for the business. The implementation model of the differential pricing strategy will involve market segmentation, market survey, setting price points and finally analyzing the effect of differential pricing in different market segments. The strategy will be effective in solving the challenges occasioned by low pricing that Costco faces.
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