Costco

Costco is not only Charlie Munger’s favorite company of all time (plus he’s on the board, natch), it’s an absolutely fascinating study in how seemingly opposite characteristics can combine to create incredible company value. For instance: Costco has the cheapest prices of any major retailer in America — and also the wealthiest customer base. They pay their hourly workers 30% above the industry norm (and give them excellent healthcare + 401k benefits) — and are almost 3x more profitable on labor than Walmart. Speaking of Walmart, Costco stocks 40x fewer SKUs than their Bentonville-based rivals — yet sells an average of 15x more volume of each. And oh yeah, practically all of Costco’s C-Suite started their careers as baggers and checkout clerks! Tune in for a mind-bending exploration of one of the world’s most iconic — and iconically unique — companies. This episode was released on August 20, 2023. Links: The Science of Hitting https://thescienceofhitting.comWarren Buffett’s Costco joke https://www.youtube.com/watch?v=Z1sTs8wkAbwEpisode sources https://docs.google.com/document/d/1tHtjZQmYr6MMUG-a_eOTi_swzWwbUlVohluwCf572s8/edit?usp=sharingCarve Outs: Tifosi sunglasses https://tifosioptics.comDwells “take off everything” https://www.youtube.com/watch?v=cwFmq69m3WAJeremy Giffon on Invest Like the Best https://www.joincolossus.com/episodes/79714195/giffon-special-situations-in-private-markets?tab=transcriptDogpatch https://en.wikipedia.org/wiki/Dogpatch,_San_FranciscoDavid Lidsky’s great piece on Acquired in Fast Company https://www.fastcompany.com/90927453/acquired-number-1-tech-podcast-sensation Sponsors: Vanta: https://bit.ly/acquiredvantaServiceNow: https://bit.ly/acquiredservicenow26Legora: https://bit.ly/acquiredlegoraStatsig: https://bit.ly/acquiredstatsig26 More Acquired! Get email updates https://www.acquired.fm/email with hints on next episode and follow-ups from recent episodesJoin the Slack http://acquired.fm/slackSubscribe to ACQ2 https://pod.link/acquiredlpMerch Store https://www.acquired.fm/store! © Copyright 2015-2026 ACQ, LLC ‍Note: Acquired hosts and guests may hold assets discussed in this episode. This podcast is not investment advice, and is intended for informational and entertainment purposes only. You should do your own research and make your own independent decisions when considering any financial transactions.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Ben Gilbert?

  Hey, Acquired listeners. We've placed this episode on Costco toward the top of the podcast feed since people frequently say it is one of their favorite episodes and a great place to start listening. It was released on August 20, 2023. I don't think I have ever been more in love with a company and a business model.

• 0:20David Rosenthal?

  What are you, Charlie Munger?

• 0:21Ben Gilbert?

  It's just, the deeper you dig, the more good things you find, and usually it's the exact opposite of that. It's like the opposite of being an early-stage venture capitalist.

• 0:32Speaker 02

  Who got the truth?

• 0:35Speaker 02

  Is it you? Is it you? Is it you? Who got the truth now? Is it you? Is it you? Is it you? Sit me down, say it straight, another story on the way. Who got the truth?

• 0:49Ben Gilbert?

  Welcome to season 13, episode 2 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert.

• 0:58David Rosenthal?

  I'm David Rosenthal.

• 0:59Ben Gilbert?

  And we are your hosts. What if I told you that there was one place where you could get all these things under one roof: a 2.5-pound container of cashews, prescription eyeglasses, a tank of gas, new tires for your car, 96 rolls of toilet paper, a new refrigerator, an outdoor shed, a 10-carat diamond ring, some fresh, prepared sushi, fine wine at a great price, and you could even grab a hot dog with a soda and a free refill on your way out for just a buck 50.

• 1:34David Rosenthal?

  Ben, I don't believe you.

• 1:35Ben Gilbert?

  Hey, it has been the same price for 40 years now?

• 1:39David Rosenthal?

  Forty-seven years.

• 1:41Ben Gilbert?

  Yes. Most of you are very familiar with this Disneyland of consumer value that I'm referring to. It is Costco. This company seems very simple on the face of it. If you sell in bulk, you have the opportunity to offer great deals to your customers. But what really makes it work are the 50 clever innovations that they've refined over the years that all work together like an orchestra that's been rehearsing for decades. Nothing about Costco is an accident. From the extra Wide parking spaces to the whole rotisserie chickens. And if your goal is to offer extremely great value to your customers on a high quality products at the lowest possible prices, there are a lot of ways that you could go about doing that.

• 2:25Ben Gilbert?

  And today, we will walk through the very specific path of decisions and trade offs that Costco has chosen to accomplish just this. So listeners, remember that. Extreme value, high quality products, lowest possible prices. And David, my God, does this method work well. There is a reason Charlie Munger loves this business.

• 2:45David Rosenthal?

  Oh, does he ever. You know, the great Warren Buffett joke about Costco, right?

• 2:49Ben Gilbert?

  Oh, no.

• 2:50David Rosenthal?

  Okay, so here it goes. Warren and Charlie are flying on a plane that gets hijacked. It's kind of macabre. The hijackers each grant one of them one last wish, and they ask Charlie first. And Charlie says, I would like to give my speech on the virtues of Costco one more time before I die. And then the hijackers turn to Warren, and he says, shoot me first.

• 3:15David Rosenthal?

  It's so great. This actually happened at a Berkshire annual meeting. It's on YouTube. We'll link to it in the show notes.

• 3:20Ben Gilbert?

  Oh, that is awesome. I mean, Charlie Munger, of course, on the board of Costco and longtime fan of the bottle, as you should be too. So here are some insane stats. Costco has grown revenue right about 10% for over 30 years in a row. Their revenue per square foot of their warehouses belongs more in a conversation with Tiffany than Walmart. They seem to have incredible running room ahead of them to expand internationally and here in North America. And David, here's one that is just for you. Their store brand, Kirkland Signature, does more revenue alone, not including anything else in the store, than all of Nike.

• 3:58David Rosenthal?

  I know. It's so great. I think I found that Kirkland Signature as a unified brand, I think, might be the largest brand in the world by revenue.

• 4:09Ben Gilbert?

  It's the largest consumer package brand in the world.

• 4:11David Rosenthal?

  Yes, which is a misnomer because like, they sell everything. You know, most other brands only sell like shoes.

• 4:18Ben Gilbert?

  But their $52 billion a year that they sell, which inches by Nike by just about $1 billion, doesn't even include the Kirkland Signature gas. All right, listeners, if you want to know every single time a new episode drops, you can sign up for email updates, acquired.fm/email. And two brand new things, we will be including little hints at what the next episode will be to the email list now. And two, we'll be including follow ups from episodes when listeners share things with us after release, be it little corrections or just additional insights. So sign up acquired.fm/email. Come talk about this episode with us at acquired.fm/Slack and learn from other listeners who may be closer to these topics than even David and I are. If you want more from David and I, check out our

• 5:03Ben Gilbert?

  second show, ACQ2, available in any podcast player. Just search ACQ2. And our next few episodes are about AI with CEOs who are leading the way as the world very rapidly changes in front of us. So without further ado, this show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only. David Rosenthal, what are the history and facts?

• 5:28David Rosenthal?

  So Costco was founded, as many people know, in Seattle, lovely city of Seattle, in 1983 by retail veterans Jim Sinagal and Jeffrey Brotman. Now Jeff came from a long line of Seattle retailers. His dad was a retailer. His brother is a retailer. Jeff was one of the first investors and board members of Starbucks. Super cool.

• 5:55Ben Gilbert?

  Yeah.

• 5:56David Rosenthal?

  And Jim, well, we'll talk about Jim as we go here. But if you were around and kind of of shopping age, shall we say, in 1983, you know that the true history of Costco dates way further back than that. To someone that we talked a lot about on our Walmart episode, the legendary Saul Price and his two companies, FedMart and Price Club. And although Costco, quote unquote, was founded in 1983, the organization that we know and love today is actually the result of a merger between Costco and its predecessor company, Price Club.

• 6:38David Rosenthal?

  And Price Club is really, of course, the actual result of Saul's previous company, FedMart, which FedMart itself really came out of, FedCo, in the 1940s.

• 6:51Ben Gilbert?

  In some ways, we sort of have to tell a whole industry history here, but in other ways, these kind of are all the same company because they're all stacked learnings from Saul Price and his various brain children over the years to create the Costco that it is today.

• 7:06David Rosenthal?

  Totally. We start, history and facts, in January 1916, in New York City, in the Bronx, where one Solomon Saul Price is born. Now Saul's parents were Jewish immigrants from Belarus. They'd arrived just a couple of years before at Ellis Island as teenagers. They had absolutely nothing. They spoke no English. They had no money. Nothing. So Saul's parents, like many Jewish immigrants around then in New York, ended up getting jobs in the garment factories in the Lower East Side. And the conditions in these factories were like terrible, just absolutely terrible.

• 7:51David Rosenthal?

  If you went to school here in the US, you might remember learning in American history class about the Triangle Shirtwaist Factory Fire.

• 7:58Ben Gilbert?

  Yes.

• 7:58David Rosenthal?

  In 1911. You remember that? This is like the start of the American labor movement and the Communist Party and the Socialist Party emerged as a reaction to this in America because it's a terrible disaster. Literally, the factory owners had locked the doors to keep the workers in the building so they wouldn't steal. And then a fire breaks out. 146 people are killed, mostly women and young girls. Like, this is terrible. So Saul's parents didn't work at Triangle, but they worked at other factories just like this.

• 8:32Ben Gilbert?

  Hmm.

• 8:33David Rosenthal?

  Crazy. And you can't make this up. Saul, maybe the most influential American retail capitalist in history, comes out of the Triangle Shirtwaist Factory Movement and communism and socialism and everything that's happening in New York and the Jewish community at this time.

• 8:50Ben Gilbert?

  Wow. And you say one of the most influential. I do think he's top two, top three with Sam Walton, of course.

• 8:57David Rosenthal?

  Sam Walton actually wrote in Made in America that he stole more ideas from Saul than anyone else in his business career.

• 9:05Ben Gilbert?

  All right, so very credible argument that he is the most important American retail capitalist.

• 9:10David Rosenthal?

  Jim Senegal, of course, co-founder, CEO of Costco. Jim tells the story that a reporter once asked him if he learned a lot from Saul. And Jim replied, no, that's inaccurate. I didn't learn a lot. I learned everything, absolutely everything I know I learned from Saul. So we found this awesome biography of Saul that's like really rare. It's out of print. It was written by his son, Robert. And if you are a fan of Costco or want to learn about retailing or just like all these business practices, you absolutely should try to get your hands on this thing.

• 9:46Ben Gilbert?

  It's self-published, too.

• 9:48David Rosenthal?

  It's self-published. I don't think there's anywhere else in the world that lays out in detail exactly how Costco works and its predecessor companies. It's amazing. Also, super fun, Blinkist, sponsor of the show, made a summary for us.

• 10:04Ben Gilbert?

  Yes, I was texting David before this, listeners, and I was like, I don't think a lot of people are going to be able to like get this book if they want it. And Blinkist agreed to order a copy and then turn it into a blink. So you can get the Blinkist summary. We'll link to the show notes on how to do that. But David, the other crazy thing is I think Robert may have signed every copy of this book because he signed yours and he signed the one that I got.

• 10:25David Rosenthal?

  Oh, amazing. That's how rare this thing is. So back to Saul's growing up years. He says in the book, there's a quote from him, "In the New York Jewish community at the time, there was no such thing as Republicans. The socialists were the conservatives and the communists were the radicals."

• 10:41Ben Gilbert?

  So it really illustrates where Saul's political ideology comes from.

• 10:46David Rosenthal?

  Absolutely. So as a young child, he develops an eye defect that causes his left eye to droop. He's really self-conscious about this, as you can imagine. But as a result, he channels all of this insecurity into being like a massive overachiever in school. So he skips two grades in school growing up. And then, in the middle of his high school years, his parents moved the family from New York City to San Diego, California.

• 11:17David Rosenthal?

  Now, San Diego, it's a town of like 150,000 people. This is not the San Diego we know today. There's no Qualcomm, there's no Illumina. There's only like just the beginnings of the US Navy and the defense industry there. But it's a small town. When Saul gets out there to San Diego, in a parallel moment to Sam Walton's early life, Saul meets his future wife while he's in high school. And it turns out that Saul's future wife's first name is Helen, just like Sam's wife name is also Helen, and Sam's wife would be very influential on him, along with her family, same thing with Saul.

• 11:59David Rosenthal?

  So, just like Helen Walton, Helen Moskowitz, soon to be Price, comes from one of the wealthiest families in San Diego.

• 12:09Ben Gilbert?

  This is literally just like San Diego Walmart.

• 12:11David Rosenthal?

  Literally, that's what's about to happen here, just like 10 years before Sam and Walmart.

• 12:16Ben Gilbert?

  Wow.

• 12:17David Rosenthal?

  So Helen's family owns and operates a scrap metal business. A scrap metal business in the 1930s in San Diego is about as well positioned as you can possibly be because San Diego is about to go through a huge transformation during World War II. It's going to become the principal port of the US Navy's Pacific Fleet, which is going to be the main naval operations of World War II. The city is going to absolutely boom, and it's going to be shipbuilding, it's going to be Navy, it's going to be metal.

• 12:50Ben Gilbert?

  David, you and I were just down in San Diego doing our episode with Doug DiMiro, and I went and stopped by the Midway Museum because we had just done our Lockheed Martin episode.

• 12:57David Rosenthal?

  Yeah.

• 12:58Ben Gilbert?

  You can feel the history dripping off that thing on all the old airplanes and everything. San Diego has been, obviously, a huge Navy culture for 75 years now.

• 13:07David Rosenthal?

  Totally. During and after the war, all these sailors and GIs come through the city. And then when the war is over and they come back home, wherever they lived in the country before, they're like, wait, why am I living in Kansas? I should be living in San Diego. San Diego is pretty great. It's really nice there. So from 150,000 people when Saul moves there, after the war, San Diego is on a path to becoming today, it's the eighth largest city in America. It's larger than Seattle, it's larger than San Francisco. Oh, I wouldn't have guessed that. Yep. So this is going to become quite the fertile market, shall we say, for a new retail enterprise in post-war America.

• 13:51David Rosenthal?

  But before then, Saul goes to USC and gets his law degree. They come back to San Diego and he starts practicing as a lawyer. Now Saul's timing is just, I mean, you could not script this any better. He becomes a lawyer right before this boom. When you're a lawyer in a small town, I mean, my parents were lawyers in a small town growing up, you're a lawyer for your clients, but you're kind of also consigliere. You're advising on business, real estate, negotiations, divorces, trusts, estates. You're like super deep with your clients. So after the war, Saul starts counseling all these entrepreneurs with these new retail concept startups that are emerging in San Diego.

• 14:35David Rosenthal?

  One of these startups is called the Seven Seas Locker Club, which ostensibly the premise for this business is literally a club of lockers where Navy sailors can store their uniforms when they're on leave and wearing their civilian clothes. And then when they go out to sea, they can store their like personal clothes and effects while they're away on the ships. Yep. But actually, that's just a Trojan horse to get all of these consumers into the door. Oh, it's foot traffic. And then they offer all kinds of goods and services to them within the locker club. So there's laundry, there's dry cleaning, there's clothing, there's jewelry, there's food, there's haircuts. Hmm. This might start to sound a little familiar here.

• 15:20David Rosenthal?

  Another client is a jewelry store called Four Star Jewelers. Now, in addition to operating their own jewelry store, these guys also sell jewelry wholesale to other retailers. And it turns out that there's one account in particular that accounts for like the vast majority of their outside wholesale business. And it's this odd retail concept operating out of Los Angeles called Fedco. And you're like, Fedco? What is a Fedco? What is happening here?

• 15:58Ben Gilbert?

  It's also like, okay, how are they doing so much volume? You should go check it out and see what's going on.

• 16:02David Rosenthal?

  Yeah, exactly. Well, Fedco, it turns out, was a nonprofit membership club. It was a customer collective. And it was called Fedco because it was only open to federal employees, primarily postal workers. After the war, about 800 postal workers in the Los Angeles area decided somehow that they wanted to pool their buying power together, and they're federal employees. And so they start this club so that they can pool the buying power and get better prices on goods that they can all participate in together. Well, it turns out there are a lot of federal employees out there, especially in San Diego.

• 16:47David Rosenthal?

  They charged a membership fee. They charged dues to join. But unlike Costco today, they didn't really make any money on the memberships. Remember, they're a nonprofit. So the cost was $5 one time for a lifetime Fedco membership.

• 17:06Ben Gilbert?

  Yeah, hard to see that working. But actually, it's not so different inflation-adjusted from REI's membership today. Very clearly, REI is not interested in making money off the membership program. I pay, what is it, $85 or something once just to grant me sort of a higher affinity to the store, and the money's not really relevant.

• 17:24David Rosenthal?

  That is the perfect analogy. That's exactly what Fedco is.

• 17:28Ben Gilbert?

  Yep.

• 17:29David Rosenthal?

  So as you can imagine, Fedco becomes quite popular amongst government employees in the LA area. And then not just the LA area, people start driving from all over Southern California, including San Diego, sometimes up to like hundreds of miles round trip to do the majority of their shopping at Fedco.

• 17:53Ben Gilbert?

  It was time to expand. Yeah. But Fedco is a nonprofit. They're not looking to like expand and build this huge empire.

• 18:00David Rosenthal?

  Exactly. So Saul and the jewelry guys, they see what's happening with all of the wholesale business that they're sending to Fedco up in LA. And they're like, man, we gotta find a way to open a Fedco here in San Diego. And Saul's like, actually, I might have just the location. It turns out that Helen's family owned a 21,000 square foot warehouse in San Diego's industrial district that's currently sitting empty. So the three of them go over, they check it out and they're like, oh yeah, we could totally recreate Fedco in this building right here in San Diego. So if Saul were Sam Walton, that would be

• 18:45David Rosenthal?

  the end of the story right there. He'd just be like, great, I'm gonna clone Fedco. No, this is how Saul is different than Sam. And I think probably hearkens back to his upbringing in New York and, you know, everything that was happening. He calls up the Fedco Board of Directors in LA and he says, hey, we want to partner with you guys. We think that a Fedco would do great in San Diego. Can we create a joint venture together? We've got the building, we'll operate the store, let's go into business together and be partners. Fedco, though, like you said, they're a nonprofit. They're not interested in expansion. So they turn him down. And Saul, God bless him. He calls them back and he's like, no, no, no, guys, we really want to do this.

• 19:30David Rosenthal?

  How about this? You can own the whole business. We'll just be a franchise down in San Diego. You get all the upside. You get all the enterprise value. Like, we don't care. We just want to bring this to San Diego. And they say no again, because it's like a nonprofit board of directors.

• 19:48Ben Gilbert?

  Yeah. On the one hand, you might think Saul Price, not a very savvy business person, just take the gift and go with it. On the other hand, ridiculously principled guy.

• 19:57David Rosenthal?

  There's a really funny Saul quote from later in his life. He's asked about how he feels about essentially being the father of modern American retailing. And he thinks about it and he sort of laughs and says, you know, maybe I should have worn a condom.

• 20:13Ben Gilbert?

  Oh, Saul.

• 20:14David Rosenthal?

  Oh, Saul. But it's not that he's a rube. He's a really good businessman. He's just also incredibly principled.

• 20:22Ben Gilbert?

  Yep.

• 20:22David Rosenthal?

  And this is going to flow through directly into Costco, as we'll see. Okay, back to Fedco. So after this second rejection, Saul and the guys are like, I guess we now can go do it ourselves. So in November 1954, they open the store in this warehouse location. And they had to think about what to call it. And they're like, well, basically this is a clone of Fedco, but we can't use that name and it's kind of a bad name anyway. What if we draft off the same brand recognition though and call it Fed Mart?

• 20:59Ben Gilbert?

  An equally bad name.

• 21:02David Rosenthal?

  An equally bad name that would have historic impact. So why do you think Walmart is called Walmart? Why do you think Kmart was called Kmart?

• 21:13Ben Gilbert?

  Oh, it was the first Mart?

• 21:14David Rosenthal?

  It's because of this. Yes, literally. I mean, Sam Walton talks about this in Made in America. By the time Walmart was starting, people knew what Fed Marts were. They were expanding across the country. And he was like, oh, great. We're going to draft off the Fed Mart brand. And it was the same thing with Kmart. FedMart becomes the first scaled quasi-national discounter. And people are like, what are discounters? Discounters are Walmarts, K-Marts, Targets. That is the industry that Saul births here.

• 21:46Ben Gilbert?

  And so, very specifically, we are not talking about what Costco is today as a wholesaler. FedMart is not big pallets with enormous quantities of things. It is much more like a Walmart. You want to go grab a can of beans off the shelf? You grab a can of beans off the shelf. And importantly, it is both packaged food and sundries or general merchandise under one roof.

• 22:09David Rosenthal?

  Yes, correct. And on the one hand, FedMart is obviously a clone of FedCo. On the other hand, the huge, single key difference that makes all the difference, it's a for-profit company. It's not a nonprofit. And so, just like all capitalist for-profit companies, Saul and the jewelry guys and FedMart have the impetus to expand.

• 22:34Ben Gilbert?

  That makes sense. And so, just to put some other fine points around what it is and what it isn't, it is still only for federal employees, right?

• 22:42David Rosenthal?

  Yes, at this time.

• 22:43Ben Gilbert?

  Okay. And it's not a membership club?

• 22:47David Rosenthal?

  Well, so it is still a membership club. You do still have to be a federal employee. You do still have to buy a membership. I think they maybe took the lifetime membership price down to $2, so they undercut FedCo or something like that. But obviously, it's not about the membership. The reason they did this, and the reason that no other discounters had really scaled before, this is crazy, there were actually laws on the books in the US at the time that manufacturers of goods could set a minimum selling price for retail. And it was actually illegal for retailers to offer products below that price to the general public.

• 23:30Ben Gilbert?

  Whoa.

• 23:31David Rosenthal?

  So, the term discounters, discounting meant selling below the manufacturer's minimum price. How did you get around this? Well, Saul kind of stumbles into figuring out that if you are a membership club, you're not open to the general public. So you can skirt these laws and sell below the manufacturer's minimum price. Interesting, huh? So this is crazy, and this is why I think there's a strong argument that Saul really is the GOAT among American capitalist retailers. We haven't even gotten to Price Club and wholesaling and Costco yet. He also invents that later.

• 24:14David Rosenthal?

  First, he invents the discounter, which then Sam Walton, Kresge with Kmart, Dayton with Target, copy and becomes the dominant retail form of America. Two totally separate things. He invents both of them. Crazy. So when Saul and the guys opened the first FedMart in 1954 in San Diego, it is a huge and immediate success. Their sort of wildest dreams, expectations are that they do a million dollars in sales in the first year. The store does $3 million in sales in 1954 in one year. Wow. And why do you get the sense that it worked? It worked because it was already working. This was a no risk bet. Clearly Fedco had proved the model in LA.

• 24:59David Rosenthal?

  They just did the same thing as a for-profit company. Makes sense. So a year after San Diego, they opened the second FedMart in Phoenix, Arizona, right off the bat, going multi-state. They want to go big here. It's another absolute banger. Literally when they open it, there are lines half a mile long to go get into the parking lot of the store, like going out in every direction from the store. They take it to Texas, they go to San Antonio, they go to Houston, they go to Dallas. All of these stores are huge successes. So at this point, two things happen that are going to prove very fateful, both for FedMart and for Costco. One, Saul fully stops practicing law and goes full time with FedMart.

• 25:44David Rosenthal?

  He becomes the president of FedMart. Two, he hires a young college student from San Diego City College as a part time bagger in the San Diego store. One, Jim Sinical. And Jim would end up working for the next 22 years at FedMart, directly for Saul. Eventually, Jim ends up running FedMart's entire distribution and centralized warehousing operations. Warehouses. You can see the Costco picture coming together here. Put a pin in that. So FedMart goes public in 1959. They raised $2 million.

• 26:28David Rosenthal?

  They plow that money into both expanding the number of stores across the country. But also, remember back to Seven Seas Locker Clubs, the suite of goods and services that they're offering under the roof, or in some cases, not under the roof. This is when they add gasoline to FedMart. So the Costco gas lines, like this started with FedMart. They would intentionally price a few cents lower than whatever the other gas stations were charging in the area. And a few cents at that time was a lot because gas was like 25 cents. And unlike gas stations, FedMart is making money on consumers shopping in the store as well. So they can price at cost on the gasoline,

• 27:11David Rosenthal?

  get all the traffic coming to the store and then monetize through the store. Hmm. They add a pharmacy to FedMart. Costco Pharmacy today, people are religious about it. So there's a crazy story. The guy who sets up the pharmacy division for FedMart starts getting death threats from people in the industry. He has a rock thrown through his window. It's literal mafia stuff because they're undercutting the fat margins in these pharmacy counters so much. That guy's protege, who then takes over the pharmacy division for FedMart when he retires, that guy goes on to start Costco's pharmacy division and run it.

• 27:55David Rosenthal?

  Amazing. Most importantly, for the Costco story here,

• 28:00David Rosenthal?

  after they go public, FedMart uses part of this capital to develop their own house brand for some of the popular products that they're selling on the shelves.

• 28:11Ben Gilbert?

  It's like the FM brand, is that right?

• 28:13David Rosenthal?

  The FM brand, yep. If you ever see FM branded old photos and stuff of like newspaper articles referring to FM, cola, FM, whatever, that's what it is. It's FedMart. And then one more piece of FedMart playbook, shall we say, that clearly makes its way over. As Saul is running the company during these first few years, he starts to codify some retail management philosophies. And he famously sort of canonizes these as FedMart's four priority order principles. And he teaches every new employee throughout the whole company about this.

• 28:55David Rosenthal?

  Number one, first priority, provide the best possible value to customers. Number two, second priority, pay good wages to employees and provide good benefits, including health insurance. This is in the 50s. Like, this is progressive stuff. Number three, maintain honest business practices. And then number four, the last one, make money for investors. So if you're a Costco nerd out there, and there are probably many Costco investor nerds listening right now, those all probably sound very familiar to Costco's priority order values.

• 29:29Ben Gilbert?

  Right. Not the same, but kind of rhymes. Put a pin in it. When it comes to Costco, we'll bring those up and go into each of them in depth.

• 29:36David Rosenthal?

  So you might be listening and saying like, yeah, yeah, yeah, that sounds good. But I'm thinking about, you know, I don't know, maybe I go to Walmart today or I walk into Target and I see some similar things written on the walls there. Isn't this kind of all the same? If you really mean them, no. There are some very, very clear trade offs that Sol is gonna make with FedMart, that Costco makes today, that are very different from what their competitors do. Like, one, do you sell loss leaders in the store? Loss leaders being when you mark down items below your cost in order to attract people into the store with sales. If you're those other retailers, yeah, of course. This is like a time honored tactic in retailing.

• 30:21David Rosenthal?

  Of course, you're gonna use this.

• 30:22Ben Gilbert?

  Sam Walton bragged about it in Made in America about we could get this incredible number of, I don't even remember what the thing was, but build a pyramid of them in the parking lot and blow them out to get people to come and participate in the spectacle.

• 30:33David Rosenthal?

  Right. If you're Sol and Costco today, you're absolutely not gonna do this stuff.

• 30:40Ben Gilbert?

  No, they won't sell something unless they can make money on it.

• 30:43David Rosenthal?

  Because the flip side of doing loss leaders is that you gotta make up for it somewhere. You gotta mark up other goods in the store to fat margins to make it worth doing the loss leader for you. Basically, it means you're treating your customers like they're stupid.

• 30:59Ben Gilbert?

  Totally. That's exactly my read on this, too. I feel like, David, acquire number one tenant, treat the audience like they're smart. If you're gonna ever do loss leaders, you're sort of violating that tenant and saying like, eh, we're gonna get one over on our customers.

• 31:13David Rosenthal?

  Totally. This is anathema to Sol. He passes that down to Jim Senegal. It's anathema to Jim. Okay, so that's one trade off. Here's another really big one. What do you pay your employees? So in 2006, Harvard Business Review published a really great piece called "The High Cost of Low Wages", where they very directly compare Costco and Walmart employee salaries and benefits.

• 31:42Ben Gilbert?

  Which, for listeners, if you want those numbers today, Costco's average hourly wage is $26 and Walmart's is $19.50. So huge, huge difference if you are gonna go get an equivalent job at one or the other. On top of that, at Costco today, you also are eligible for a 401k with a match and very, very good healthcare, shockingly good healthcare, even for hourly workers. So if you're going to go work at one or the other today, you'd be very lucky to go work at Costco.

• 32:13David Rosenthal?

  So obviously, the trade off of this is for FedMart at the time and straight through to Costco today. This creates meaningfully higher per employee labor costs for the company.

• 32:26Ben Gilbert?

  Yep, totally. But what are the benefits? And this is where we get this beautifully interlinked set of trade offs that play well together. So what do you get? Well, you get low employee turnover. And when I say low, I mean very low. After the first year, Costco today has only a 7% attrition rate among their workforce.

• 32:45David Rosenthal?

  This is wow. This is for hourly labor.

• 32:48Ben Gilbert?

  Yes, typical retail is 20%. So it is a meaningfully lower cost to onboard and train new employees. Like, you normally have to spend a lot of your money ramping people to get them up to speed. Costco, Price Club, FedMart doesn't have to do any of that because they're really rewarding their employees. Employee loyalty also reinforces the idea that people shouldn't steal. They feel grateful for this job. They're excited to be in it. The shrinkage or the unaccounted for merchandise at Costco today is astonishingly low. It is 0.15% of sales.

• 33:24David Rosenthal?

  That's crazy.

• 33:26Ben Gilbert?

  So merchandise does not walk out the door. Their strong bias also is to promote internally. So if you look at Costco today, 36% of US employees have over 10 years of service.

• 33:40David Rosenthal?

  And this is truly unique, I think, about Costco among major American at least corporations and was true at Price Club and FedMart before it. The senior, senior management, this is the same story. I mean, Jim started as a grocery bagger in the 50s at FedMart. Craig Jelinek started his career as an hourly employee at FedMart. This is how long the tenure is of these people and how linked these stories are.

• 34:09Ben Gilbert?

  If you look at their executive team at Costco today, basically all of them have been there for over 25 years. The only vice presidents at the company who have not are the digital e-commerce people that they had to bring in to address some issues.

• 34:23David Rosenthal?

  Decades ago.

• 34:24Ben Gilbert?

  It's crazy.

• 34:25David Rosenthal?

  So what happens? FedMart truly was the first discounter that scaled nationally. All of these innovations, even though Saul came up with them, as these other companies are scaling, and I think particularly Kmart, they don't really have the large-scale operational expertise nor the access to capital to really fend off the competition. Kmart, if you remember back to our Walmart episode, came out of the Kresge department store chain, which was huge. So they had so much more access to capital, certainly than FedMart and even than Sam Walton and Walmart. You know, Sam had to fight bitterly, last mile by last mile, building out his distribution

• 35:10David Rosenthal?

  network to beat Kmart. Saul and FedMart, they don't really have the firepower to compete.

• 35:17Ben Gilbert?

  So they need capital or they need to sell the business, one or the other. And it seems like what they kind of did was accidentally both.

• 35:25David Rosenthal?

  Yeah. In the biography, Saul comments to his son, Robert, who had also joined the company, joined FedMart at this time. He says, quote, "We're good at creating businesses. We're not as good at running businesses."

• 35:37Ben Gilbert?

  Yeah. All right, listeners, now is a great time to tell you about a longtime friend of the show, Vanta. AI has scrambled the whole security picture. It used to be that you proved that you were secure once a year on audit or a static PDF, then everyone would nod and you're done. But in an AI-first world, that doesn't hold up anymore.

• 35:57David Rosenthal?

  Yep, your risk surface changes every week now. A vendor turns on an AI feature, or someone writes in a new model without telling IT, and your posture is different than it was last week, let alone at your last audit. Vanta's own research found that around 70% of companies have this quote-unquote "shadow AI" running with no security review at all.

• 36:18Ben Gilbert?

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• 36:40David Rosenthal?

  In half, which is exactly why more than 16,000 companies today run on Vanta. Companies like Ramp, Cursor, and Snowflake all stay audit-ready and catch the risks that crop up between audits across every vendor, every AI tool, the whole environment.

• 36:58Ben Gilbert?

  And that's the real value. Trust has to be continuous now, which is why Vanta automates your security, your compliance, and the work to earn and prove trust. We're huge fans of Vanta over here, and literally hundreds of acquired listeners have become Vanta customers at their companies over the years. So you can get $1,000 off Vanta at vanta.com/acquired. That's V-A-N-T-A dot com slash acquired for $1,000 off, and just tell them that Ben and David sent you. All right, David, so what happens with FedMart?

• 37:30David Rosenthal?

  So, like you say, by the time we get to the end of the 60s, early 70s, Saul's burned out. He and Robert, they don't want to be running this business at scale. First, he brings in quote-unquote "professional management" and moves up to chairman of the board. Second, he starts looking around for a capital partner to help the business compete on a more level playing field with the other discounters. They end up going to Europe, and this is super important, both for the drama that happens, but also leading into Price Club and Costco. At the time, in the 70s, this new retail concept in Europe was getting going, actually pioneered by the French company Carrefour, which is still a huge global retailer today.

• 38:13David Rosenthal?

  And that concept is the hypermarket. So what are hypermarkets? Hypermarkets are smashing together everything we were just talking about with the discounters, the general goods retailing, with a full-scale grocery store supermarket. So fresh food, everything. This is what almost every Walmart is today, the supercenters. It's grocery and hard goods in one huge, enormous warehouse, you might say.

• 38:44Ben Gilbert?

  Which is funny. You would have assumed that the Americans would pioneer that. It's hilarious that the French did.

• 38:48David Rosenthal?

  It was the French, of all people. So this concept didn't exist yet, and it wasn't until the late 80s that Walmart would really embrace it and roll it out across America. So as Saul and Robert are looking for partners to take FedMart to the next level and going across Europe, they're meeting with all these hypermarket operators. So they end up getting into bed with one of the German clones, run by a retail entrepreneur named Hugo Man. The idea was that Man was gonna help Saul and FedMart take this hypermarket concept and morph the existing FedMart stores into hypermarkets, which Walmart would do to great success, but like 15 years later.

• 39:33David Rosenthal?

  Had this happened, we would be telling a very different story today.

• 39:37Ben Gilbert?

  And we might all be shopping at FedMarts.

• 39:39David Rosenthal?

  Totally.

• 39:40Ben Gilbert?

  In practice, what ended up happening is this weird thing where Saul Price was an innovator and a great merchant, but not a deal guy. And so it seems like there's two cardinal sins that get committed. One, not really asking Hugo Man, why do you want to do this deal? And what is interesting about this to you? And what do you want to do with the combined company? And then, two, selling the majority of it and treating them like a minority investor.

• 40:10David Rosenthal?

  Yeah, Saul is looking for a growth investor, and he ends up getting a buyout.

• 40:14Ben Gilbert?

  Yeah, one with misaligned interests.

• 40:16David Rosenthal?

  So, within a few months of when the deal actually closes, perhaps predictably, Saul and Hugo get in a huge fight.

• 40:25Ben Gilbert?

  At the very first board meeting.

• 40:27David Rosenthal?

  The very first board meeting, they're yelling at each other. This is not going well. Man fires Saul, literally fires Saul, I think, and Robert, too, and changes the locks on their office doors.

• 40:41Ben Gilbert?

  Oh.

• 40:42David Rosenthal?

  Literally boots Saul out of his own company. It's super ugly. And then the person at FedMart of the remaining executives, who they task with, you think, like, doing an all hands or the equivalent of, and, you know, inform the rest of the company what's just happened? You know who that was?

• 41:00Ben Gilbert?

  No.

• 41:01David Rosenthal?

  Jim Sinegal.

• 41:02Ben Gilbert?

  No way. Wow.

• 41:05David Rosenthal?

  Isn't that hilarious? Oh, my gosh.

• 41:09Ben Gilbert?

  Oh, that is crazy. And I think what was going on here is Hugo Mann just realized that FedMart was sitting on a gold mine of real estate and just wanted the real estate portfolio. And what Saul and Robert wanted was operating capital from the parent company, from Hugo Mann, to invest more and aggressively opening more FedMart stores.

• 41:27David Rosenthal?

  And pioneering hypermarkets in America.

• 41:29Ben Gilbert?

  Yeah, which, of course, Hugo Mann had no interest in.

• 41:31David Rosenthal?

  Yep. So, had this not gone down like this, I think Saul probably would have just retired as new management took over at FedMart and all would have been amicable. He wasn't really interested in continuing his career.

• 41:47Ben Gilbert?

  But.

• 41:48David Rosenthal?

  But because of how this went down, with him getting locked out of his office, he is pissed. He is now 60 years old at this point, and he is a man on a mission.

• 42:00Ben Gilbert?

  Great time to be a founder.

• 42:02David Rosenthal?

  Totally amazing. I love that. He's like the Morris Chang of American retail.

• 42:06Ben Gilbert?

  Yes.

• 42:07David Rosenthal?

  Morris Chang, of course, being the founder and CEO of TSMC, who was booted out of Texas Instruments at age 56, I think.

• 42:13Ben Gilbert?

  Something like that.

• 42:14David Rosenthal?

  Yeah, and then would go on to start TSMC. So Saul and Robert, together, they get a lease on an office, literally the next day after they're booted out, and they're like, we're doing it again. We're back in the saddle. Let's go.

• 42:30David Rosenthal?

  But they know they're not going to compete directly with FedMart because FedMart is failing at that. They're going to get steamrolled by Walmart and Kmart and Target and everybody else.

• 42:39Ben Gilbert?

  By the way, FedMart within five years was like completely dead after this acquisition.

• 42:44David Rosenthal?

  Totally ran into the ground.

• 42:45Ben Gilbert?

  And Hugo Man did make a fortune on the real estate, but yeah, FedMart's dead.

• 42:51David Rosenthal?

  Yep. So Saul and Robert are sitting around in their new office brainstorming, what's their angle of attack here? And they keep coming back to one part of the FedMart business that they felt was underappreciated and they didn't really exploit enough while they were at FedMart. And that is the division that Jim Sinagal ran, the centralized warehousing operations. So the two of them are like, you know, if we zoom out, there really is kind of a different and orthogonal way to think about the FedMart business. You really could

• 43:34David Rosenthal?

  say that Jim ran our warehouse operations kind of like its own business. They were supplying the individual FedMart stores, which were sort of smaller businesses. And when you look at it that way, almost all of the margin that we made at the company was at the warehouse level. The stores themselves were not particularly profitable and pretty hard to compete with the competition out there.

• 44:03Ben Gilbert?

  I didn't realize that they thought to sort of slice the margin up into those two, almost like places in the value chain.

• 44:10David Rosenthal?

  Yeah. So they're like, well, is there a way that we could take Jim's operation, recreate it and make that the core business instead? And so the business plan that they come up with is literally that. Create warehouses for other individual small businesses, other retailers. And they're envisioning like gas stations, restaurants, small variety stores and the like, independent chains that they can come and shop to stock their own shelves at this centralized warehouse that we're going to operate.

• 44:48Ben Gilbert?

  So just business owners can be members?

• 44:51David Rosenthal?

  Just business owners. And they're like, man, if we did that. I think that would be providing a huge service to these small businesses because one of their big problems that we know from operating the FedMart stores is actually how you manage your inventory, like physically where you put it. You need a centralized warehouse to hold your inventory. If you're a small gas station, you don't have your own warehouse. We can be your warehouse.

• 45:18Ben Gilbert?

  Right. And to put a finer point on it, the reason why it's awesome to just run warehouse operations is because the logistics are simple. You are taking pallets of stuff and you are moving it to a location in a warehouse. And then the customer comes and takes a huge amount of it off your hands. You don't really have to turn and make sure the labels are facing out and you don't have to deal with, oh, little one-off. We've only sold 16 units, but there's actually 127 units on this thing. So that you just, everything is nice, easy, big quantities, doesn't require a lot of attention from your staff. Being in the wholesale business is good if you can get it, but their inclination at

• 46:00Ben Gilbert?

  this time is, well, the only people who would be willing to shop and buy in that way are business owners. This would never work as a consumer concept.

• 46:07David Rosenthal?

  Yep. All of that, totally true and amazing parts of the Costco model. There's one piece in particular that really, really makes this a crown jewel. And it's the reason why they were so enamored of what Jim was doing. If you're operating a wholesale warehouse, you don't have to operate any logistics. The manufacturers deliver the product right into your warehouse. You don't need to run trucks. You don't need to operate other warehouses. You don't need to move stuff around the country.

• 46:40Ben Gilbert?

  Right. And the business owners just come to you and pick it up right from the warehouse where it was delivered, right from the manufacturer.

• 46:48David Rosenthal?

  Totally. And because of all this, because this new business, this Costco Price Club, gonna be called Price Club, is providing such a valuable service to the small businesses that are shopping there in managing all these logistics for them, or I shouldn't say managing because Price Club doesn't manage it either, the manufacturers do, they're like, we can actually...

• 47:13David Rosenthal?

  Go back to that original Fedco membership idea. And instead of having it just be like a way to skirt around the law, we can charge real money for this membership because we're providing real value out of this to the businesses.

• 47:28Ben Gilbert?

  Yep.

• 47:29David Rosenthal?

  So, once they hit on this business plan, Saul and Robert poach a few people from FedMart and elsewhere, including they hired this super bright young guy from Harvard Business School named Giles Bateman as their CFO. And then they go get started. Giles would later go on to become chairman of, do you know this Ben?

• 47:50Ben Gilbert?

  No.

• 47:51David Rosenthal?

  CompUSA.

• 47:52Ben Gilbert?

  Really?

• 47:53David Rosenthal?

  A big part of my childhood. And part of the enormous diaspora of retailers that come out of not only FedMart but Price Club. Jim Senegal, after, I think he was probably locked up at FedMart under new management for a while. After that, he would come over and briefly work at Price Club a couple of years later. So like, the best of the best are coming through this place.

• 48:16Ben Gilbert?

  Hmm.

• 48:17David Rosenthal?

  So they decide, as they're getting started, that in order to keep the operations really tight and realize the maximum benefit, Ben, of everything you are describing of how these warehouses operate, they're only going to stock about 3,000 of the highest volume items that they think most other retailers are going to sell to their customers. So, at the time, Walmarts and K-Marts had on the order of about 50,000 SKUs. And even FedMart had probably close to that many at the time. Going all the way down to 3,000. This is a non-consensus move.

• 48:52Ben Gilbert?

  Totally. But if you're only selling to businesses and they have small stores, it's not like we need to stock basically everything under the sun. It just needs to kind of be sufficient.

• 49:02David Rosenthal?

  Right, super important. Remember, they are not thinking about consumers just yet. However, when they launch the first store, when they opened the first Price Club in San Diego, unlike FedMart, it's not an initial gangbuster success. Turns out it's a lot harder to sell and recruit businesses to come be your customers than it is just putting out a shingle and attracting consumers.

• 49:32Ben Gilbert?

  And there's not like a viral word of mouth necessarily among these business owners. They're not just encountering each other everywhere all the time.

• 49:38David Rosenthal?

  Exactly. So- They're worried after a couple of months that this thing might not work. They might need to shut it down. And then they have the greatest stroke of luck. So they're going around San Diego trying to sell memberships to businesses. And they get a meeting with the San Diego City Credit Union. And the credit union management are like, we're a credit union. We're not a retailer. We don't really buy much stuff. We're not interested in this. But you know what? Our members, if we could find a way to get them access to what you're doing here, that might be a really good benefit that we could offer of like, oh, you can get wholesale prices on goods.

• 50:20David Rosenthal?

  So Giles, the wonderkin young CFO, he goes over to the credit union, hammers out a deal whereby any credit union member can qualify for a new quote unquote, group membership plan at Price Club and be allowed to shop there just at slightly higher prices than the business members. It turns out that this does two things. One, this unlocks the gusher of consumers into Price Club.

• 50:50Ben Gilbert?

  Which allows for not only volume, but word of mouth. This is the seeds that are sown of Costco today doesn't really advertise. And this is the first moment that they realize, oh, my gosh, consumers are going to tell each other about this thing.

• 51:04David Rosenthal?

  Exactly. And it's even better than that because not only do consumers tell other consumers, it turns out that a lot of small business owners are also consumers. So it also drives small business owner membership. And because the business members get slightly better pricing on things, all of a sudden all these consumers are running around being like, oh, hey, I think my aunt owns a nail salon or something like that. Like, let me get her to go sign up and get a membership and then I can use her card and get better prices.

• 51:35Ben Gilbert?

  Yep. And David, do you know what I did this week?

• 51:38David Rosenthal?

  Uh, I suspect that you drove to a Costco.

• 51:40Ben Gilbert?

  And do you know what now has a business membership to Costco?

• 51:43David Rosenthal?

  Oh, hell yeah. Where's my card?

• 51:46Ben Gilbert?

  Actually, I think you need to go in and have your picture taken. I was on a personal one before, but while I was there, I was like, you know, it would be appropriate this week. So we now have a business membership.

• 51:54David Rosenthal?

  Hey, we are a small business.

• 51:56Ben Gilbert?

  That's right.

• 51:57David Rosenthal?

  I love it. Another fun story. As this unlocks the viral consumer word of mouth channel, of course, traffic at this first San Diego Price Club store starts growing and growing and growing. Saul and Robert start getting calls from local hot dog vendors that want to set up carts at the store's exit.

• 52:18Ben Gilbert?

  If you got traffic, you know, you may as well.

• 52:21David Rosenthal?

  You're going to attract hot dog vendors.

• 52:22Ben Gilbert?

  That's right.

• 52:23David Rosenthal?

  So at first, they ignore them. Eventually, though, they start getting enough calls. They're like, huh, maybe we should do something about this. And maybe rather than letting these guys come set up their carts, what if we do it ourselves? So Saul calls up Hebrew National Hot Dogs and asks them if they can supply them with hot dogs to sell at the stores. And Hebrew says, not only will we sell you hot dogs to sell, we'll supply the cart, too. And thus, the Costco $1.50 hot dog and soda deal is born. And still, to this day, it's a buck fifty, 47 years later.

• 53:08Ben Gilbert?

  There's a decent chance this is the one and only lost leader that Costco sells today.

• 53:12David Rosenthal?

  Yeah, they're a little cagey about what the actual costs are. I do know that they've gone through many, many iterations in housing all of the operations to try and keep their costs down.

• 53:23Ben Gilbert?

  Oh, they actually make the hot dogs now?

• 53:25David Rosenthal?

  Yep.

• 53:25Ben Gilbert?

  They also sell 130 million of them per year.

• 53:28David Rosenthal?

  Wow.

• 53:30Ben Gilbert?

  That's not all in America, but if it were, that's like a third of America going to Costco and getting a hot dog every year.

• 53:38David Rosenthal?

  Yeah.

• 53:39Ben Gilbert?

  So there is this interesting question that has now been answered, which is, there's this kind of horrible way of shopping where I need to go buy in bulk directly from the warehouse. No good retail experience. Are consumers actually going to do that? You know, this whole thing was intended for business owners, and there's all these benefits that come from selling to business owners. Again, you don't need a separate retail area and wholesale area. The logistics are all much easier. You know, you don't have to ever have your own logistics to move stuff from your warehouse to a different store to sell it. But are consumers going to do this? And they learn immediately, yes. It's sort of this shocking thing where it's like, whoa, consumers are willing to just go to a warehouse and buy stuff right off the pallet.

• 54:25Ben Gilbert?

  That's a pretty unexpected thing that happened.

• 54:28David Rosenthal?

  It turns out that there is really one pretty sure thing, at least in America, probably the whole world, that if you sell something at lower prices than anywhere else, you're going to sell a lot of it, no matter what hoops people have to jump through.

• 54:42Ben Gilbert?

  Yep. One other fun thing, do you know what the building that this warehouse was in was previously?

• 54:49David Rosenthal?

  I do, and it's super cool.

• 54:51Ben Gilbert?

  It is, listeners. The airplane hangar of the Howard Hughes Aircraft Corporation.

• 54:57David Rosenthal?

  One of the many, I'm sure, that Howard Hughes had, but

• 55:01Ben Gilbert?

  Yes.

• 55:01David Rosenthal?

  we got to cover Howard Hughes at some point on Acquired.

• 55:04Ben Gilbert?

  Definitely.

• 55:05David Rosenthal?

  So on the back of this wild success in San Diego, once again, Sol and Price Club quickly expand, just like with FedMart, first to Arizona and then beyond. This time, though, it's way different than FedMart vis a vis competition and capital dynamics. So whereas FedMart was capital constrained relative to the competitors, because of the genius aspects of this Price Club model, they are cash flow geysers, these stores. So the suppliers handle the logistics, deliver directly into the warehouses.

• 55:44Ben Gilbert?

  So let's just follow the cash flow cycle. They deliver to the warehouse, the moment they drop off that pallet is when they invoice Price Club. And invoices tend to be about net 30. So that means the pallet gets dropped off and you have 30 days to pay the supplier.

• 56:01David Rosenthal?

  But the minute that the pallet gets dropped off in the warehouse, those goods are for sale.

• 56:06Ben Gilbert?

  Right. No more internal supply chain, no more unpacking, no more shelving. It's just available to buy now.

• 56:14David Rosenthal?

  So in many, if not close to all cases with Price Club and then with Costco today,

• 56:21David Rosenthal?

  Those goods are sold before Price Club has to pay the invoice to the supplier. It's amazing.

• 56:26Ben Gilbert?

  All right, David, I got a bunch of great stuff for you on this one. So we're going to flash forward a little bit to today, but I have a huge thank you for Costco. Chief Financial Officer, Richard Galanti, spent an entire afternoon with me walking through a lot of these characteristics that really make Costco work. So I got a bunch of great tidbits while I was hanging out in their campus outside Seattle.

• 56:50David Rosenthal?

  Where was my invite?

• 56:52Ben Gilbert?

  I invited you. You could have gotten on a plane. All right, so here's how it all works today. So Costco actually turns their inventory 12.4 times per year. And just for comparison, Walmart turns their inventory eight times per year. Home Depot is more like five times per year. So at this number, north of 12 times a year, David, exactly what you're saying. It means Costco can sell through its inventory faster and more often than every 30 days. To be specific, they're on about a 26, 27 day sale.

• 57:22David Rosenthal?

  This is amazing.

• 57:23Ben Gilbert?

  So with typical payment terms being net 30, it means they literally have $0 tied up in inventory. And in fact, they're able, to your point, to make a few bucks on the float. So this is of course, an average. There are some things that will sell in a week or two. Other big ticket items might sit for a month or two. Sometimes Costco can even turn things two or three times before they have to pay a supplier for it. So this is called a negative cash conversion cycle where vendors effectively finance Costco's inventory for them.

• 57:56David Rosenthal?

  You know what? I'm in, I capitulately, I'm with Charlie on this one. He can come in here and give the speech 10 times in a row about how great Costco is. I will listen to all of it. I am in love with this company.

• 58:08Ben Gilbert?

  So there's a couple of interesting components here. There are companies that can achieve a negative cash conversion cycle, but the way they do it is by having predatory terms where they go to their suppliers and say, I'm not going to pay you for like three or six months. And that is one way to do it. Costco is using standard payment terms here.

• 58:26David Rosenthal?

  Right, 30 days.

• 58:28Ben Gilbert?

  And so there's two unique things that enable them to do it. One is this warehouse model where things are instantly available for sale. Customers come right to the place where they were dropped off. Not quite anymore, and we'll get to that later, but at Price Club, that's definitely what it was, and grab stuff right off the pellet. The other thing that makes it all work is To this day, Costco has kept their SKU count very low. SKU, S-K-U, being a unique item that a store has for sale. I think, David, you mentioned before about 3,000 at Price Club is what they had available for sale. If you look at a Walmart today, they have something like 100,000 to 150,000 different SKUs that they sell.

• 59:05David Rosenthal?

  Supercenters, indeed.

• 59:06Ben Gilbert?

  Costco, in the last 10 years, was around 4,500. And then they sort of looked and said, can we bring it down and went to 4,000? And today, they're sitting at 3,800. So this number is still going down, not up. And if you do the math and you start thinking, well, jeez, if you're not selling a lot of SKUs, but you have a lot of customers coming through your stores, what does that mean? It means that any given item is going to turn faster. It's sort of this magical unlock. In addition to the instantly available for sale in the warehouse thing, it is the low SKU count that directly gives you the ability to turn your inventory over quickly.

• 59:44David Rosenthal?

  It's just so awesome. I mean, like, if you look at a Price Club then, and certainly a Costco today, capital light, quote unquote, would be the farthest thing from your mind. You're like, these are massive structures. There must be so much money that goes into this. Well, yes, that's true. But it's a capital light business model.

• 1:00:03Ben Gilbert?

  It's wild.

• 1:00:04David Rosenthal?

  It's all being financed for you by your suppliers because of these dynamics.

• 1:00:09Ben Gilbert?

  And of course, today, as Costco opens new warehouses, they can very tightly predict how they'll perform because they know how all the other ones perform. And so, sure, there's a lot of upfront money in opening a new store. But once it happens, you sort of know exactly what it's going to mature to and exactly how your ROI is positive on all your fixed costs to invest in that new location. And you have this negative cash conversion cycle with all of your inventory being effectively free, if not profitable for you while it sits there.

• 1:00:36David Rosenthal?

  Amazing.

• 1:00:37Ben Gilbert?

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• 1:00:51David Rosenthal?

  Yeah. The hard part is knowing what permissions they have, what employees are using them for, or what decisions AI is making. AI security for an enterprise at scale is not a small concern. Like, the risks are real.

• 1:01:05Ben Gilbert?

  Exactly. And the challenge with AI is governing it, securing it, measuring it, and making sure that it actually delivers value. That is why ServiceNow built the AI Control Tower.

• 1:01:15David Rosenthal?

  Yep. AI Control Tower gives enterprises a single place to see, manage, govern, and optimize AI across the entire business. And it works with any AI, not just theirs. Every device on your network, every permission across every system, every AI agent, visible and secure in one place.

• 1:01:33Ben Gilbert?

  And ServiceNow can do this because they've spent more than 20 years building the operational backbone of the enterprise: the workflows, governance, approvals, security controls, and institutional knowledge that power how work actually gets done across IT, HR, customer service, finance, and security.

• 1:01:49David Rosenthal?

  ServiceNow already runs more than 100 billion workflows annually, and trillions of transactions for more than 85% of the Fortune 500. So when companies need a place to govern AI at enterprise scale, they're building on a platform at the center of how their business already operates.

• 1:02:06Ben Gilbert?

  And in a future that isn't going to be one AI, it's going to be thousands of AI agents working across every function of the company. But the question is, who's managing them all?

• 1:02:15David Rosenthal?

  So if you're trying to turn AI ambition into real business outcomes and make it work safely, securely, at scale, go check out servicenow.com/acquired and tell them that Ben and David sent you.

• 1:02:26Ben Gilbert?

  Okay, David, so take us from the first Price Club through to Costco.

• 1:02:30David Rosenthal?

  So, on the back of these eighth-wonder-of-the-world-like cash flow dynamics that these Price Club warehouses have, Price Club goes public in 1979, three years after founding. And I say, go public, not in an IPO, not in a direct listing. They don't list anywhere. They don't raise any money because they don't need any capital. So what happens is there's so much buying and selling activity among the original shareholders because this thing has become so valuable that this is the first time I've actually ever heard of this happening. Price Club crosses the 500 shareholder mark that at the time the SEC mandated if you

• 1:03:13David Rosenthal?

  had more than 500 separate shareholders of a company, you had to start filing as a public company. So Price Club's just like, okay, we'll file, we'll be a public company. They don't list on an exchange. They're just like, sure, we don't need the money.

• 1:03:26Ben Gilbert?

  That's crazy. So they're registered with the SEC, but they're not listed on a...

• 1:03:31David Rosenthal?

  Yeah, it's traded over the counter. They're not on the New York Stock Exchange or on the NASDAQ or anything like that.

• 1:03:35Ben Gilbert?

  Wow. So for those first three years, I need to know a Price Club shareholder in order to buy the shares.

• 1:03:42David Rosenthal?

  Yeah, there probably are some market making systems. I think this is what the over the counter market kind of does. But yeah, you can't just go trade it on an exchange.

• 1:03:51Ben Gilbert?

  Wow.

• 1:03:52David Rosenthal?

  Hilarious. So 1982, they do ultimately list on NASDAQ, probably just to get more liquidity in the trading. Also in 1982, Saul gets a call from his old buddy, Sam Walton. He wants to come out. He wants to see Saul, wants to have dinner with the two Helens, get the families together.

• 1:04:12Ben Gilbert?

  He wants to shop his competitor like he always does.

• 1:04:14David Rosenthal?

  Yeah, you know, and he's like, you're doing so great with these Price Clubs. I love your second act. I want to come see it in action. And Saul is like, sure, come on out. I think he knows what Sam is up to, but he doesn't really care.

• 1:04:26Ben Gilbert?

  What's he going to stop him from going into a store, you know?

• 1:04:29David Rosenthal?

  Totally. So Sam and Helen come out, they all have a nice dinner in La Jolla. Saul tells them all about Price Club, how the model works, the cash flow dynamics, everything. Sam, of course, goes back to Bentonville and within 12 months, guess what pops up? Sam's Club.

• 1:04:47David Rosenthal?

  Amazing. And this is really the major difference here between Saul and Sam. Saul doesn't care. He's like, sure. You know, again, what am I gonna do? Stop you? They stay friends. There's this amazing story that Sam tells in Made in America, where a few years later, Sam is going around again to Price Club shopping his competitors with his tape recorder, making notes about how they're doing pricing and inventory and stuff. And the security at the store confiscates Sam's tape recorder. Saul ends up just mailing it right back to Sam and he's like, keep your notes, it's all good.

• 1:05:22David Rosenthal?

  Uh, it's so funny. Right around the same time, another person comes out to San Diego to visit Saul and Price Club, a guy named Bernie Marcus. And for some listeners, that is gonna ring a lot of bells. Bernie has a story very much like Saul's. He was the president running the Handy Dan hardware store chain. And he had gotten kicked out by the board and was pretty salty about it and was looking for a second act. So Saul has him out to San Diego. He shows him the Price Club warehouse. He gives him the playbook

• 1:06:01David Rosenthal?

  and he says, look Bernie, you've got all this hardware expertise. Take the Price Club playbook. Go kick their butt and open the Price Club of hardware stores. Bernie Marcus, of course, then goes home, turns around and starts Home Depot.

• 1:06:19Ben Gilbert?

  Which we have heard from listeners 10 times that we need to do the Home Depot story at some point. I actually did not know Bernie Marcus's name or that he was the founder of Home Depot. So I think now we have to.

• 1:06:29David Rosenthal?

  Now we have to. So this now brings us finally to one more call that Saul gets also in 1982. There are these like years in retailing, 1962 when Walmart and Kmart and Target start, 1982 when all this is happening. Another Bernie, this time a Seattle retailer named Bernie Brotman and his son Jeff call up Saul. And they say, Saul, this Price Club thing is fantastic. We're retailers up in the Northwest, up in Seattle. We'd love to open a franchise up here, a Price Club franchise in Seattle.

• 1:07:09David Rosenthal?

  This is just like the Fedco FedMart days and Saul and the Price Club management team think about it and they make the very poor decision to say no. And in a same echo of what happened, gosh, 30 years earlier, Bernie and Jeff say, okay, we understand, we're going to do it anyway. We're going to clone the Price Club model and start the same thing up in Seattle. And again, I think Saul is totally fine with this.

• 1:07:35Ben Gilbert?

  Cause was Price Club growing aggressively?

• 1:07:38David Rosenthal?

  They were, but they weren't planning to go to the Northwest. They were following the old sort of trade routes of the FedMart playbook of Arizona, Texas, Florida, going out across the South and the Midwest.

• 1:07:51Ben Gilbert?

  Hmm.

• 1:07:52David Rosenthal?

  So what happens next is pretty hilarious. Jeff Brotman cold calls Price Club's head of merchandising and says, hey, my family and us, we're starting up a Price Club clone up in Seattle. We actually think the Northwest is a great market for this. Would you be willing to leave Price Club and come up and be my co-founder? And the head of merchandising is like, well, no, not because I don't think it's a good idea, but you see Saul Price is my uncle.

• 1:08:25David Rosenthal?

  And he's like, but let me give you the number of somebody else who you really should call. I think this guy is the right guy for you. We've worked with him for a long time here at FedMart and Price Club. He's now left, he's doing some retail consulting, so he'll probably be willing to talk to you. His name is Jim Sinical.

• 1:08:46Ben Gilbert?

  Ba na na.

• 1:08:47David Rosenthal?

  And this is how it all comes together. Jeff calls Jim, convinces him to come up to Seattle. He's ready. He's ready to run his own show, as they say. So Jim moves up to Seattle, they start Costco and the business plan is really pretty much exactly just clone Price Club.

• 1:09:07Ben Gilbert?

  And Jim really is Saul's protege. It's like clone Price Club, but with a guy at the helm who is built for scale and absolute focus on the details.

• 1:09:20David Rosenthal?

  Yep. And not only was he Saul's protege, not only is he a tremendous generational talent executor, he also is the guy who ran the division that inspired the whole thing.

• 1:09:34David Rosenthal?

  He really is the perfect guy.

• 1:09:37Ben Gilbert?

  And so listeners, you might be realizing now, when we were saying at the top of the episode, this really is kind of all one company story. It really is. There is a straight line through from Fedco to FedMart, or let's even just start it at FedMart, since it's all the same people through to Costco today.

• 1:09:54David Rosenthal?

  So Jim moves up to Seattle. He and the Brotmans raise $7.5 million to get going.

• 1:10:01Ben Gilbert?

  Yep. They sell 50% of the company to do that. They recruit eight people immediately, mostly from FedMart, some from Price Club, and they're all sort of 40s and 50s. This is like a gang of 10, 12 people who have all worked together before. Industry veterans have shorthand and they are just like, we've got the money. Okay, go. We know exactly what to do.

• 1:10:24David Rosenthal?

  I mean, literally, it's like the TSMC story.

• 1:10:26Ben Gilbert?

  Or like the Zoom story. It's like Eric Yuan finding 40 people who knew exactly how to build Zoom and then just doing it.

• 1:10:33David Rosenthal?

  Yep. So great. So within a couple of months, they opened the first Costco warehouse in Seattle. Then a few months later, they opened the second in Portland. Of course, both of them take off immediately. Then they go to Utah, to Northern California, to British Columbia. And this is where you can see that what Saul said about being really great creatively in business at the prices in Price Club, but not great at execution. Why was Price Club not in Northern California, given that they started in Southern California? These are the kind of mistakes that they made. So this new Costco under Jim hits $1 billion in revenue in less than three years after getting started. This is in the 80s.

• 1:11:18Ben Gilbert?

  And $3 billion in less than six years, which is the first company ever to hit that milestone, too.

• 1:11:23David Rosenthal?

  It's wild. They go public in what, two plus years after founding?

• 1:11:29Ben Gilbert?

  Yeah, 1985, they go public.

• 1:11:30David Rosenthal?

  Crazy. Once this plays out, and of course, Sam's Club is also becoming a juggernaut at this point in time. Price Club is doing fine. Again, capital is not the competitive vector here, but they're not being as aggressive. They're not expanding as fast as Costco and Sam's Club. What happens with Price Club is in some ways sort of the same as what happened with FedMart. You know, as Saul readily admits, he and Robert are great at creative ideas in retail. They're not so great at scale execution. Now, it's different in that capital is not a competitive vector here. Back in the FedMart days, FedMart was constrained. You know, the whole reason

• 1:12:14David Rosenthal?

  they went looking for a capital partner was they needed more capital in order to be able to grow stores and compete with Walmart and Kmart. These Price Club warehouses were paying back their capital investment quite quickly, especially relative to FedMart because of the cash flow dynamics that we were talking about. So Price Club was certainly doing fine. It wasn't declining, but Jim and Jeff at Costco and certainly Sam at Walmart and Sam's Club, they are pedal to the metal aggressively expanding, and that's not really Saul and Robert's MO.

• 1:12:51Ben Gilbert?

  No. And it does, if you kind of read between the lines in some of this stuff, it does kind of seem like Costco wasn't poaching people from Price Club, but a lot of really good people sort of found their way and went and got jobs at Costco. So Costco definitely had at this point the base of the sort of most aggressive, talented wholesalers of the West Coast.

• 1:13:12David Rosenthal?

  Yep, totally. And Saul, at this point in his life, he's sort of proved himself again. He's made his point after his terrible exit out of FedMart. He steps back from the day to day of the business. He hands that over to Robert. He gets really into real estate. He's not as aggressive as he once was. So in June 1993, Costco and Price Club merged together to form the united Price Costco. And as we've talked about, this really is a reuniting of them.

• 1:13:45Ben Gilbert?

  And at the end of the day, Price Club was either going to land with Walmart or with Costco. And Sol Price didn't want it to be Walmart and very, very much wanted to join forces with Jim Senegal. And so they sort of made that happen. This was the natural successor for this combined business in Jim Senegal.

• 1:14:04David Rosenthal?

  Now, interestingly, the transaction really is about as close to a merger of equals as I think we've ever seen on the show, with the caveat that Jim is clearly going to be the CEO that's going to run the combined company. At the transaction, 52% of the equity in the combined company goes to Costco shareholders, 48% to Price Club shareholders. They're about the same size, about 100 stores each at the time of the transaction, but Costco is growing way faster. So had they just waited a couple of years, the balance of favor would have been way far in the Costco side of things.

• 1:14:42Ben Gilbert?

  Yeah. And you sort of get the sense that the Costco folks were being very respectful of the Price Club folks because I believe it was something like a 30-plus percent premium paid for Price Club stock. And so I think it was everyone sort of looking at each other and Costco sort of knowing that they could really buy Price Club for a much smaller relative percentage in the future, but why don't we just do this today? I know it's a good deal for Price Club folks. And let's just say pseudo-merger of equals, let's call it, and let's be one team from now on.

• 1:15:18David Rosenthal?

  Yep. And there was a forcing function to this. It wasn't just that Jim had a soft spot for his mentor Sol and for Price Club. Sam's Club and Walmart was aggressively expanding at this point in time. And so if they had waited too much longer, Sam's Club would have just gotten huge and potentially run away with the market. So after the merger happens, even the newly combined Price Costco is still only a hair bigger than Sam's Club in terms of number of stores and revenue. So they kind of needed to do it pretty quickly or Sam's was going to run away with it.

• 1:15:54Ben Gilbert?

  Fascinating, which is so funny because it's a much less disciplined business. Every bit of DNA in Costco and Price Club is just so unbelievably disciplined and an admirable way to run a business. And Sam's Club strikes me as a bunch of cowboys who are changing strategies all the time.

• 1:16:14David Rosenthal?

  Well, you know, it's a second business line under Walmart, of which the main Walmart super center business line is one of, if not the greatest retail business of all time. It's certainly the biggest still to this day.

• 1:16:28Ben Gilbert?

  Yep.

• 1:16:29David Rosenthal?

  Saul, kind of amazingly, lives to be 93 years old. He passes away in 2009. After the merger, he really devotes the rest of his life, the next 15-plus years, to philanthropy and politics. So he does a ton of charitable development in San Diego. He gives back to USC. USC's Public Policy School is the Price School of Public Policy because he also becomes super involved in democratic politics. And actually, when Obama is running for president in his first campaign in 2008, he comes through San Diego and meets with Saul Price, you know, 92-year-old Saul Price. That's how influential he is, how much money he's giving to the Democratic Party in this kind of last chapter of his life.

• 1:17:14Ben Gilbert?

  Do you know who speaks at the 2012 DNC when Obama is getting reelected?

• 1:17:19David Rosenthal?

  I do, Jim Senegal.

• 1:17:21Ben Gilbert?

  Yep. So they really are, when I say ideologically similar, or the natural successor, or almost like another son of Saul Price, Jim Senegal and Saul Price really are of one mind in many ways.

• 1:17:35David Rosenthal?

  Except Jim is a way better executor.

• 1:17:39Ben Gilbert?

  All right, so let's talk about the execution of this business a little bit. And there's some concepts that I think we've talked about at a high level, but we haven't really drilled into why they work so well. And honestly, I have like 10 or 12 of these, David. So we're going to talk about two important ones now, and then we'll get into more as we sort of make our way to modern day a little bit.

• 1:17:58David Rosenthal?

  Yeah, let's do it.

• 1:17:59Ben Gilbert?

  So one that we haven't talked about is the economics of membership.

• 1:18:05Ben Gilbert?

  And there's the obvious ones that everyone realizes today. The base level of membership is $60. And as a consumer, I assume I'm getting some kind of good deal by paying $60. And that even before learning too much about Costco, I'm aware that that $60 is something I'm paying upfront to get the benefit of some low prices later. But let's analyze some of the second order effects of membership, which I think are potentially even more interesting than the obvious ones.

• 1:18:32David Rosenthal?

  There's a lot of psychology happening here.

• 1:18:34Ben Gilbert?

  Yes. The first one is that it actually selects for wealthy customers.

• 1:18:40David Rosenthal?

  Yes, this is amazing.

• 1:18:42Ben Gilbert?

  As does buying in bulk. So the items that you're buying are literally cheaper per unit. So you're saving money, but you need to buy a lot of it upfront, just like you need to pay a membership fee upfront, which means that they tend to get members who are not sensitive to cash flow. And they also tend to get members who have space to store stuff at home. And so I looked into some of the data on this to try and put some numbers to it. There was an independent research firm that found that the typical Costco consumer makes about $125,000 a year in household income and has a four-year degree. Walmart, by comparison, has a median income of about $80,000. And keep in mind, the median US income is $71,000.

• 1:19:25Ben Gilbert?

  So Costco shoppers have a 70% higher income than the US median.

• 1:19:30David Rosenthal?

  Yeah, this is one of the most surprising things about Costco. They have the lowest prices, but they have the wealthiest consumers of any major retailer.

• 1:19:41Ben Gilbert?

  Yes, it's totally fascinating and very smart consumers. People who can kind of look at the deal and go, actually, I know I'm coming out ahead on this. Another interesting psychology around this is when you pay $60 upfront, it encourages you to come and use the membership. You are more likely to shop because you've prepaid some of your margin dollars.

• 1:20:02David Rosenthal?

  I think this is called the endowment effect, if I remember back to my psychology classes.

• 1:20:06Ben Gilbert?

  Yes, you just sort of assume that you're getting some kind of good deal by prepaying for a membership upfront. So you want to go maximize the margin dollars that you're able to get on their discounts, which is totally fascinating. Another one is that membership further decreases shrinkage. We already talked about the fact that employee retention is great for making sure people don't steal things. So this membership makes it so members don't want to lose their membership. You sort of feel like you're part of some sort of club. On top of that, these items are huge. They're hard to steal. How do you steal a TV? How do you steal a two and a half pound thing of nuts? And so there's like all these factors. Membership is one of them that really contribute to low shrinkage.

• 1:20:49David Rosenthal?

  Yes, now you mentioned getting a good deal. We talked earlier, back in the FedMart days, about how loss leaders and sales was kind of an anathema to solve price. How does that play into this?

• 1:21:03Ben Gilbert?

  Yes, this is super interesting. So Costco basically wants to provide insane value to consumers. They want you to get a better deal as a member than you could possibly get by shopping anywhere else. And so how do they go about doing this? They have enforced a strict cap on the margin that they are willing to make on any product. So they have decided internally that they are not allowed to mark up anything more than 14% above what these suppliers sell it to them for. And I'll tell you, they are tough but fair with their suppliers in making sure that they get a great price for their members. And so Costco decides we will only mark up anything a maximum of 14%.

• 1:21:46Ben Gilbert?

  They actually do mark other things up less than that because things like electronics, they actually can only mark up 6, 7, 8%. So maximum 14%. The only exception to this is Kirkland Signature where they cheat a little bit and let themselves go up to 15%. Quite indulgent. So how does this compare? I think that's the interesting thing here. A common practice at department stores is literally 100% markup. Someone gets a good for 50 bucks, they sell it for 100 bucks. I mean, even at Walmart, a discounter, quote unquote, marks up 25%, which is almost twice as much as Costco's margin. And so Jim Senegal has a great quote on this. He was asked about it and his response was, "You could raise the price of a bottle of ketchup to $1.03 instead of $1, and no one would know.

• 1:22:31Ben Gilbert?

  Raising prices just 3% would add 50% to our pre-tax income. Why not do it? It's like heroin. You do it a little bit and you want a little more. Raising prices is the easy way."

• 1:22:43David Rosenthal?

  Well, and I think also, back to the membership, it all comes back to member trust. The members have to trust that they are gonna get the absolute best price on everything and that Costco isn't gonna be playing these games. Otherwise, they would just go shop at Amazon or Walmart or wherever.

• 1:23:03Ben Gilbert?

  You're exactly right. The value proposition 40 years ago was you are going to get the very best deal possible on the goods that you're buying here. Extreme value proposition is what they like to say. And the fact that they've just made that true every year for 40 years is something that really does stick in people's psyche. And I totally get the heroin line. I think it's so easy to decide to cheat one year. And then in all the future years, you're gonna cheat because you've broken expectations with customers, with shareholders. There's something kind of magical, even in the relationship between Costco and a supplier, where a supplier knows that when Costco is being really tough on them to give the lowest price, Costco is not gonna turn around and then mark it up 50%, make a bunch of money. Costco is going to make the same margin that they've always made on that good.

• 1:23:48David Rosenthal?

  Totally. It's worth double clicking on the supplier relationship for a sec. Costco's relationship with their suppliers is worlds apart from Walmart's relationship with their suppliers. You go to Bentonville as a supplier and you are getting put through the gauntlet. It is designed to squeeze you as much as possible. That is not how the supplier relationships work with Costco. They'll work with their suppliers. They'll understand your business. They'll come see you.

• 1:24:18Ben Gilbert?

  Yep. Okay, I was gonna save this for later, but we gotta do it now. The Costco code of ethics, as it exists today, largely inspired by the FedMart values from 40, 50 years before, are in order. Obey the law. Number one, first and foremost, obey the law. And we will save that for a moment. And I've got a fun story of how that came to be. Number two, take care of our members. And listeners, when you're listening through these, the order is important, the subject of each statement is important, and the phrasing of each statement is important. So one, obey the law. Two, take care of our members. Three, take care of our employees. Four, respect our suppliers.

• 1:25:04Ben Gilbert?

  And I find it fascinating that they use the word respect because they have a posture of tough but fair. And so there's this great anecdote, and I mean, I heard one, but there's 50 examples of this that you can find in various Tegus calls or talking with people who are suppliers to the company where Costco buyers always ask why when a supplier tries to increase the price. And that part's not that novel. I imagine a Walmart buyer also tries to ask why. The buyers are very deep, so they actually know the commodity prices of ingredients from suppliers. So let's take like a chocolate company, for example, that sells a chocolate product. If the chocolate company said, hey, the chocolate costs more now, the Costco buyer would say, well, I know the price of cocoa. I've been watching the commodities market.

• 1:25:48Ben Gilbert?

  I understand milk, sugar, butter. Why is it more expensive? Just give me feedback on that. And a lot of the times it is like a commodity price has gone up or they use labor in a certain area that's gone up. Or maybe they have a long dated contract with a supplier of their own that, you know, has an artificially high price for some reason until the contract expires. And so the Costco buyers will write all of this down, will keep track of it. And because they manage so few accounts, they actually can keep track of it. Like each buyer is only really adding three, five, 10, maybe 15 new SKUs a year, but you manage a very tight set of relationships. So they'll just call the supplier back and say, hey, last time we talked, you'd mentioned that cocoa prices were high. I've noticed they've gone down. Are you lowering the prices so that we can lower it for our members?

• 1:26:34Ben Gilbert?

  It's like this really amazing side benefit of having the low SKU count is that they can be tough but fair with suppliers and really stick to it.

• 1:26:44David Rosenthal?

  So awesome.

• 1:26:45Ben Gilbert?

  And because of Costco's gross margins always being targeted at 11%, capped at 14%, this means that for every dollar that Costco gets a supplier to reduce the price on something, again, tough but fair, the customer actually sees most, you know, 89% of the benefit. And so Costco really does just get to pass whenever they get a benefit, 89% of that benefit goes to the member. So the way I look at this is some companies always Look for ways to make more margin. Costco specifically does the opposite. They look for ways to provide more value to members and retain them for members as longer and get them to get their friends to be members. And they try hard across the board to get lower overhead costs through cleverness and

• 1:27:30Ben Gilbert?

  efficiency, not through squeezing or underpaying or anything like that.

• 1:27:35David Rosenthal?

  So there's a really fun acquired canon, acquired cinematic universe story related to this, which is the famous, as chronicled by Brad Stone in The Everything Store, coffee date between Jim Senegal and Jeff Bezos in 2001, which occurs at the Starbucks inside of the Bellevue Barnes and Noble of all places.

• 1:27:59Ben Gilbert?

  That's right.

• 1:27:59David Rosenthal?

  So perfect. And at the time, this is 2001, Amazon's stock was in the dumps. They were under pressure from Wall Street. Jeff and the organization were embarking on a campaign of raising prices on amazon.com to get profitable. And they had just started this rolling out. It was super important. Jeff has this coffee with Jim and Jim explains this philosophy to Jeff. Jeff comes back to Amazon HQ the next day and is like, I'm reversing the policy and says exactly what you just said. There are two types of companies in this world. Companies that work hard to charge their customers more and companies that work hard to charge their customers less.

• 1:28:40David Rosenthal?

  Henceforth, as of today, Amazon is a company that works hard to charge its customers less. And that is directly from Jim Senegal.

• 1:28:48Ben Gilbert?

  Wow. That's awesome. So on this point number four of suppliers, here's some quick math that illustrates why they do have to be so careful and why they do wield such an enormously large stick. So Walmart's revenue today is about three times Costco in the US. But since Costco sells so few items, they are a massive customer for any given supplier. They always have this super lopsided relationship. The average revenue per product because of the SKU count at Costco is about 10 times Walmart.

• 1:29:23David Rosenthal?

  Wow.

• 1:29:23Ben Gilbert?

  So anytime they're in a negotiation, I mean, like almost every time, the person sitting across the table is looking at Costco like, you are my largest customer.

• 1:29:32David Rosenthal?

  You're like 50% of my business.

• 1:29:34Ben Gilbert?

  I think they try not to have that be the case, but it's very easy for it to become that. So it is really important that they have it as one of their sort of four main tenets. Respect our suppliers. Now notoriously missing from these four is the notion of a shareholder. And Jim Senegal articulates, if we do these four things throughout our organization, and again, those four things are obey the law, take care of our members, take care of our employees, respect our suppliers, in that order, then we will achieve our ultimate goal, which is to reward our shareholders.

• 1:30:06David Rosenthal?

  It's so funny, going back to our previous episode and Rob Strasser's 10 Principles at Nike. And like, on the one hand, the Nike Principles and the Costco Principles are about as far apart as you could imagine. On the other hand, Rob Strasser Nike Principle number 10 is if we do the right things, we'll make money damn near automatic.

• 1:30:27Ben Gilbert?

  Right.

• 1:30:28David Rosenthal?

  And that really is the same thing at Costco.

• 1:30:30Ben Gilbert?

  100%. So fun story of how these code of ethics came to be. So in the mid 80s, the Washington State Liquor Control Board was putting Costco through the wringer when Costco was applying to sell alcohol. And I think at the time it was just beer and wine. And basically, the Liquor Control Board was looking for any possible reason to deny them. And I think there might have been some corruption going on. The state had a vested interest in preventing very large retailers from becoming the volume of selling beer and wine. And Costco, because they were started with this ethos, came through squeaky clean and actually got the permit. There was literally nothing that you could sort of drudge up on them to deny them.

• 1:31:14Ben Gilbert?

  And so the company was fortunate to realize at very early days, how much it would pay off to be truly above reproach. No matter how tempting anything was, they had to build a culture that was completely obsessed with this code of ethics. And you just see it everywhere. I mean, the wages, the way they treat suppliers, the fierce fixed cap on markups, the discipline not to raise memberships constantly. I think it's been like six years between the last two times they raised the membership, even $5. It's a ludicrously squeaky clean and long-term oriented mindset.

• 1:31:47David Rosenthal?

  So back to the story. At the time of the merger, the combined company was about 16 billion in revenue. That was up from Costco alone was 3 billion in 1989. So by the merger in 93, Costco and Price Club are each about 8 billion in revenue and then 16 together. So fast growing, impressive scale already.

• 1:32:09Ben Gilbert?

  And stores more concentrated on the West Coast, but around America by this point?

• 1:32:14David Rosenthal?

  Yeah, combined 200 stores. So pretty large footprint. They're in Canada, they're in Mexico, they've already started international expansion, which then is going to become huge throughout the 2000s, as we'll see for Costco. But right around the time they merger, Costco takes a pretty important step that unlocks a huge part of the next chapter for the company. And that is the creation of the famous Kirkland Signature House brand. And there's a fun story around this. When they were talking about creating their house brand, the company's corporate headquarters was in Kirkland, Washington, right near Bellevue, right across the lake from Seattle. And so that's where the Kirkland Signature name came from.

• 1:32:56David Rosenthal?

  I think by the time they actually launched it, they had relocated to Issaquah, a little farther south. And they're like, we can't call this Issaquah Signature.

• 1:33:04Ben Gilbert?

  No, Kirkland Signature is good.

• 1:33:06David Rosenthal?

  But it was tied in with international expansion because they needed a brand name and a trademark that they could clear across all the countries that they were operating in and planning to operate in. And so Kirkland Signature, like that works in Japan, that works in Korea, that works in Taiwan.

• 1:33:24Ben Gilbert?

  It sounds so generic. Like, I didn't even put it together when I first moved to Seattle 12 years ago, that the Kirkland over there was of Kirkland Signature, because Kirkland kind of just meant nothing to me. It meant, you know, what's the Whole Foods version, the 365?

• 1:33:40David Rosenthal?

  Yeah.

• 1:33:41Ben Gilbert?

  Interestingly, over time, Kirkland Signature has come to mean something, and that is a certain level of quality. Nobody is attesting that this Kirkland Signature sweatshirt is a Lululemon sweatshirt that has fancy materials and the most cutting-edge technology in it, but it is of a certain bar of quality that is sufficient for Costco members. And that is sort of the ethos that Costco has around Kirkland Signature, that we're only going to put something out there if we feel that we can create value for you, that it's going to be a lower price than what you could get otherwise. Or the flip side of that, that we can make a better product than you could get from any of these branded products that we were either previously stocking or evaluating stocking.

• 1:34:26David Rosenthal?

  And maybe the most obviously and perhaps most famously where this comes to bear is in wine and liquor sales. The Kirkland Signature wine, you know, you'll get people who are wine snobs that'll drink Kirkland Signature wine. They're like, yeah, yeah, yeah, it's Costco, but like, this is actually good stuff. And tequila and vodka, it's the same thing.

• 1:34:47Ben Gilbert?

  Oh, and especially for these things that are very clearly difficult to make, and therefore it's made by one of a few people, like made by a real winemaker, or like the batteries, definitely made by a company that makes other batteries. It's not like they're low-quality batteries. So I do think, much like their 11% target gross margin on everything, Costco looks at their house brand as an opportunity to provide value to members, not an opportunity to capture more margin for themselves.

• 1:35:15David Rosenthal?

  Yep. Now, they also have a pretty unique opportunity, they realize, with their house brand. Because of the very small number of SKUs that they're putting in the warehouse, there's much less competition on the shelves for any given product category for the house brand. So like, yeah, you mentioned, you know, Whole Foods has the 365 House brand, Walmart has their house brand, you know, blah, blah, blah, all these big retailers do. Safeway certainly does. But in a standard retail environment, the house brand is going to be one of like five or six or 10 different brands of a given product category on the shelves. At Costco... It's one of two, three?

• 1:35:58Ben Gilbert?

  Or one of one. I mean, if you go buy the mixed nuts, the mixed nuts are Kirkland Signature mixed nuts. The jumbo cashews are Kirkland Signature jumbo cashews. And in part because the buyers were evaluating the whole landscape and they determined we can do something better for less. I think the Costco fancy mixed nuts is the best mixed nut blend. But I think that that was an enterprising buyer who was being creative and working with suppliers and thought like, I actually think we can provide a better product for a lower price than what exists on the market. And I don't know, I think there's a lot of scenarios where they have. Certainly, consumers agree, $52 billion of Kirkland Signature sales were done last year.

• 1:36:40Ben Gilbert?

  That does not include the Kirkland Signature gas. So out of Costco's $230 billion top line, a little under a quarter of it was Kirkland Signature sales and closer to a third if you include the gas.

• 1:36:53David Rosenthal?

  Wow, that's incredible.

• 1:36:55Ben Gilbert?

  It's America's largest consumer package brand.

• 1:36:57David Rosenthal?

  So at the same time, too, as they're spinning up Kirkland Signature in the kind of mid to late 90s, they also start expanding internationally. So first they go to the UK, then they go to Korea, to Taiwan, to Japan, ultimately China, which is now a big initiative for them. What's interesting is, I think at the time, I suspect there were very few other Western-style, global or globally aspiring retailers that were entering Asian markets because it's not exactly obvious that a huge warehouse with bulk packaging would work in cultures like, say, Japan, where people live in tightly packed, dense urban environments,

• 1:37:42David Rosenthal?

  much smaller houses and apartments than in America. This is not the land of SUVs and suburbs.

• 1:37:48Ben Gilbert?

  Right.

• 1:37:49David Rosenthal?

  But it works great.

• 1:37:52Ben Gilbert?

  Yeah. I mean, at the end of the day, people really like value. High-quality products at a great value is a super compelling value proposition for anyone in the entire world.

• 1:38:02David Rosenthal?

  Totally.

• 1:38:03Ben Gilbert?

  I want to go back to something that we've been wading into in the discussion of Kirkland Signature, which is, why is it okay that at Costco, they can only have 3,800 SKUs? Like, why are people okay with this deal where I don't need selection when I shop here? And I think there's a few illustrative examples of the story from here that get into that. All right, listeners. Now is a great time to talk about a new partner of ours here on Acquired, Logora, the agentic operating system that is redefining how the world's best legal teams work.

• 1:38:37David Rosenthal?

  Yep. It's sort of obvious that AI is going to completely change the legal industry. I bet most of you listening have dropped a contract into some sort of AI chatbot out there. Logora took that insight and asked the question, what if you really built something with that power from the ground up for the legal industry?

• 1:38:54Ben Gilbert?

  So the founders did exactly what great founders do, operate with obsessive customer focus. They embedded inside a massive law firm for months. They sat with the lawyers just watching how the work really gets done.

• 1:39:09David Rosenthal?

  And that's how you get features that customers love, like Tabular Review, where you drop in a folder of hundreds of contracts and it pulls every key term into a grid a lawyer can actually work with. Logora's bet here is interesting. Since it lets each lawyer handle more complexity, any given person can increase the quality of their work and do higher value work. And this means that the pie can grow even as each individual task takes less time.

• 1:39:33Ben Gilbert?

  And they recently launched Logora Agent, offering greater intelligence and performance. The agent lets lawyers set an objective. Then it can handle the planning and the execution and delivery of the final product. Legal teams get to maintain full control and transparency since they're still involved where judgment is required.

• 1:39:52David Rosenthal?

  And Logora works where you already work. You can use it within Microsoft Word while redlining or drafting. The early Logora numbers essentially speak for themselves. When they have a head-to-head pilot with their top competitor, they win 70% of the time. Logora now has over 100,000 lawyers on the platform from 1,200 legal teams in 50 countries. And crazily, they went from 1 million to 100 million in ARR in about 18 months.

• 1:40:22Ben Gilbert?

  Truly insane numbers. And that is the real test. Plenty of things demo well, but the question is whether a busy associate actually reaches for it during crunch time, or whether a partner trusts it before going into a conversation with a major client. If your legal team wants to check it out, whether you're a law firm or you're in-house at a company, you can learn more at logora.com/acquired and just tell them that Ben and David sent you. So David, let's talk about low selection and how that's okay. So Walmart and other retailers operated under the assumption that shoppers require selection. It seems like a reasonable assumption unless you started your life as a B2B wholesaler

• 1:41:03Ben Gilbert?

  that then fell backwards into consumer and then realized it was fine for consumers, too. So obviously, if you have selection, it makes the life of a retailer very difficult in a lot of ways, but it was just assumed that you had to. But Costco makes the opposite bet. They bet that you don't need selection as long as you ensure that everything you can buy is high quality. And that is the crazy thing that has worked. Costco essentially has its entire buying team's ethos, sort of shopping for you. They're pre-selecting the best one or two items in every category. And consumers, because they do all that work ahead of time, are basically just okay sacrificing selection entirely and saying, yeah, as long as you give us good value on great stuff, we're totally okay with that.

• 1:41:48Ben Gilbert?

  That's an important unlock. You can't just have low selection and be like, well, it's all cheap stuff. It has to be like, high quality in its category and the best deal on the market in order for people to be okay with low selection, which drives low SKU count, which drives all the amazing things we've talked about so far.

• 1:42:06David Rosenthal?

  Yep. It comes back to trust. And part of this, too, also hearkens back to Saul and the FedMart days. Saul developed this kind of principle back in FedMart that he called the intelligent loss of sales.

• 1:42:20Ben Gilbert?

  Yes, I was waiting for you to bring this up.

• 1:42:22David Rosenthal?

  Yeah. So this isn't necessarily the number of brands in terms of the selection out there. This is about product sizes. So today Costco has taken this to the extreme of like, you can only buy the two and a half pound jar of nuts. There's no like, eight ounce jar of nuts.

• 1:42:38Ben Gilbert?

  Well, you could buy a whole bunch of little packs of, afternoon packs of nuts.

• 1:42:42David Rosenthal?

  Either way, you're walking out with a lot of nuts.

• 1:42:44Ben Gilbert?

  Yes.

• 1:42:45David Rosenthal?

  But other retailers and everybody back in the FedMart days had all sorts of different sizes of products. And the idea was that by having different sizes, you would maximize the surface area of customers in market that you could reach. Like Saul uses the example in the book of household lubricating oil, like kind of WD-40 type stuff. He's like, we only carried the eight ounce can, even though there was like a three ounce can out there. We lost some sales from customers that only needed one or two ounces and thus would only buy a three ounce can. And they just didn't buy the eight ounce can. But it was worth it to us to forego that because by only having the eight ounce can, we could reduce the number of SKUs that we had and get all these benefits that you're talking about, Ben.

• 1:43:31Ben Gilbert?

  I mean, yes. You and I have been trying to do this without having a name for it for years. People sponsor acquired seasons. There are lots of other podcasts that let you do all kinds of crazy stuff. And we're just like, look, we have a SKU. It's called the season. We would love to work with you on that. And it makes our lives so much better. And we can run our business in a completely different way by having a low SKU count.

• 1:43:52David Rosenthal?

  Totally. If we didn't do it this way, we would need to have an ad sales team or work with, you know, an outsourced network or something like that. That would add way more overhead to our business that we don't want.

• 1:44:01Ben Gilbert?

  Right. This stuff is all about the trade offs you are willing to make and just daisy chaining them together such that the benefit of each trade off plays into the benefit of another trade off that you are making in a way that's aligned.

• 1:44:14David Rosenthal?

  Yep. I knew we were gonna love Costco.

• 1:44:17Ben Gilbert?

  Honestly, it's like maybe my favorite business that we've studied. Let's wait till the end to talk about that. But there's a few more things along the way that happened in the 90s and 2000s before we get to today that I think are important to touch on. We've mentioned logistics a few times and that the low SKU count means that they can meaningfully simplify their logistics. And to put a point on that, they only have so many suppliers who are bringing goods to Costco. The fact that they sell in bulk means that they can bring a whole pallet into a warehouse and consumers just sort of come and pluck it off the pallet. It's wholesale. It's a wholesale club. But there's something we haven't talked about, which is Costco's distribution centers. So they use something called a cross-dock system for their distribution centers. Now, remember I mentioned back in the Price Club days, it's a little bit more complicated today.

• 1:45:02Ben Gilbert?

  Not all the suppliers just show up to the one store, the one warehouse with all the goods. They actually do need some system to receive things from suppliers and bring them to stores.

• 1:45:11David Rosenthal?

  Yeah, back in the Price Club days, there were no distribution centers.

• 1:45:14Ben Gilbert?

  Exactly. But here's how the distribution centers work. Trucks pull up on one side and unload pallets, and that's where the suppliers' trucks are. On the other side of the warehouse, there are Costco trucks. And so what happens is, since they move stuff entirely by the pallet, no partial pallets, no, these few things go to this store, these few things go to that store. The supplier trucks unload the pallets. They just get scooted across the dock to go directly to a Costco warehouse. And then, within minutes to hours, that truck leaves. And there's no unwrapping of individual boxes. There's nothing sitting overnight in the facility. This is so much simpler, and it really plays into that cash flow dynamic,

• 1:45:56Ben Gilbert?

  where things can be available for sale so fast. And just to underscore how differentiated this system is, 92% of Costco's merchandise is cross-docked. Only 10% of Walmart has cross-docked merchandise on a pallet system like this.

• 1:46:12David Rosenthal?

  And it's not like Walmart hasn't invested many tens of billions in their distribution and logistics systems.

• 1:46:19Ben Gilbert?

  Totally. It's just that Costco has made a trade-off that makes it so that they just have a much simpler operation. And they've got all the downsides that come with the trade-off, no selection, but they get all the upside that comes from it, too. And so this also plays into this labor thing. You can totally pay your employees more when you need less people to generate the same amount of sales. You don't have wasted manpower unwrapping items from pallets, no one turning the labels out to look pretty. The customers do all of this. So it legitimately means they just need less people. And this is why they generate over $730,000 of revenue per employee. They're just efficient in aligning their trade-offs.

• 1:46:57David Rosenthal?

  I love it. This is the bricks and mortar retail version of the SaaS business fallacy, which we fall prey to all the time on the show, which is if you invest in or build around SaaS companies and SaaS company margins, you can fall into the trap of thinking, well, why would I ever want to be involved in a business that doesn't have 90% margins? But actually, what you should really care about, especially as an investor, is not your margin percentage, but your absolute margin dollars. And so, yes, Costco has much lower margins than their competitors, but the volume that they drive and the actual dollars end up being worth it.

• 1:47:42Ben Gilbert?

  Yeah, even though Costco is only an 11% gross margin business and only ever will be an 11% gross margin business, it's still a pretty amazing business to own.

• 1:47:51David Rosenthal?

  Yeah, I mean, it's, what did you say, $230 plus billion of revenue?

• 1:47:56Ben Gilbert?

  And $7.5 billion of operating income off that. So again, tiny little sliver margins, but $7.5 billion of operating income falling out the bottom is pretty awesome.

• 1:48:08David Rosenthal?

  Yep, especially $7.5 billion of highly defensible operating income.

• 1:48:14Ben Gilbert?

  Yeah, seriously. And as you've been talking about, because of the way that their inventory is financed, a reasonably capital light business, all things considered, I mean, they're building these warehouses on huge pieces of real estate, you know, with gigantic shelving and all this headcount. And it's an amazingly capital efficient business. It's weird.

• 1:48:34David Rosenthal?

  Yeah. Okay, I think it's time to talk about investing nerds' favorite aspect of the Costco story, which is that there really are two different businesses here under one roof. There is the retailer, and then there is the membership business. It's almost like way back Saul and Robert sitting in the office after FedMart thinking, you know what, we actually had two different businesses at FedMart. Costco is also two different businesses. There is the operations of the retailer, and then there is the membership business.

• 1:49:08Ben Gilbert?

  Right. And psychologically, they're one thing. It's one experience for the customer, but financially, it's two entirely different things.

• 1:49:15David Rosenthal?

  Yep.

• 1:49:16Ben Gilbert?

  So a lot of people like to make a lot of hay about the idea that Costco generates all their profit on memberships and that retail is just a break even business. And this has been popular to say because they run the retail business at such thin margins and memberships are nearly a 100% margin business. I mean, really, what does it take to run a membership business?

• 1:49:39David Rosenthal?

  Yeah, with like a, what, 90% renewal rate?

• 1:49:42Ben Gilbert?

  Something crazy high like that.

• 1:49:43David Rosenthal?

  Talk about a SaaS company.

• 1:49:44Ben Gilbert?

  Yeah, but it's not quite true. It is accurate to say that membership fees represent about 70% of the company's operating income with the other 30% of the profit margins coming from retail. It's been a little bit more than 30% in recent years, but that's sort of the historical split. Think about it as sort of a 70/30 thing. It really is staggering that a business that does $230 billion top line, 70% of the profits can come from the $4 billion of revenue they generate from memberships. That tells you how razor thin the margins are on their retail business, almost to the point where you're like, why do they care about growing sales at all? All they should care about is increasing retention of members.

• 1:50:28Ben Gilbert?

  The split is just significant enough for the retail business where you're like, okay, yeah, we should care about growing sales in the retail business. But if it wasn't 70/30, if it was 90/10 or 95/5, you'd kind of be like, well, I'm actually not sure why we care about making a single nother sale of toilet paper because unless it is increasing the likelihood someone retains, I don't care about it. And they're not quite there, but they're almost there.

• 1:50:52David Rosenthal?

  Well, except though, the way that you grow memberships is you grow retail sales.

• 1:50:57Ben Gilbert?

  Right. But for the last several years, they have totally been growing retail sales per member. And if it was like a 95/5 split, you sort of could make the argument of like, why do they care about growing the retail sales per member? But at this sort of more 70/30-ish split, there's just enough profit dollars coming from the retail side of the house where you care about that, too.

• 1:51:17David Rosenthal?

  I love it. It's like Amazon and AWS versus Amazon Retail.

• 1:51:21Ben Gilbert?

  Yes. In the last 25 years, membership has grown from nearly nothing, if you look at what the numbers were in the early 90s compared to today, $4.5 billion.

• 1:51:30David Rosenthal?

  Yeah. I mean, when we were talking about the FedMart days, like, it was $2 for a lifetime membership.

• 1:51:35Ben Gilbert?

  Crazy. And again, David, this membership business takes almost no investment.

• 1:51:41David Rosenthal?

  They don't do any advertising.

• 1:51:43Ben Gilbert?

  Right. To quote our friend Andrew Marks, "I basically think that Costco has decided to only be a decent return on invested capital retailer, which allows them to have an insane return on invested capital membership club business."

• 1:51:56David Rosenthal?

  Yup.

• 1:51:56Ben Gilbert?

  It's so true. Again, to quote Andrew, "insanely stable growth on a huge capital-light fee stream."

• 1:52:03David Rosenthal?

  I mean, that sounds like a venture capital management company.

• 1:52:07Ben Gilbert?

  It's pretty wild.

• 1:52:09David Rosenthal?

  All right. Speaking of membership, let's talk about the last big innovation piece of the puzzle before we get to the business today. And that is the two-tiered Costco membership system and the executive memberships, which they launched in 1998. Is that right?

• 1:52:26Ben Gilbert?

  Yes, 1998, the executive membership. So what is the executive membership and why are we bothering to spend time on it? Isn't it just a second, higher-priced membership? It is super illustrative of management's thinking. So I love this as a microcosm for all of Costco. So you can spend an extra $60, so total 120 instead of 60, and what you get for that is 2% cash back on your transactions. Now, that 2% cash back is limited, but it's limited at something crazy. Like, you can only get $1,000 back.

• 1:52:59David Rosenthal?

  A $60 incremental investment for $1,000 back is pretty good.

• 1:53:03Ben Gilbert?

  Right. And if you actually hit that $1,000, it would mean you're spending $50,000 at Costco a year.

• 1:53:09David Rosenthal?

  Oh, wow. I'm sure there are people that do it.

• 1:53:12Ben Gilbert?

  So the break even point of this $60 is $3,000, which is not that hard to hit. In fact, it's right around, and I suspect this is why management priced it that way, it's right around the average household spend at Costco. So they want to make it basically break even for basically everyone.

• 1:53:29David Rosenthal?

  Which is so awesome and also different than other retailers. I mean, now there's all sorts of fancy technology systems to do this, but Costco has always been able to track customer spend at the individual level because they're all members. They have accounts for all of them.

• 1:53:44Ben Gilbert?

  100%. And other people might invent something like this to say, well, we're going to bet that they won't use it, they won't shop here enough, and we'll get to make some money on the people who are infrequent shoppers, and we're excited about that. And we'll basically get the breakage on people who pay for the upgraded membership but don't, you know, shop enough. That's not at all what Costco is doing here. And to illustrate that, here's the insane part of it. If you do not use it, they will refund it.

• 1:54:12David Rosenthal?

  So great.

• 1:54:12Ben Gilbert?

  Is there anything more Costco than that? It is an amazing value for members. It is such a good value that 55% of US members now do it. But, much like everything else we've talked about with Costco, it is also amazing for Costco because they get your money at the beginning of the year, further advantaging their cash flow position. And it gets even better because it makes you more likely to go shop there now, since you get even better deals with the cash back. You effectively, instead of getting the 14% gross margin, Costco's now only making a 12% margin on you when you shop there. So as long as you're spending $3,000 or more, it basically just makes Costco's margin even lower for everything

• 1:54:54Ben Gilbert?

  you purchase. Interestingly, 45% of paid members worldwide are executive members, but those members represent 73% of sales. So whether by causation or correlation, executive members just spend more. And estimates are that regular members buy less than one-third of what executive members do. So it's this fascinating customer segmentation thing where Costco just gets to know and reward the most frequent shoppers who do the highest volume purchasing. Executive members, as you would guess, also renew at a higher rate, and so it helps with retention. On top of that, which they call the triple play, membership-

• 1:55:35David Rosenthal?

  These guys are so folksy. I love it.

• 1:55:38Ben Gilbert?

  If you get the Costco issued Citi Visa card, you renew at an even higher rate. So they have these layers of letting you opt into loyalty. And all of this, David, as you mentioned earlier, is on top of a high renewal rate anyway. 93% of members in the US renew every single year.

• 1:55:55David Rosenthal?

  Amazing. And you can really see the fingerprints of this DNA in Amazon Prime. Obviously, the whole thing is inspired by the Costco membership writ large, but these same dynamics definitely play out for our Prime members at Amazon. Of order more frequently, much more likely to renew, access a whole suite of services.

• 1:56:20Ben Gilbert?

  It keeps you in the Amazon ecosystem and it makes sure that you're buying more stuff.

• 1:56:24David Rosenthal?

  Yep.

• 1:56:25Ben Gilbert?

  Amazon makes money on the stuff. Costco makes money on the membership. But at the end of the day, it is nice to retain a loyal customer. To contextualize the 93% member retention, again, that's just all members. That's not even the executive members or the credit card owners. Subscriptions to streaming services renew like half of their customers every year. So consumer subscriptions retaining at 93% plus is nuts. That's the monthly retention of most streaming services. It's crazy. On top of all of this, I'm pretty sure that this has never been disclosed and I haven't asked anyone about it, but if you sort of read trade publications, people seem pretty convinced that Costco is making money, which of course they are,

• 1:57:08Ben Gilbert?

  on the deal that they cut with Citi and Visa in order to have the Costco card be the Citi Visa card. I mean, most of the time when you are processing payments, you owe 2% to 3% of each transaction to the issuer of the card. I think the dynamics are actually the opposite way with Costco, where Costco gets to hold an auction and say, "We have an enormous amount of payment volume with enormously good customers with good credit. Would you like to do business with us? And who would like to pay us for the privilege of being the Costco card rails?"

• 1:57:42David Rosenthal?

  Yeah, I imagine there's not a lot of defaults in the Costco customer segment base. There's also some fun history to all this, too. So that deal, which you may know, Ben, used to be with American Express. And then they essentially kind of held an auction, as you say. I think the origins of this, though, start all the way back with the original Price Club business plan. Not to offer credit, but specifically not to offer credit. Another one of the big benefits of moving to this business wholesale model was they could get out of the credit card game that they had to play at FedMart. When they were only selling to businesses, when that was the plan, it was like, hey, cash or check. That's it. No credit card exchange fees that we're going to have to bear.

• 1:58:26David Rosenthal?

  And then when they opened to consumers in the group model, they kept that. So for a long, long, long time, you couldn't use credit cards at all in Price Club Costcos.

• 1:58:35Ben Gilbert?

  And that's the importance of doing the hard thing first. By proving that they could exist and set customer expectations around, we're only cash and check. It meant that they never had some scary moment where if credit card companies were putting the screws to them, they had a bunch of fear around, will customers not shop here? They were, just from the very beginning, getting 100% of the dollars rolling in. And so they knew the counterfactual. They knew customers are going to shop with us no matter what. Credit card companies, if you want to work with us, you're welcome to, but we do not need to pay for the privilege because we know that our customers are not going to leave us. For a fact.

• 1:59:10David Rosenthal?

  Yep. You'll be happy to have our business, not the other way around.

• 1:59:14Ben Gilbert?

  It's crazy. Of course, with Costco's margin structure, they literally couldn't. I mean, speaking of trade-offs, they literally couldn't ever accept credit. How, with an 11% gross margin, are you going to go give three percentage points of that 11% to a Visa like it actually would flip the business upside down? We talked about it a minute ago. They make, what, $7.5 billion of operating income on $230 billion of sales. The credit card companies eat all your profitability if you let them in the door. And so it's a pretty incredible position, toughing it out and doing the hard thing first, and then being able to sort of flip to the other side of the table.

• 1:59:50David Rosenthal?

  Yep.

• 1:59:51Ben Gilbert?

  Anyway, I love that point on the payment processing. I think it's an amazing playbook that Costco ran over the years and a necessary one. Every single time Costco does something amazing, they needed to because of the trade offs that they chose.

• 2:00:03David Rosenthal?

  Yep. So I think that's the last big piece. Let's take it to the business today.

• 2:00:08Ben Gilbert?

  Definitely. So David, to your point, we talked about very few things between, to be honest, like the late 80s and today. And it's because the model was basically cast in stone. I mean, they added things like gas, they added ancillary services and you can go get glasses and you can go buy diamond rings. And I don't know, maybe some of that was done earlier.

• 2:00:28David Rosenthal?

  I think a lot of that was from the Fed Part days.

• 2:00:30Ben Gilbert?

  Big yard goods, I bought a shed there. But the story is intentionally boring. It's what if you grow at 10% for decades, doing exactly the same thing, having a well understood set of trade offs and a strong culture? Where does it go?

• 2:00:44David Rosenthal?

  Yep. And you operate in arguably the second or maybe third biggest market in the world.

• 2:00:50Ben Gilbert?

  Right.

• 2:00:51David Rosenthal?

  Which is global retail.

• 2:00:53Ben Gilbert?

  Right. And you're the third biggest player in the largest market, you know, America, behind Amazon and Walmart. So this acquired episode is different because so much of it is just nerding out over the awesome nuances of Costco's business model and actually less of, and then this crazy thing happened because it was a bunch of like stand up guys making an intelligent set of trade offs, really thinking hard, and then a whole bunch of people working hard for a long time. That's the story.

• 2:01:19David Rosenthal?

  Once Saul got things figured out in the second iteration with Price Club, really straight line to today. So let's paint the picture today. And then I think what's interesting to talk about next is, okay, everybody knows how this all works. How is it defensible? Why does only Costco do Costco? But first, tell us about Costco today.

• 2:01:36Ben Gilbert?

  So I don't think people realize, maybe by this point of the episode they do, but certainly not before, how big Costco is. It's sort of a sleepy story since it's tucked away in a Seattle suburb. They don't do a lot of chest pounding. They just are quiet and they do 230 billion in revenue. They're the third largest retailer in the US. They have 124 million members worldwide. One third of US shoppers are Costco customers. They have a little over 300,000 employees at 860 stores. We talked about this. They do 750-ish thousand dollars of revenue per employee.

• 2:02:15David Rosenthal?

  Yeah, that's wild. If I remember from our Walmart episode, Walmart, I think, has over 2 million employees. I believe Amazon has well over a million.

• 2:02:23Ben Gilbert?

  Yeah, so Costco is doing somewhere between a third and a half the total revenue of Walmart, but they're doing it with, what, almost an order of magnitude fewer people.

• 2:02:31David Rosenthal?

  Yeah.

• 2:02:32Ben Gilbert?

  It's crazy. They have the highest revenue dollars per square foot of any wholesaler or discount store. Target's about $450 per square foot of revenue. Walmart's about $600. Costco is $1,800 per square foot of revenue.

• 2:02:48David Rosenthal?

  Wow. Is that a Costco or an Apple store?

• 2:02:50Ben Gilbert?

  And they have a lot of square feet.

• 2:02:52David Rosenthal?

  Yeah.

• 2:02:53Ben Gilbert?

  And this is up from, let me look at this graph. In 1998, they had $600 a foot, and now they're at $1,800 a foot. So meaningfully grown it. It's important to point out, you made the comment about Apple. Costco's margins are a lot lower than Apple, so they're generating a huge amount of revenue dollars, not so much on the margin dollars, but as we've been talking about, that's the point.

• 2:03:16David Rosenthal?

  Yep. The individual warehouses these days, you may have these stats exactly, but I think an average Costco warehouse generates over $200 million in revenue, and the top ones generate $300-400 million of revenue for a single store. Single Costcos could be scaled public companies on their own.

• 2:03:36Ben Gilbert?

  Yeah, $269 million of sales per store on average per year.

• 2:03:42David Rosenthal?

  Wow.

• 2:03:43Ben Gilbert?

  Nuts. So just for fun, let's go north of 1,800, just to see who else is out there. Tiffany is 3,000, so kind of within spitting distance, like it's only 2X or it's less than 2X, and they sell diamonds.

• 2:03:57David Rosenthal?

  Well, so does Costco.

• 2:03:58Ben Gilbert?

  Yeah, that's true. Apple, of course, is the GOAT at $5,500 a square foot with high margins. I mean, Apple's just a nuts business. But it's worth pointing out Lululemon is approaching Costco level two. They're around $1,600 a foot, but of course, much smaller stores than Costco. Costco is just unbelievably efficient. We talked earlier about how that's illustrated in the headcount efficiency, but now we see it in the real estate efficiency, too.

• 2:04:24David Rosenthal?

  Yep.

• 2:04:25Ben Gilbert?

  This point on growing revenue per foot is interesting. You know, I mentioned it went from 600 to 1800 over the last 25 years because it reminds us to look at an important similar metric in retail, which is same-store sales. So Costco grew this by 14% last year.

• 2:04:42David Rosenthal?

  Wow.

• 2:04:42Ben Gilbert?

  Same-store sales, 14%, which is how you get to that $269 million of revenue per store. They are so good at this that they actually publish their stores by cohort year in their annual report, which almost no other company and certainly no other retailer does. And they clearly illustrate that not only does the average store increase meaningfully over the previous year in most years, but new stores also inherit a lot of the learnings. So the first year of a new store is dramatically better than what first years of stores were years ago. And to illustrate this, year one of a store opened last year was better than year five of a store opened in 2014.

• 2:05:25David Rosenthal?

  Wow.

• 2:05:26Ben Gilbert?

  It's crazy.

• 2:05:27David Rosenthal?

  It's also wild that these stores are still growing at those rates year over year, given that many Costco stores have been open for like 30-plus years at this point.

• 2:05:40Ben Gilbert?

  Right? It's crazy. I mean, part of it is the addition of gas and the other big ancillary items they're selling, but part of it also is just being really good merchants and finding these little things that members love and find value in and doing little optimizations everywhere.

• 2:05:54David Rosenthal?

  Yeah, and exactly to that point, you know, one of the sort of famous aspects today of the Costco shopping experience is the treasure hunt nature of it. And this is something that they've learned over time. You know, the original Sol Price Price Club business plan was just the 3,000 core SKUs for businesses and then opening that up to consumers. Along the way, they kind of realized that, hey, if in addition to the core staples we have, which pretty much don't change, we could change the brands, we could change the exact details of what they are, but we're always going to have nuts. You know, we're always going to have chicken, stuff like that. If we have a small number of additional ooh and ah,

• 2:06:39David Rosenthal?

  wow, one-time items, such that every time as a member you come into the store, there's something new and different for you to find and buy at a really low price, that would drive repeat traffic and make coming to Costco more of a novelty, more of an entertainment event. And so today, I think about 25% of their SKUs are these treasure hunt items.

• 2:07:02Ben Gilbert?

  Huh, I did not realize that. I mean, I know they've sort of learned a bunch of things over the years, like when they brought in fresh food for the first time, they didn't optimize the place in the store where they put that, but they still saw a huge spike because it drove repeat. When you have fresh food, people come in, they want to buy that, they add some other stuff. But they've been very clever in figuring out where to put it in the store to make sure that you have to walk by a bunch of other stuff to get, I mean, the fresh food is in the back, right? It's like, if you're coming in for fresh food, congratulations, you get to see all these other cool things that our buyers have managed to find out in the world for you. And of course, you get some of those, too.

• 2:07:34David Rosenthal?

  Yep, and I think for the items, again, the non-staples, the treasure hunt type items, they intentionally want to run out so that they're not going to be there next time you come.

• 2:07:45Ben Gilbert?

  Yes, that's a good point.

• 2:07:47David Rosenthal?

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• 2:07:53Ben Gilbert?

  Yes, there is a reason why the best product teams rely on Statsig, whether they are iterating on their core product features or shipping AI-powered experiences at scale.

• 2:08:04David Rosenthal?

  Yep, in the crazy speed of today's AI world, shipping fast is just table stakes now. It's basically trivial to build and deploy your app constantly. The real advantage is how quickly you learn what changes actually created value for customers and how fast you can use that signal to guide what you ship next.

• 2:08:24Ben Gilbert?

  This is where Statsig comes in. It brings experimentation, feature flags, and product analytics into one unified system so teams can ship safely, test rigorously, and directly link what they changed to how users actually behaved.

• 2:08:37David Rosenthal?

  So if you want to make learning your competitive advantage, whether you're building new AI experiences or just evolving your existing core product, go to statsig.com/acquired to get started.

• 2:08:48Ben Gilbert?

  Okay, analysis time?

• 2:08:50David Rosenthal?

  Analysis, let's do it.

• 2:08:51Ben Gilbert?

  Because we haven't been analyzing this business yet. Yeah, so the first segment that we're going to do in our analysis here is power, which is adapted from Hamilton Helmer's Seven Powers book, which is an amazing framework for business strategy. The question here is, what is it that enables the business to achieve persistent differential returns? Or put another way, how can a business be way more profitable than their closest competitor and do so sustainably? The seven options are counterpositioning, scale economies, switching costs, network economies, process power, branding, and cornered resource.

• 2:09:33Ben Gilbert?

  There is one here that is so painfully obvious that it has been observed over and over again over the years, and the original credit goes to investor Nick Sleep. And the power is scale economies. It's Hamilton Helmer's notion that Costco has the ability to leverage their scale to compete for items that their competitors can't get, or perhaps get a better price from suppliers than any of their competitors. Nick Sleep has this phrase that I think is possibly the best way to describe Costco: "Scale economies shared with customers." And the flywheel looks like this. Costco has enormous volume, and what they do with that volume is they go to the supplier

• 2:10:17Ben Gilbert?

  and they say, "What is your absolute lowest price where you're still making an honest margin on this, but you're willing to sell it to us?" And then Costco makes sure of that, and they do their research, and they come to a price and they say, "Great." And then Costco looks at their own business and they say, "How can we have the lowest possible overhead? What is the smallest amount of dollars we can spend at our head office, turning the lights on at facilities? What is literally the leanest we could possibly run and still break even or generate a small profit?" That's how they come up with this 11% target gross margin number. And so what they do then is they mark up the goods, literally the smallest amount that they can, in order to share the most value with their shoppers, with their members.

• 2:11:01Ben Gilbert?

  And then the cycle repeats. They get more members, they get better deals from suppliers. And to be honest, this scale economies that they then share with customers... I don't know how anyone could ever catch them in this moat that they've built from that.

• 2:11:16David Rosenthal?

  Well, because as we were talking about, for most, if not all of their suppliers, they are by far the biggest buyer of their goods, even bigger than Walmart, because they have so many fewer SKUs in the store.

• 2:11:28Ben Gilbert?

  Yep.

• 2:11:29David Rosenthal?

  This is so fun. I feel like there is such a resonance between Costco and Nike, even though on the surface, they're so different. Maybe this is like a Pacific Northwest thing. But I really think Nike has incredible brand power, but they choose not to use it to increase their margins. They choose to use it to keep prices low and accessible for customers. And Costco does the exact same thing here. Costco could definitely make a higher margin than they do now and still charge lower prices than Walmart, but they choose not to. And instead, they share that benefit back with customers.

• 2:12:07Ben Gilbert?

  And that is an investment in their enterprise value. Costco is choosing to invest those dollars in making the franchise more durable by getting more customer love.

• 2:12:17David Rosenthal?

  Yep. It really is a choice in durability, I think.

• 2:12:20Ben Gilbert?

  Yes. In fact, it's what Jeff Bezos meant when he said, "Your margin is my opportunity." But Costco just runs the playbook so consistently. And when you look at their overhead, the fact that Costco runs at 10, 11% overhead and Amazon runs closer to like 30% overhead, Costco has chosen a business model where they actually can just have lower margins on stuff because they don't need to do things like ship goods to your home. They need way fewer people. They need way fewer investments in technology to do crazy robotic sorting at warehouses, picking and packing. The Costco business model is one where they've just gotten rid of all of that. They say, "We're not even going to play that game.

• 2:13:02Ben Gilbert?

  Our goal is to lower our overhead so we can pass along the most savings to customers."

• 2:13:08David Rosenthal?

  Lower our overhead and lower the prices that we're paying suppliers so we can pass that on to customers, too. This is amazing. So this might be the first example, I think, that we've found in the history of the show. I think Costco has incredible counter positioning power today as a large incumbent in a way that they did not have when they got started.

• 2:13:32Ben Gilbert?

  Ooh, this is rare.

• 2:13:33David Rosenthal?

  They probably had some counter positioning in other ways, but today I think they have huge counter positioning versus Amazon and e-commerce. And we should talk as we go here about Costco's e-commerce operations, but they are famously Spartan, shall we say, to me. The whole point of Costco is you go to the Costco.

• 2:13:54Ben Gilbert?

  And the Costco HQ believes that, too.

• 2:13:56David Rosenthal?

  Yeah. It is completely counter positioned to Amazon's whole reason for being, which is convenience. Certainly, if price is no object, it is way more convenient to just click, click, click in the shopping cart in Amazon and have it show up at your door.

• 2:14:13Ben Gilbert?

  Yes, different set of trade offs, for sure. But it is rare that as an incumbent, you have the counter positioning power. It's usually a thing that startups do against incumbents, but Costco is a $230 billion company that none of the other big companies can copy. I mean, Walmart is trying and still is not succeeding at it.

• 2:14:33David Rosenthal?

  So as we've been researching this episode, naively in the past, I always thought, oh, yeah, Costco is great, but they really don't get the internet.

• 2:14:42Ben Gilbert?

  Which I think that also is kind of true. Like 15 years ago, I think they thought the internet was going to be a fad, which is why they missed it at first. And now they're sort of intentionally missing it. But we'll get into it, but they're doing it in their own way. But I actually do think they underestimated it at first.

• 2:14:56David Rosenthal?

  Yep. But I think where they've ended up is actually in a pretty good place and in a better place, I think, than Walmart. And that place being that, no, no, the whole point is we are not an e-commerce company. And the whole point is you come to the warehouse. And because you come physically to the warehouse and you take the stuff off the shelves, you're going to be able to get absolutely the best price versus anywhere else. And Amazon today has really become something else from what Jeff wanted it to be after his coffee with Jim Sinegal.

• 2:15:29Ben Gilbert?

  It's not always the lowest price. Often you are paying for convenience.

• 2:15:33David Rosenthal?

  Far, far from it. You are very much paying for the convenience of shopping on Amazon. I think on almost every product these days.

• 2:15:40Ben Gilbert?

  Or the brand. Very often I will buy something that's a little bit more expensive on Amazon because I'm like, well, it's going to be easy to return. Or, well, I trust this company. That's a very different premise than the original idea.

• 2:15:52David Rosenthal?

  Yep. So yeah, I really think that Costco amazingly has this huge incumbent, has developed a lot of counter positioning power.

• 2:16:01Ben Gilbert?

  Yeah, that's a good point. Switching costs, I guess there's some, I'm not going to go join BJ's Wholesale Club or Sam's Club when I already have a membership. So to some extent, but I don't think that's the reason that they win. Network economies, not really.

• 2:16:16David Rosenthal?

  No, I think it's scale economies.

• 2:16:18Ben Gilbert?

  Yeah. Process power, definitely. I mean, there's a culture at Costco that others have failed to replicate or haven't tried hard enough to replicate.

• 2:16:27David Rosenthal?

  Yep. I don't think there's a cornered resource, but branding is an interesting one. Let's talk about that.

• 2:16:32Ben Gilbert?

  Right. So recently, a bunch of folks from Costco got to go ring the bell at the NASDAQ and they're all wearing their Kirkland Signature sweatshirts. And a joke is made about the idea of Kirkland couture. And it's worth footnoting this, it's not the main point here, but it is weird how Kirkland sort of has a passionate following in a way where it's turning into a real brand when that was not the intention.

• 2:17:02David Rosenthal?

  The brand identity is that it's the anti-brand.

• 2:17:05Ben Gilbert?

  Right. There's a lot about our current consumerism climate that I think fuels that. Also, quick aside, Costco has never tweeted. The account has a lot of followers and zero tweets. They're not really a participant in social media, but they have a massive tailwind from all the Costco TikTokers. There's people constantly sharing videos about, here's this amazing thing I found, or here's how I've structured my day to work Costco in, or...

• 2:17:32David Rosenthal?

  Here's my haul.

• 2:17:34Ben Gilbert?

  Yes, they've benefited enormously from influencers.

• 2:17:38David Rosenthal?

  Well, and this has always been part of the strategy, even going back to the Fed, Martin Price Club days. Saul and then now Costco doesn't advertise either at all or like very, very minimally. But they very intentionally, back in the day, tried to get local six o'clock news stories. About like, oh, the lines at Costco. Oh, this crazy treasure hunt item at Costco. And it always worked. Whenever there was a store opening, news crews would go nuts. And it's kind of like the Nike athletes wearing the shoes on the cover of Sports Illustrated sort of thing. That's worth a lot more in earned media than anything you could ever buy.

• 2:18:15Ben Gilbert?

  All right, David, while we're here, we have to tell the hot dog story. So this comes up literally every time there's any sort of writing or podcast or book or anything about Costco. Very famously, as David and I talked about, the hot dog and drink combo has been $1.50 for many, many years. And when Jim Senegal handed over the reins to Craig Jelinek, Craig went to him and said, you know, hey, we're close on margin here, or maybe we're upside down, nobody really knows, on the hot dogs. We might need to raise the price. And of course, Jim Senegal looks at him and goes, if you raise the price of the hot dog and drink combo, I will effing kill you.

• 2:18:51Ben Gilbert?

  So that is why it is still priced the way it is today. And this story has gotten so much airtime.

• 2:18:56David Rosenthal?

  And it's classic Costco. Like, I'm sure this didn't actually happen. They just kind of like made up this story.

• 2:19:01Ben Gilbert?

  It might have actually happened.

• 2:19:02David Rosenthal?

  Oh, I mean, Craig has been working in FedMart since the 70s. He would never raise the price of the hot dog.

• 2:19:08Ben Gilbert?

  Right. He would have known. Anyway, back to branding, you know, earned media branding. There's this kind of interesting thing where it's almost like Nike where I think they have latent branding power. And I'm not talking about Kirkland here. I'm talking about the buyers, like trusting the buyers. Members trust the pre-selected inventory from Costco. And I don't know where that shows up. It definitionally doesn't show up in price. Costco will never generate excess margin because of their brand, but their brand earns them something. I mean, people become members and trust them, and that leads to something. I assume it leads to volume. It leads to willingness to buy, which leads to volume, or it leads to retention.

• 2:19:50Ben Gilbert?

  So this is the second episode where it's not branding power under Hamilton's definition. It's latent branding power.

• 2:19:57David Rosenthal?

  Yep, just like the big one with scale economies here.

• 2:20:00Ben Gilbert?

  Yep. In a lot of ways, I think what Costco is sort of doing is they realize that they have latent branding power and latent scale economies and they sort of choose not to recognize short-term profits from those. And I think it's all this super long-term game where this is why the market is willing to pay a much higher multiple for Costco than any of their competitors. There are a lot of ways that if Costco wanted to, they could make more money today than they currently do, but they've decided not to. And so, you know, it's the same result, whether you look at it as, let's assume that they did take a little bit more margin, or let's assume that they did raise prices on members, or

• 2:20:42Ben Gilbert?

  let's assume that they leaned into their branding power in some way and actually charged the prices that they've earned. Would the multiple then be reasonable? Yes, absolutely. Or the other way to look at it is, is this business just going to be around predictably for a longer period of time than any of their competitors because they're doing all these things? You get to the same answer, which is, it is worth paying a higher multiple of the dollars they're recognizing today for a company that has made these choices.

• 2:21:11David Rosenthal?

  Totally. I mean, let's just say, I don't think we've talked market cap yet. Costco does what, 240 billion in revenue today?

• 2:21:17Ben Gilbert?

  Yep, and Walmart does 620 billion.

• 2:21:20David Rosenthal?

  There you go. Costco obviously trades at a much higher multiple than Walmart. You are exactly right. I think it's because of this. It's because of the durability. It's because of the membership model. It's like, you know that that revenue is not going anywhere.

• 2:21:35Ben Gilbert?

  And there are profits that they could take today and they choose not to.

• 2:21:39David Rosenthal?

  Yes. Costco, I think, is pretty uniquely positioned in that they're gonna do well, I think, in any economic climate. Because in a recessionary environment, they're gonna do well because they are the lowest-priced retailer of goods out there.

• 2:21:57David Rosenthal?

  In a boom environment, I think they're also going to do well because of the nature of their customer base. As more people become affluent, they're going to be more likely to shop at Costco.

• 2:22:10Ben Gilbert?

  I think that's exactly right. And you can see it in the numbers. They do very well in every economic environment.

• 2:22:16David Rosenthal?

  Whereas Walmart is kind of getting squeezed on both directions, I think. In recessionary times, they probably do well, but not as well as Costco because they don't have the absolute lowest prices. And then in boom times, I think people migrate out of Walmart into shopping on Amazon, shopping at Costco.

• 2:22:32Ben Gilbert?

  Well, should we move into playbook themes?

• 2:22:34David Rosenthal?

  Let's do it.

• 2:22:35Ben Gilbert?

  Awesome. Well, to start, I want to say a huge thank you to Alex Morris, who writes the investment Substack, The Science of Hitting. He has two pieces that were just excellently written analyzing Costco's financials. And he was also very kind, David. I spent a lot of his Sunday, last Sunday, emailing him and asking clarifying questions. And he shared a bunch of data with me. It was super helpful. So, thank you, Alex. We'll put a link to The Science of Hitting in the show notes. To open this section, I want to say a Jim Senegal quote, "This isn't a tricky business. We just try to sell high-quality merchandise at a lower cost than everybody else." And I think it's hilariously farcical. He's both right and so cheeky. This is a extremely tricky business.

• 2:23:19David Rosenthal?

  Yeah. I have heard him say that many times, too, in my research. And I occasionally hear him say the second part of the quote that he selectively leaves off. The second part is, "Anybody can sell goods for cheap. The trick is to make money while doing so."

• 2:23:36Ben Gilbert?

  We've talked about a bunch on this episode. It's the 50 little things that they do that all sort of synchronize with each other that makes it work. You don't do one of those, it falls apart. "Oh, I want 10,000 SKUs." "Oh, I want to be a leader in e-commerce." "Oh, I don't want a membership fee." "Oh, I want to blow out a bunch of merchandise and do a sale." Any of these trade-offs, you break them, the whole thing breaks.

• 2:23:57David Rosenthal?

  Yep.

• 2:23:58Ben Gilbert?

  There are so many fun little paradoxical things about this company. They sell goods at the lowest possible price, but that means that they have a wealthy customer base. It always breaks my brain when I keep coming back to this point. And I think it broke the brain of a lot of name brand companies too, who refuse to sell at Costco. I mean, until like 10 years ago, a lot of brands, they just had this idea that low prices had too much of a negative signal about their brand. And it took decades for Costco to prove that they really did care about quality. That was part of their value proposition. And also, it took decades to prove that they could facilitate a huge amount of volume. And, you know, they've won over everyone from Apple to Dom Perignon.

• 2:24:40David Rosenthal?

  Yeah, I think this is a critical playbook theme for them. They've managed to create this sort of walled garden inside a Costco. And I use that in not the typical walled garden term of being like, consumer unfriendly, you're keeping them in the walled garden. It's exactly the opposite. Within the garden walls of a Costco warehouse, whatever price products are, doesn't in consumers' mind equate to like their value or what their price should be outside of the walls of the garden?

• 2:25:10Ben Gilbert?

  A hundred percent. You can go and buy right now $500 on Southwest Airlines for $450 at Costco. You can literally buy dollars for smaller dollars. And with an enormous company that a huge swath of the US uses, it's not so obscure restaurant or movie theater or something. It's like, here's a thing that you're likely going to spend money on anyway. And this company has decided to put it in here for a lower price.

• 2:25:33David Rosenthal?

  And that works somehow.

• 2:25:35Ben Gilbert?

  Yeah. And another big piece of this is that for the majority of suppliers, Costco mandates that the item you sell them is a unique SKU that the shopper can't buy anywhere else. So there's not even any comparison shopping. If you're buying a blender, the Costco version will come with, you know, some extra cups. Or maybe a two-pack of Sonic Hairs comes with a bunch of extra toothbrush heads. You know, it's these things that are custom, uniquely made for Costco shoppers. It is such a walled garden. David, check this out. Nike normally refuses to sell at Costco because of- Of course they do. They're Nike. They won't even sell on Amazon. Except, right now, as we talked about in our last episode, they have a lot of inventory, and they need to discount it to move it through the channel.

• 2:26:17Ben Gilbert?

  Nike can't really discount anywhere. I guess they have their Nike outlets. But for the next couple of years, they're going to be moving a lot of merchandise through Costco. Because, you know, it's Costco. It's all, it's different. Oh, people pay to get in there. It's a whole different thing. This isn't just like, whatever the psychology is, Nike is actually willing to sell through Costco until they work through these inventory challenges. And then I'm sure that they won't do business with Costco again for a while. But even Nike, the most brand-conscious company in the world, plays ball sometimes.

• 2:26:45David Rosenthal?

  Yep. You mentioned Apple. Apple sells through Costco.

• 2:26:48Ben Gilbert?

  You buy iPads there, buy computers there. Okay, so there is a thing that we haven't addressed yet. And that is the conflict between operationally light, you know, low overhead, and a tremendous amount of vertical integration. And when you're selling $50 billion of Kirkland, you have some vertical integration. You do some things yourselves. The finest illustration of this is chickens.

• 2:27:16David Rosenthal?

  Yes. I knew you were going to get to the chickens. I was just waiting the whole time. It's like, when is Ben going to talk chickens?

• 2:27:21Ben Gilbert?

  I want to do a whole episode on Costco chickens.

• 2:27:24David Rosenthal?

  We need to have Richard, Costco's CFO, on the show to talk chickens.

• 2:27:28Ben Gilbert?

  I know, right? We should ask him. Okay, so when do they vertically integrate? They will do it when they can provide enough value to members to make it worth increasing their overhead. And so here's the chickens example. They sell 500 million chickens a year. Not pounds, chickens.

• 2:27:46David Rosenthal?

  That's like a US and Canada population worth of chickens a year.

• 2:27:51Ben Gilbert?

  That is exactly right. And don't think about it too much. That's also the thing with the chickens. 130 million of which are rotisserie chickens. So even just the rotisserie chicken business alone, that's a third of the US eats a rotisserie chicken every year. The rest, of course, are chicken breasts, chicken thighs and legs and everything. The chicken's used in the food court for the chicken bake because of course, when they make stuff, they actually make it themselves. When you go buy muffins, those are baked at Costco in their bakery. There are really only four or five chicken processing companies in America. And when you have supplier concentration like that, prices can get artificially inflated. You could be on the wrong end of the stick as the buyer when there's so few suppliers.

• 2:28:34Ben Gilbert?

  So Costco decided, we're going to be doing this for a long time. We think our members might be getting a raw deal, so what should we do? We can provide more value to members by doing the insane work of processing this ourselves. So first, they sort of figured out, we can rent 100% of the capacity of a plant in Alabama to kind of learn the ropes of like, we're warehouse merchants, now we're becoming chicken processors? How does this work? They learned, and then they proceeded to build their own, fully owned facility in Fremont, Nebraska, outside of Omaha, and build relationships with 150 local farmers in the surrounding area. I mean, this is nuts.

• 2:29:15Ben Gilbert?

  That facility processes 2 million chickens a week now. It worked.

• 2:29:21David Rosenthal?

  Wow.

• 2:29:22Ben Gilbert?

  To take that even further, there's two other dedicated facilities that they don't fully own, but that just are for Costco. They can now process 200 million chickens a year. So while they're still working with the other big chicken processors, at least Costco can keep them honest on pricing now by taking on this huge amount of vertical integration themselves.

• 2:29:41David Rosenthal?

  Wow. We are going to convert a lot of people to vegans in this part of the episode.

• 2:29:45Ben Gilbert?

  Yeah, and we didn't even talk about the hot dogs.

• 2:29:47David Rosenthal?

  Yeah, oh boy. Okay, let's move on, let's move on.

• 2:29:51Ben Gilbert?

  So, a much nicer example is like the fancy mixed nuts that I was talking about earlier. Saw an opportunity to make a better product, work directly with farmers and suppliers, and kind of clean up that whole supply chain. They do the same thing in coffee, bring down the price, increase the amount of fair trade stuff going into the little Keurig pods. It is just fascinating to watch when they are willing to leverage their scale to take on additional complexity, like when they feel that's in the interest of members versus when they say, you know what, I think we're going to be a merchant on this one.

• 2:30:19David Rosenthal?

  Yep.

• 2:30:20Ben Gilbert?

  So that's the chickens. One thing is whenever you talk to any of these current or former Costco employees, or you watch any of the YouTube videos of the talks, or you read anything, they talk in cents. It's the craziest thing. You hear most executives talk and they talk in dollars, especially like, you know, Jensen and Nvidia, you listen to him talk, he has CEO speak. I can't remember exactly what he says, CEO language, something like that. But it's all in these like plus or minus 10% swags.

• 2:30:48David Rosenthal?

  A few billion here, a few billion there, you know, whatever. We're talking 70% gross margin business for Nvidia.

• 2:30:54Ben Gilbert?

  Yes, exactly. I love the concept previous to this episode of CEO math. It's like, get the high level concepts right and the rest will follow. You talk to someone at Costco and then what they tell you is that that costs $3.89. And it's not just $3 things. They'll tell you that that costs $180.89. It's ingrained in the culture that every cent matters. And I kind of love that because it's just so different than other companies.

• 2:31:16David Rosenthal?

  Yeah, well, it's so fitting to the nature of the business and their margins. When you have 11% gross margins, you're like, yeah, I care about every penny.

• 2:31:25Ben Gilbert?

  You bet. The thing that kept echoing my head is that these people, and you know, this isn't quite a hero's journey, the way that some of our episodes are. It's not the same person all the way through because it's Saul Price, it's Jim Senegal, it's all the executives who are currently on the team today because most of them have been there for 30 plus years. The way that all these people think and act are sort of a different type of hero's journey because they're a different type of hero. I mean, a lot of the times in our society, the people we've built up are these crazy sociopath, shoot the moon type people. And this is just a group of people who spent their life's work, all working at the same combined company, just trying to improve the model in little ways. There's so little personal ambition.

• 2:32:09Ben Gilbert?

  I mean, none of these people have LinkedIn profiles. They do, but like they have one job on it and no picture and no description. Or like, you know, the Costco Twitter account made no tweets ever. There's a crazy consistency to the culture. I walked into the headquarters and the coffee was Kirkland pods from a Keurig. Like when you sit down in the lobby and you know, someone says, oh, would you like a water? And like, you bet the water that they hand you is a Kirkland signature water bottle. I mean, the executives, you walk by the executives, they're in cubicles. It's exactly as you would imagine it. It's perfectly consistent with Costco.

• 2:32:40David Rosenthal?

  Yes, it's so great. A few more things to say on this. One, I literally just looked up as you were talking Craig Jelenek's LinkedIn profile. It still says he's an EVP at Costco.

• 2:32:52Ben Gilbert?

  The dude has been CEO for like a decade.

• 2:32:58David Rosenthal?

  Amazing.

• 2:32:58Ben Gilbert?

  Yeah.

• 2:32:59David Rosenthal?

  The reason I looked up his LinkedIn profile is that the backgrounds of these people are so different too than what you would typically think of as like the management team of an American Fortune 50 company. Jim went to San Diego City College, right? Craig went to San Diego State University. They started as baggers at FedMart when they were teenagers and they've just worked through the business all the way through. Yeah, occasionally there's somebody like Giles Bateman who comes in who went to Harvard Business School, but like that is the exception, not the rule.

• 2:33:35Ben Gilbert?

  And it's a hundreds of billion dollar market cap company now.

• 2:33:39David Rosenthal?

  Yep.

• 2:33:39Ben Gilbert?

  It's amazing. I will say too, that there's this famous quote about Amazon being a charity that's run for the benefit of customers. Do you remember that?

• 2:33:47David Rosenthal?

  I do. It's actually Costco.

• 2:33:49Ben Gilbert?

  It's actually Costco, right? On 230 billion of sales, they keep 7.5 billion in operating income. I've just never seen a company give more consumer surplus than Costco. They just leave so much on the table for their ecosystem around them.

• 2:34:02David Rosenthal?

  Yep. While we're talking about the people here, I think a related but separate playbook theme is truly the promoting from within culture there. It's always been the case going all the way back to FedMart and really carries through to this day. And it's just astonishing to me that a 250 billion dollar market cap company, this is so ingrained in the culture. Other companies talk about this, but then you'll see like, oh, they go do a CEO search and they bring in somebody from McKinsey or something like that. Nobody walks the walk on this, except Costco.

• 2:34:37Ben Gilbert?

  And they're a very noble company and all the decisions they make are very noble. And you get the sense that they're having a lot of fun being noble. But you only earn the right to be noble if your machine works. And their machine really works. And I think that's kind of the point is they've earned the right. Acting this nobly partially got them to where they are. But where they are earns them the right to continue to be noble. The company has never done a layoff. If they needed to, they would have done a layoff, but they've run the business in such a way and figured out the way that they've never needed to do that, even after they did a merger. They merged two nearly identical companies and they did not lay anybody off.

• 2:35:16David Rosenthal?

  Right, that's wild.

• 2:35:17Ben Gilbert?

  It's crazy. So amazing management. All right, my last big playbook item is an old quote. There was a Deutsche Bank analyst that said, "It is better to be an employee or a customer than a shareholder." Which Costco management would say, "Yeah, that's literally like we've printed it. It's in a PDF on our website that's called our code of ethics."

• 2:35:39David Rosenthal?

  Yeah, do you read our annual report?

• 2:35:42Ben Gilbert?

  So in the short term, maybe. That is a totally reasonable thing to say and no one would argue with it. But in the long term, it has been fantastic to be a shareholder. I did the math. If you bought $10,000 of shares in their IPO in 1985, you would have $3.3 million today, a 330x. And this does not include the dividends you would have earned along the way, which they've actually done a lot of dividends, including four-ish special dividends too that were huge. I don't know, it's funny how if you want to dip in and out of the stock in a year or two, it's not going to be great for you. It'll be predictable, it'll be high priced when you come in. But you know, it's not going to be world changing. But there's a chance that over 30 years, it is world changing for you.

• 2:36:25David Rosenthal?

  You know, there are no hard and fast rules in investing, obviously. And if you think there are, that's a great way to lose your shirt. But it's funny to note that every time we've used a version of that phrase on acquired when studying a company that Wall Street analysts think XYZ company is a charity being run for the benefit of X. Turns out that those are pretty great stocks to own.

• 2:36:49Ben Gilbert?

  And great for the long term.

• 2:36:51David Rosenthal?

  Yep.

• 2:36:51Ben Gilbert?

  Those are the ones that are the most enduring, as our friends at NZS Capital would remind us.

• 2:36:56David Rosenthal?

  Indeed.

• 2:36:57Ben Gilbert?

  All right, David, bear bull.

• 2:36:59David Rosenthal?

  Yeah, let's do it. You want to start with bear case?

• 2:37:01Ben Gilbert?

  Yes, starting with bear case.

• 2:37:03David Rosenthal?

  How are you ever going to find a bear case about this company? I mean, kind of like, can we bring Charlie in here and lecture you on this?

• 2:37:10Ben Gilbert?

  Well, for better or for worse, they have been very slow to e-commerce.

• 2:37:14David Rosenthal?

  Maybe for better, as we talked about, but maybe for worse.

• 2:37:18Ben Gilbert?

  And we talked about most of it, but there's a thing that we haven't really discussed yet, which is Amazon's overhead is like 30%, targeted Walmarts is something like 20%. The fact that Costco needs to run at 11% for it to work really did blind them to e-commerce. I don't think this was a conscious choice. This was a miss that they got really lucky on and happened to work out well for them, where they could continue to run their same playbook and kind of skip e-commerce for a long time. I mean, they were 15 years late to e-commerce. And structurally, Costco can provide things at a far lower cost than Amazon. But at the end of the day, like, there really is no way that Costco can do e-commerce like

• 2:38:03Ben Gilbert?

  these other companies. I mean, even Walmart's figured it out. Walmart is as good for most use cases as Amazon, but they're paying the price. It is a huge amount of overhead to set up the infrastructure to do home delivery. So one of the things we're going to talk about here in bear bull, and I think we should transition, is what Costco is doing that is Costco-flavored e-commerce instead of Amazon-flavored e-commerce, but I will save that for my bull case. A second bear case, it was popular in the past to say that Costco would have an issue with young people, but I mean, I guess this isn't really a bear case. This is false for a couple of reasons.

• 2:38:40David Rosenthal?

  There is nothing more Gen Z than Costco.

• 2:38:43Ben Gilbert?

  I know. Costco has been blowing up on TikTok, as we've talked about, but also, from all available data, young people are getting memberships at the same rate they always have. Like, of course, the bulk of members will be people in their 40s and 50s with a family and a house, but that hasn't really changed over time. If you liked the Costco business in the last decade as an investor, all signs are it's going to be pretty similar in the next decade, too, in terms of, you know, the ramp of when people become members. There's another one that's like, I'll put it in bear case, but again, I'm not really sure it's a bear case. It is worth pointing out, it is either true that this business cannot grow at more than 10% per year on average. They've had little years where they spiked,

• 2:39:24Ben Gilbert?

  but sort of on average, or management just doesn't want it to, which also would be fine, because there are lots of benefits to slow, steady, durable. But the company has a lot of cash on the balance sheet and regularly does dividends and buybacks. There's this crazy stat from the Science of Hitting that the company has returned 80% of net income to shareholders in the last decade, rather than reinvesting it in growth. And the key reason for this is that it's just really, really hard to expand. They need to hire the people, like the right people, train them well, promote internally, and the work to scale is so physical. The new construction, expanding suppliers, shipping large pallets into new geographies. I mean, cash is not the constraint stopping them

• 2:40:08Ben Gilbert?

  from expanding. There is a physical limit to the speed at which this company can grow. So I'm calling that a bear case because it's more like, you know, you should be aware that this thing can't scale like Zoom scaled during the pandemic. That's like the polar opposite of the spectrum. Zoom or Slack or any of these has like, basically no bottlenecks to infinite instant growth, or Instagram launching threads, you know, instantly has 100 million members. Costco is the literal opposite. There are bottlenecks everywhere to scaling, and no amount of cash is going to solve that problem.

• 2:40:41David Rosenthal?

  Yep.

• 2:40:42Ben Gilbert?

  Got any bear cases?

• 2:40:43David Rosenthal?

  Uh, I think I'm gonna quote Charlie on this one and say I have nothing more to add.

• 2:40:48Ben Gilbert?

  I thought you might go there. All right. Bull case. I mean, the biggest one is the flywheel is spinning, and I'm not really sure who can catch them. So here's, again, from the Science of Hitting, Substack, quote, "The average Sam's Club only generates about half the revenues of a Costco, and that gap has widened over time. Given the unit economics of the business, that's a tough hurdle to overcome, which explains why Sam's Club has a smaller unit base today than it did a decade ago." Crazy, right? "Over the same period, Costco increased its US warehouse count by one-third. Anyone who could have challenged them is just done."

• 2:41:26David Rosenthal?

  Yep. Maybe part of that is because Wal-Mart has just been placing their resources elsewhere, particularly in the e-commerce fight against Amazon. Like, I think Walmart has basically decided, look, we're not going to kill the Sam's Club business, but this is not where we're focusing our competitive energies right now.

• 2:41:44Ben Gilbert?

  And to be more fair, this is no longer a market share fight for the warehouse retail business. This is global retail. And then the question is, how much of global retail can Costco's model address? It's not Costco versus a specific competitor. It's Costco versus human behavior.

• 2:42:04David Rosenthal?

  Yeah. How big is this market?

• 2:42:06Ben Gilbert?

  Exactly.

• 2:42:07David Rosenthal?

  And that, I think, is actually a bull case for Costco, because you could argue, maybe they are, maybe they aren't saturated in like North America, but-

• 2:42:16Ben Gilbert?

  They're not. They're totally not.

• 2:42:17David Rosenthal?

  Yeah, I think they're not. And they are definitely not saturated in Asia, in the rest of the world, in Europe, in Africa, in Australia. They have a lot of global room to run.

• 2:42:31Ben Gilbert?

  So this is my second bull case, which you touched on the domestic thing, just as an aside. Every five years on earnings calls and in annual letters, Costco management reveals that they're surprised by how unsaturated they are in the US market. They'll open a store in a city where they already have three or four stores and they're like, and this one did just as well. And of course, it doesn't have as many members, because you do actually saturate the population of a city, but the convenience of having the store closer means that, you know, it hits the payback targets that you'd want it to hit just as fast as a store that was in a brand new market for them. And at some point, they'll stop being surprised, or at some point, they actually will saturate the North American market, but it's amazing that they keep thinking it's soon and it's never soon.

• 2:43:16David Rosenthal?

  Yep.

• 2:43:17Ben Gilbert?

  My third one is international expansion, exactly as you're saying, in particular, China. There is incredible pent up demand. So here's an illustration from the science of hitting, which is just so good. The average US store has 68,000 members. The first store in China opened in 2019, which popped to 400,000 members within two years. The US at maturity is at 68,000 members.

• 2:43:42David Rosenthal?

  China.

• 2:43:43Ben Gilbert?

  Right?

• 2:43:43David Rosenthal?

  I miss doing our China tech episodes because I feel like every 10 minutes in those episodes, we'd just be like, China. Like, things are of a different scale there.

• 2:43:52Ben Gilbert?

  If you can operate there. I mean, that's the big thing is like for US companies, it is very complicated to operate there. So there's going to be six stores in China within the next year. And all indicators are that this concept performs just as well, if not better than it does in the US. They have a lot of running room.

• 2:44:09David Rosenthal?

  So much running room.

• 2:44:10Ben Gilbert?

  And they've been very deliberate about the China strategy. They got a permit to open their first store 20 years before they actually did. The Chinese government issued them a permit. What is more Costco than waiting 20 years after you're allowed to do something to do it when you feel you're in a good place to do it?

• 2:44:27David Rosenthal?

  Well, A, they're playing the long game. B, the executives at the time probably were reasonably assured they were still going to be the executives 20 years from then. So like, why not?

• 2:44:37Ben Gilbert?

  Oh, it's awesome. All right, here's my fourth bull case, and it's actually e-commerce. Bear with me for a minute on this. They're approaching e-commerce in a very Costco way, and they have a bunch of different approaches, but there's two specific ones I want to highlight. One, where they have differentiation, which is on big and bulky items, that's where they're putting a lot of their energy. They spent $1 billion to buy a company that became Costco Logistics, and they do things like deliver sheds to your house. And this is a pretty difficult thing to do from a traditional e-commerce company or an e-commerce native company.

• 2:45:10David Rosenthal?

  This is sheds. This is refrigerators. This is washing machines. This is water heaters.

• 2:45:16Ben Gilbert?

  Right. Didn't you almost just order a fridge this morning on Costco?

• 2:45:19David Rosenthal?

  Exactly. I'm saying this because I almost had to replace my refrigerator. Turns out I was able to get it repaired, thankfully. But I was briefly in the market for a refrigerator, and it was super interesting dynamics. Costco had the lowest price on the model that I was looking at, but only by like $20 versus Best Buy and Home Depot.

• 2:45:41Ben Gilbert?

  It's like $1,500 or something.

• 2:45:43David Rosenthal?

  Yeah, like a $1,500 refrigerator, which I'm glad I didn't have to buy. But all the other players, clearly the manufacturer was a Samsung refrigerator, was running a promotion. So the MSRP was $2,000 and all those other retailers were saying, "Oh, this week only it's on sale for 1,500 and Costco had it for like 1,470. Next week Costco will still have it for 1,470 and it'll be 2,000 at Best Buy."

• 2:46:11Ben Gilbert?

  Yep, that's exactly right. And so I do think this is an interesting area for Costco and e-commerce. The second one is CostcoNext.com. Do you know what this is, David?

• 2:46:20David Rosenthal?

  Hmm, no, I didn't find this.

• 2:46:21Ben Gilbert?

  It allows you to shop directly on other websites and put in your Costco number and get a discount.

• 2:46:29David Rosenthal?

  Oh, that's awesome.

• 2:46:30Ben Gilbert?

  Costco cuts a deal with those companies to say, "We're going to send you traffic as long as the traffic we send you. Once you verify it, you give those people a discount."

• 2:46:40David Rosenthal?

  Wait, so this is literally like eBay's or Rakuten for Costco?

• 2:46:44Ben Gilbert?

  Yes. So Costco looks at it like, "Oh, great. We get to give yet another value to our members without having to take on the e-commerce logistics that they hate, that complicates their business, that changes people's impression of what Costco is."

• 2:46:59David Rosenthal?

  Fascinating.

• 2:47:00Ben Gilbert?

  It's like the obvious way for them to play this market for anyone who's willing to partner with them.

• 2:47:05David Rosenthal?

  Which, again, to the supplier dynamics, it's the same thing here. Like, on the surface, if you're XYZ e-commerce player, that'd be crazy. But then you think about it and you're like, "Well, we could get a lot of very high-value traffic. Maybe we should do this."

• 2:47:21Ben Gilbert?

  It's like selling through Costco without having to sell through Costco, without having to physically drop stuff at their warehouse. And it's the internet way to sell through Costco.

• 2:47:31David Rosenthal?

  Amazing.

• 2:47:31Ben Gilbert?

  So my last bull case really is Costco's culture. It just outlives any given quarter, year, or economic cycle, or even any CEO. Normally, when companies get bigger, things get worse, standards of excellence fall, and execution gets sloppy. And Costco's just been exactly the opposite of that.

• 2:47:48David Rosenthal?

  I mean, Costco was sort of technically founded in 1976 with Price Club. You can really say it was started with FedMart before that. Let's just say it was 1976. Here we are in 2023. There have been three CEOs in the history of Costco: Saul Price, Jim Sinigal, Craig Jelinek, all of whom worked at FedMart.

• 2:48:11Ben Gilbert?

  Yes, crazy. Okay, I have a bunch of Costco trivia before we get to carve outs.

• 2:48:17David Rosenthal?

  Yeah, let's do it.

• 2:48:18Ben Gilbert?

  All right. Costco is the largest seller in the world of fine wines. Fine wines are defined as $20 to $300 bottles. Like, what? Costco is the... But they're just the largest seller of things.

• 2:48:32David Rosenthal?

  Well, that is the most amazing encapsulation of their demographic.

• 2:48:35Ben Gilbert?

  Yes.

• 2:48:36David Rosenthal?

  It's wealthy people who like value.

• 2:48:38Ben Gilbert?

  A deal. Yes, exactly. Do you know their refund policy?

• 2:48:43David Rosenthal?

  No questions asked, right?

• 2:48:45Ben Gilbert?

  No questions asked. How long do you think it lasts?

• 2:48:49David Rosenthal?

  Infinite.

• 2:48:50Ben Gilbert?

  Infinite. There is an exception on things like electronics. Those are 90 days, but that's 75 more days than anywhere else.

• 2:49:00David Rosenthal?

  Yep, Apple is two weeks.

• 2:49:02Ben Gilbert?

  If I buy a MacBook Pro at Costco, it's a 90-day return policy. If I buy it at Apple, it's a 14-day return policy.

• 2:49:09David Rosenthal?

  Yep.

• 2:49:09Ben Gilbert?

  In fact, I'm sitting here. I really want to buy a 13-inch MacBook Air, but I'm afraid that the 13-inch MacBook Air is about to become the M3 later this year. I should just go buy it at Costco. Now, that is not really the behavior that they want to encourage, and I do know that if you sort of take advantage of it over and over and over again, they do sort of take you aside and say, "Hey, it seems like we're not providing enough value to you. Let us refund the membership. We're so sorry. We couldn't do a great job."

• 2:49:37David Rosenthal?

  What a great way to phrase kicking you out.

• 2:49:39Ben Gilbert?

  But I will tell you, the infinite return policy includes things like diamond rings.

• 2:49:46David Rosenthal?

  Whoa. Wait, if you get divorced, you can return the engagement ring?

• 2:49:51Ben Gilbert?

  Last year, they sold a 10-carat diamond ring, and that diamond ring, to my knowledge, has a lifetime, no questions asked, full value return policy.

• 2:50:00David Rosenthal?

  Wow. So there's some fun Seattle history around this. Do you know where the inspiration?

• 2:50:06Ben Gilbert?

  Nordstrom.

• 2:50:07David Rosenthal?

  Yeah, for this policy came from.

• 2:50:09Ben Gilbert?

  It's funny, I didn't know, but it's just Nordstrom is such a famous local story around their favorable return policy.

• 2:50:16David Rosenthal?

  Yeah, so Jim and Jeff Brotman, before he tragically too young passed away a few years ago, they would talk about this, especially Jeff and the Brotmans being Seattle retailers. They were hugely influenced by Nordstrom and Nordstrom famously has the same return policy.

• 2:50:31Ben Gilbert?

  Do you know the potentially apocryphal story about the famous return at Nordstrom?

• 2:50:36David Rosenthal?

  No.

• 2:50:37Ben Gilbert?

  It may not be real, but at some point, somebody brought tires back to Nordstrom and said, I'd like to return these. And instead of saying, well, we don't sell tires. The person thought about it for a while and said, well, could you just tell me a little bit more information? And they said, well, I bought these here and they named a year. And it turns out that before that real estate was a Nordstrom, it was actually a tire center. And Nordstrom gave the guy money and took the tires.

• 2:51:02David Rosenthal?

  Amazing. Okay, well, while we're on Costco trivia and tires, there's a famous Saul Price story. I think this was in the Price Club days when they were opening one of the early non San Diego locations, the first new expansion sites. He showed up and he saw tires, their tires was one of the things that they sold at Price Club. And the tires were all like neatly stacked on the warehouse shelves. And he walks up and he starts throwing them off the shelves onto the floor. And the police are like, Saul, what are you doing? Have you gone crazy? What's happening? And he's like, you effing idiots. How are the customers going to be able to pick up the tires when they're up high on the shelves?

• 2:51:45David Rosenthal?

  They gotta be down on the floor.

• 2:51:48Ben Gilbert?

  Oh, wow. I do know, by the way, Nordstrom has since adjusted its return policy to actually be capped, not infinite. And so now Costco has a better return policy than Nordstrom.

• 2:51:59David Rosenthal?

  Amazing.

• 2:52:00Ben Gilbert?

  Wild. All right, more stats, just for fun. They sold 2.2 million pumpkin pies in the three days leading up to Thanksgiving last year. They sell one third of the jumbo cashews in the entire world.

• 2:52:15Ben Gilbert?

  They of course sell eyeglasses and this is one of the areas where they felt they should vertically integrate. I actually don't know why, but I suspect it's because prices are artificially high in the entire glasses supply chain.

• 2:52:29David Rosenthal?

  Oh yeah, the eyeglass industry is notoriously brutal on this.

• 2:52:32Ben Gilbert?

  So Costco now owns and operates three optical grinding labs to make prescription eyeglasses.

• 2:52:40David Rosenthal?

  So great.

• 2:52:41Ben Gilbert?

  It's the craziest thing. And then lastly, here's an illustration of their culture. I think they definitely believe that you must work long, smart and hard if you're going to be a leader there and none are optional. You just have to do it. And to illustrate this, all of their market managers and country managers come to headquarters for two days every single month. So no matter what market you manage, you fly to Issaquah, that's 160 people, to all sit in a room for two days and just talk about what's working, what's not, what you're seeing, and how the whole company can get better and share learnings.

• 2:53:15David Rosenthal?

  Oh man. Jim talks about this a lot in the talks I watched on YouTube, that when he was CEO, and I think Craig does the same thing to this day, he visited every store every year.

• 2:53:24Ben Gilbert?

  Yes, he did.

• 2:53:25David Rosenthal?

  And there are hundreds of stores around the world. There are way more Costco stores out there than there are days in the year.

• 2:53:33Ben Gilbert?

  Yep. The dedication's incredible. Crazy. All right, carve outs?

• 2:53:38David Rosenthal?

  Carve outs.

• 2:53:39Ben Gilbert?

  All right. I have two and I'm going to do them both because they're fast and small. The first one, there's a brand called Tifosi, T-I-F-O-S-I, that makes sunglasses for running. And you can wear them for other stuff too, but I love them because they are sunglasses that don't slip off my face when you're running or doing something and you get sweaty. They have these little grippy pads that sit on the nose and I feel like I've solved this like thing that was mildly annoying in my life for a very long time, which is continually pushing up my sunglasses while running. So highly recommend Tifosi. They're also pretty cheap. I bought like three pair and they're goofy and different colors and they're fun.

• 2:54:17David Rosenthal?

  Amazing. You are becoming Phil Knight during his Oakley phase.

• 2:54:22Ben Gilbert?

  Yes, exactly. The second is a mashup that I found last night when I was looking for cool stuff to listen to while finishing the research and editing the script. Thank you to Jason Kotke, author of Kotke.org for posting this. There is a New York City DJ named Dwells who released a mashup about four months ago of Everything in Its Right Place by Radiohead and Kendrick Lamar's N95. And it is so sick.

• 2:54:49David Rosenthal?

  That sounds awesome.

• 2:54:50Ben Gilbert?

  It's probably because I'm like a huge, I don't listen to Radiohead that much anymore, but like in college I-

• 2:54:55David Rosenthal?

  Oh, you used to be really into it.

• 2:54:56Ben Gilbert?

  Seven hours a day or something, yeah. Like whenever I was programming, it was just Radiohead all the time. But it like instantly took me back to that place in my life and is honestly one of the best mashups I've ever heard.

• 2:55:08David Rosenthal?

  I didn't know mashups were still a thing. That's awesome. I used to love mashups.

• 2:55:12Ben Gilbert?

  In some like DJ subculture, I mean, it is crazy how mainstream like Girl Talk-

• 2:55:16David Rosenthal?

  Yeah.

• 2:55:17Ben Gilbert?

  What was the other one? The White Panda were for a while.

• 2:55:19David Rosenthal?

  Mashups, love it.

• 2:55:20Ben Gilbert?

  Yeah. Radiohead and Kendrick Lamar. We'll link to it in the show notes.

• 2:55:24David Rosenthal?

  All right. Inspired by you, since you did two carve outs, I'm also gonna do two carve outs. The first is a great episode of Invest Like the Best. Friend of the show, Patrick over there with Jeremy Jifan-

• 2:55:37Ben Gilbert?

  So good.

• 2:55:37David Rosenthal?

  Also a friend of the show.

• 2:55:38Ben Gilbert?

  This was gonna be my third also.

• 2:55:40David Rosenthal?

  Yeah, it was so good. One of the best podcast episodes. Just period all year, I think, but especially because we know Jeremy pretty well from Tiny and, you know, we know Patrick very well. Like even hanging out with them a lot, learned a ton still listening to their conversation.

• 2:55:58Ben Gilbert?

  And this conversation, I'll tell you, is exactly like hanging out with Jeremy, but in higher density. His personality is exactly how he comes across on the podcast, but it's definitely a best of. You know, whenever I hang out with Jeremy, I get like six or seven kind of mind blowing one liners, these like insights that just come to him out of nowhere. And the podcast has 30 in an hour and a half. It's just awesome.

• 2:56:22David Rosenthal?

  Yeah, it's just awesome. Go listen to it. Well, well, well worth your time.

• 2:56:26Ben Gilbert?

  Yep.

• 2:56:26David Rosenthal?

  My second carve out, this is a fun, local one. Jenny and I did a date night last week. Highly recommend for any parents out there. We have a standing babysitter who we love. Friday night, weekly date night, unless something changes.

• 2:56:39Ben Gilbert?

  Wow, good for you.

• 2:56:40David Rosenthal?

  Highly recommend that. But we went out in Dogpatch in San Francisco, which I hadn't been to in a long time. It's become such a cool neighborhood. Went to this awesome wine bar there. We walked around. We got ice cream at Humphrey's Slocum afterwards. Dog Patch is right on the water in the bay. It's got an interesting history. It was the headquarters, I think, of Hell's Angels for a long time during like the 50s and 60s. You worked there, right? Didn't you when you were an intern?

• 2:57:08Ben Gilbert?

  Dog Patch Labs on Pier. I'm trying to remember the actual number. But yeah, there was a coworking space. When I worked at CoTweed, actually, they condemned the pier and took it down because it was like, we were the last year that it was still. I don't know, we probably shouldn't have had an office in it. But yeah, I worked at CoTweed and above us was the coworking space where the Instagram guys launched Instagram.

• 2:57:26David Rosenthal?

  That's right. But yeah, you probably remember back then. I mean, Dog Patch was kind of like a random outskirts of San Francisco. Sleepy little neighborhood. It's become awesome. Walked by a game shop where they had ladies D and D night going on. Like, this is super cool. Going to hang out there more often. So if you come to San Francisco, don't hang out downtown. Downtown is not a good place.

• 2:57:50Ben Gilbert?

  Yeah.

• 2:57:50David Rosenthal?

  The rest of the city is awesome. Go to Dog Patch. It's a very different experience.

• 2:57:55Ben Gilbert?

  Thank you for saving me from. I was going to stay at a hotel on Market Street and you were like, do not do that.

• 2:57:59David Rosenthal?

  Dear God, do not do that. I may never see you again.

• 2:58:02Ben Gilbert?

  But that's where all the hotels are. It's a big problem.

• 2:58:04David Rosenthal?

  I know. Airbnb is a thing.

• 2:58:06Ben Gilbert?

  Airbnb. All right. With that, sign up for notifications of new episodes. We just flipped this thing live. Acquired.fm/ email. We are going to be including little tidbits after we release episodes, including listener corrections and little fun stories that we didn't have in time for recording. We'll also be teasing future episodes. So if you want, play a little trivia game with us to try and guess what next episode is going to be, that is when we're going to be dropping those hints. You can become an LP. Acquired.fm/LP. Become closer to the show. Do Zoom calls with us every other month or so. And at least once a season, help pick the next episode. Acquired.fm/LP.

• 2:58:45David Rosenthal?

  LP's chose Nike, our most recent episode before this one.

• 2:58:49Ben Gilbert?

  They did. Oh, one thing we should say, in case you don't follow us on social media and didn't see the tweets about it, friend of the show David Lidsky did an awesome, truly awesome piece in Fast Company about Acquired, and we're super grateful that he took the time and dove deep and spent-

• 2:59:05David Rosenthal?

  Many hours with both of us. It was super cool.

• 2:59:08Ben Gilbert?

  Lots and lots of time, basically tracking us as we were preparing the Nike episode. And since he's been listening since 2017, 18, he knew a lot of the history of the show, and so wrote this really cool piece. If you are one of the people who has emailed us over the years and said, "It'd be great if you guys did something talking about how your research process for Acquired works," David chronicled that, and much better than David or I ever could have. So, thank you, David Lidsky. Really appreciate it. We will link to the Fast Company piece in the show notes, too. Look for ACQ2 if you want to learn more about AI in any podcast player, and check out the Slack. Come discuss it with us, acquired.fm/slash/Slack. Listeners, we'll see you next time.

• 2:59:48David Rosenthal?

  I'm gonna go get a hot dog and a soda.

• 2:59:50Ben Gilbert?

  I'll see you there and get a chicken bake.

• 2:59:52David Rosenthal?

  How much are the chicken bakes?

• 2:59:54Ben Gilbert?

  More than a buck fifty. But, you know, it's more substantial than a hot dog.

• 2:59:57David Rosenthal?

  It's like 3,000 calories.

• 2:59:59Ben Gilbert?

  It's like 900 calories.

• 3:00:00David Rosenthal?

  Wow.

• 3:00:01Ben Gilbert?

  But yeah, you're not doing a lot of other eating that day.

• 3:00:05David Rosenthal?

  I love it. All right, listeners.

• 3:00:07Ben Gilbert?

  We'll see you next time.

• 3:00:07David Rosenthal?

  We'll see you next time.