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Decoding the Business Philosophy and Strategic Concepts Behind Costco's Succes

Date: 2023-11-10Views:

Entering the hearts of people is the key to sustainable business and the foundation for truly making it happen.
From Evolutionary System Strategy Ma Beicang

This passage is an introduction to a presentation by Mr. Ma Beicang, the founder of Huaxia Junzhi, at the China Pharmacy Eco Forum Retail Technology Conference. The presentation aims to decode the philosophical principles and key elements behind Costco's success for the benefit of pharmacy colleagues and friends in the retail and consumer sectors.
Costco's business philosophy and strategic concepts are far ahead of this era; they belong to the future business philosophy, indicating the evolutionary laws of business philosophy in the era of intelligence. Costco's success is not the success of a single link but the success of constructing systematic advantages, encompassing every link in the value chain and supply chain. In this era of learning from Costco, we need to study not only strategies and capabilities to solve problems, not only innovation and concepts to reshape systems but, more importantly, the laws and principles closest to the essence of business. This knowledge helps us navigate the era of significant integration and embrace the age of intelligence.
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Costco Decoding Business Philosophy and Strategic Concepts

Why is Costco successful? This is a very interesting topic. Costco is one of the most advanced and cutting-edge forms of retail in the retail industry. Its foresight is not only reflected in the business model, operational model, and specific execution strategies but, more importantly, Costco's business philosophy and strategic principles are far ahead of their time. Costco's business philosophy is an insightful understanding of time and space, standing in the future as a business philosophy that surpasses the "focus on word of mouth and extreme speed" in internet business thinking. It belongs to the future business philosophy of the intelligent era. It is truly remarkable how such an advanced business form emerged in the 70s and 80s.

On August 26th this year, Costco's opening in Hangzhou caused a bustling scene. On the opening day, 60,000 people queued under the scorching sun, and an additional 30,000 people flooded in, with queues extending as far as the eye could see. It is said that the surrounding real estate that was originally difficult to sell saw a direct increase in the average price to 28,000-30,000 yuan per square meter due to Costco's arrival. Two rounds of property releases were sold out. The entry and opening of a supermarket directly boosted the housing prices in an area, which is truly magical. What is most crucial is that Costco never engages in advertising and discount marketing, yet its brand effect is powerful and deeply ingrained in people's minds. Behind all this, what are the reasons? We will gradually unravel the mystery.

Before we delve into the main topic, let me talk about three individuals. Firstly, everyone knows Charlie Munger, Warren Buffett's right-hand man. Munger's love for Costco has reached an obsessive and fervent level. There's a famous anecdote where Buffett said that if he and Munger were hijacked on a plane, and the hijackers allowed each of them to make one wish before execution, Munger would undoubtedly wish to talk about how good Costco is again, while Buffett would painfully say, "Just kill me now."

You see, Munger's passion for Costco is intense, while Buffett has grown tired of it. Munger almost talks about the goodness of Costco every day. Munger evaluates Costco, saying, "Costco is honest with customers, honest with suppliers, honest with employees. As Franklin said, honesty may not be the best morality, but it is certainly the best business strategy." This story is quite enlightening.

The second person is Amazon's founder, Jeff Bezos. When it comes to supply chain management and customer-centricity, everyone immediately thinks of Bezos, especially customer-centric supply chain management, which is almost the golden rule for all retail formats. What many people don't know is that Costco's founder is the patriarch of the retail industry, and Bezos's retail business philosophy and ideas originated from Costco's founder. The story behind this is quite rich. Whenever Amazon faces strategic and operational challenges, Bezos goes to consult with Costco's founder, Sol Price. Price always emphasizes that he believes everything they do is conveying the core values and philosophy of the company. People come to this peculiar place to consume because they can create value for customers and persistently adhere to and convey this value system. It's about creating a value system of happiness, which is remarkable. Please think about whether our retail enterprises have a value system that they adhere to and whether they are creating happiness for customers. Taking a step further, retail enterprises are truly the most convenient, direct, and closest places to happiness, and they are also the easiest places to create happiness for customers.

The third person is Lei Jun from Xiaomi. The most familiar seven-word dictum of internet thinking, "Focus, Extreme, Word of Mouth, Fast," is Lei Jun's masterpiece. There is also the saying, "Wool comes from the pig," which reveals the essence of the internet business model. When Lei Jun created Xiaomi's business model and business philosophy, he focused on learning and integrating Costco's business philosophy and model. Lei Jun believes that Costco has a business philosophy that surpasses internet thinking. You will find that Xiaomi's customer-centric service model and Xiaomi's hardware entry and software charging model are derived from Costco.

So, after mentioning these individuals, let me summarize with three sentences. The first sentence is that Costco's business philosophy is beyond its time; it belongs to the future business philosophy. The second sentence is that it's hard to imagine how Costco built such a business philosophy in the context of its time and space. The third sentence is that Costco guides us on the evolutionary direction and trend of business philosophy in the intelligent era. Whether it's technology companies, manufacturing companies, internet companies, or retail companies, we all need to deeply understand and learn from it.

Costco was founded in 1976 and has a development history of 46 years. In 2022, its total revenue reached $227 billion, showing a year-on-year growth of 15.83%. The company currently operates 847 stores globally, with a per-store consumption exceeding $240 million. Each store is approximately 13,500 square meters, offering around 3,700-4,000 SKUs. In 2022, the total number of paid members exceeded 120 million, with a renewal rate of 90.45%, a staggering figure for anyone familiar with membership systems.

Costco's development can be divided into three stages:

1. **Exploration Phase (Initial Stage):** This is the startup period, and two key figures are worth noting here. The first is Sol Price, the founder of Costco's predecessor, Price Club. He is considered the patriarch of the global retail industry and also the mentor of Costco's founder, Jim Sinegal.

2. **Global Expansion Phase:** In this phase, Costco focused on establishing branches globally while also venturing into online e-commerce and developing its private label brands.

3. **Maturity Phase:** Starting from the 2008 economic crisis, most traditional department stores faced a development crisis. Retail giants like Walmart, Sears, and Best Buy experienced significant drops in revenue and stock prices. However, Costco's stock price and revenue not only did not decline but rose significantly. Its stock price increased fivefold, and it continued global expansion. In the decade after 2008, Costco solidified its position as a global retail giant.

The emergence of these retail giants in the 1970s to 1980s is related to the historical context. During this period, the world experienced two oil crises, and the U.S. economy entered a phase of slow growth and a mature economy. With inflation on one side and economic downturn on the other, everyone's income was decreasing. The majority, especially the middle class, became more conservative in their consumption. The most typical feature was a preference for cost-effective products. People bought less, but they had high expectations, seeking the best quality at the lowest price. Essentially, it was an era of demand for high cost-effectiveness and cost-effective consumption.

Comparing this with the current economic environment, most people have switched to an era of high cost-effectiveness in consumption. The majority no longer engages in impulsive consumption. This era is also characterized by a demand for high cost-effectiveness and cost-effective consumption.

In this background, Costco put forward its core value proposition: satisfying the mainstream customers' high-cost performance lifestyle.

The fundamental rule of retail is to earn the price difference as a channel business. In the end, retail relies on surviving through earning more price differences. Apart from raising product prices, the constant enhancement of efficiency and cost compression is crucial. There are limits to efficiency improvement and cost compression. Once reaching the limit, technological innovation and transformation become necessary. Hence, we witness the emergence of internet e-commerce. In the past two years, with the saturation of traffic growth, new retail and live-streaming e-commerce have become popular again. Technological breakthroughs ultimately rely on efficiency improvement and cost compression.

Future technologies will continue to evolve towards intelligent technology and the intelligent era. However, whether the extreme squeeze brought about by technology will satisfy customers' real demand for high-cost performance, cost-effective and inexpensive retail remains uncertain. Behind live-streaming e-commerce, apart from emotional stimulation, grass-roots campaigns, and large-scale price pressure, I cannot see other breakthroughs. After all, in the past two years, many things have not become much cheaper. Instead, some items have become more expensive after repackaging, indicating contradictions between demand and supply.

So, Costco starts with meeting customers' demand for a quality lifestyle and high cost-effectiveness. This business philosophy actually comes from the mentor of Costco's founder, Jim Sinegal, which is Sol Price. His philosophy is very simple: first, sell products at the lowest profit margin; second, prioritize service, with the customer at the center; and third, adhere to the philosophy of happiness. Each of these points represents a fundamental rule of retail. Let's decode the origin and essence of retail customer demands.

Firstly, let's look at the fundamental demands of middle-class families in retail:

1. **Quality Products:** Customers demand high-quality products, placing significant requirements on the products themselves.
2. **Low Prices:** Customers seek lower prices, placing high demands on sales and operations.

3. **Habit of Stockpiling:** Customers have a habit of stockpiling, placing new requirements on product packaging and form.

4. **Process Experience:** Customers emphasize the overall shopping experience, placing high demands on service.

Costco simplifies these four aspects into one—returning to service. All sales and services are just means to satisfy customer needs. Selling products is fundamentally about meeting customer needs and is a form of service, not just being a channel provider.

Satisfying customer needs means making customers satisfied, comfortable, happy, and even happy. Whether it's products, sales, or value-added services, all are ultimately for satisfying customer needs, making customers satisfied; they are just means of service. So, under this core philosophy, Costco creatively puts forward its business proposition, which is revolutionary and ahead of its time.

Firstly, let's look at Costco's mission—to continually provide members with quality products and services at the lowest possible prices. The company defines itself as a service provider for members, not just a seller of goods.

Secondly, let's look at Costco's business philosophy—not competing for profits with customers and not relying on earning price differences for profit. This is almost against our traditional business knowledge. Not competing for profits with customers and not relying on earning price differences for profit; how can you earn a profit? This mission and philosophy are the most creative and revolutionary. The core proposition it summarizes is not relying on earning price differences for profit but on providing customers with cost-effective, high-cost-performance products and value-added services to earn a profit—relying on service to earn a profit. Its positioning is as a service provider for retail services to customers, not a retail channel provider earning price differences. The model of earning a profit through service is based on membership fees, which are essentially service fees. This is a disruptive business change.

Let's compare in detail: traditional retailers rely on earning price differences for profit, while Costco relies on membership fees for profit. The essence of traditional retailers is a channel provider, while the essence of Costco is a service provider. Traditional retailers earn price differences by offering products to customers, while Costco earns service fees by providing customers with cost-effective, high-cost-performance products and value-added services. The core is that the model of earning service fees depends on whether your retail service is extreme or not. The essence of retail is a tool and carrier for shopping experience. Service and sales are different. The essence of service is to satisfy customers, make them happy, comfortable, happy, warm, at ease, comfortable, happy, and moved. This is the essence of service. Once retail becomes a service, all business philosophies, concepts, and systems undergo earth-shaking changes. This is the most fundamental.

The principle behind this is that retail satisfies customers' material attribute needs by providing products to meet their material needs. In contrast, retail services and value-added services satisfy customers' spiritual attribute needs, including emotions, experiences, feelings, spirituality, pleasure, and community awareness. These spiritual attribute needs are closer to the essence of customer needs and will be the most core elements of future customer consumption demands. Almost all products and services need to meet spiritual attribute needs or possess characteristics of spiritual attribute consumption. This is why many business leaders say that the essence of all business is essentially service; the underlying factor is the issue of spiritual consumption attributes, which is the most fundamental.

To understand the essence of this model, let's consider two somewhat inappropriate but very similar examples. One is a buffet, an experience many people have had. Once you've purchased the ticket, you're bound to eat a lot, eat well, earn more, and be much happier. After you've paid the entrance fee, you won't be charged for anything inside—all items are free. The essence is to maximize your satisfaction with your palate, satisfy your desires for all kinds of delicacies and wines, release and enjoy a feast, and maximize your happiness. You don't have to pay for any food inside; providing you with delicious food is just a means of service. Profit is not earned by selling food; it essentially relies on this extreme experience to charge fees.

Another example is an amusement park. Similarly, once you've paid the entrance fee, you won't be charged for other items inside. You can experience all the items to the extreme, essentially designed to bring you extreme joy. All items are means to provide services and won't charge you again for each item. The essence is to rely on bundled and integrated services, earning money through amusement services. This is the essence of an amusement park—it is service-oriented, with the focus on the experience.

However, you might say, drugstores are different; buying medicine is a painful and joyless experience. Wrong, completely wrong. A person who needs to buy medicine is precisely the one who needs happiness and joy the most and is in an extremely unlucky situation. If you make them comfortable, treat them well, and give them warmth and care, that person will remember you for a lifetime. Of course, if you disgust them, trick them, and exploit them limitlessly, they will also remember you for a lifetime.

The two images below illustrate two examples of Costco prioritizing the experience. One is the sale of Maotai at a price of 1499, significantly lower than the market price of 2500. The other is unlimited sampling; Costco's sampling is well-known. Not only is there a wide variety, but the quantity is also sufficient. You can basically eat your fill by walking around. They never care about whether you've taken advantage of them or not. Sampling itself is a form of experiential service, a crucial aspect of enhancing the overall experience.

The profit model for this kind of service is the membership fee. Take a look at the types of membership services offered by Costco, including individual and business memberships. In addition to unlimited shopping in reality, members can also enjoy cashback and more discount benefits. Business members have even more privileges, including additional cards, more cashback, and discounts. Moreover, membership cards can be resold.

Yes, Costco does rely on membership fees for profitability. The image shows that, before 2018, membership fees and net profit were almost on par, and membership fees were even lower than managerial fees. This is because Costco used a portion of the membership fees to offset the loss from the retail sales part. After 2018, net profit surpassed membership fees, mainly due to the strong profitability of value-added services, the high cost-effectiveness, and the rapid increase in service unit volume, which couldn't be lowered.

In summary, all of Costco's retail and service environments are similar to amusement park attractions and facilities. Costco is like a service provider offering this kind of amusement experience. Whether the membership fee is worth it depends on whether the experience is enjoyable enough, whether it is an extreme experience, and whether customers want to renew and repurchase after the experience. This is the most fundamental aspect.

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Costco Extreme Cost-Effectiveness:

Moving on to the key success factors that support Costco's systematic business model, we'll break down the system behind it and explore its characteristics.
  • Product Selection Strategy: Costco selects the best products from the source, choosing globally renowned suppliers and hand-picking products with explosive potential from first and second-tier brands. The products undergo a thorough evaluation and reconstruction across the entire value or supply chain until they meet Costco's shelf standards. Each product is limited to 1-3 SKUs.
  • Bulk Purchases: Costco's products are sold in large packages with low SKU numbers, high sales frequency, and large shipment volumes, creating the effect of bulk or centralized purchasing. This leads to significant improvements in the pricing power of the supply chain. The purchase unit price is generally 10% lower than the industry average, and the gross profit margin is 10-15% lower than Walmart's average. This large-scale centralized purchasing model provides Costco with systematic advantages in supply chain management.

Continuing with the key success factors supporting Costco's business model, we'll delve into the pricing control and cost control aspects.

2. **Pricing Control:**
   - Costco adheres to a well-known agreement that the gross profit margin for any product cannot exceed the mysterious number of 14%. The average gross profit margin for Costco is between 10% and 13%. After deducting costs and taxes, Costco's net profit is around 2%. The net profit from the retail sales part is essentially zero or even negative. This is why Costco allocates a portion of the membership fee to subsidize the retail section.

3. **Cost Control:**
   - Costco maintains a significantly lower sales and management expense ratio compared to industry peers, consistently staying around 10%. In contrast, Walmart's expense ratio is approximately 22%. Costco's cost efficiency is exemplary, with its expense costs being half or even lower than Walmart's. This highlights Costco's efficiency in retail and cost control.

From the breakdown earlier, we can see that Costco's retail service capability is founded on revolutionary business and profit models. The establishment of an advantage is built on extreme cost-effectiveness and services, with a robust supply chain management capability serving as the foundation.

Appendix pages provide information on Costco's product categories, allowing further exploration.

The price survey image in the appendix compares Costco's prices with Amazon's. The comparison of 39 typical products shows that Costco's products are approximately 12.1% cheaper overall than Amazon's. This is quite remarkable, considering that Amazon is known for its high cost-effectiveness. Costco's ability to offer even lower prices while ensuring cost-effectiveness demonstrates its strong capability in this regard.

The gross profit margin comparison graph in the appendix shows that Costco's gross profit margin is significantly lower than the industry standard, being half of Walmart's and much lower than Uniqlo's. The financial report in the appendix provides more details, indicating a net profit in the range of 2%-3%.

The second key element is supply chain management capability. Costco excels in low procurement costs, low operating costs, and an agile supply chain. The advantage of large-scale centralized purchasing contributes to strong bargaining power with suppliers, leading to low-cost procurement advantages, about 10% lower than the industry average.

Moreover, Costco maintains low operating costs due to its efficient procurement and high sales turnover, resulting in high operational efficiency and low operating costs. The agile supply chain enables quick reactions and efficient operations throughout various stages, from negotiation and procurement to distribution. This agility contributes to a highly efficient and low-cost supply chain.

The appendix chart is something everyone should look at carefully. In 2021, Costco contributed $192.1 billion in sales with 4,000 SKUs, averaging $48 million in sales per SKU. It leverages economies of scale to obtain low prices, demonstrating a strong ability to command premium prices from suppliers.

Now, let's elaborate on Costco's inventory turnover. Building on the previously mentioned advantages of extreme cost-effectiveness, superior supply chain management, and cost control, Costco's inventory turnover is only 29-32 days, while Walmart has 42 days. Walmart's rise and sustained success primarily stem from its supply chain management and inventory turnover, highlighting the robustness of Costco's supply chain capabilities. With fewer than 4,000 SKUs, equivalent to one-tenth of Walmart's, each SKU is logically selected as a potential bestseller. Combined with extreme cost-effectiveness and large packaging, it forms the advantage of "selected bestsellers + cost-effectiveness + large packaging + ultimate experience." This represents a superlative capacity for service experience satisfaction, realizing a system advantage of high-frequency consumption, high average transaction value, and high membership renewal rates—a truly formidable achievement.

Costco's cost control capabilities are extremely robust. Costco must maximize the compression of operational costs without compromising the ultimate shopping experience. If operational costs cannot be maximally compressed, Costco may need to allocate a portion of membership fees to offset profit losses due to low-priced products. First is the control of management expenses; Costco's sales and general administrative expense ratio is around 10%, with the latest fiscal year's expense ratio below 10%. In comparison, Walmart's expense ratio is 21.9%. Costco's sales and management expense ratio is significantly lower than the overall retail industry average. Next is the ownership of core properties; approximately 80% of Costco's global stores own land and building property rights, amortizing property costs and remaining resilient to rising rents. Then comes the site selection strategy; Costco stores are typically 10,000-20,000 square meters, located in areas with lower rental costs such as suburban highways, utilizing the developed car culture and efficient highway system of the United States to ensure accessibility while reducing land costs.

Costco's store design is warehouse-style, assuming some warehousing functions. Thirty percent of goods are directly delivered to stores by manufacturers, while the remaining 70% are sent to central warehouses by manufacturers. Goods are then stocked and displayed directly using the original pallet transportation method, without unpacking during the process. This saves warehousing space and reduces labor costs. Costco employs 12-14 people per thousand square meters, lower than Walmart's 20-24 people. Finally, there are distribution costs; after goods leave manufacturing facilities, Costco ships them directly to its self-owned distribution centers. Once at the distribution center, goods are sent directly to stores from the platform, significantly reducing logistics costs. The warehousing design and distribution costs fundamentally represent a warehousing-style shopping center, where inventory and the store are integrated. The cost advantage is very apparent, making cost control the most crucial aspect, and Costco's cost control is undoubtedly the best.

Costco's worry-free shopping and blockbuster strategy go beyond offering high-quality and cost-effective products. The most important aspect of worry-free shopping is the no-questions-asked, no-cost return and exchange policy. Costco's return and exchange policy surpasses that of all online e-commerce platforms, not to mention traditional offline stores. A notable example is the return and exchange policy for perishable and depreciating products such as computers, digital cameras, projectors, and other electronic products, which can be returned or exchanged within 90 days without any reason, and no receipts or vouchers are required—only the presence of purchase records on the membership card is sufficient. This exceptionally lenient return and exchange policy completely eliminates customer concerns about shopping and enables almost worry-free shopping with an ultimate experience. This is truly remarkable.

I have included two images here. One image features Costco's most famous $4.99 rotisserie chicken product, selling 50 million units annually. This product incurs a $40 million loss for Costco each year. The other blockbuster is the $1.50 hot dog combo, maintaining its price for 40 years. These examples showcase Costco's ultimate experience and blockbuster strategy.

Now, let's discuss Costco's private label brand, Kirkland. The fundamental purpose of Costco's private label brand is to better serve customers by delivering more cost-effective products. Costco found that many suppliers were unable to meet procurement demands and standards, with significant room for improvement in cost-effectiveness. Costco then decided to establish its own brand, strengthening control over multiple supply chains. Most Kirkland products are large-packaging, economical, and prioritize delivering benefits to consumers. They offer extreme cost-effectiveness. Kirkland's sales revenue is approaching around 25% of Costco's total sales, making it the top-selling health brand in the United States. Importantly, Kirkland's product prices are on average about 20% cheaper than similar national brand products. This extreme cost-effectiveness contributes to its popularity. In terms of product selection strategy, Kirkland focuses on products with high market potential, high cost-effectiveness, and high repurchase rates. It generally adopts an OEM private-label model, rigorously controlling every step from design to manufacturing and shipment. Personalized design and reconstruction are done according to market demands. The attached image shows Kirkland's product categories and revenue distribution, providing a clear overview for further research.

I won't have time to elaborate on the highly regarded value-added services at Costco. You can explore them in-depth later on. Costco's value-added services are well-known, offering a rich variety of categories with a crucial emphasis on high cost-effectiveness and quality assurance. This is the key to their success, including services such as restaurants, tire maintenance, pharmacies, optical clinics, gas stations, photo printing, travel agencies, eyewear stores, and even car sales. I would like to mention Costco's credit card associated with the membership, which provides a range of cashback benefits surpassing those of all professional bank credit cards. This demonstrates that Costco spares no effort or method to satisfy consumers, enhance their shopping experience, and increase customer satisfaction. In essence, all value-added services and retail transactions are designed to enhance the consumer's shopping experience, emphasizing service as the fundamental principle in Costco's system design.

Therefore, you can see that Costco's biggest moat or competitive advantage lies in systemic superiority, rather than excelling in a particular aspect or strategy. The reason why Costco gains global customer recognition and trust without the need for extensive advertising is fundamentally due to its ability to captivate hearts with exceptionally strong service capabilities. It satisfies the fundamental human need for service at its core. This systematic operational advantage and the establishment of systematic capabilities are the true secrets behind Costco's success. This includes global product selection strategies, raw material management strategies, ultimate supply chain management capabilities, OEM control systems, research and collaborative innovation mechanisms, production process optimization mechanisms, self-built production manufacturing capabilities, systematic quality control, warehouse-style transportation optimization, private label capabilities, inventory and on-site management, selling and membership management systems, pricing and supplier management systems, cost management control systems, value-added service management systems, and chain store management systems—sixteen management systems in total. These cover almost all aspects of the retail value chain, retail supply chain, and retail industry chain, forming systematic operational capabilities and advantages. This is the most remarkable aspect of Costco.

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Deciphering the Principles behind Costco's Success

In the two sections above, I have interpreted the key strategies and systemic advantages that make Costco successful. However, this is not enough; we haven't reached the essence yet. Now, let's decode the secrets behind Costco's systemic advantage using the universal concepts of economics.

Firstly, there's subconscious consumption or subconscious purchasing, which refers to the consumption process without any consideration, relying entirely on fundamental and instinctive needs for purchasing. It involves purely enjoying the atmosphere and fun of shopping without any additional thoughts during the purchase. For example, our most familiar utilities like water, electricity, gas, and telephone bills. When purchasing these, you don't think much; it's purely based on the necessity of basic living. It's almost subconscious consumption. So, what are the characteristics of subconscious consumption? The first is not considering too much during the subconscious purchase. The second is carefree purchasing without worries about returns or exchanges. The third is opportunistic shopping, where buying more means gaining more without too much consideration. The fourth is experiential purchasing, fully enjoying the atmosphere and fun of buying. The fifth is decision-free purchasing, where you buy directly according to immediate needs without unnecessary strategic thinking.

The fundamental reason for achieving this kind of subconscious purchasing is the absence of concerns about quality and price. There are no worries about the expense brought by prices, no concerns about the inability to return goods, no worries about being deceived by comparing prices at different stores—just the enjoyment of the shopping atmosphere. The key is eliminating all worries and concerns about shopping for customers, allowing them to experience the pure atmosphere and joy of shopping. This is the most powerful aspect. Think about the supermarkets you like to visit in your daily life. They are undoubtedly the ones that allow you to experience the joy of subconscious consumption. This is the key concept.

The second economic concept is consumer surplus, which is crucial for understanding the theoretical basis behind Costco's business philosophy and business logic. Consumer surplus refers to the highest price a customer is willing to pay minus the actual purchase price paid by the customer. In other words, the actual purchase price is lower than the customer's psychological expectation, making it cheaper than the customer anticipated. The part that is cheaper than expected is the consumer surplus. While this is a concept within customer expectations, it represents tangible benefits in reality. For example, Costco's product prices are generally cheaper than other supermarkets, and even cheaper than Amazon. The prices of Kirkland, Costco's private label brand, are about 20% lower than similar products from other brands. This cost savings is real money that customers save, commonly referred to as "found money" or "consumer surplus." Almost all of Costco's products contribute to creating consumer surplus, helping customers save money. The more customers buy, the more consumer surplus they accumulate, resulting in higher customer retention and renewal rates—a positive feedback loop.

Just as Costco's Asia President, Zhang Sihan, believes: "Giving benefits and gaining profits are actually on the same line. When a company offers benefits to consumers, creating greater value for them, consumers quickly realize that becoming a member is a worthwhile investment. As a result, they are willing to join as members, and the company begins to profit." The essence behind consumer surplus is this simple principle, yet it is precisely the most challenging to achieve.

The third important concept is utility, corresponding to the essence of Costco's philosophy of happiness. In the field of economics, utility refers to the satisfaction that consumers derive from consuming goods and services or the satisfaction of desires resulting from such consumption. It can also be seen as the maximum satisfaction derived from spending a unit cost, representing what is commonly known as happiness. In situations with limited conditions or limited purchasing power, Costco's goal is to achieve the maximum satisfaction with the minimum cost, obtaining the greatest happiness with the smallest expenditure. Essentially, this is the philosophy of ultimate value for money, which is the secret behind Costco's philosophy of happiness.

For example, with the same amount of money, you might buy products worth a hundred dollars in an ordinary supermarket. However, at Costco, you not only purchase items equivalent to 120 dollars at other supermarkets but also enjoy an ultimate shopping experience. More importantly, you can indulge in Costco's rich ecosystem of value-added services. All of this is robust and directly appeals to the human psyche. When measured in terms of satisfaction obtained per unit cost, you'll find that Costco not only satisfies your material needs but also fulfills your spiritual desires. This maximizes the utility derived from consumption, and utility essentially translates into satisfaction and happiness. As we previously analyzed, consumer surplus is essentially the happiness beyond consumers' expectations. This is the essence of Costco's systemic advantage. Costco aims to create more consumer surplus from the source, generating greater satisfaction and happiness for customers through the most ultimate retail and value-added services.

To achieve the philosophy of happiness, the key is to ensure the happiness of employees. Costco provides its employees with the best welfare benefits, with an average hourly wage of $20.89, nearly double that of Walmart and three times that of regular supermarkets. The average annual salary for Costco employees is approximately $10,000 more than that of Amazon employees. Additionally, Costco offers health insurance and vacation plans. New employees who have completed one year of service are eligible for stock option rewards—a feature that is rare, even for executive incentives in most companies. This commitment to the happiness of both customers and employees is Costco's greatest weapon.

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Implications for the Pharmacy Industry from Costco

So, what insights does Costco offer for those in the pharmacy business? Our research on Costco spans hundreds of pages of systematic plans, including the decoding of sixteen systems and the deconstruction of business philosophy. More importantly, we look towards the future and the evolutionary trends in corporate business philosophy.

The first question I want to address is: What is the essence of a pharmacy?
Some might say, isn't it obvious? A pharmacy sells medicines, right? And why do I sell medicines? Isn't it to make money? It may sound frightening, but anyone with a bit of insight wouldn't answer this way. Selling medicines is undoubtedly aimed at helping customers recover as quickly as possible. If we can say that, it indicates that we are still considering the customer. A pharmacy is much more than just selling medicines; selling medicines is the most basic and fundamental function. If customers want to buy medicines, can't they go to a hospital or buy them online? It's not only convenient but might also be cheaper, right? So, a pharmacy is much more than just selling medicines. The fundamental purpose of a pharmacy is to provide customers with the most convenient medical and health management services.

Now, what is the biggest advantage of a pharmacy compared to hospitals and e-commerce? Some might say it's close to home, maybe right next to the community or even inside the community. Yes, this is a significant advantage, but more crucially, pharmacies have offline scenes and spaces with real people on-site to provide services to customers. Online platforms lack this advantage, and hospitals can be too far and inconvenient. From this perspective, a pharmacy is the most convenient place to provide medical and health services to customers. This is the fundamental advantage of a pharmacy, and I believe there is no place better suited to provide medical and health management services to customers than a pharmacy. These two services are the pharmacy's inherent duties and essence.

So, combining the two questions above, we can understand that pharmacies are the most convenient physical spaces to provide medical and health services to customers, as they have both space and personnel.

Now, who goes to pharmacies? It must be people who are feeling unwell themselves or have someone in their family who is unwell. Such individuals are likely to be unhappy, even distressed and vulnerable. What they lack the most in such situations is service, particularly the expertise, reliability, sincerity, care, warmth, empathy, and understanding that services carry.

Therefore, pharmacies are the places closest to people's happiness, and the easiest to create warmth and happiness. Even more so than supermarkets, so the fundamental aspect is still service. Service is the essence of a pharmacy. If you guard such a place that can infinitely create happiness and warmth, and you still can't win the hearts of customers and make money, it is definitely your own fault. Therefore, learning from Costco and learning systematically is crucial.

Many people see diversification in a pharmacy as having multiple profit projects, but if you look closely, it's not essentially about serving customers; it's essentially about tricking customers. This is quite frightening. The essence of project diversification is to enhance the aggregation and value hierarchy of services. Essentially, it is about solving more problems for customers, providing more services, and helping customers gain more value and happiness.

For the pharmacy industry, what will the next era look like? I believe it will be an era of industry integration and restructuring. Compared to the pharmacy industry, we have a time gap of several decades with foreign countries, possibly 50 years, as mentioned in many research materials. For instance, the environmental protection industry may have a gap of over a hundred years. Whether it's industry-level factors like separating medicine from pharmacy, prescription externalization, medical insurance cost control, and quantity-based procurement, or pharmacy-level factors like diversification, specialization, chain operation, and centralization, fundamentally, the pharmacy industry is ushering in an era of integration. In this era, big fish will eat small fish, fast fish will eat slow fish, good fish will eat bad fish, and fish that learn from Costco will eat those that don't. This is an era of integration.

In this era, if you don't cultivate your inner strength, undergo management and operational changes, and even strategic and conceptual transformations, you'll not only be overtaken by online e-commerce pharmacies and offline hospital pharmacies, but also by stronger pharmacy brands that are always ready to consume you. Don't think it's far away from you. Once targeted and marked, getting rid of you is easy, almost just changing the brand. The people and shelves inside may not need to be changed. This is the era of intelligence. Perhaps a product quality issue or mishandling a crisis PR could easily lead to your elimination, to being consumed. This is the most fundamental aspect.

So, when it comes to values and happiness, we cannot ignore the spirit of the intelligent era. Any transformation of a business can truly grasp the market and capture the pulse of people's hearts only when it resonates fully with the spirit of the times. This is the most fundamental aspect. Regarding the spirit of the intelligent era, I believe the most crucial elements are two-fold: a return to values and meaning, and a return to humanism.

The return to values and meaning represents the shift from the virtual to the real in both material and spiritual aspects. What does this mean? In any business, firstly, the material value you create must be tangible, with products being both high-quality and cost-effective. Equally important is the spiritual value you create. In the era of abundance of material wealth, addressing spiritual and emotional deserts becomes an urgent and important problem. Every business, every product, and service should focus on the importance of spiritual and emotional value. This is equally important for the pharmacy industry. The essence of your service should not only meet the medical needs of customers but, more importantly, satisfy their spiritual and emotional needs. This is crucial.

The other aspect is the return of humanistic spirit. What does this mean? Humanism is about returning to human nature, truly understanding the basic laws of human nature, and being able to connect with people. A truly great business must grasp the basic laws of human nature and be able to enter people's hearts. Businesses that win people's hearts, that enter people's hearts, can be sustainable and truly successful. This is not an empty phrase. Pharmacies are essentially a business built on relationships. If you cannot understand the hearts of your core customers, how can you sell medicines or provide services? Such a business will naturally find it difficult to operate and won't be able to sustain itself. The fundamental aspect of any pharmacy is to manage the hearts of people, to nurture their hearts. Therefore, starting from the hearts of people is crucial in thinking about how a pharmacy should be run. This is the most critical aspect.

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