Costco 2011 Annual Report Download - page 28

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(dollars in millions, except per share and warehouse number data)
OVERVIEW
We believe that the most important driver of increasing our profitability is sales growth, particularly
comparable sales growth (sales in warehouses open for at least one year). Comparable sales growth
is achieved through increasing the frequency with which our members shop and the amounts they
spend on each visit. Sales comparisons can also be particularly influenced by two factors that are
beyond our control, including fluctuations in currency exchange rates (with respect to the consolidation
of the results of our international operations) and changes in the cost of gasoline and associated
competitive conditions (primarily impacting domestic operations). The higher our comparable sales the
more we can leverage certain of our selling, general and administrative expenses, reducing them as a
percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a
question of making available to our members the right merchandise at the right prices, a skill that we
believe we have repeatedly demonstrated over the long term. Another substantial factor in sales
growth is the health of the economies in which we do business, especially the United States. Sales
growth and our gross margin are also impacted by our competition, which is vigorous and widespread,
including a wide range of global, national and regional wholesalers and retailers, including
supermarkets, supercenter stores, department and specialty stores, gasoline stations, and internet-
based retailers. While we cannot control or reliably predict general economic health or changes in
competition, we believe that we have been successful historically in adapting our business to these
changes, such as through adjustments to our pricing and to our merchandise mix, including increasing
the penetration of our private label items. Our philosophy is not to focus in the short term on
maximizing prices that our members can be charged but to maintain what we believe is a perception
among our members of our “pricing authority”—consistently providing the most competitive values.
This may cause us, for example, to absorb increases in merchandise costs at certain times rather than
immediately passing them along to our members, negatively impacting gross margin.
We also achieve sales growth by opening new warehouses and relocating existing warehouses to
larger and better-located facilities. As our warehouse base grows, available and desirable potential
sites become more difficult to secure, and square footage growth becomes a comparatively less
substantial component of growth. However, the negative aspects of such growth, including lower initial
operating profitability relative to existing warehouses and cannibalization of sales at existing
warehouses when openings occur in existing markets, are ameliorated. Our rate of square footage
growth is higher in foreign markets, due to the smaller base in those markets, and we expect that to
continue.
Our financial performance also depends heavily on our ability to control costs. While we believe that
we have achieved successes in this area historically, some significant costs are partially outside our
control, most particularly health care and utility expenses. With respect to expenses relating to the
compensation of our employees, our philosophy is not to seek to minimize the wages and benefits that
they earn. Rather, we believe that achieving our longer-term objectives of reducing employee turnover
and enhancing employee satisfaction requires maintaining compensation levels that are better than the
industry average for much of our workforce. This may cause us, for example, to absorb costs that other
employers might seek to pass through to their workforces. Because our business is operated on low
margins, modest changes in various items in the income statement, particularly gross margin and
selling, general and administrative expenses, can have substantial impacts on net income.
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