Review and analyze the case on Costco and answer the follow questions (Page 303):

Explain the success of Costco in terms of the three performance determinants in flexible leadership theory (efficiency, adaptation, and human capital).
Explain how Costco can provide higher compensation to its employees and still be successful in the use of a lower price competitive strategy.
Use relevant leadership theories to analyze the behavior of the CEO and describe his influence on the company.
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Costco is one of the largest retail sales companies in the United States, and it has more than 500 stores in 37 states and eight countries. Despite low profit margins in the retailing industry, the company is more profitable than most competitors, and it is growing rapidly. In the University of Michigan’s annual survey of customer satisfaction with U.S. retailers, Costco has had the highest ratings in recent years. The company’s basic strategy is to provide quality products at the lowest available prices, and the products include clothing, electronics, and food. Costco’s leading competitor—Wal‐Mart’s Sam’s Club—offers more variety and some lower priced items, but Costco’s products are generally of a higher quality. Around 20% of the products consist of limited‐time supplies of deeply discounted luxury goods and other special bargains. Examples include Rolex and Movado watches, gourmet imported chocolates, Waterford crystal, plasma televisions, and Burberry and Coach handbags. This strategy of temporary special bargains creates customer excitement and increases purchases of items that shoppers had not intended to buy when they visited the store. Charging customers for the privilege of shopping at Costco provides a steady source of revenue for the company and increases customer loyalty. Costco has two types of members: businesses and individuals. Even though the cost of membership is a little higher than for competitors, Costco’s card renewal rate was over 86% in 2006, and membership increased by 14%. To increase the value of the memberships and attract additional customers, Costco also offers services such as travel plans, health and home insurance, banking, and financial planning. Individual shoppers average two Costco visits per month, and many travel great distances to stock up on supplies. Unlike most discount stores, Costco has many affluent customers who are “treasure hunting” for the special bargains on luxury goods rather than merely looking for low prices on basic commodities. Costco’s merchandise buyers have to experiment and take big risks with luxury items, because a lot of money is tied up in inventory if the items do not sell quickly. The buyers need to rely on their intuition and creativity to find items that will be popular and profitable. Innovation in design and packaging is also important for making some types of products such as food items more appealing to customers. Recent initiatives, for instance, include the elimination of Styrofoam trays from meat packages and the use of individually sealed packets. The design is more environmentally sound and enables consumers to freeze unused portions without repackaging or rewrapping products. Costco has generous pay, excellent health benefits, and a good 401(k) plan for its more than 120,000 hourly employees in the Unites States. The average wage for a full‐time worker at Costco is around 40% higher than at Sam’s Club. Around 82% of Costco employees have health‐insurance coverage, as compared with less than half of the employees at Wal‐Mart, and Costco employees pay much less of their health premiums. Around 91% of Costco’s employees are covered by retirement plans, as compared to 64% of employees at Sam’s Club, and company contributions to the plan are nearly twice as high per employee at Costco. The company policy is to promote from within the ranks, and workers at all levels have good opportunities for advancement. The company has one of the most loyal and productive workforces in the retailing industry. The high level of organizational commitment is reflected in the turnover rate (around 6% for workers on the job for more than one year) which is well below the average rate of 44% for the industry. The cost from turnover (lost productivity, recruiting and training new employees) is 40% lower at Costco than at Sam’s Club. Employee theft at Costco is the lowest in the industry. The savings from lower turnover costs, lower employee theft, and higher employee productivity more than offsets the higher cost of compensation at Costco. The operating profit per hourly employee in the United States is nearly twice as high at Costco as at Sam’s Club. The high level of employee motivation and commitment is not only because they are well compensated, but there is also a high level of intrinsic motivation among Costco employees. They are encouraged to suggest ways to improve the stores and product mix, and creativity is valued. Each morning before the store opens there is a conversation about ways to be more efficient and to provide better customer service. All employees are trained to be friendly and helpful when customers need assistance. When shoppers need assistance in locating an item, employees are expected to show them where it is rather than merely pointing to a distant spot or providing vague directions. The methods Costco uses to minimize costs include a no‐frills approach to their stores, which also function as their warehouses. The buildings have metal exteriors and steel racks. Instead of individual products on shelves, there are pallets on steel frames that soar to the ceilings. Above every pallet is a card with a simple product description, and they keep everything as simple as possible for the product displays. Marketing costs are low because Costco does not do any advertising; there is no public relations manager or expensive advertising agency. Instead, Costco depends entirely on happy customers who tell their friends about the fantastic bargains available at Costco stores. The company keeps layouts standard in its stores to reduce costs and give shoppers a feeling of familiarity at every location. The products sold in each store are similar, except for foods, which vary according to local tastes. Inventory costs are reduced by having only a limited variety of product sizes, and by packaging many products for bulk sales. Products move right from the delivery truck to the sales floor, and the signage looks like it was made with a cheap laser printer. There are not even any shopping bags for customers. A computer system that tracks sales in the stores makes it possible to determine when more fresh foods are needed in the display cases and reduces costs from waste and overproduction. Jim Sinegal, the CEO of Costco, is very modest about his contribution to the success of the company and quick to share credit with others. He understands how important it is to have talented people working for a company, and he does many things to attract and retain them. At the company headquarters in a Seattle suburb, his office is an open space with no door. His desk is pushed up against the wall so that, at first glance, he appears to be someone else’s secretary. Sinegal usually answers his own phone, uses a nametag like other employees, and usually wears one of the low‐priced dress shirts sold in his stores. As the cofounder of Costco, Sinegal is a major shareholder, but his annual compensation is only 10% of the average amount for CEOs. He tries to limit his salary and bonus to no more than twice what a Costco store manager earns, and he declined his bonus for the last three years in order to achieve that objective. At the annual Managers’ Conference, Sinegal meets with more than 1,000 Costco managers and product buyers to review the past, discuss the present, and plan the future. He also has monthly budget meetings with groups of around 70 store managers to talk about the importance of exercising tight cost controls, getting the details right, and adhering to the Costco credo. Important values at Costco include hard work, respect for customers, and high ethical standards. Sinegal communicates a strong concern for high performance, but he is not coercive or overly critical. He is careful not to discourage his product buyers when they take risks on new products. Employees are empowered and encouraged to “think outside the box.” Sinegal still attends every new store opening, and he tries to visit every Costco store twice a year. He spends nearly half of his time on the road checking out his stores as well as the competition to make sure they are not undercutting Costco’s prices. Sinegal has a strong concern for his employees, and he is perceived as dedicated, caring, and hard‐working. He is able to remember the names of most of his managers, and they know him by sight. At a recent annual meeting when he answered a question by stating that he had no plans to retire soon, the audience gave him a spontaneous standing ovation. In 2003, the rising cost of health care made it necessary to increase the employee contribution to their health insurance. Sinegal sent a letter to employees explaining why the increase was necessary, and the letter generated more than 100 responses, nearly all of which were supportive. Sinegal tries to do what is right for employees, customers, vendors, and stockholders. Recently a major decision was made to put a 90‐day limit on customer returns of electronics products. The old policy was unique in American retailing, but it was becoming too costly. The new policy could save the company more than $100 million a year, but Sinegal did not want to change it without a viable alternative. Thus, as part of the new policy, he decided to extend the manufacturer warranty by a year.