The Elegance of the Costco Supply Chain!


To begin I must admit that Costco is one of my favourite stores. I started thinking about the Costco Supply Chain.

Stereotypically I almost always buy more than I intended given the unique things that you find in their aisles. And the standard items are invariably great deals, even if the quantities are larger than you will find in other stores.

When you consider the physical layout of the store you are really walking through a warehouse. High ceilings, rows and rows of pallet racking, and concrete floors.

At its core the Costco business structure is a great example of a lot of Supply Chain principles implemented with great efficiency.

What is it that makes Costco’s Supply Chain so effective?

Having worked at a Retailer myself I have first hand knowledge of the challenges there can be in running a Retail Supply Chain. The typical consumer has no idea what really goes on behind the scenes to get that item on your store shelf or delivered to your front door. As such we wrote The Hidden Complexity of the Retail Supply Chain to share some of these experiences.

Low SKU Count

Let’s start off discussing SKU count, in store not online. A store like Walmart typically carries over 100,000 SKUs in a single store. Many retailers easily carry tens of thousands of SKUs. And anyone in Supply Chain knows that every single one of those SKUs needs to be managed, ordered, move and handled.

Costco only carries 3700 SKUs per store on average. ONLY 3700! That includes a mix of standard items and custom, or seasonal, items. This gives Costco an enormous advantage throughout ever aspect of the Supply Chain.

A low SKU count means fewer Merchants and Category Managers are required. They can hire exceptional people in this area and they can micromanage the small number of SKUs with great efficiency.

There are fewer suppliers which means fewer negotiations, contracts, purchase orders and changes. There is less Master Data to be managed. There is less forecasting and replenishment activity. Particularly for seasonal goods, and other items, there is no replenishment required at all: a store receives all the goods that they are going to get and when they are gone they are gone.

Fewer SKUs and suppliers mean less complicated logistics. Costco operates depots which become the cross docking transfer points for all of their goods to go directly to the stores.

“Don’t Touch”

And most of the items in Costco are handled on a full pallet basis. This is a massive source of efficiency. We call this a “Don’t Touch” Supply Chain strategy. Simply put for many individual SKUs the first time a unit is touched after it leaves the supplier is when the customer in the store picks it up.

Given the set up of the store Costco has all goods shipped, replenished and fulfilled in full pallet quantities. If you walk in the store you will find most of the goods stacked high on a single pallet. There are exceptions (eg. books, clothing, meat products).

By handling goods in full pallet quantities only Costco is able to receive goods from their suppliers at their depots and cross dock them directly onto a truck destined for the store. When the goods are received at the store the full pallet is either moved onto pallet racking or put in place right on the floor. The over carton is removed and the goods are ready for a customer to take what they want.

Further the Category Managers due a great job focussing on packaging design and palletization. By working with suppliers to optimize the amount of product on a pallet Costco is able to reduce handling, maximize truck capacity utilization, and lower logistics costs.

My experience in Retail involved a company that insisted on handling picking and packing individual units of any given SKU, not even just case handling. The result was a disastrously expensive and difficult Supply Chain to manage.

Eliminating all unnecessary touches and hand-offs enables Costco to run a very lean and efficient Supply Chain. Even however if you are not able to put pallets onto your showroom floor you can emulate this by handling goods in full pallet, or at least full case quantities, up to that point.

We should also emphasize the importance of cross-docking. Whenever you are moving goods from one location to another including manufacturers, distribution centres, warehouses, stores and other channels you are adding non-value added steps, time and costs. Costco eliminates the middle man in logistics bypassing distributors all together.

With this pallet size focus the company is also able to maximize cubic space utilization in their stores. Look up any of their aisles and you will find multiple levels of pallets all waiting to be put on the sales floor on demand. Costco has given retail selling space the dual role of also serving as storage space. The effect is to eliminate the need for offsite storage, and handling, which every other retailer has to contend with.

Inventory Turnover

Now a key metric to reflect how efficient Costco’s Supply Chain is would be inventory turnover. Costco operates with 11.85 turns, or 32 days of inventory on hand. That is very good compared with other large retailers.

Notable is that with controlled entrances and exits at their stores they also experience a low rate of inventory shrinkage or loss, often a very big problem in retail.

I actually thought that Costco’s turns could be much higher, especially given the fast pace that their inventory seems to move.

Another key metric for an efficient Supply Chain would be cash flow. Because of the speed of material movement inventory is often sold before payment is due to their suppliers. A negative cash flow position is the goal for many, many companies as the more business you do the more cash you generate. And the more cash you generate finances even more growth. And the circle goes round and round.

And finally let’s consider the reverse logistics aspect of Costco’s Supply Chain. If you have gone through this experience as a customer you know that it is very easy to return goods there. This is one area where store personnel will have to handle and process individual items. But they make it so easy for the consumer that it just builds goodwill and encourages even more buying.

Costco Supply Chain in Conclusion

It’s hard to go into a Costco store on virtually any day of the week without finding the parking lot full and customers streaming in and out of the store. Their Supply Chain model is a fundamental part of their success.

The other lesson here is that Supply Chain can be a differentiator for those competing in any industry. It can take out of the box thinking but the long term benefits are enormous.

I remember when I worked in retail and I started creating strategies to start handling full cases and pallets instead of individual pieces of every SKU. The culture was locked into a paradigm that they couldn’t snap out of which made my efforts feel like pushing rope uphill. They wanted lower costs, faster fulfillment and replenishment, and quicker delivery but they couldn’t get their heads around the fact that their own policies were inconsistent with these objectives.

Take a lesson from Costco in whatever industry you are in. This is completely consistent with Lean thinking. Eliminate waste, transportation, handling and inventory.

Then maybe you will have an exceptional Supply Chain like Costco too!

Originally published on January 21, 2020.