Professional Documents
Culture Documents
Overview
The acquisition target company’s risk exposure often adds to that of the acquisition company,
creating new risk exposure for the combined entity. Determining what that risk may be is part
Company Profile
Mission Statement- To continually provide our members with quality goods and services
Exchange- NASDAQ
Industry Profile
Costco is part of the Consumer Goods market sector of the economy. This sector is
comprised of companies that are engaged in the production of consumer goods as well as any
retail operations and related services. Costco is involved in production through its private label
of products called Kirkland Signature, and obviously operates a lot of retail space for consumers.
It also provides warranties and consumer benefits through its membership program.
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Costco is more specifically in the discount and variety store industry. As a wholesale
retailer, Costco promotes its low prices. It has a maximum limit of a 15% markup on all
products, and will refuse to deal with producers that don’t have low enough wholesale prices.
Costco also sells a huge variety of products, from car parts, to contacts, to caskets. The huge
warehouse stores have sections devoted to groceries, electronics, books, home supplies and
more.
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1. Costco published a relatively weak 3rd quarter financial report on May 25, 2016.
membership credit card Company, and encouraged buying of the stock, which caused the
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2. 2015 Stock Market Crash- Following a burst of a Chinese real-estate bubble, global stock
markets fell dramatically, as signaled by the DOW Jones 581 point fall in Early August.
This nearly instantly wiped out most gains made in 2015. Like most companies, Costco
3. On June 6, 2016 HR software provider ADP published their monthly employment report,
which included a growth of 287,000 jobs in the US nonfarm job market. This beat
expectations and caused the stock market to surge as a whole in the following days.
Market Capitalization
Market capitalization describes the total value of a firm’s outstanding shares. This is
calculated by multiplying the closing stock price of the company by the amount of shares
outstanding. It is a better signal of the value of a company than its stock price. It is not, however,
comprehensive. It doesn’t take into account other factors of a company’s value such as its debt.
250 267.71
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99.9 88.295
50 67.07
60.62 43.22 43.46 28.05 31.1
0
2014 2016 2014 2016 2014 2016 2014 2016 2014 2016
Costco Walmart Target Kroger Average
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As shown, Costco has the second largest market share in the industry, yet trails significantly
behind the largest company, Wal-Mart. Walmart’s market share, however, is the only one falling
whereas all others are rising. As a whole, the industry is declining in total market capitalization.
Costco’s market share raised the most of any firm, possibly due to its current expansion strategy
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Metric 2015 % Change 2016
Total Current
Gross Profit: Costco’s increase in gross profit shows strong performance in its new and existing
stores. Sales are up at a higher rate than cost of sales, which goes against market expectations
from 2015. Analysts predicted a decline in gross profit due to Costco’s inability to raise
markups. Stiff competition in the warehouse sector makes it difficult to raise prices when
competitors are able to maintain low prices. I think that it’s possible that Costco’s expansion into
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new markets entirely is what allowed its gross profit to rise. Another contributing factor could be
Net Income: Whereas Costco’s expansion into new markets had a positive impact on its gross
profit, I think that it’s likely the cause of its current decline in Net Income. The high costs of
expanding into new markets (construction, marketing, etc.) bring down the bottom line. I would
like to know if net income will rise in the future as revenues from these new stores come in and
Total Current Assets: Costco’s decline in Total Current Assets may be tied to its decline in Total
Current Liabilities and Total Debt, as it pays off many of the obligations it acquired during rapid
expansion.
Current Assets/Current
Inventory
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Current Ratio
1.800
1.600
1.400
1.200
1.000
0.800
0.600
0.400
0.200
0.000
2015 2016
COSTCO AVG
0.200
0.150
0.100
0.050
0.000
2015 2016
COSTCO AVG
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Financial Statement Analysis
Current Ratio: Costco’s low current ratio is somewhat alarming at first glance, but is acceptable
to analysts, considering that the retail industry generally keeps low current ratios due to financed
inventory. I don’t understand, however, why Costco’s is even lower than other companies in the
industry. I’d be curious to see how a consistently low ratio would affect Costco’s ability to
Debt to Equity: Costco’s decreased debt-to-equity ratio has lowered from 2015 to 2016, likely
due to its slowed expansion in that period. Costco opened 23 new stores in 2015, but only 11 in
2016. This likely cut down on the amount of debt financing required and therefore lowered its
D/E ratio. Costco recognizes the possible risk of last year’s high D/E ratio in the 2015 annual
report, stating that “We may be unsuccessful implementing our growth strategy, including
expanding our business, both in existing markets and in new markets, which could have an
adverse impact on our business, financial condition and results of operations.” The profitability
Inventory Turnover: Costco’s abnormally high inventory turnover rate is helpful for several
reasons. It reduces the risk of the need to liquidate inventory at a lower price, and allows for
more competitive pricing. By increasing turnover, a greater value of goods can be sold with
consistent fixed costs. One question I’d like to look into is how Costco manages such a high
turnover, but I have a feeling it’s related to its status as a wholesale retailer.
Sales model
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Costco focuses on selling products at low prices, often at very high volume. These goods are
usually bulk-packaged and marketed primarily to large families and businesses. Furthermore,
Costco does not carry multiple brands or varieties where the item is essentially the same except
when it has a house brand to sell, generally by the Kirkland Signature label. This results in a high
volume of sales from a vendor, allowing further reductions in price, and reducing marketing
costs. If Costco management feels the wholesale price of a product is too high, they will refuse to
Lighting costs are reduced on sunny days, as most Costco locations have several skylights.
During the day, electronic light meters measure how much light is coming in the skylights and
turn off an appropriate percentage of the interior lights. During an average sunny day, it is very
normal for the center section of the warehouse not to have interior lights in use.
Most products are delivered to the warehouse on shipping pallets and these pallets are used to
display products for sale on the warehouse floor. This contrasts with retail stores that break down
pallets and stock individual products on shelves. Costco limits its price markup on items to 14%.
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Key Partner Key Activities Value Propositions Customer Customer Segments
Engines Branding
Lawyers Marketing
&Promotion
operation
development
partners
Capital
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Strategy
Costco’s generic strategy is cost leadership. This strategy entails maintaining the lowest prices
possible. Retail giants like Wal-Mart also use the cost leadership strategy. Costco’s strategy also
combines the membership warehouse club business model to differentiate it from other retail
firms.
The company’s business model is a core factor that enables Costco to follow its mission. In fact,
this business model aligns with the company’s mission. The generic strategy of cost leadership
also agrees with and is needed to sustain Costco’s business model. A firm’s vision statement
guides the overall direction of organizational development. In Costco Wholesale’s case, the
vision statement emphasizes customer experience and satisfaction. On the other hand, a firm’s
mission statement determines the strategies and tactics needed to achieve the vision. Costco
Wholesale’s mission statement highlights the importance of creating value for customers,
Mission: Costco’s mission is “to continually provide members with quality goods and services at
the lowest possible prices.” This mission is directly linked to its business model and strategy.
The firm’s mission emphasizes quality and cost leadership, which are factors consumers usually
Vision: The vision of Costco is to give the costumer the best value that they can and Costco is
Business objective: The main business objective of Costco is not to try to be too much and
know on what level they are competing. Its main objective is to stay focused on its core business
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Interpretive Analysis
1. Liquidity refers to how easily an asset or group of assets can be converted to cash or a
ability to meet short-term financial obligations. This can quickly be assessed using the
current ratio. From 2015 to 2016, Costco’s current ratio fell from 1.046 to 0.977. This
means that Costco may have issues paying off liabilities due in the next 12 months. Both
of these figures are dismal compared to the industry average current ratio, which runs at
around 1.5. In the short term, such a low current ratio can lead to missed payments on
short-term obligations and lost efficiency. In the long term, a low ratio can lead to issues
in finding creditors. Consistently low current ratios signal that a loan may not be paid
back on time.
2. Profit margin is a measure of a company’s net income compared to its net sales. For
every dollar of revenue, the profit margin refers to the amount kept as earnings. Costco
saw a slight decrease in profit margin from 2.05% to 1.98%. This is against the industry
average trend, which rose from 2.41% to 2.86%. Profit margin figures don’t signal future
performance as much as they describe prior conditions. They can signal that a company is
going through a sales slump. A low profit margin can also signal that a firm is under
pricing goods in order to gain market share. Companies in Costco’s industry generally
maintain low profit-margins, as they are marketed as discount retailers. Costco’s current
expansion plan, as well as its recent and costly switch from AMEX to Visa for its
membership cards, is reasons why its profit margins may be lower than competitors in
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3. The debt-to-equity ratio is essentially a ratio describing the risk that a company takes on
in its financing. It compares the amount of financing acquired through debt to the amount
acquired through its equity. Costco lowered its ratio from 2.15 to 1.74, signaling that it is
relying less on debt for financing now. Its current figure is in line with the industry
average, 1.73. A high debt-to-equity ratio can result in great gains for owners, but can
also result in high losses, dependent on earnings. Costco’s previous ratio likely is related
to its expansion plan, where many new stores were financed. Currently, its more standard
ratio signals that it’s likely financing normally within its industry, taking on an average
amount of risk. It will not likely experience excessive growth or losses due to this lower
ratio.
4. Inventory increases liquidity in certain measures, but it’s really dependent on inventory
turnover. Inventory only increases liquidity if it can be sold quickly without changing its
price. High inventory turnover means that a company is able to sell its inventory quickly
and is therefore more liquid. Costco experienced a slight increase in inventory turnover
from 13.04 to 13.27, with both figures greater compared to the industry change from
11.42 to 11.50.
Strategy Map
Profitability
Financial
Increase Revenue
Manage development
Expenses ROI
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Strengthen customer Improve customer
interaction value
Customer
Financial Perspective: Costco accomplished 14.1% sales growth and a 17.4% increase in
operational financial gain. This can be because of the 10.4% increase in membership fees that
flowed on to operational financial gain. This ability to extend sales together with undefeated
Customer Perspective: Costco has set the vision to give the customer the best value that they
can. Entrepreneurial ability to continuously reinvent itself has given it a powerful world-wide
competitive advantage. Through its unyielding insistence on the highest quality to yield the best
value for its members, Costco has indeed earned the trust of its members. That my products
were sold in Costco thus ensured customers and other potential partners that the products were of
the highest standard. This same trusted reputation has also allowed Costco to expand.
Business Process Improvement: Costco had recently redesigned the store layout, so much so
that I simply gave up on a few of the items I was trying to find. They assess their market
properly, manage product life cycle and improve concept development. There are few other steps
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Keeping their Immigrant Perspective
development. Intellectual asset development and their value creation capabilities need to be
considered. It is a safe bet that Costco’s good fortune will continue as it keeps innovating – like
an entrepreneur. The result is a perpetual harvest that continues to benefit the company, its
vendors, and its members. Costco clearly sets the standard for not only living its entrepreneurial
spirit, but also through its passionate pursuit to reinvent an industry. And it has created new
opportunities for others every step of the way. Costco has brought improvement in innovation
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Business Process Improvement of Costco
Costco Wholesale Corporation implemented a high volume Captovation Capture scanning and
barcode indexing process for accounts payable, legal and employee documents.
Costco operates an international chain of more than 386 membership warehouses that carry
brand name merchandise at substantially lower prices targeted for small to medium size
businesses. Enterprise Content Management software industry. Costco continues to utilize Oracle
Imaging and Process Management software for content storage and retrieval. Captovation
Capture is used for image scanning and automated barcode indexing process. Initially, 50 Costco
users scanned approximately 25,000 documents per day, which equaled to 550,000 images per
The Challenge
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In order for Costco to provide high quality products at lower prices it had to be able to
communicate quickly and effectively with thousands of vendors. The company could no longer
afford slow response times when accessing accounts payable documents such as purchase orders,
debit memos or invoices. There was no direct access to these transaction documents. The image
quality from microfilming was unsatisfactory and storage space was becoming limited. Costco
also processes and stores a large volume of legal documents including agreements and claims
which need to be stored and accessed easily. They began searching for a technology that could
Costco believes the Image Source solution is a strategic and competitive advantage in their
market space. While these technologies are new to some organizations Costco simply sees the
One of the main steps in the operations process with potential for improvement at Costco is
Costco Supply Management Business Process Options to create ROI in store merchandising. The
store merchandising system is one of the beginning steps of the operations process at Costco.
The Costco store merchandising system helps Costco determine what products to offer to
members, the price range of these products, and the audience for the products carried. Currently
Costco offers a wide range of products that are deemed essential to middle class families.
Costco is a success story of multiple partners, teams, and champions. And they’ve achieved that
success because they’ve been able to build support across constituencies inside and outside their
organization. Costco has grown so much over 25 years that many of the systems haven’t kept
pace.
• “Green screens” for the business were synonymous with business inflexibility.
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• work lost in stacks of paper and email, actually speaks to non-standard manual processes
• “Business” felt that BPMS meant no more green screens – in other words, return of
business flexibility
• “IT” felt that BPMS meant continuous process management and improvement, in other
words, tracking down all these ungoverned processes and improving them
There was also great BPM consulting advice conveyed in this presentation. Tie your efforts back
to company culture and mission. In Costco’s case, how can BPM fail to be tied to?
• continually provide our members with quality goods and services at the lowest possible
prices
• take care of our customers (members), take care of our employees, respect our suppliers
Costco.com hopes to launch mobile apps for Apple and Android this month, grow internationally
Costco cares more about its customers and employees than its shareholders; it pays workers an
average of $17 an hour and covers 90% of health-insurance costs for both full-timers and part-
timers. Yet revenues have grown by 70% in the past five years, and its stock has doubled.
To continually provide our members with quality goods and services at the lowest possible
prices. In order to achieve the mission it will conduct its business with the following Code of
Ethics in mind:
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Take care of our members
There are a few big lean leadership lessons we can gain from Costco, they are:
The true definition of quality control is the stabilization and maintenance of a process to produce
consistent output. The key to Costco's ability to maintain their low prices and quality is because
of good wages and benefits. According to CEO Jim Sinegal, this is why Costco has extremely
low rates of turnover and theft by employees. And Costco’s customers, who are more affluent
than other warehouse store shoppers, stay loyal because they like that low prices do not come at
the workers’ expense. Also by selling a limited number of items, keep costs down, rely on high
volume, have customers buy memberships and aim for upscale shoppers, especially small-
business owners.
Costco has in place a quality assurance program. Its objective is to ensure that all products are
placed under the same stringent Costco quality guidelines. Each produce item has a Costco-
supplier confidential specification sheet that lists specific acceptability factors. Inspections
(testing) for fresh produce start at the very beginning while being grown and end at warehouse
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checkout as customers make the final purchase. If concerns arise, production ceases. Costco is
known for its high quality control process especially in produce, jewelry and meats.
Costco wants to provide great products to its customers while also keeping their prices down. In
order to do this, Costco decided to improve its transportation methods by adopting new
technology to better not only their shipping time but costs as well. Costco has provided different
Costco’s sustainable business model is embedded in how they have embraced the 6
1. Keeping their Immigrant Perspective: They stay true to their cultural perspective by
continuously seeing and seizing opportunities that others don’t see and are fearless to take action
2. Employing a Circular Vision: Costco anticipated crisis and change in the retail industry as
Wal-Mart’s low price strategy forced consolidation amongst the many retail outlets. As such,
Costco’s circular vision helps them reinvent a new retail distribution channel that focused on
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3. Unleashing their Passion: Costco pioneered the warehouse industry. Its passionate pursuit
4. Living Your Entrepreneurial Spirit: Costco’s leadership is all about the entrepreneurial
spirit. They have worked the warehouse floors themselves and understand the specific needs of
their members to keep the buying experience fresh, dynamic and new. Every visit to Costco is
an entrepreneurial experience and their treasure hunt merchandising approach proves this to be
true.
5. Working with a Generous Purpose: Costco is all about servicing the needs of others just as
much as their own. They are meticulous about listening, learning, and implementing the ideas of
their members and vendors voices. They share ideas to their partners to deliver momentous
outcomes.
6. Embracing a Cultural Promise: From the time one walk into the warehouse location, he
feels the promise that Costco is delivering to its culture. He always senses that it is delivering
value in every aisle and with a promise that is consistent, honest and true.
Innovations of Costco
Costco is the largest membership warehouse club. Costco’s process of innovation has been
continuously beneficial to the corporation because it has enhanced their selling power. The new
innovative growth segment of Costco is Costco Gas, Costco Car Wash, Costco.com (online
business), Costco Travel and Costco Home. They offer a wide variety of products that attract
consumers of different purchasing needs. They carry an assortment of products and home
essentials such as produce, food services, home electronics and jewelry. Costco also offers
pharmacy services, gas stations and Costco travel. Their target markets are not only business
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owners as the first wholesale warehouse Price Club did, but Costco opened up the markets to the
general public.
Both Sinegal and Brotman used strategic entrepreneurial ship of selling products at a low price,
but at a high capacity. Costco is also innovative by not selling products from various brands that
are fundamentally the same, but they sell more of their store brand Kirkland Signature label. This
enables Costco to sell more goods from one label which initially reduces the price of the
products and marketing costs. They also save on bags for packing material, lighting by using
skylights and refusing to stock products from companies that sell to them at high wholesale
prices.
Another innovative strategy that Costco acquired was being a wholesale corporation that only
members and their guests can use at a yearly fee of $55.00. Costco’s entrepreneurial approaches
are to seek innovation from suppliers and complete productivity and value.
Costco has managed to earn a net income of $1.462 billion dollars throughout this year. Part of
Costco’s ability to earn and provide trustworthy services to the general public is due to the
founders of the corporation. Costco has the potential to earn a high net income in a fluctuated
economy because they have the means and resources in order to do so. Costco’s vision,
entrepreneurial perspectives and cultural promise has benefited Costco in numerous ways that
has allowed them to continue their success. Costco Wholesale’s entrepreneurial ability to
With offerings as diverse as merchant accounts, banking, and financial planning to Web
development and group health plans, there is often little need today for members to venture
anywhere else. Today, Costco holds the position of fourth-largest retailer in the United States
overall, after Wal-Mart, The Home Depot, and Kroger. Costco is firmly entrenched as the
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number one warehouse club chain in terms of sales volume even though it has approximately
two hundred fewer stores than its next closest competitor, Sam’s Club.
It is a safe bet that Costco’s good fortune will continue as it keeps innovating – like an
entrepreneur. The result is a perpetual harvest that continues to benefit the company, its vendors,
and its members. Costco clearly sets the standard for not only living its entrepreneurial spirit, but
also through its passionate pursuit to reinvent an industry. And it has created new opportunities
Integration Issues
Leadership selection
Costco will implement its employee its own specific design in terms of hiring and managing its
employment. Current Costco CEO Craig Jelinek is a very fair and generous individual who
believes in paying individuals a livable wage. He has been an advocate for raising the federal
minimum wage to $10.10 an hour. Currently Costco’s current starting pay is at $11.50 per hour.
The average wage for Costco employees is a substantial $21 per hour and this does not include
overtime which many employees tend to work on a routine basis. Due to this policy of Costco
most likely the strategy for the first year would be to not change Sprouts Farmers Market current
employee wages unless they are receiving below $11.50. During the year after the acquisition an
evaluation of wages and impact analysis will be conducted. Also, the current plan for
employees would be that all employees would remain. There will not be an immediate firing of
Sprouts Farmers Market employees. The employees currently employed by Sprouts would be
incorporated into the Costco employment plan and will receive all benefits and compensation as
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Currently, about 88% of Costco’s employees receive company-sponsored health insurance.
According to Costco’s benefits structure, equivalent level Sprouts Farmers Market employees
will be offered the same health care benefits. The Mr. Jelinek told Bloomberg in an interview “I
just think people need to make a living wage with health benefits. It also puts more money back
into the economy and creates a healthier country. It’s really that simple” (Short, K. 19 Nov
2013). A trend that has been implemented over the last many years has been working on
Thanksgiving. Costco has traditionally been closed on Thanksgiving. Costco and Sprouts will
be closed on Thanksgiving. The employees will be able to spend it with their family. Costco
and Sprouts will also be closed on other major American holidays like New Year's Day, Easter,
Costco will implement and embrace diversity as it always has within the company. Sprouts
Farmers Market will follow the Costco’s model on this topic for Human Rights and Equal
Opportunity. Another hiring model used by Costco that will be implemented at Sprouts Farmers
Market is internal hiring. Seventy percent of Costco warehouse managers started at a register or
on the store floor. This is a great prospect for current employees of Sprouts as they now have a
great opportunity for growth within the company. Costco has always promoted this aspect in its
business because who better to manage a location then someone who is a veteran and knows the
business better than any new individual. From a business perspective, this is essential because
any new individual who is not familiar with the industry may not so easily grasp the job and may
take time and possibly hinder growth. One of the beliefs of Costco is that if employees are
treated well they will treat Costco well. The current employee turnover is less than 6%. In
several articles, there seems to be some employee dissatisfaction about upward movement.
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While Costco want to keep highly qualified and talented employees within Costco, the merger
Corporate culture
The corporate culture of Costco is a major success factor for the business, especially since there
is very high employee morale, along with customer satisfaction and overall performance. The
2. Positive attitude
4. Service orientation
5. Teamwork
believes that “good enough” is not enough. This characteristic of the organizational culture
allows Costco to push its employees further to achieve high quality service to satisfy customers.
This focus on excellence creates a sense of direction among workers in terms of their personal
and career development. It allows employees to strive to achieve higher knowing that their hard
work will pay off in the long run and their determination will be rewarded and acknowledged.
The positive attitude portrayed allows for courteousness and friendliness for all consumers of
Costco Wholesale. The company believes that these behaviors are important in attracting more
customers to its warehouses/stores. This is essential to their business as everyone loves to shop at
a location where they feel comfortable and respected as well as a location where they are helped
in purchasing anything their heart desires. The various departments filled with knowledgeable
personnel help consumers in determining and satisfying their needs and wants.
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The next factor is the high energy and fast pace of Costco employees. Efficiency is also included
in Costco Wholesale Corporation’s organizational culture. Through high energy and a fast pace,
organizational culture also contributes to the energetic buzz that helps satisfy customers based on
speed and efficiency of service. Because, in any store consumers want to get what they need and
leave as soon as they have found what they were looking for. This leads to our next factor of
culture of retail firms like Costco. The emphasis on service helps align workers to the business
goal of providing effective retail service. Costco also uses this service-oriented characteristic to
encourage employees to interact with customers in a productive and profitable way, such as by
Another factor is the teamwork aspect of Costco which helps facilitate work teams. This
synergy of teams. Through teamwork, employees achieve flexibility that enables Costco to
address variations in customer preferences. These work teams also enable the company to
facilitate camaraderie among its employees. Such a method will form strong bonds between
employees and will similarly affect their customer service. Being able to rely on your fellow
employees is key between departments because it allows for the satisfaction of customers and
excellent customer service as consumers are helped and guided in all aspects of their shopping
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When all else fails, follow this rule... “Pick the Right Team, will give you a fighting chance, a
margin of safety even if you make a mistake on the other rules. The M&A team requires legal
leadership but also requires teamwork – finance, tax, sales, R&D, manufacturing, marketing,
HR, and IT. Virtually every department will, sometime during the process, need to help with
diligence or integration planning” (Levinson, 2012). In any business, no one is immune to risk
factors. Costco faces many risks factors that can have adverse actions on their business. For
Costco and Sprouts membership loyalty and growth are essential to a business model. Failure to
operations.
With the economic prospects looking up, Costco may be in a great position to acquire Sprouts
making it a strategic acquisition, however digging a little deeper, Costco has to look at the
acquisition more than a financial transaction; there must be thought and planning to make
everything mesh together. It’s key to have a steady flow, you want to ensure that people can see
and understand the steps clearly, forecasting the performance and results. Furthermore, to have
the ability to envision and solve challenges that will be faced with integration is a must. It’s
imperative Costco create a smooth transition to Sprouts. Throughout the acquisition process
there will be many conversations with stakeholders. It is important to set a realistic pace and
goals focusing to make sure the projected benefits, synergies and teamwork can be realized.
Communication plan
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In creating a plan, Costco needs to analyze both the competitive position beside the future
objectives. We need to know what is feasible. Costco has to have a strong platform for how they
do business during the acquisition. They need to know how to integrate the companies
understanding the organizational and operational challenges. Their business model needs to state
where they’re going and what is most valuable. The Executive Team needs to evaluate targets in
revenue and layout cost models for the future combined companies. A strong plan carries
accountability. It is important that they maintain uninterrupted operation with the high volume
of transactions they process. For example, some key thoughts would be as followed;
Will they set up or expand a product line, eliminate or change processes, or distributions?
Regardless, Costco needs to have a plan aligning the acquisitions and building a bridge removing
The best way to tackle acquiring Sprouts is to give a thorough financial check, shifting the focus
to liquidity which shows that the capital structure is not strain. Costco will need to do their due
diligence on the best way to perform and future prospective targeting. They need to define key
success factors and threshold position forecasting what you must achieve to have a successful
merge. They should not overlook the customers, understanding the positions they hold in both
companies and looking to see how to sustain them once the acquisition goes through.
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Being in an acquisition requires strong leadership. It is critical to place a steering committee
beside other for the business model. These leaders should engage in both side of the acquisition
giving the expectations and support throughout the merge. Processing two cultures Costco and
Sprouts must validate the business model, remembering the values, critical spots and not to sweat
the small stuff and taking the time to watch each milestone, embracing creative plans, and having
a successful execution.
The transition of non-management staff will be difficult initially but Sprouts employees will
accept the Costco benefits package with open arms. With the ability to have growth through hard
work and dedication as well as health care benefits every employee should be satisfied with the
acquisition. Since Costco will most likely keep the business separate and slowly incorporate the
acquisition into its own stores the employees of Sprouts will have ample time to adjust. Being
part of a larger company will allow even non-essential personnel to strive to achieve new
lengths. This motivation will hopefully drive sales and allow for further growth of Costco and
Sprouts as time progresses. The incentive of being able to move up the corporate ladder will
Facilities
The facilities managed by Costco already carry organic and fresh grown products. The products
and uniqueness of the facilities does not come from the items but from how they are made. The
overall structure and building of a Costco facility is comprised of many recycled materials.
Costco in its construction adheres to the standards of the leadership in Energy and Environmental
Design, as they are internationally accepted as the benchmark of green building design and
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construction. The way these standards are employed varies from the part of the facility being
considered. The main structure utilizes up to 80 percent of recycled steel. The roofing and
exterior also consists of a portion of recycled materials as per LEED standards. Costco goes as
far as utilizing recycled asphalt in their new parking lots to aim for a high usage of recycled
materials to manage new landscaping requirements that arise in the business. The water is also
managed using bio-swales which preserves the groundwater and also helps to prevent runoff in
certain areas.
Costco began the management of water usage initially in Mexico, from their it has moved on to
manage facilities within the southern United States. These facilities have saved up to 30 million
gallons of water due to the management of water. With software analytics, the process has been
made even more efficient as now they are able to detect mechanical failures along with any water
waste as a result of operations. The water management system helps to cut costs as well as
saving water in large amounts throughout all of Costco’s facilities. This leads to the usage of
non-chemical water treatment systems that help in cooling towers and is great because it prevents
chemicals to be deposited into the sewer systems. Every single Mexico warehouse has their own
wastewater treatment systems. By coordinating with local and national incentive programs, these
and other energy-saving systems help us lower the cost of operating our facilities (Costco
Sustainability, 2017).
Franchise Services
Franchising as we know it today is a recent phenomenon. In the private sector, franchising was
used by privately owned businesses with methods of expansion. Costco, as a successful business
owner does not have any ties to franchising and has no future intentions of pursuing this avenue.
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International operations
Costco has been very successful in the retail industry. Due to their successful ventures, it has
brought on many competitors from large chains to high – end retail stores. To be competitive,
Costco must focus on delivering the highest quality of products, customer experience, bargain
prices, and convenience to the member. In the US, an ongoing focus has been on larger
competitors which would be very similar in the international market, which could hinder growth
Just as Costco has success in the American market, Costco also wants this success mirrored in its
overseas market. Costco in 2016 operated 214 warehouses in eight countries outside of the U.S.
Costco plans on expanding the international operations, the annual reports go on to say future
constraints or other matters in the countries or regions in which they operate (Sinegal, 2016).
Costco formula works well with consumers. The unorthodox strategy works not just on the U.S
side but all outs the U.S. Its states that Costco international stores in ten countries have proven
successful quoted “Apparently to know Costco is to love Costco, no matter where in the world
Costco is. And the international consumers who are quickly becoming part of the Costco Craze
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probably don't care which candidates of which political party do (or don't) shop there. They just
want quality merchandise, good prices, and a low-tech touchy-feely experience” (Farfan, August
2017).
Strategic Risk
The analysis of Sprouts so far has not identified any moderate or significant financial issues.
Sprouts are a popular small chain that is recognized for organic products. There is a strong
trend in customer desire for healthy and organic food at a good price. As long as this trend has a
large following, Sprouts sales will be strong based on the business model.
Sprouts have a slightly larger debt ratio than Costco but it is at a manageable level. It has also
been successfully managed by Sprouts over the years. The culture has also been identified as
similar to Costco with respect to treating employees, charitable giving and possessing a loyal
customer base.
As Costco evaluates the strategic risks there are relatively low risks at this time based on the
analysis. When evaluating a company for acquisition there are a few reasons to execute the
merger. According to The Risk Perspective, there are four reasons for companies to merge.
Acquiring a business in a totally different space that will allow your organization to move
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Sprouts would be identified in the second category of being a smaller company whose business
is similar. This strategy is often used to strengthen the parent’s position or compliments
customer trends in the industry. A sprout is known for his philanthropic activities and organic
products at a 20-30% discounted price when compared to competitors. The lower prices
capitalize on the current popular trends of purchasing organic products. Customers increase their
volume purchase because of the lower prices. This helps sprouts which reduce waste costs.
“Perishables generate significant amounts of waste in the traditional grocery store model, with an
estimated $15 billion being discarded annually in the United States, so Sprouts has focused on
unlocking the operating margin potential embedded here” (Downie, R., 2016).
The supply leverage Costco has with its suppliers could help improve Sprouts net revenue.
Costco offers organic products and can incorporate these deliveries to include Sprouts stores.
Utilizing economies of scale, the potential lower unit costs and the larger volume purchases of
Because there is no proprietary technology advantage about Sprouts or new product lines to
assist Costco in sales, a risk to Costco is the organic trend ends soon. Sprouts primary advantage
to Costco is the popularity of Sprouts in the organic grocery shopping. If Costco can maintain
Sprouts image and the customers continue to welcome the Sprouts atmosphere the merger should
As with any merger discussion, the acquisition should be kept confidential. When the market
identifies a public company might be acquired, the demand usually increases the stock price.
The increased stock price can inflate the value of the company past a favorable market
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Reliance on Franchises
Sprouts Farmers Market does not offer franchising opportunities. All of our stores are operated
Reliance on Growth
realize significant revenue growth in the grocery industry, one has to expand location to gain
those significant volume increases. Sprouts is modernizing its stores and expanding locations to
The year 2016 was a busy time for Sprouts. They made improvements to several of their stores.
The result was a growth in sales 15% over 2015 to $4 billion. Sprouts have seen significant
growth in its private label brands. It has matured to 10% of sales. It also makes up 2,100 items.
Sprouts increased the size and offerings of 76 delis its stores. They have a plan to expand 50
more in 2017. Sprouts will also be expanding their digital engagement to customers via email, a
Sprouts have plans to continue growth in 2017 by expanding into two new states, Florida and
North Carolina. They have targeted to open 32 new stores in 2017. Sprouts have publicly
announced a vision to open 30 stores each year. Sprouts are working with Amazon Prime Now
to offer delivery to new markets. They expect their private label will continue to grow and the
new media avenue will help expand those lines (Pogorelc, D., 2017).
Sprouts do realize that the new stores may not realize the same sales or revenue volume our
current stores experience. In the competitive marketplace and opening a new store in a new
region, could cause a negative impact on the financials in the short term. Sprouts have been
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successful in gaining customers once the area becomes familiar with the business model and
Spouts’ products.
Credit Risk
Sprouts have an agreement governing its credit facility that requires it to maintain a specified
total net leverage ratio and minimum interest coverage ratio at the end of each quarter” (Sprouts
Farmers Market, Jan 2017). The allowable aggregate that can be borrowed is $450 million.
Sprouts must also “maintain a maximum total net leverage ratio not to exceed 3.00 to 1.00 and a
minimum interest coverage ratio not to be less than 1.75 to 1.00. The covenants are tested on the
last day of each quarter” (Sprouts Farmers Market, 2017). Sprouts total debt as of 1 January
2017 was $255 million. Sprouts are well below their debt allowance.
Liquidity Risk
According to the Retail Owners Institute, the average grocery store current ratio is 1.6. Sprouts
current ratio at the end of 2016 was 1.1. This is below the industry average. However,
analyzing the financial and knowing the company recently executed a $250 million stock
purchase buy back, some through debt financing, the 1.1 current ratio is not that concerning at
this time.
Capital Requirements
Sprouts forecasts their operation will sufficiently meet their anticipated cash needs for the next
12 months. Combining this forecast with their debt flexibility and room to take on more debt the
company appears to be financially healthy. Sprouts collects majority of cash from sales to its
customers in the same day. In the case of credit and debit cards payment is collect within days
of the transaction. Cash flows from operating activities increased $14.5 million to $254.4
million in 2016 from $239.9 million. The average of Cost of Capital in the grocery industry for
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2016 was 4.9%. Sprouts Weighted Average Cost of Capital is 5.23% in 2016 (Damodaran, A.,
2017).
Sprouts exposure to interest rates is mainly based on their outstanding debt under their $450
million Credit Facility. This outstanding debt is currently $255 million, and the interest rate is
based on LIBOR plus 1.25%. Based on the current amount of $255 million, each hundred basis-
point rise in LIBOR would result in an increase of $2.55 million in annual interest expense.
With interest rates at historically low rates this is a risk that is likely to occur in the future.
Sprouts Credit Facility has covenants regarding mergers. Because Sprouts overall debt of $255
million is not a significant amount, if Costco decided to acquire Sprouts, it would have a
negligible effect to Costco. Costco would most likely pay off the debt in cash or absorb it into
A change in interest rates would also affect the amount of the capital and lease obligations on the
company’s balance sheet. Any increase in the borrowing rate would decrease the NPV of the
Sprouts do not currently have any exposure to foreign currency rate changes, as all of their sales
Sprouts do not currently own any assets that would be affected by the markets other than their
long-term leases which were discussed under the interest rate risk section.
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Transaction Risk
Because Sprouts has no exposure to exchange rates they have no transaction risk. They do have
risk associated with the price of commodities, and do not currently hedge that risk with the use of
derivatives.
Compliance Risk
As with all companies in the grocery business, Sprouts is subject to many local, state and federal
laws they must comply with. These laws are regulated by the following agencies:
FDA/USDA
o Food safety
o Labeling
o Promotion
o Dietary supplements
FTC
o Advertising
Department of Labor
o Equal employment
o Minimum wages
Accounting
o SOX
o Dodd-Frank
Failure of Sprouts, or their suppliers to comply with all regulations regarding the above could
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Reputation
Any claims of non-compliance, as well as being found guilty of non-compliance with any of the
above regulations would cause not only cause hardship to the financial well-being of the
company, but would also cause significant damage to the company’s reputation. Sprouts have
built a great reputation with not only their customers, but their suppliers and employees as well.
Any claims of non-compliance with any food safety regulations would be especially hard to
recover from for Sprouts because of their reputation of a company being dedicated to healthy
living, and could be extremely hard to overcome in the competitive organic grocery sector.
Strategic Risk
Difficulty in adhering the strategic vision: Proper alignment of business vision is required for a
successful business acquisition (Rothaermel, 2011). Costco and Sprouts both are engaged in the
retail grocery industry, and the goals and business strategies of these companies show high levels
of convergence. Costco can ensure proper integration of the vision of both companies by actively
Cultural Difference: The cultural differences between the two organizations may create a
divergence can create strategic risks in the merger and acquisition process. Usually, as the both
firms are from the same industry, the internal cultural difference is considered to be low. The
cultural difference issue can be mitigated by Costco with due diligence, and providing support to
Difficulty in the integration of marketing strategies, distribution channel, and brand name:
Problems may arise during the integration of marketing strategies, distribution channel, and
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brand name of the combined companies after acquisition and merger. Since Costco and Sprouts
both have the same business nature, the integration of marketing strategies, and distribution
channels will be an easier process. Costco can consider opening the products under the joint
name of Costco- Sprouts to create a quality image and high acceptance from consumers.
management of the two companies can result in non-achievement of objectives for the merger
and acquisition (Allen, 2013). Costco can mitigate this risk by approaching with a friendly
takeover bid, convincing the management of the benefits of the merger to both companies, and
Credit Risk
There exists low debt in the capital structure of Costco. The current debt ratio of Costco is 0.64.
The usage of low debt in the capital structure implies low leverage of the company, and a high
credit rating. Additionally, the earnings of the company will be less volatile (due to less
mandatory of the requirement of debt burden) (Vishwanath, 2007). The company has adequate
capacity to meet up its periodic interest burden. The current time-interest-earned ratio of the
Costco is 28.21 (Morningstar, 2017). The acquisition to Costco will increase overall leverage as
well as credit risk of Costco slightly. The current debt ratio of the Sprouts Farmer is 0.53. Given
consideration of the financing of the acquisition with debt and without debt, the post-acquisition
debt ratio of the combined company will be 0.67 and 0.63. Currently, Costco has an AA- credit
rating (Morningstar, 2017). The company has $6 million in bonds outstanding on the market.
Thus, arranging of the bond issue or bank loan will not be a problem for Costco. Overall credit
risk of Spouts is said to be low. Currently, Sprouts is one of the fastest growing retailers in the
USA (Sprouts Farmer, 2017), and Costco has already established a strong position in the market.
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After the acquisition, the sales and income of the combined firm is expected to increase. Thus,
Costco will have no problem in meeting its incremental periodic interest burden if the acquisition
Liquidity Risk
The current ratio and quick ratio of Costco are 0.98 and 0.38, respectively (Morningstar, 2017).
The current ratio and quick ratio of Sprouts are 1.02 and 0.15, respectively. Given consideration
of the 100% ownership of Sprouts, after acquisition the current ratio and quick ratio of the
combined company will be 0.89 and 0.31, respectively. After the acquisition, the current ratio
and quick ratio of the combined company will still be strong. Given the post-acquisition current
and quick ratios of the combined company, the liquidity risk of the acquisition of Sprouts would
remain low.
At the end of August 2016, total cash balance (including cash and cash equivalent, and
marketable securities) of Costco was $4,729 million. Current total assets size and the market
capitalization of Sprouts Farmer are $1,440 million (Morningstar, 2017), and $2,560 million
(Yahoo Finance, 2017). In 2016, the additional investment in the non-current assets of the
Costco to support the growth was $1,804 million. Given consideration of continuation of the
same pattern of capital expenditure in this year, Costco will have enough cash to acquire the
Sprouts Farmer in any format, asset purchase or stock purchase. After the acquisition, Costco
will not have to face a severe liquidity problem. Thus, the liquidity risk of the acquisition of
Sprouts is low.
Costco can consider issuing debt in the market to finance the acquisition of the Sprouts Farmer.
Interest rate risk may arise in that case. The interest rate in the U.S. is on an upward trend (See
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Figure 1), thus, debt payment choice, as well as consideration increasing debt by $1,440 million
to finance the purchase of Sprouts Farmer, is subject to high-interest rate risk. The current prime
rate is 4.25%. Based on the opinion of market experts, this rate is expected to increase in the
upcoming period (Fed Prime Rate, 2017). According to Trading Economics, by the end of last
quarter of 2017, the interest rate in the U.S. is expected to be 1.25%, up from current level of
1.05% (Trading Economics, 2017). The high-interest cost in debt financing will lower the net
Figure 1: Federal Fund Rate of USA (Past and Future Trend) (Trading Economics, 2017)
Except for the interest rate risk, the risk factors for the acquisition of Sprouts are low. High-
interest rate risk can be avoided with the choosing of acquisition mode of cash payment or stock
issuance. Thus, the overall risk in the acquisition of Sprouts Farmer is low.
At the end of fiscal year 2016, Costco operated 715 membership warehouses, with 501 (70%) of
these warehouses being located within the United States or Puerto Rico. The remaining 214
(30%) warehouses were operated internationally, primarily in Canada (91, or 12.7%). The
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internationally operating segments generated 27% and 39% of net sales and operating income,
respectively, during FY2016. Over recent years, the new warehouse opening data reflect that the
gap between the U.S and International locations has been shrinking. Since the beginning of
FY2013, 107 warehouses have been opened, net of closings and relocations, and of these, 58%
(62) were located within the US, and 42% (45) were located internationally (Costco Annual
Report, 2016).
Costco operations are primarily conducted in the local currency of the respective countries in
which the warehouses are located. While the majority of locations and net sales are located
within the U.S., foreign exchange risk still applies to a signification portion of Costco operations,
particularly to that of the Canadian Dollar (CAD) vs. the U.S. Dollar (USD). The adverse impact
of exchange rates on net sales was predominantly due to CAD ($1.65 billion), with an overall
Over recent years, the USD has been gaining strength relative to the local currencies that
denominate significant international operations of Costco, which accounts for the significant
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year-over-year increase in the adverse impact of foreign currency exchange reflected in the chart
above.
Market Risk
Economic and market conditions may cause Costco’s investments in financial instruments to lose
value or increased the cost of energy related commodities, such as natural gas, oil, and any others
uses in electricity production. Many Costco locations include car fueling stations and severe
increases in the market price of oil may have a direct impact on gasoline sales. Additionally, all
of these commodities are significant costs in operations of Costco warehouses as well as integral
distribution network.
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Compliance Risk
Costco is subject to many laws and regulations, and non-compliance could adversely affect the
success of operations. Since the company operations are international, Costco must contend with
a wide scope of regulations that will vary by country and any significant changes to the laws,
Pharmacy
- Labor
Minimum Wages
Audit results
Reputation
A recent Harris Poll ranked several of the top companies by their reputation, in which Costco
ranked 13th by the general public, and 6th by “opinion elites” (defined as more informed and
engaged segment of the general public). Membership renewal rates reinforce this high ranking,
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as 90% of member renews membership in Costco’s primary markets, the U.S. and Canada, and
If Costco cannot maintain the high reputation that it has garnered thus far, it runs the risk of
losing a competitive edge in the industry. Other factors that could adversely affect the reputation
could include issues with suppliers that may leave Costco short on stock levels for essential
items that customers expect to find, or a high level of product recalls that are disproportionately
associated with Costco. Continued issues of this nature could cause Costco to be seen as less
reliable to consumers and affect their purchasing decisions or the companies they purchase goods
from. Additionally, Costco has benefited from higher satisfaction of their workforce due to
better compensation levels (Ton, 2012). A reduction in the overall employee compensation or
cuts to staff may adversely affect the reputation among customers and their financial condition.
Costco Wholesale Corporation’s main competitors in the highly competitive retail market of
large discount stores are Wal-Mart Stores and Target Corporation. These companies are also
sometimes classified as consumer defensive stocks. While Wal-Mart and Target pour money into
marketing, Costco has a no-frills approach and doesn't advertise. The company also sells a
limited number of items. Despite Costco's large store volume, it has been known to sell a fraction
of the number of toothpaste brands as Wal-Mart, according to The New York Times. Selling
fewer items increases sales volume and helps drive discounts. Costco's focus on driving sales
also helps explain why it offers better pay and benefits than competitors. Many retailers drive
profits by paying workers less, but Costco wants to retain good employees who will motivate
Wal-Mart Stores, Inc. operates retail stores around the world through three primary segments:
Wal-Mart U.S., Wal-Mart International and Sam’s Club. Sam’s Club most closely resembles
46
Costco’s sales format; however, Costco is still considered to be in direct competition with both
Wal-Mart and its subsidiary. Wal-Mart stores offer a wide variety of goods including deli and
bakery items; meat; produce; frozen foods; dry groceries; health and beauty aids; photo
electronics. The company also provides some financial services and product including money
orders and prepaid cards, check cashing and bill payment. Wal-Mart Stores, Inc. operates retail
stores around the world through three primary segments: Wal-Mart U.S., Wal-Mart International
and Sam’s Club. Sam’s Club most closely resembles Costco’s sales format; however Costco is
still considered to be in direct competition with both Wal-Mart and its subsidiary.
The Target Corporation is a general merchandise discount retailer operating in the U.S. This
chain offers household essentials; pharmaceuticals; personal care items; cleaning and paper
products; apparel; accessories; sporting goods; electronics; and food items, along with furniture
and other products. Target also offers Red card debit and credit cards that provide consumers
with a 5% discount on purchases. Though slightly lower than Wal-Mart’s, Target’s yield, at
2.9%, is substantially higher than both Costco’s and the industry and overall market average. The
five-year expected PEG ratio for Target is the lowest of all three companies at 1.58, and is lower
than the industry’s average of 1.6. This is significant because it indicates Target’s stock price is
not outpacing the company’s actual projected growth rate. Target has the lowest inventory
turnover ratio of the three, at six, indicating it only turns its inventory half as often as Costco and
slightly less often than Wal-Mart. The relatively lower ratio may indicate that, on average,
Target carries a somewhat more dated inventory than Wal-Mart or Costco. Costco's focus on
driving sales also helps explain why it offers better pay and benefits than competitors. Many
47
retailers drive profits by paying workers less, but Costco wants to retain good employees who
Conclusion
Generally speaking, Costco and Sprouts operate in similar manners when it comes to overall
corporate and capital structure. The alignment should allow for a much more manageable
acquisition process than if the companies varied drastically. Given the similarities of various
risks and risk management strategies between the two companies, the combined entity should see
48
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