TIP691: Sol Price: The Retail Visionary Behind Costco w/ Clay Finck
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You're listening to TIP. Hey, everybody. Welcome to the Investors Podcast. I'm your host, Clay Fink. On today's episode, I'll be telling the story of Sol Price and the foundational beginnings of Costco. Sol Price was the founder of FedMart and Price Club. Price Club would ultimately merge with Costco in 1993. When Jim Senegal, the founder of Costco, was asked what he learned from Sol Price, he mentioned he learned everything from Sol Price.

Somebody like Saul especially catches your attention when you see entrepreneurs like Sam Walton of Walmart, Bernie Marcus of Home Depot, and Jeff Bezos of Amazon cloning his business tactics. During this episode, I'll cover what led Saul to get into the retail business in the first place, the key ingredients that led to the success of FedMart and Price Club, the story of Costco launching the $1.50 hot dog, which they've kept the same price since its opening day in 1984,

why Saul believed in paying his employees better than all of his competitors, what led to the merger of Price Club and Costco in 1993, what has allowed Costco to be so dominant over the past 40 years in the ruthlessly competitive retail industry, and much more. Shares of Costco are up nearly 400 times since the IPO in 1985, which makes this a company well worth studying. So with that, I bring you today's episode on Saul Price and the foundational roots of Costco.

Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Playthink.

Robert Leonard : All right. So on today's episode, I wanted to discuss the genius behind Costco. That is a man by the name of Sol Price. Sol Price is a pioneer in crafting the fundamental strategy of the major discount retailer we know of today as Costco. But Sol Price is not the founder of Costco. That was Jim Senegal. Sol Price was the founder of Price Club, which he built up to 94 locations before they merged with Costco in 1993.

Today, Costco does $250 billion in revenue, $9 billion in earnings before interest and taxes, and they also have 890 warehouse stores and 136 million paying members. When Charlie Munger was asked about Costco last year, he stated, "I love everything about Costco. I'm a total addict and I'm never going to sell a share." Of course, this is not a recommendation to buy the stock.

Munger even admitted himself that the only problem with Costco is that the stock trades at inexpensive multiple. As of the time of recording, nearly 60 times earnings. During this episode, I'd rather focus on the story of Price Club and Costco and what makes their business models just work so, so well. So I picked up this book titled "Saul Price: Retail Revolutionary and Social Innovator," which I must say is a very difficult book to get a hold of. The book was written by Robert Price, son of Saul,

Saul is known as the pioneer of the retail membership warehouse concept, and he was born in 1916 and passed away in 2009 at the age of 93. Jim Senegal, the founder of Costco, wrote the foreword to this book. Jim talked about how he had received a complimentary letter from Price not long before his passing, and how he'd been working for that compliment from him for more than 50 years. And he reflected on how one person could just

garner so much admiration and so much respect from just thousands and thousands of people. Senegal writes, "Certainly there was his intelligence and creativity, but that's not the complete answer because as we know, there are millions of bright people in the world and only a handful make a lasting impact." So there's another quote from the book from Senegal, "We owe Costco's legacy to the retail concept that Saul pioneered with FedMart and Price Club,

as do our competitors in the industry in big box retailing in general. So Senegal, he actually worked at FedMart, which was the first retailer that Sol Price started, and many Costco executives would be previous employees under Price at FedMart. Price believed in developing strong operational efficiencies, and he continually emphasized passing on savings to customers. He also insisted that suppliers and employees be treated very well and be treated with respect

and that the latter be paid competitive wages. There would be many iconic businessmen who would actually copy the ideas of Sol Price. We have Sam Walton. He actually admitted it. And we know that after Jeff Bezos learned about the membership model at Costco, he immediately wanted to implement something similar at Amazon, which today has over 200 million Prime subscribers. Trey Lockerbie : Toward the end of the forward here, Senegal writes, "The remarkable thing about Sol was not just that he knew what was right,

Most people know the right thing to do, but he was able to be creative and had the courage to do what was right in the face of a lot of opposition. It's not easy to stick to your guns if you're swimming against the current of traditional thought. His lessons on philosophy, that business is about more than making money, and that a company also has an obligation to serve society are still valuable reminders for many of us in business today. Robert Leonard :

The fact he instilled these concepts in so many who were around him is, in my mind, his greatest legacy." End quote. So I recently actually rejoined Costco as a member myself, and I sort of gained this renewed appreciation for just how good this business is. Just from the perspective of the customer experience, it's just obvious that they sell really high quality products. Their employees are really friendly.

And they just take care of you with regards to things like membership services, the checkout experience. And when I went and signed up again a few weeks ago, the customer service worker made sure to tell me that if I ever had any issues with any product, then for pretty much everything, you can just return it without any issues, no questions asked. So they're just all about providing a really good customer experience. Back to the book here. The book was written by Saul's son, Robert.

In the intro, he highlights that Saul was not only very intelligent, but what really set him apart was his exceptional wisdom. Stephen Hall, in his book Wisdom, wrote about the qualities of a wise person. He got knowing what's important, moral reasoning, being able to judge right from wrong, compassion, kindness and empathy, humility, altruism, patience, successfully dealing with uncertainty. Saul's life encompassed all of these qualities.

Saul was born in the Bronx in January of 1916. His parents immigrated from Russia to the United States well before World War II. Many families in the area worked for the booming garment industry, and his dad was a tailor, and his mother worked in the garment factories as well. From an early age, Saul was an overachiever, and he was also an avid reader.

He did so well in school that he ended up skipping two grades and getting into high school at the age of 13. The way that Robert had described it was that Saul had been blessed with his father's charm, wit, and creativity, and with his mother's work ethic. In 1929, Saul moved to San Diego, California, which was a city of only 150,000 people at the time. Then he met Helen, who would become his wife while attending San Diego High School. He bounced around different colleges during the Great Depression. One interesting stat that was from the book

was that while he was enrolled at NYU, he worked during the day at a grocery store for $1 a day. He would eventually move back to California, attend USC, and get his undergraduate degree, and then he attended law school. After passing the bar exam, he went off to be an attorney for $100 a month, which was a pretty good job, just out of school at the time around 1938. I didn't want to get too much into his pre-retailing days here, but he worked for a number of years as a lawyer in San Diego, which was

really impactful for him. So he immersed himself in the community, serving different clients. He got his name out there and was able to develop a lot of good relationships. And he just got a lot of exposure to different types of businesses in that line of work. So there's one client he worked with that would serve Navy workers when they came back from service. And the client sold all sorts of things. You have clothing, jewelry, general merchandise, food, and other convenient items and services.

That really showed Saul how a large store selling a variety of goods and services under one roof could be successful catering to a focus segment of the marketplace. All right, so getting into the retail side of things here, Saul's mind was just too active and his interest in business was just too strong for him to just be a lawyer his whole life. Up to this point, Robert shared how lucky Saul had been in many aspects of his life.

It's not like Saul grew up always wanting to get into retail. So the story of him getting into retail in the first place is sort of this serendipity at play and being open to these different opportunities that life presents us. Saul's father-in-law passed away in 1947, and his mother-in-law was now stuck with a property that wasn't producing any income. It was a full city block in San Francisco, and Saul suggested that she sell the property and go and buy another one that actually produced cash flow.

She was a bit hesitant to do this, one reason being she was sitting on a big capital gain on the investment and she didn't really have much experience in real estate. So Saul was keeping his eyes open for properties she could buy, and he ended up finding an empty warehouse building that he was sure was worth much more than the $150,000 list price. His mother-in-law was a bit hesitant and didn't want to make the mistake with making that purchase and it not working out. So

Saul had said that he was going to buy it. So she did go up and end up buying that property then. So while Saul was searching for a tenant for the property, he came across this business called Fedco. This was a Los Angeles-based retailer that sold only to federal employees and was a nonprofit corporation. Saul, he went and visited the store with his two friends, Mandel Weiss and Sidney Friedman. After visiting the store, they were fascinated with the membership concept

and the nonprofit nature of the business, and then also the wide variety of products they sold. After they discussed it amongst themselves, they were pretty convinced that a similar business model could be successful in San Diego. Even better, Sol's mother-in-law had a property that would make for a great site to put together a similar model. Initially, they tried to launch a Fedco, but the company turned them down after multiple attempts. Again, this is another example of Sol getting lucky and people just saying no to him.

And this was a great time to launch a retail business in San Diego. So it was post-World War II, so the economy was just booming, and San Diego was experiencing substantial population growth. So a ton of business activity in the city, of course. Now, Saul and his partners obviously weren't the only ones getting into retail. This was also a time when discount retailers were starting to become more and more common.

One little note in the book I thought was interesting was that there was what was referred to as a fair trade law, which allowed manufacturers to set a minimum selling price for their products. So a common practice for many retailers generally was they would have pretty high markups and then occasionally they would run steep discounts. So these fair trade laws prevented some of these bigger retailers from heavily discounting their products much lower than the smaller stores. And there was actually one loophole to this practice.

A retailer called Corvette sold home appliances and other household products at deep discounts from the manufacturers suggested fair trade prices. And the reason they could do this is because shoppers were required to be members in order to shop there. So all of a sudden, the place was just very popular to shop at because the prices were just so ridiculously low. So it's not that this business really cared that much about the membership model.

what they really wanted to deliver was the lowest available prices that customers could find anywhere. So let's take a refrigerator, for example. At Macy's, that might have costed $400. And that same refrigerator might have sold for $300 at Corvette's, turning just a very slim profit. So in 1954, Saul, Weiss, and Friedman launched FedMart. And this stood for Federal Employees Merchandise Mart. And the company followed the FedCo template in terms of the membership, considering

concessionaires, and the warehouse store format. Saul had raised $50,000 in capital from investors, and then he invested $5,000 himself. Now, I do see the irony here that Saul is sort of painted as this person in retail that revolutionized the industry and brought all these new ideas, yet his very first retail business was largely an idea that was just copied from somebody else. I'm reminded of the Picasso quote that good artists copy and great artists steal.

Anyways, one of the funny things about this story of FedMart is that it was just really breaking all the rules of retail. And the only reason someone would ever want to operate a model like this that was just so different from the conventional norms is that the person opening such a store is someone that didn't have any previous retail experience. So Saul was able to come in really with a fresh perspective, fresh eyes, and really look at the entire industry differently.

So to be a member at FedMart, shoppers had to be military or government employees, and it costs $2 for a lifetime membership. They sold mattresses, clothing, luggage, furniture, appliances, hardware, among other items. From the day FedMart opened, it was a huge success. Saul anticipated doing $1 million in revenue in the first year, and they ended up doing more than 3 million. Saul's background as a lawyer really carried over well into the world of retail.

He put together these strict operating procedures for how business was to be done, and he was very careful about not showing his hand to other retailers who were interested in what was going on in the store. For example, in their printed materials, they would never use a superlative such as they sell the best, they sell at the lowest prices, or the cheapest. He described his business approach as a professional fiduciary relationship between us, the retailer, and the member, the customer. He found

He felt he was representing the customer. He wanted to be very honest and fair to customers, so he decided to avoid sales and avoid advertising. He always believed that the best advertising is done by their members, the unsolicited testimonial of the satisfied customer. The way Saul put it, "If you want to be successful in retail, just put yourself in the place of a cranky, demanding customer." In other words, see your business through the eyes of the customer.

Based on the success of the first location, they went on to open a second in Phoenix, Arizona. One reason being that the city had many government employees based there. The format was almost exactly the same as the first store, except that they would own the land the store was built on. After the Phoenix location was also a big success, the three founders felt pretty vindicated in the success of their business idea.

Saul was still an attorney for a couple of years, but eventually he would give up his law practice to become the president of the Fedmark Corporation. At the start of chapter four here on the expansion of Fedmark, there's a quote from Saul Price, "Our first duty is to our customers. Our second duty is to our employees. Our third duty is to our stockholders." Now that sure sounds like the Costco model here 70 years later.

Robert Leonard : FedMart's third location would go in San Antonio. And one of the big things he learned about San Antonio was there was a pretty big wealth and racial divide present in the city at the time. While he was paying workers $1 an hour in San Diego and Phoenix, it was pretty common for people in San Antonio to only get paid 50 cents an hour. He didn't see any reason why he couldn't pay the same wage in San Antonio as the other cities. And he didn't care if the cost of paying employees was going to be twice that of his competitors.

because he really cared about employees more than he did profits. To add to his conviction in the decision, he had paid employees well in the first two locations and the profits really just took care of itself, so he took the same approach with that third location. In order to raise capital, FedMart would go public in 1959, raising nearly $2 million. In the fiscal year 1959, the company had five locations. They reported $26 million in sales,

$470,000 in profit. So it was just a tiny margin of just 1.8%, just looking at the accounting figures here. And as Fedmark grew, so did their assortment of products. The first food item they sold was Planters Peanuts, and it sold so well that they would start purchasing this item by the truckload. They sold so many of these peanuts that the president of Planters would visit San Diego to just see for himself that

these numbers weren't just overstated to the benefit of the sales rep. He actually wanted to see what sort of business was buying this many peanuts and actually selling them. As they started to dip their toes into different business segments, I can't help but see similarities to a business like Amazon. For example, FedMart opened their own pharmacy in their store, and the local pharmacists would just become outraged knowing that their prices were going to be drastically undercut.

And as a result, FedMart received pressure from local and state pharmacy organizations. Pressure was placed on wholesale companies not to deliver or sell to FedMart. And they had difficulty obtaining a permit from the state. And the director of their pharmacy division received numerous death threats. A rock was thrown through his living room window, and he was treated like a traitor to his own profession. FedMart then expanded into gasoline.

which was just a brutal business to be in due to the constant price wars amongst competitors. And of course, FedMart would be remarkably successful in this arena as well. In fact, FedMart's gasoline suppliers, they stopped supplying them with gasoline because they had become such a big competitor to their own locations. So FedMart decided to open up their own wholesale supplier that acquired gasoline directly from Texas.

Robert Leonard : FedMart even launched their own private label branding to pass off even more savings relative to the big brands that would sell their products at a big markup. FedMart was beginning to make a major impact on the world of retail, the most notable of which was that retailers started to reduce their prices in order to remain somewhat competitive. Department stores would eliminate entire product categories, finding it impossible to compete with FedMart and other discount stores.

FedMart, of course, wouldn't be the only low-priced retailer out there. Some other big names were Kmart, Walmart, and Target. As FedMart continued to grow, they opened a couple of distribution facilities that would supply all of the stores. Eventually, Jim Senegal would become FedMart's executive vice president responsible for the two facilities, and Senegal would later become the founder of Costco, which he started in 1983. Robert has a chapter here on teaching. Robert

Saul had said that if you're not spending 90% of your time teaching, you're not doing your job. Jim Senegal, he had actually joined FedMart at the age of 18. A reporter once remarked to Senegal that since he worked with Saul Price for multiple decades, he must have learned a lot. And he corrected the reporter by saying he didn't just learn a lot from Saul Price. He learned everything he knows from Saul Price.

One of his favorite adages was that you train an animal, but you teach a person. He really wanted his employees to think about and understand why their jobs were important to the success of the organization. He wasn't a big fan of procedures and training manuals because he believed that manuals were really a substitute for thinking. Let's take a quick break and hear from today's sponsors.

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All right, back to the show. There was a story of one store manager's encounter with Saul where the flagship store was exceptionally busy and all sorts of things were happening all at once and the place was just a total mess. And Saul brought the manager aside and told him that he isn't running the store. The store is running him. That manager was just reacting to what was happening in front of him. And Saul had told him that he really needed to take charge of what was happening and to run the place and stay ahead of it.

Robert shares four points to Saul's business philosophy. First, provide the best value to customers that mean excellent quality products at the lowest possible prices. Second, pay good wages and provide good benefits, including health insurance to employees. Third, maintain honest business practices. And finally, make money for investors. He also believed in building a long-term relationship with customers,

Because of this mindset, he knew that he really shouldn't be making too much money from customers. Saul had a policy at FedMart that they would give an immediate cash refund to any customer that wasn't satisfied with the purchase, no questions asked. So I thought this was a good place to play a clip from Charlie Munger and how he viewed this commitment to low prices and developing a long-term relationship with customers.

So this clip was from Berkshire's 2011 shareholder meeting that I thought our audience would really enjoy. Well, Costco, of course, is a business that became the best in the world in its category. And it did it with an extreme meritocracy and an extreme ethical duty, self-imposed to...

take all its cost advantages as fast as it could accumulate them and pass them on to the customers. And of course that created ferocious customer loyalty. It's been a wonderful business to watch and of course strange things happen when you do that and do that long enough. Costco has one store in Korea that will do over 400 million in sales this year. These are figures that can't exist in retailing, but of course they do.

And so that's an example of somebody having the right managerial system, the right personnel selection system, the right ethics, the right diligence, etc., etc. That is quite rare. And if you once or twice in a lifetime you're associated with such a business, you're a very lucky person.

So in the world of retailers, discount stores were all the craze, but Saul opted for the term low margin retailer when it came to FedMart. While other retailers would put an emphasis on the suggested retail price, FedMart would start with what the product actually costs and then add the smallest possible markup. Saul also rejected the idea of selling any item below cost because that would need to be subsidized by other products with excessive markups.

I think the one exception today would be the $1.50 hot dog and drink at Costco, which is the price the meal has been ever since it was introduced in 1984. Craig Jelinek, the CEO who took over at Costco in 2012, he had told Jim Senegal that they just couldn't keep selling the hot dog for $1.50. And Senegal had said, "If you raise the hot dog price, I'll kill you. Figure it out."

In 2023 alone, Costco would go on to sell over 200 million hot dog and drink combos. Just an insane statistic. So TIP, the investors podcast, has this policy of radical transparency that we adopted from Ray Dalio's firm, Bridgewater. Many team members will be radically transparent even when it might not feel that rational to do so.

The intention is to allow for an open forum for anyone to contribute new ideas and provide pushback when necessary. I was reminded of this because when Saul would see other retailers selling at a loss, Saul would tell his managers at FedMart to put out signs telling them where to shop so they can go and get that item at a better price. So if a bag of coffee was $3 at FedMart, they purchased it slightly cheaper than that, say they bought it for $2.75.

And the retailer down the street, if they were selling it for 250, then they would put out a sign that would tell customers they can go get a better price at the other store. So just imagine the level of trust that builds with customers when they know 100% that you are trying to provide the best value and the best price possible. Saul also took a unique approach to retail in the sense of providing a limited selection in large pack sizes.

So the large pack sizes essentially allowed customers to buy in bulk, which led to more revenue for each customer entering the store. And then the low SKU count went totally against conventional retail. The playbook for conventional retail was to stock the shelves with as many items as possible to meet all customer needs, wants, and desires. Saul believed that one of the biggest determinants to the purchase decision was price. So he decided to hone in on price and limit the SKU count

which would help them be a more efficient operator and offer the lowest prices out of anybody. Robert lays out an example of a three-in-one oil, which is a lubricant. The manufacturer produces three sizes of the product, and most retailers would buy all three, stock their shelves with each size. And even though the largest eight-ounce container provided the best bang for their buck, the retailer would still stock the store with each of them in case the customer wanted the smaller one. Robert Leonard :

FedMart would only stock the shelves with the largest item, which was the eight ounce, and they would end up doing far more business than had they stocked all three. So the thought process behind this was that if someone needs the product and the eight ounce is the only option, they're still likely to make the purchase. And the product might be a bit much in terms of the amount they're getting, but most of the customers will still end up using the product.

So FedMart, they might be losing some customers that would have bought the smallest item, but they didn't want the larger size. But it turns out that because they have that super low SKU count, it really brings down their operating costs a lot for their store relative to their competitors. So I just did a quick search on the number of SKUs at Costco and Walmart. Costco averages around 4,000 SKUs in their store.

Walmart, they typically average anywhere between 120,000 to 150,000 SKUs. So that's 97% less SKUs to handle, which really creates this tremendous opportunity to create these operational efficiencies on a relative basis. So FedMart's focus was fewer SKUs, low prices and low margins, and high quality merchandise. I also love that Sol took this approach of taking this

radical approach of treating employees really, really well. So he felt a fiduciary duty to provide excellent wages, excellent benefits, and excellent working conditions for employees. He wrote once here to his employees, I quote, we believe that you should be paid the best wages in your community for the job you perform. We believe that you should be provided with an opportunity to invest in the company so that you can prosper as it prospers.

"We believe that you should be encouraged to express yourself freely and without fear of recrimination or retaliation. We believe that you should be happy with your work so that your occupation becomes a source of satisfaction as well as a means of livelihood." End quote. So of course, Saul wanted to pay workers well, but this can also make for good business, just like the decision to always stick to low margins. When you pay your employees better, you tend to attract higher quality people to work for you.

Say if somebody wants to work in retail, they do really good work. If they see retailer A pays $15 an hour and Costco pays $25 an hour, or FedMart in this case, where do you think that employee is going to want to go work? Robert writes here, "Providing excellent compensation and treating all employees as a part of the team would also result in better job performance, loyalty, and honesty." I think if you put yourself in the shoes of a management team,

in their fancy office that's largely removed from the day-to-day operations, I think it can be so easy to not treat employees as well as Costco does. So with all the short-term pressure from Wall Street, why not hand out a 2% raise instead of a 5% raise? Why not cut health insurance benefits to try and boost EPS by two cents a share? It's so easy to reach for that low-hanging fruit while ignoring the longer-term consequences of such actions.

And then this ethos of treating others well even extended to the suppliers that FedMart purchased from. There was a story in the book that FedMart was selling a product for $4 or 3.99, and they thought that they should try and bring the price down to 2.99. So FedMart proposed that they give up 50 cents and the supplier give up 50 cents on the deal. So the supplier agreed to that deal, but the price decrease really didn't move the needle in terms of the volume they were looking to get.

So FedMart decided to just give back the 50 cents to the supplier, which was just an unheard of practice at the time. That supplier had never dealt with a retailer with that level of integrity. When FedMart knew that a supplier didn't treat their employees well, then they would just simply stop working with that supplier. Saul had this moral obligation to treating people well and supporting people who treated others well. The book here gets into the competition that FedMart would start to face.

So retail is a business that's just out in the open for the whole world to see. So when a new concept catches steam, one can only expect new entrants to try and join the party. In 1962, Walmart, Kmart, and Target all opened their first stores, which would prove to be more serious competition for FedMart. Sam Walton had visited FedMart and was pretty convinced that he should also try the FedMart format. He stated,

"I learned a lot from Saul Price, a great operator who had started FedMart out in Southern California in 1955. I guess I've stolen, I actually prefer the word borrowed, as many ideas from Saul Price as from anybody else in business." End quote. Kmart would especially be an early player that would open in markets FedMart operated in, and they would use their competitive pricing practices to steal share from FedMart.

By the 1970s, I think Sol had gotten a bit burnt out from retail. He had once remarked that they were good at creating the business, but they weren't as good at actually running it. They had grown and expanded, and it got to the point where he just wasn't enjoying the process as much in the 1970s than he was in the '50s. So he started to consider the sale or merger of FedMart. Sol had met with a firm out of Germany that would end up taking a major stake in FedMart,

The people Saul ended up deciding to partner with in the investment ended up not being really honorable people. After the deal was done, the gentleman they had done these negotiations with just turned into a totally different person, and he had started to criticize the FedMart model. This led to Saul actually being terminated from his position as president, not receiving any severance that was in the management agreement because they claimed he was fired for cause.

And then in December of '75, his office doors were locked, so he couldn't even enter his office of the $300 million retail giant that he had built.

Saul's son, Robert, he had resigned as director and executive vice president, and then Jim Senegal was given the unpleasant responsibility of telling Fedmark colleagues that Saul had been fired. Despite this incredibly difficult time period, Saul remained calm, optimistic, and certain that better times lied ahead for him. One week later, he signed a lease for the office one floor above his previous office in San Diego. On the front door of his office, he put up a sign that said, The Price Company.

Robert Leonard : Saul's two boys, Robert and Larry, they were out of jobs at FedMart, so Saul brought them on board in the office as well. Now, it would be easy to think that Saul had this grand vision for his next business idea, but this whole ordeal with FedMart really took him by surprise, so he didn't really know what was going to come next. Robert writes here, "The name that my dad had placed on the office door, The Price Company, was nothing more than a name. There was no real company, we did not have a business, and we had no idea what we were going to do."

"Sull suggested we spend time exploring alternatives for a new business. He and I started taking walks almost every day talking about what he had learned from our FedMart experience, successes and failures. We tried to wipe the slate clean in terms of any assumptions about what we should do next." So just to zoom out a little bit here, Sull Price, he started FedMart in 1954, exited the business after an amazing run in 1975. They had around 44 locations at that time.

And by that time, Robert Price had started to play a major role with the company, but a lot of the executive team were people that were much older than him. They were more Saul's age. And Robert felt that it wouldn't have been a smooth transition for the son of the founder to just waltz his way and to run the company. So Saul decided that the next venture should be more about Robert than it should be about Saul. Robert Price :

They landed on starting Price Club in January 1976, which would be a wholesale business selling merchandise to small independent businesses. They had really gotten this idea from a company called Macro, which was based in Europe at the time. Business owners would stop by a large warehouse, select products from a steel rack display, and pay either by check or cash, and then have the products back to their stores, restaurants, offices, and of course,

Price Club would have very slim markups as well. So instead of a small business working with multiple different suppliers to get what they needed for their day-to-day operations, they could just do everything through Price Club. They started the business with $2.5 million in equity and $4 million in a credit line they would tap into. When he started Price Club, Saul was worth roughly $1 million. So he was certainly well off, but he still risked a lot in this new venture.

He had invested most of what he had into the company just to get it up and running. The name of the company, Price Club, was very intentional. Price was, of course, Saul's last name and would imply that the company offered low prices. Club was included because there would be a membership fee to shop at the store. So the fee was $25, which would actually meaningfully contribute to the business's financials rather than the $2 fee they used at FedMart.

The fee would be used to help offer more competitive prices overall as well. It was assumed that the average customer would spend around $1,000 a year, which would mean that the fee alone would compose of around 2% of the customer's overall spend, which they would work into what sort of markup they should put on each product. Robert Leonard :

The membership fee also encouraged each member to make full use of their membership. For example, when I walk into Costco, I instinctively want to take advantage of their advantageous prices while I'm there, and those prices aren't really available anywhere else. This leads to higher sales volume for the company than they would get if there was no membership fee because customers wouldn't appreciate the low prices as much. Robert Leonard :

They already opened the first Price Club by January of 1976, just five months after the company was incorporated. The club would only be open to businesses and the general public wouldn't be allowed in because you needed a resale permit in order to get a membership. One of the things I found interesting was that Sol Price was 60 years old when he launched Price Club. And I think that really highlights just how much he loved business. Most people, I think when they're 60, they're likely thinking about retirement,

closing the doors on their career. I'm sure at this point in his life, he could have just bought a vacation home and enjoyed his time on the beach or traveling or whatever. But to see him start another business in retail of all places just shows how much he loved the game of business. Part of what would make Price Club a success was simply Saul's reputation he had built within the community, which I think is a lesson for all of us.

Buffett had said that it takes 20 years to build a reputation and five minutes to ruin one. And that was part of the competitive advantage that Saul could bring to the table in an industry that's just ruthlessly competitive. So he certainly took advantage of that. He sent a letter to small businesses, pitching them on the price club idea. He wrote, I would like to tell you about a unique opportunity for you to substantially increase your business and profits at no risk and without any capital.

Price Club makes sense. It will offer one, lower prices on the merchandise you sell. Two, lower prices on the supplies you sell. Three, increased sales and merchandise mix without more capital. Four, time saved talking to salesmen, ordering and waiting for goods to arrive. Five, whether you buy one or 100, the price will be the same. No price increase because you don't buy in quantity.

"And six, my associates, all from San Diego, "and I have designed a very efficient, low-cost method "of getting the goods from the manufacturer to you." It gets to the point of crafting an offer so good for your customers that they would essentially be dumb to say no to you. Who wouldn't want lower prices, higher revenues, and more time saved?

Essentially, everybody would. And this ties into Jeff Bezos and his idea of focusing on what the customers want, which is always low prices, vast selection, and fast delivery in setting up Amazon. Sol Price would be the chairman of the board, chief corporate strategist, and an advisor for the management team. And then Robert Price would be the CEO. The launch of Price Club turned out to actually start out on a rocky start, and it was actually on its way to

closing its doors if things didn't change within that first year since they weren't getting near the sales that they were expecting to get. So what ended up happening is that they wanted to open up the store to not just small businesses, but try and get retail customers as well. So they ended up working with the San Diego City Credit Union to allow their members to shop at Price Club. They wouldn't pay the $25 membership fee, but they would have to pay an extra 5% markup above the wholesale price

So people who were a part of the credit union, they already had access to things like opportunities to save money, lower interest rates on loans, a number of other benefits in their local community. So it made sense for them to partner with Price Club because it just added more value to them. And then the other thing for Price Club is that the credit union already had all of these members. So they sent out mailers to everyone to let them know about this new benefit that they would be getting, probably at no extra cost.

The unintended consequence of this was that many of the credit union members were business owners. They went and signed up as a small business at Price Club because they just saw how incredible the prices were at the location. By January of 1977, they reported 13,000 group memberships, which paid the 5% markup, and then 1,500 business memberships, which I would consider to be

a remarkable success in less than a year, and they were already cashflow positive at this time. With the launch of Price Club, Robert was thinking that one location with sales of $10 million would be a huge success. And Saul, he thought bigger. He wanted to expand. So he had his sights on opening a second location in Phoenix, just like he did with FedMart. So the second location opened in the fall of 1977, and it was also pretty successful. Robert Leonard :

So since Saul was largely removed from the day-to-day operations, he would look at a lot of the numbers. He looked at the daily sales, the quarterly figures, the balance sheet, the cash flow. He started to compare these numbers to what he saw at FedMart. So when FedMart in their early days, they had a 30% markup, whereas Price Club had a markup of just under 12%. In Price Club's operating expenses as a percentage of sales were almost half that of FedMart's.

He also noticed that by 1981, Price Club's accounts payable ratio had increased to 120%, which effectively meant that Price Club's suppliers were financing their business. So while they would get paid by their customers today, they might not have to pay their suppliers for that product for say another 30 days. Let's take a quick break and hear from today's sponsors.

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All right, back to the show. Robert Leonard : Interestingly, Robert was getting a number of requests from people who wanted to sell hot dogs outside of the Price Club locations. And after getting so many calls and declining these requests, he figured that if anyone was going to sell hot dogs at Price Club, it was going to be them. So they started to work with Hebrew National to supply the hot dogs and Price Club would start selling a hot dog and a drink

combo meal for $1.50 in 1984. And here, 40 years later, that is the exact same price you pay for a hot dog and a drink at Costco. They also started providing samples to customers, which also boosted sales as well. And I'm sure Charlie Munger probably loved this idea due to the rule of reciprocity. Once we're given something, we almost instinctively feel that we're indebted to that person and we must repay that person.

for what they've given to us, oftentimes for free. Of course, other retailers were starting to take notice of Price Club. In 1978, Bernie Marcus would visit the store, connect with Saul, and Bernie would go out and start Home Depot in 1978. In 1982, Sam Walton would pay a visit to have a look at Price Club. He wanted to learn as much as possible about the warehouse club business. Once again, Saul was just open and generous with his time and what he knew.

Sam then went back to Bentonville, Arkansas, and he opened the first Sam's Club in Oklahoma City in 1983. So time after time again, it seems that these brilliant entrepreneurs are just copying Sol Price's ideas with his businesses. The Price Company would end up going public in 1979. This was the, I believe it was the holding company that owned Price Club. And the reason they went public was because they had more than 500 stockholders, which

required them to go public under SEC guidelines. Another visitor for Saul was Ken Perlman. He was an investment banker from Lehman Brothers. Saul was, again, very generous with his time, generous with his knowledge, and Perlman would go on to write a comprehensive investment report on the price company. So they were now discovered by Wall Street, and the stock price just took off like a rocket.

In 1982, a man by the name of Bernie Brotman asked Saul if he'd be willing to enter a franchise agreement to launch a location in Seattle. And Saul declined this offer. So Brotman, he would go on to raise some money and hire Jim Senegal as the CEO of the company called Costco. Senegal, of course, had a history with Saul and Fedmar and had a brief stint at Price Club before taking this role. So the first Costco location would open in 1983 in Seattle.

And it turns out that Price Club would have a seven-year head start, both on Costco and Sam's Club at the time. When looking at the success of Price Club, I love how Robert included a section here on luck, which really just points to the humility of Sol Price. So it's easy for any of us to look back and think about all the hard work we put in, all the right decisions we made, and how skilled we are in whatever field we're in. But it's so easy to overlook the aspect of luck.

Saul always said that luck played a major role in his success at Price Club. He was lucky to have sold out of FedMart and terminated because that led to the launch of Price Club. He's lucky he had the right contact at Bank of America to secure that $4 million line of credit. And he was lucky that he had young and smart executives working for him.

Robert adds here, "Luck alone, however, could not account for Price Club's success. Price Club was the product of Sol's brilliant business acumen and of everything he had experienced and had learned at FedMart." Then there were some developments here that shook things up at Price Club. First, they started to get into real estate and development. Sol was big on owning the land that Price Club sat on. They partnered with a commercial real estate firm to buy these big plots of land for shopping.

center development. Wall Street felt that Price Club was moving away from its core competency of retail. Then second is later in the 1980s, Price Club lost a couple of key managers and Robert's son at the age of 14 had developed a life-threatening illness. He actually passed away one year later, unfortunately. Around that time, Robert just wasn't able to fully commit to growing Price Club. Robert Leonard

So Saul was sort of toying with the idea of selling Price Club in the late 1980s, but he and Robert didn't really get it done for a few years. By 1990, Saul had resigned as the chairman of the board. And at this point, he would have been around 74 years old. He was spending more time on philanthropy and public policy. And then by 1992, they made a serious push to try and make a sale of Price Club.

And really, there were only two viable buyers. That would be Costco and Sam's Club. And I find it funny that Sam Walton not only copied the Price Club business model, but he also copied the name as well. There were some organizational differences at Sam's Club between the two companies. They didn't pay employees as well. They weren't providing as good of benefits. And Costco's compensation and benefits just aligned much better with Price Club.

And the way Robert puts it is that Price Club and Costco's culture was likely a carbon copy because Senegal had worked with Sol Price for so many years. They ended up agreeing on a merger. This would close on June 16th of 1993. The year prior, Price Club had generated a whopping $6.6 billion in revenue and $130 million in profit.

Costco was slightly bigger. They did 7.2 billion in revenue since they were more aggressive in their expansion than Price Club was. In Sam's Club, they were actually the number one warehouse club operator at the time based on number of stores. At the time of the merger, Price Club and Costco would have a combined 195 stores in the US, Canada, and Mexico, $16 billion in revenue.

The name of the new company, it's so weird to say, but it's Price Costco, which just sounds so off given how well-known Costco is today. They also spun off the real estate side of Price Club under the name Price Enterprises. Jim Senegal would be the CEO of the newly merged company, and then Robert Price would be the CEO of the spinoff, which was largely run by Sol in a lot of ways. Robert writes here that, "Unlike the FedMart transaction with Hugo Mon 18 years earlier,

The price company merger with Costco was done right. Employees from both companies were guaranteed employment. No one was terminated. The operations and merchandising going forward were seamlessly continued with the same philosophy and policies that both companies believed in." Through the Price Enterprises vehicle, they would go on to expand into yet another retail business in Central America and the Caribbean. There's a whole backstory on that, but I wanted to

focus more on the newly formed Costco entity. But before I do, I guess the big takeaway from Sol Price is that he just really pioneered the discount retail industry. It just wouldn't be what it is today without him due to all the unique innovations he brought nationwide to all these retailers. His success in retail was grounded in trying to provide the most value to customers. In addition to paying high wages,

providing good benefits to employees, he really wanted to give a great deal for everybody, which coincidentally also happened to provide significant returns to shareholders. Shares of Costco are up nearly 400 times since the IPO in 1985. And of course, again, Saul wasn't the founder of Costco, but he played a major role in Jim Senegal's life, and then his company would end up merging with Costco. So the shares for Costco

since 1985. They've compounded at 16% excluding dividends, and they paid plenty of dividends along the way. So I think the total return would be closer to around 18% per year. And Costco, of course, is known for being a discount retailer, but ironically, they don't really make too much money from actually selling goods, at least relative to their market cap. They have their two membership fees. Here in the US, it's $65 a year for a basic membership,

and $130 a year for the executive membership. The basic membership earns members access to the store under two cards and the ability to shop online. And then the executive membership has some extra features, including 2% cash back on shopping in the store, discounts on Costco services and other features. And then they also have the business membership as well, which is another type of membership they offer. When I look at the business today, it generates $250 billion in revenue.

$7.3 billion in net income. And when I just look at the membership fees, that alone brings in 4.8 billion. So over half of their net income is from the membership fee, which is a relatively small amount of your customer's total spend if they're spending $100, $200, $300, $400 each time they visit the store. And Costco's net profit margin is a measly 2.9% up from 2% back in 2015.

And Costco, they actually have a policy that they'll never mark up a product more than 14% above the cost for brand name products. And then they have a markup of 15% for the Kirkland products. And this creates just an insane level of customer loyalty as customers simply know that they're going to be getting a good price and quality goods in their store. Robert Leonard :

Where Costco is really making their money is by offering fairly slim margins, but selling in really high volumes. So when I look at some of the alternatives to Costco for getting food, for example, in Sam's Club and Walmart, the experience just isn't as good. So you're sacrificing in that department. If you go to Whole Foods, you're getting maybe a better experience and possibly better quality, but you're paying a lot higher prices.

And then Target, it might be similar, but again, you're just not getting the same value in terms of the experience and the value you're getting in the products. So I just feel there isn't a great competitor to Costco, at least in my eyes. It's the only game in town in terms of the high quality products purchased in bulk. In the United States, Costco's membership retention rate is 92%. For reference, Sam's Club is 89%, so fairly similar retention rates.

And when we look at the employee turnover, retailers are prevalent for just having a ton of turnover. Retail turnover is typically 60% to 70% in a lot of companies. Costco's employee turnover is 6%. I repeat, 6% employee turnover at Costco. It's just unbelievable. This is due to their competitive wages, their comprehensive benefits packages, and strong company culture that really emphasizes

employee satisfaction, and growth opportunities.

Turning to some of the things that Costco sells, one of the things I find really fascinating is the fact that many Costco locations sell gasoline. Oftentimes when I show up to these, there's a long line of cars because of course they provide very competitive prices. Costco's gas is anywhere from 10 cents to 30 cents cheaper per gallon than the nearby competitors. And it's just another reason to just stop by Costco on your way home from work or on your Sundays or whatnot when you go get groceries because

you know you'll have the chance to knock out two birds with one stone by filling up your tank and picking up whatever you need in the store.

I also picked up one other book on Costco. It's called The Joy of Costco. In it, they share, in 2020, Costco sold $14.7 billion worth of gasoline at a whopping 21 cents below the competition per gallon. Another aspect I find super fascinating with regards to Costco is their private label Kirkland Brand. It's estimated that the Kirkland Brand comprises of nearly one-third of its sales.

Oftentimes, with these private label or generic brands, people sort of assume that they're priced lower and they thus bring lower quality. But Costco, I think, does a pretty dang good job of not just delivering on lower prices, but also maintaining a high-quality product. For example, the other day, I picked up a package of alkaline water bottles from Costco, and it was sitting next to Smartwater. And the Kirkland brand was around half the price of that of Smartwater.

Oftentimes, it just seems like a total no-brainer to go with the Kirkland brand unless you have a really special affinity for the name brand. According to the Joy of Costco book, Kirkland Signature did $58 billion in revenue. They have over 1,000 items under the private label brand, and it's no secret that brand names like Duracell, Huggies, and others, they produce the Kirkland product

and they compete head to head with their own national brands within Costco stores. And like I mentioned earlier, Costco has a policy of not marking up the Kirkland items by more than 15% above what they paid for them.

But one potential drawback of Costco from an investment standpoint, at least, might be their e-commerce segment. So with the way Costco's business model is structured, they really want you to be in the store. But let's say if we look out 20 or 30 years from now, is everyone still going to be making a weekly trip to Costco? Or perhaps Amazon or another company has this weekly delivery service for everybody, so you don't have to even drive to the store and spend time at the store. Well,

Or maybe online shopping becomes so normalized that less and less people over time make that trip to Costco. I don't think it's sort of a binary outcome. I think there's always going to be some things. We just want to get it in person, pick it out in person, and then Costco has things like delivery services to take it to your place. When we look at the e-commerce segment, Costco launched this in 1998. Today, it generates over $10 billion in revenue, which is just 7% of sales.

And they've seen some pretty good e-commerce growth ever since COVID hit. The way Jim Senegal sees it is that retail is just a ruthless industry. When you look at companies like Aldi, Walmart, Trader Joe's, these companies are going to do well. And Costco is just one slice of the pie. And then you have Amazon, of course, they're getting a bigger and bigger slice as a result of the growth in e-commerce and Amazon dominating that space.

And then you have companies like the Radio Shacks and the Best Buys of the World who really aren't doing as well as a result of things like the growth in e-commerce. In Costco, they just have some of the most loyal customers on the planet.

I checked out an interview that Jim Senegal did with The Motley Fool. Senegal talked about how Costco had what he referred to as absolute pricing authority, meaning that when a customer is looking at a product on the Costco shelves, they expect that to be the best value they can find anywhere. Capturing that perception in the eyes of consumers is just incredibly valuable. Senegal stated, "We really very zealously

work on protecting that image. That's what we're all about, saving customers money. We don't want to just be better in terms of price. We want to be better on every single product that we sell." I think another big takeaway from studying Costco is how they didn't just want to grow for the sake of growth. They highly value growing thoughtfully, being strategic about the new locations they select, and hiring people from within to help support that growth.

This helps maintain the culture and it ensures that you're growing, let's call it the right way. They value durability over maximizing year-over-year sales growth. And this means putting more of a focus on culture rather than short-term growth. Senegal highlighted that culture is not the most important thing in the world, it's the only thing. And that is the major competitive advantage for Costco. He also stated, this isn't a tricky business.

"We just try to sell high-quality merchandise at a cost lower than everybody else." But when you really look at it, it's just not that simple. My friend, Alex Morris from the Science of Hitting Substack, he highlighted some of the key drivers to Costco's success. So they have this membership model, which encourages repeat visits and higher cardholder spend, and it also sustains lower gross margins with low prices for those consumers.

They have a much smaller SKU count than their competitors. This drives higher inventory turnover, supply chain efficiencies, and lower shrink. And they just have best in class customer service, employee satisfaction, merchandising, and brand equity, which leads to high customer loyalty, a limited need for marketing spend, happy and productive employees, negotiating leverage with suppliers, and a significant private label mix. Robert Leonard :

So it's this combination of all of these factors that makes the Costco model just so effective. And as Costco has grown, they've implemented what Nick Sleep would refer to as scale economy shared. So this means that as Costco gets bigger, they're able to get better prices from their suppliers, which is then passed on as savings to customers. And it creates this flywheel of high loyalty. It attracts more members. And it's just this flywheel that just keeps spinning and spinning.

the competitive moat really gets deeper as the company grows. So as Costco grows, the threat of a new entrant replicating this sort of model just gets lower and lower. Alex also shared that in 2020, Costco generated double the revenue per store that Sam's Club did, one of their major competitors. So Costco averages over $200 million in revenue per store per year.

So it's just insane levels of volume. And that gap between the two has actually been widening over time between them and Sam's Club. One of my favorite tables from their financials and annual reports is the average sales by warehouse. And they segmented out by year that the warehouse was open. So in 2023, for example, they opened 23 warehouses. And the total number of warehouses was 861 in the most recent year. And you can clearly see that they have a history of

all of their stores just growing revenue at a healthy clip as a result of both the increase in the number of members that go to the warehouse and then the increase in the average spend per customer. So these are two tailwinds that will allow Costco's business to grow for many years ahead. So as a store gets more mature, it just tends to generate more and more revenue as a result of these two tailwinds. And then they're also opening more and more stores each year globally. And it's no secret that

Shares of Costco are not a screaming bargain. Their enterprise value to EBIT is around 50. So if I were an investor in Costco, I would want to understand their growth drivers. So I want to look at the international expansion. What's that going to look like? And what is their e-commerce growth really going to look like going forward? Because the core business of US warehouses, I would say it's fairly mature and fairly predictable, and it's really a core part of what they do.

but a lot of their growth, I think, is going to come from what's going to happen internationally and what's going to happen with e-commerce. When we look at the international side, there's still a lot of room for growth. So today, 87% of their revenue comes from either the US or Canada. And after the US, Canada, and Mexico, their next largest markets are Japan, the UK, South Korea, and Australia. Robert Leonard :

Surprisingly, it looks like they only have six warehouses in China, so a lot of room to grow in China especially. Whenever I see news of the openings in China, it just seems like it's a massive success. With that said, I wouldn't expect Costco to get super aggressive with their international expansion. It's likely going to be slow to moderate growth that's very methodical, very thoughtful. With over 600 warehouses in the US today,

it's not hard to imagine them expanding and opening 500 plus stores in international markets over the longer term. Now for the e-commerce segment, this has really taken off post COVID, like I mentioned, and it seems some really strong growth. And I think management really still wants people to drive to the store, go into the store, but they have been leaning more into e-commerce than they have historically. For example,

They now do home delivery, installation, and hallway services for products like, say, washing machines or refrigerators. I feel I have to share this piece here from Alex Morris on Buffett's error of omission with regards to Costco. I quote, "A few years ago, Warren Buffett admitted to an error of omission on Costco. Buffett stated, 'Costco is an absolutely fabulous organization. We should have owned a lot of Costco over the years, and I blew it.'

Charlie was for it, but I blew it. I should clarify, by a few years ago, I meant at the shareholder meeting in 2000. The point is that even the best investors can fall into the trap of telling themselves, I blew it, or I missed it. Personally, I've had a similar experience to Warren. I followed Costco for many years. I understand the value proposition. I'm a loyal customer myself, and I understood why the company was likely to keep stamping out strong business results.

But as I looked at the headline valuation, I always shied away from the stock. In hindsight, at least based on where it currently trades, that has been a mistake." Now, by no means is that to say that Costco is a buy today. In fact, Jon Huber and I discussed on episode 634 why it isn't likely a great buy relative to other opportunities in the market, which most people probably would agree with, I think.

But it's an interesting antidote that might be applied to other great companies today with long runways to growth that might not be as expensive valuations. With that, that's all I have for today's episode. Thanks so much for tuning in. I really enjoyed putting this one together. So I really hope you gained some interesting insights on Sol Price and Costco. So with that, I hope to see you again next week. Thank you for listening to TIP.

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