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Costco CEO Craig Jelinek Leads the Cheapest, Happiest Company in the World


How this week's cover got madeHow this week's cover got made Joe Carcello has a great job. The 59-year-old has an annual salary of $52,700, gets five weeks of vacation a year, and is looking forward to retiring on the sizable nest egg in his 401(k), which his employer augments with matching funds. After 26 years at his company, he’s not worried about layoffs. In 2009, as the recession deepened, his bosses handed out raises. “I’m just grateful to come here to work every day,” he says.

This wouldn’t be remarkable except that Carcello works in retail, one of the stingiest industries in America, with some of the most dissatisfied workers. On May 29, Wal-Mart Stores (WMT) employees in Miami, Boston, and the San Francisco Bay Area began a weeklong strike. (A Walmart spokesman told MSNBC the strike was a “publicity stunt.”) Workers at an Amazon.com (AMZN) fulfillment center in Leipzig, Germany, also recently held strikes to demand higher pay and better benefits. (An Amazon spokesman says its employees earn more than the average warehouse worker.) In its 30-year history, Carcello’s employer, Costco, has never had significant labor troubles.

Costco Wholesale (COST), the second-largest retailer in the U.S. behind Walmart, is an anomaly in an age marked by turmoil and downsizing. Known for its $55-a-year membership fee and its massive, austere warehouses stocked floor to ceiling with indulgent portions of everything from tilapia to toilet paper, Costco has thrived over the last five years. While competitors lost customers to the Internet and weathered a wave of investor pessimism, Costco’s sales have grown 39 percent and its stock price has doubled since 2009. The hot streak continued through last year’s retirement of widely admired co-founder and Chief Executive Officer Jim Sinegal. The share price is up 30 percent under the leadership of its new, plain-spoken CEO, Craig Jelinek.

Costco CEO Craig JelinekPhotograph by Ryan Lowry for Bloomberg BusinessweekCostco CEO Craig JelinekDespite the sagging economy and challenges to the industry, Costco pays its hourly workers an average of $20.89 an hour, not including overtime (vs. the minimum wage of $7.25 an hour). By comparison, Walmart said its average wage for full-time employees in the U.S. is $12.67 an hour, according to a letter it sent in April to activist Ralph Nader. Eighty-eight percent of Costco employees have company-sponsored health insurance; Walmart says that “more than half” of its do. Costco workers with coverage pay premiums that amount to less than 10 percent of the overall cost of their plans. It treats its employees well in the belief that a happier work environment will result in a more profitable company. “I just think people need to make a living wage with health benefits,” says Jelinek. “It also puts more money back into the economy and creates a healthier country. It’s really that simple.”

In February, Jelinek set Costco’s convictions in ink, writing a public letter at the behest of Nader, urging Congress to increase the federal minimum wage for the first time since 2009. “We know it’s a lot more profitable in the long term to minimize employee turnover and maximize employee productivity, commitment and loyalty,” he wrote.

Jose Almaraz, 6 years at CostcoPhotograph by Ryan Lowry for Bloomberg BusinessweekJose Almaraz, 6 years at CostcoThe letter barely moved the needle. Although President Obama echoed Jelinek’s sentiment and called for a $9-an-hour wage in his State of the Union address, Congress is deadlocked on the issue. But Jelinek’s letter had a secondary effect. It cast a brighter light on Costco’s philosophy and created a stark contrast with its competitors.

That juxtaposition raises an important question: Can the rest of corporate America become more like Costco? Or will Costco, buffeted by the same disruptive changes affecting all of retail, be forced to become more like everyone else?
 
 
The Issaquah (Wash.) headquarters of Costco, 20 miles from Seattle, radiate frugality. The floor of the executive wing is covered in faded blue carpet, and in the boardroom, six faux-wood tables—which would look at home in a public school teachers’ lounge—are jammed together. On the walls are several Van Gogh and Picasso prints (less than $15 at Art.com), along with two badly staged photographs of the company’s board of directors. In one, a picture of Jelinek’s head has been awkwardly taped onto the frame, hovering above a Weber grill.

Jelinek earned $650,000 in 2012, plus a $200,000 bonus and stock options worth about $4 million, based on the company’s performance. That’s more than Sinegal, who made $325,000 a year. By contrast, Walmart CEO Mike Duke’s 2012 base salary was $1.3 million; he was also awarded a $4.4 million cash bonus and $13.6 million in stock grants.

Christopher Mrozek, 11 years at CostcoPhotograph by Ryan Lowry for Bloomberg BusinessweekChristopher Mrozek, 11 years at CostcoCostco has no public-relations staff. Jelinek conducts an interview with a journalist alone, an anomaly at major corporations, and afterward Costco Chief Financial Officer Richard Galanti calls to inquire whether the boss inadvertently said anything negative. Sinegal returns a reporter’s phone call on a Saturday morning, leaving his cell number.

No-frills is the defining style of the 627 Costco warehouses around the world. Each stocks around 4,000 different products, and almost everything is marked up 14 percent or less over cost. Items like diapers, suitcases, and wine, which it sells under its in-house Kirkland Signature brand, get a maximum 15 percent bump. All of the stock sits on industrial shelving that the company internally calls “the steel,” or in piles that spill from pallets. After accounting for expenses such as real estate costs and wages, Costco barely ekes out a profit on many of its products. Eighty percent of its gross profit comes from membership fees; customers renew their memberships at a rate of close to 90 percent, the company says. It raised its fee by 10 percent in 2011 to few complaints.

“They are buying and selling more olive oil, more cranberry juice, more throw rugs than just about anybody,” says David Schick, an analyst at Stifel Nicolaus. And that allows Costco to get bulk discounts from its suppliers, often setting the industry’s lowest price. Even Amazon can’t beat Costco’s prices, which means that “showrooming,” or browsing in stores but buying online for the better price, isn’t much of a concern for Jelinek.

The company’s obsession with selling brand-name merchandise at cut-rate prices occasionally gets it into trouble. In February, Tiffany (TIF) filed a multimillion-dollar trademark infringement suit against Costco alleging it improperly labeled merchandise as “Tiffany engagement rings.” Galanti calls it “an honest mistake” and says they should have been labeled “Tiffany-style.” The suit is pending.

Costco’s constitutional thrift makes its generous pay and health packages all the more remarkable. About 4 percent of its workers, including those who give away samples and sell mobile phones, are part-time and employed by contractors, though Costco says it seeks to ensure they have above-industry-average pay. And while Walmart, Amazon, and others actively avoid unionization, Costco, while not exactly embracing it, is comfortable that the International Brotherhood of Teamsters represents about 15 percent of its U.S. employees. “They are philosophically much better than anyone else I have worked with,” says Rome Aloise, a Teamsters vice president.

Most retailers “see their employees as a cost to be minimized and typically end up underinvesting in them,” says Zeynep Ton, an adjunct associate professor of operations management at the MIT Sloan School of Management. She thinks that ends up creating operational problems that shoppers are all too familiar with: surly employees in stores engulfed in chaos, an environment that makes ordering online look a lot better. One solution to surly cashiers is to get rid of them completely. Walmart said that this year it would add 10,000 self-service checkout systems (though it did not say whether these systems would displace workers). Costco has also experimented with self-service checkouts, but Jelinek says he’s now removing them because employees do the work more efficiently. “They are great for low-volume warehouses, but we don’t want to be in the low-volume warehouse business,” he says.

Dennise McDonald, 13 years at CostcoPhotograph by Ryan Lowry for Bloomberg BusinessweekDennise McDonald, 13 years at CostcoBill Durling, a spokesman for the Sam’s Club division of Walmart, notes that Costco charges a higher annual membership fee than Sam’s Club ($55 vs. $45) and asserts that Costco’s wages are higher because it got its start on the West Coast and in urban markets, “which dictates a higher cost of living.” He says that “Sam’s Club wages and compensation packages are well above the industry average for retail.”

Many conscientious companies such as Costco are performing well financially. Over the last few years, Nordstrom (JWN), the Container Store, Sephora, REI, and Whole Foods Market (WFM), all of which are known for treating employees well, have outpaced rivals. “This is the lesson Costco teaches,” says Doug Stephens, founder of the consulting firm Retail Prophet and author of the forthcoming The Retail Revival. “You don’t have to be Nordstrom selling $1,200 suits in order to pay people a living wage. That is what Walmart has lost sight of. A lot of people working at Walmart go home and live below the poverty line. You expect that person to come in and develop a rapport with customers who may be spending more than that person is making in a week? You expect them to be civil and happy about that?”
 
 
Costco may be a different species than most big-box chains, but it shares genetic material with Walmart, Kmart, Kohl’s (KSS), and Target (TGT), all born in 1962 to cater to the boundless consumer appetites of an expanding middle class. The companies had the same inspiration: FedMart, whose founder, Sol Price, opened some of the first discount department stores in San Diego in the early 1950s, for the first time pairing diverse merchandise and bargain basement prices under a single roof.

Price was a liberal Jewish attorney from New York who embraced organized labor. According to Ralph Nader, who met him during Nader’s 1996 presidential run, Price often told a joke about meeting some discount retail executives who reverentially told him, “Sol, you are the father of everything we have inherited.” To which Price replied: “I really wish I had worn a condom.”

In the wake of FedMart’s collapse after a failed acquisition, Price and his son Robert created Price Club in 1976. The new store stocked only a few thousand products, all in large quantity, and marked everything up a set amount in the belief that retailers added only limited value; prices should reflect that. Price, who died in 2009, was a demanding boss known for knocking fragile merchandise onto the floor if it blocked customer sightlines. Yet he had a devotion to fair labor practices: He solicited the Teamsters to represent his employees. “Sol’s message was always very much the same if you saw through the rough exterior,” says Paul Latham, the vice president of marketing and membership services at Costco, who, like many Costco executives, started his career working for Price. “It was about creating value, about treating your employees and customers well, and respecting your vendors—and ultimately rewarding your shareholders in the process.”

Nick Draper, Costco memberPhotograph by Ryan Lowry for Bloomberg BusinessweekNick Draper, Costco memberSinegal was one of Price’s top lieutenants. He brought the Price Club model to Washington in 1983 to start Costco with local attorney Jeff Brotman. Price Club and Costco merged in 1992, and though the combination was troubled and Price left soon after, Sinegal maintained Price’s pro-labor principles. Costco went public in 1985, and over the years, Wall Street repeatedly asked it to reduce wages and health benefits. Sinegal instead boosted them every three years.

As the economic downturn worsened in the fall of 2009, Costco, like every other retailer, started seeing declines in same-store sales. Macy’s (M), Best Buy (BBY), Home Depot (HD), and Office Depot (ODP) were resorting to layoffs and wage cuts, but Sinegal approved a $1.50-an-hour wage increase for hourly employees, spread out over three years. “The first thing out of Jim’s mouth was, ‘This economy is bad. We should be figuring out how to give them more, not less,’ ” says CFO Galanti, who adds that Sinegal’s decision to parcel out the raise in three annual 50-cent increments, instead of more gradually, cost an extra $20 million. The founder’s stubborn resolve remains a point of pride. “Could Costco make more money if the average wage was two or three dollars lower?” asks Galanti. “The answer is yes. But we’re not going to do it.”
 
 
Jelinek has a strong opinion about one of Costco’s best-known products, the $1.50 hot dog the company makes in a facility in California’s Central Valley and distributes to all of its North American warehouses. “I’m a purist,” he says, noting that he has a hot dog for lunch every day when he’s traveling. “No mustard. No ketchup. I savor that hot dog. I eat ’em plain.” He says he never touches the pizza. (It’s good, he says, he just doesn’t care for it.)

He started his career at FedMart, working as a box boy in Lancaster, Calif., during high school. He got his degree at San Diego State University, Sinegal’s alma mater, and spent two years with grocery chain Lucky before joining Costco in 1983.

Maribel Ortiz, 11 years at CostcoPhotograph by Ryan Lowry for Bloomberg BusinessweekMaribel Ortiz, 11 years at CostcoLike his predecessor, Jelinek, 59, preaches simplicity, and he has a propensity for aphorisms ending with “good things will happen to you.” “This isn’t Harvard grad stuff,” he says. “We sell quality stuff at the best possible price. If you treat consumers with respect and treat employees with respect, good things are going to happen to you.” He vows to continue Sinegal’s legacy and doesn’t seem to mind a widespread characterization of himself as a “Jim clone.” “We don’t want to be casualties like some of these other big retailers, like the Sears (SHLD) of the world and Kmart and Circuit City. We are in for the long haul,” he says.

Jelinek has veered from a handful of the policies fashioned under his predecessor. He recently canceled an effort to up-sell shoppers on the $110-per-year executive club membership while they were waiting in line—“We were starting to alienate people,” he says. He’s also courting prestige brands like Coach (COH), Ralph Lauren (RL), and Louis Vuitton (MC:FP).

As CEO, his biggest move is increasing Costco’s international presence. Over the next two years, Costco will open its first locations in France and Spain. Two-thirds of Costco’s expansion over the next five years will be international, according to Galanti, with a focus on Japan, Taiwan, and South Korea. Jelinek’s strategy is to require Costco’s suppliers to give it global deals, even if it upsets their relationships with other retailers in different countries. “If you are going to do business with us, you are not going to say that we can’t sell to you in this country,” he says. “They are not really respecting our business if they do that.”

Costco is sensitive to any perceived slights from its vendors. It canceled a relationship with Apple (AAPL) in 2010 because the company wouldn’t sell it anything other than the iPod, and wouldn’t allow it to sell any Apple products online. It has also at times curtailed its sale of products from Sony (SNE) and Panasonic (6752:JP) over such issues.

Another challenge for Jelinek is making his voice heard over Sinegal’s. Even after his official retirement in early 2012, the co-founder stuck around as an adviser for another year, sitting in on meetings and surreptitiously funneling questions through Joseph Portera, executive vice president of Costco’s eastern division. “I became his Charlie McCarthy doll,” says Portera.

Executives say Sinegal has backed off recently, though he’s still a presence. During an interview with another executive, Sinegal, 77, walks into the boardroom unannounced. Asked why he’s here, he jokes, “It’s the only way I get to keep my badge,” before inquiring casually about Apple’s stock price after its recent quarterly earnings announcement. (One gets the sense Costco executives do bear a little bit of a grudge.) Apple declined to comment.

Barbara Osmolak, 10 years at CostcoPhotograph by Ryan Lowry for Bloomberg BusinessweekBarbara Osmolak, 10 years at CostcoJelinek concedes he’s in a peculiar position, considering Sinegal’s presence and the iron-like grip he had over the company, but he says he’s happy to have his former boss around. “It’s kind of like, your dad is still your dad, no matter how old he is. So it’s been great. He lets me run the business, and every once in a while he says, ‘Have you rethought this?’ ”
 
 
Despite its recession-defying success, Costco faces the same rapidly changing retail environment as other big-box chains. Online retail grew at a 15.8 percent clip in 2012, according to the U.S. Census Bureau, far faster than the 5 percent rate for retail overall. Young people in particular are doing more of their shopping on the Internet. Costco has a decent website and logged an estimated $2.08 billion in online sales in 2012, according to the tracking firm Internet Retailer. But as the 17th most popular retail site in the U.S., its online popularity lags the success of its physical stores.

Costco executives are concerned about the discrepancy. “I used to get up every morning worried about Walmart,” says Costco Chairman Brotman, who still runs the company’s real estate operation, selecting new sites for warehouses around the world. “Now I worry about them, and I worry whether we are up to the challenge of the shift in retail buying habits.” Recently Costco moved its website from a platform hosted by Microsoft (MSFT) to one run by IBM (IBM). “We won’t ever be as fancy as Amazon,” Brotman says, but he insists the site is improving.

Since much of Costco’s growth is concentrated in food, it could be particularly vulnerable if Amazon ever cracks the grocery delivery business. (Amazon has been testing such a service, AmazonFresh, in Seattle since 2007, and is reportedly set to expand nationally in the next few months.) Jelinek says Costco has studied online grocery delivery but can’t figure out how anyone can do it profitably.

Beyond Amazon, another pressing issue is the age of the company’s executive team, most of whom are in their late 50s. “We’re all old,” says Brotman, who is 70. Jelinek says his team talks about succession planning constantly and recently expanded a program to ready the next wave of company leaders.

It will have to look inside, since Costco does not hire business school graduates—thanks to another idiosyncrasy meant to preserve its distinct company culture. It cultivates employees who work the floor in its warehouses and sponsors them through graduate school. Seventy percent of its warehouse managers started at the company by pushing carts and ringing cash registers. Employees rarely leave: The company turnover rate is 5 percent among employees who have been there over a year, and less than 1 percent among the executive ranks. That’s impressive, but it also suggests the company does not have a regular influx of outside views. Even John Matthews, vice president in charge of human resources, calls the company “awfully inbred.”

Federico Rodriguez, 11 years at CostcoPhotograph by Ryan Lowry for Bloomberg BusinessweekFederico Rodriguez, 11 years at CostcoAlthough Sol Price’s virtuous cycle continues to work for the company—happy employees are more productive, effective workers—Costco’s own leaders are pessimistic about seeing broad changes in the way American businesses treat employees, particularly amid the continuing resistance to Obamacare. Brotman thinks it’s shameful that so many American companies are now cutting the hours of part-time employees to less than 30 hours a week so they won’t be required to cover their health insurance, as required under the new law. “If you ask me if I’m optimistic about it, I’m not,” he says. “There’s a large part of the country that doesn’t necessarily believe in these principles. If you have 30 percent of the population that wants to reduce government or eliminate it, then how are we going to talk about minimum wage and health care, let alone adequate pay?”

Jelinek is content to focus on the future of Costco, vowing to keep prices low, volumes high, and his employees happy. “As long as you continue to take care of the customer, take care of employees, and keep your expenses in line, good things are going to happen to you,” he says. “I don’t ever want us to become irrelevant. I hope when I’m 90, and this company is around 30 years from now, I can go eat a hot dog at a Costco food court and hear someone say, ‘I remember you.’”

Stone_190
Stone is a senior writer for Bloomberg Businessweek in San Francisco. He is the author of The Everything Store: Jeff Bezos and the Age of Amazon (Little, Brown; October 2013). Follow him on Twitter @BradStone.

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