Analysis of Key Macroeconomic Variables Affecting Costs, Demand, Business Environment of Costco Wholesale

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Costco Wholesale can be affected economically through many factors such as, unemployment rate, inflation, consumer debt levels, foreign-currency exchange rates, healthcare costs, reduced consumer confidence, and other economic factors could harmfully affect demand for Costco’s products and services. Prices of certain commodity products, including gasoline and other food products, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, as well as labor costs (Costco Annual Report, 2018).

Figure 1: GDP Value of USA (Trading Economics, 2019)

The United States economy increased by an annualized 2.1% in the third quarter of 2019, compared to an advance estimate of 1.9% and following a 2.0 percent growth in the prior three month period. GDP Growth Rate in USA averaged 3.21% from 1947 until 2019, achieving an all-time high of 16.70% in the beginning of 1950 and a record low of -10% in the first quarter of 1958. With an increasing GDP, it indicates that the economy is growing. This can also be an indicator that consumer spending is increasing, which will then lead to a rise in demand for Costco Wholesale and the retail industry.

Figure 2: Unemployment Rate in USA (Trading Economics, 2019)

Unemployment rate in the US rose to 3.6% in Oct 2019 from 3.5% in the prior month and in line with market expectations. Over the month, the amount of unemployed individuals rose by 86,000. The labor force participation rate went up to 63.3% from 63.2% in the month of September. Unemployment Rate in the US averaged 5.74% from 1948 until 2019, reaching an all time high of 10.80% in November of 1982. As the unemployment rate in the US decreases, Costco shoppers can purchase more consumer goods. However, due to the nature of consumer staples, we believe the unemployment rate has little to no effect on the outcome of the overall industry (Danahoe and Pedersen, 2018). If consumer wages are decreasing and unemployment is rising, consumers will opt to buy cheaper and lower margin products (Eklin and Zecchin, 2018).[image: ]

Figure 3: Inflation Rate in the US (Trading Economics, 2019)

Annual inflation rate in USA rose to 1.8% in Oct 2019 from 1.7% in September and above market expectations of 1.7%. The food index grew 2.1% over the last year, whilst the energy index dropped 4.2% over the last year even though rising in October. Consumer prices rose 0.4% on a monthly basis, higher than a flat reading in September and forecasts of 0.3%. Although overall demand for food is not expected to fluctuate outrageously. Costco Wholesale Corp. is still seeing strong demand for its merchandise but is dealing with broad inflation for products ranging from dog food to plastic cups (Talley, 2011). With rising inflation, Costco may be affected due to prices for goods and services becoming more costly and the value of money in consumers’ pockets reduces. However, a slightly lower rate will benefit the consumer staples sector to continue to grow because it gives customers more encouragement to buy products.

Figure 4: USA Balance of Trade (Trading Economics, 2019)

The United States trade deficit reduced to $52.5 billion in the month of September from $55 billion in the prior month, reaching market expectations. It’s been the lowest trade gap since April as imports from China and Germany declined and the United States stated first petroleum surplus since 1978. Exports dropped 0.9% led by soybeans and automobiles, while imports dropped 1.7% due to purchases of cell phones, toys, sporting gear, semiconductors and vehicles. Balance of Trade in the US averaged $-15029.11 million from 1950 until 2019, reaching a record high of $1946 million in June of 1975 and an all-time low of $-67823 million in August of 2006. Costco said prices will rise due to the trade war between China and the U.S. and the tariffs imposed on Chinese goods (Joyce, 2019). The trade war escalated earlier this month after the Trump administration increased tariffs on $200 billion worth of Chinese goods to 25% from 10% (Joyce, 2019). Costco is doing as much as it can to speed up the shipment of items before a few tariffs went into effect, but It was not immediately obvious how the tariffs would influence prices on imports from China.

Costco Wholesale announced its operating results for the third quarter and the first 36 weeks of fiscal 2019, ended May 12, 2019. Net sales for the quarter grew 7.4%, to $33.96 billion, from $31.62 billion last year. Net sales for the first 36 weeks increased 8.3%, to $102.90 billion, from $95.02 billion last year.

Fast and major changes in commodity prices and Costco’s ability and desire to pass them through to their members may possibly affect their sales and profit margins. These economic factors might also increase Costco’s merchandise costs and selling, general and administrative expenses, and otherwise negatively affect Costco Wholesale’s operations and financial results.

Government Business Policies:

Many Government policies can affect Costco or any other business negatively and even positively. Government policies affect interest rates, a rise in which increases the cost of borrowing in the business community. Greater rates also lead to reduced consumer spending which then leads to a decrease in demand for Costco products. On the other hand, Reduced interest rates entice investment as businesses increase production. Therefore, consumer demand for Costco’s products will rise.

Trade Policies:

Costco updated the risk factors section of its most recent annual reports to add a warning that import taxes are a risk to its business success. The trade war between the US and China intensified after the Trump administration increased tariffs on $200 billion worth of Chinese products from 10% to 25%. Costco said prices will rise due to the trade war between the U.S. and China and the tariffs enforced on Chinese goods. Costco’s business model relies on selling a few products in a broad range of categories, all at a low-low price (Kelleher, 2019). Costco Wholesale operates membership warehouses based on the model that offers their customers low prices on a limited selection of nationally branded and private-label products in a broad range of categories that produce high sales volumes and fast inventory turnover. Which will then, enable Costco to operate profitably at much lower gross margins than most other retailers. Costco Wholesale generally sells inventory before they are even required to pay for it.

Effects of Environmental regulations:

Vital changes in state, federal, and international environmental laws and regulations related to the discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental issues may negatively impact Costco Wholesale’s financial status and results of operations. If Costco fails to obey these laws then the result could harm their customers and employees, weighty costs to please environmental compliance, or harsh penalties and restrictions on operations by government agencies that possibly will unfavorably affect Costco’s business, financial condition and results of operations.

Potential Risks in Foreign/ Domestic Market:

Economic Risks:

General economic factors, foreign and domestic, may unfavorably affect Costco’s business and outcomes of operations. Levels of unemployment, inflation, gasoline costs, higher energy, consumer debt levels, uncertainties linked to government fiscal and tax policies, foreign exchange rates, and other economic factors could negatively affect operations and demand for Costco’s products and services. Prices of some commodity products, including gasoline and other food products, are volatile and subject to fluctuations happening from changes in international and domestic supply and demand, and labor costs. These factors could also raise Costco’s merchandising costs, general and administrative expenses, and if not unfavorably affect Costco’s financial results and operations.

Political Risks:

In 2017, Costco operated 227 warehouses in 10 countries outside of the United States of America. Costco’s operations globally could be negatively influenced by a range of factors, many of them like those Costco challenges in the U.S. Some factors contain political, governing limitations, and policy changes such as the U.K.’s vote to withdraw from the European Union. All these factors play a role in Costco and can be a threat to its operations in foreign or domestic markets. The government policies of the U.S. and international governments, and risks linked with having major warehouses located in countries which have been known to be less stable than the U.S. may have a huge impact on Costco Wholesale financially and threat towards its operations worldwide. Risks in Costco’s foreign operations also consist of the costs and complexities of managing international operations, unfavorable tax consequences, and greater difficulty in implementing property rights.

Financial Risks:

Costco’s financial and operational performance is very much dependent on the U.S. and Canadian operations. In 2017, 85% and 87% compromised operating income and net sales, respectively. Within the U.S., Costco is very well dependent on their California operations, which generated 30% of U.S. net sales in 2017. The market in California, has a bigger percentage of greater volume warehouses as compared to Costco’s other domestic markets. Any significant slowing or decline in those operations could greatly negatively affect Costco Wholesale’s financial results. The economy in California is booming as of now as the population spears higher and companies bring resources into California. Costco has done a terrific job at gaining sales profits from that growth, but the downside to that success is that Costco could be harmed if California’s economic growth stumbles.

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