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Built on Bulk: Costco Earns a Wide Moat

A competitive cost structure allows Costco to pass along more savings to customers, move more volume through its stores, and build a loyal membership base.

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Ken Perkins: We recently upgraded Costco's economic moat to wide from narrow. We did this primarily to reflect what we consider to be a combination of cost advantages and brand equity. If you look at Costco's returns on invested capital, they are much higher than its peers; but its gross margins are much lower than its peers. If you compare it to Wal-Mart, Target, or Whole Foods, Costco's gross margins are about half of what the other competitors' [gross margins] are.

But if you look closely at Costco's cost structure, you actually can see that Costco has a pretty competitive cost structure relative to its peer base--despite being smaller in size than some firms like Wal-Mart. We think that Costco's profitability is lower because the company passes through its lower cost in the form of lower prices. Costco only marks up its products by about 12%, which is about half of what traditional grocers and Wal-Mart might mark up their products.

Ken Perkins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.