Costco's $9B clothes business, explained

The retailer has that incredible Kirkland drip and sells more clothes than Lululemon, Ralph Lauren or Levi Strauss.

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Today, we will talk about Costco’s $9B+ clothing business.

Also this week:

• The future of podcasts

• AI bubble vs. the Telecom bubble

• And them wild memes (including Taylor Swift)

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Costco has a new incoming CEO.

That person is Ron Vachris, who is currently the retailer’s COO. He began his 40+ year Costco journey with the classic Fortune 500 entry-level job of forklift driver. His predecessor Craig Jelinek became CEO in 2012, decades after starting as a warehouse manager in 1984 (a year after Costco’s founding). Jelinek had originally been hired from discount retailer FedMart, where he worked with legendary Costco co-founder Jim Sinegal.

This is a long way of saying that the corporate ladder at Costco sounds a lot like checking into the “Hotel California”. You can never leave.

Famously, the CEO transition from Sinegal to Jelinek created the greatest headline in business press history:

I scoured the internet for a comparable Jelinek warning in his handover to Vachris but found nothing (so far, only 50% of Costco CEO transitions have involved a death threat).

However, I did find many concerned voices on the r/Costco subreddit. For those who are not familiar, this corner of the internet has 469,000 Reddit users including current and former Costco employees. And since the forum is anonymous, you get great intel and also hysterical takes.

The vast majority of r/Costco’s responses to the news of Vachris’ appointment are about the food court items:

• “Ron Vachris has been with the company for decades…I’m sure the $1.50 dog combo will remain and if he tries to raise it, Jim Sinegal will threaten to kill him too. Everybody chilllllll.”

• “Say night night to your $1.50 dogs and $4.50 roasters. Good companies can only last so long.”

• “Top priorities should be: 1) Bring back pizza combo…”

The r/Costco crowd seems pretty bummed on the news, which is in stark contrast to the time when Costco dropped brand-new Kirkland Signature sweatpants and the subreddit went crazy.

When I saw this original post in October 2021, the comments made me spit out my sugar-free Red Bull:

I didn’t know that it was possible to “raise the bar” on a $19.99 sweatshirt, but u/Mr-Duck1 proved me very very wrong.

Based on sales figures, u/Mr-Duck1’s sentiment about Kirkland clothes are shared by a lot of people.

Costco doesn’t share official sales for its clothes business — which includes name brands and the in-house Kirkland swag — but it was estimated to hit $9B+ in 2022, per the Wall Street Journal.

While this may only account for 4% of the retailer’s total sales ($223B), it still compares favourably to other clothes retailers that I wore a lot of in high school:

• Gap ($16B)

• Costco Drip ($9B)

• Lululemon ($8B)

• Ralph Lauren ($6B)

• Levi Strauss & Co ($6B)

• American Eagle Outfitters ($5B)

Costco’s impressive sales number is occurring at huge volumes and very low sticker prices: $14 for jeans, $25 for dress shirts and $100 for suits (also, bar-raising sweatpants and sweatshirts that cost under $20).

As with all things at Costco, the retailer keeps its margins very low in order to drive turnover as it derives most its profit from the annual membership (~70% of its $6B net profit comes from membership fees).

The maximum margin for Costco products is 14-15%, with the majority of products having a mark-up of less than 10%. In comparison, a typical fashion brand will have a mark-up of 55-70%.

Here is how Costco offers cut-rate prices on its clothing:

• Name-brands: It is common to find clothes from Calvin Klein, Adidas, Ralph Lauren, Columbia, Eddie Bauer and Tommy Hilfiger at Costco. These brands aren’t doing direct deals, though. Per Refinery29, “Costco often obtains its inventory in unexpected ways: picking up cancelled or excess orders from apparel factories, for example, or third-party sources that have somehow landed on a pile of stock”. This alternate supply chain — which is legal but unintended by the original manufacturer — is known as “gray market goods”. The clothing may have ended up in Costco because it didn’t meet the original quality standards, which is something to keep an eye on when you’re scooping up ten pairs of jeans.

• Kirkland Signature: As detailed by Every, Costco’s private-label brand does so much volume ($50B+ in sales) that vendors will bend-over backwards to get into the warehouse. The vendors will even produce a Kirkland-branded product that is “at least 1% better than the equivalent branded products (on some metric of Costco’s choosing)”. Even if this Kirkland product cannibalizes sales from a vendor’s own business, the Costco volume is worth it. This applies to all types of products from instant coffee to cashews to golf balls. The aforementioned WSJ piece flags Levi Strauss & Co. as one of Costco’s main vendors for Kirkland Signature drip (neither Levi or Costco will confirm).

At this point, I should confess that I own a comical amount of Kirkland Signature socks and have purchased every available color of Puma gym shirt that Costco has been selling in the past year (true story: a few months ago, I saw another dad rocking the same Puma shirt while doing a 5km run and randomly fist-bumped him).

My ownership of these Puma shirts is a perfect example of how clothing can increase the cart size for an average shopper’s trip to Costco:

• Treasure-hunting: Here is how the 2nd Costco CEO Craig Jelinek explains the ideal Costco customer trip “…you don't want people coming in and getting out as quick as they can. You want them walking around, because one of the keys of our business is, people come in to pick up four things and spend $300. That's the treasure hunt." In other words, people go into stores to purchase staples such as 10lb cans of tuna and 5 litre jugs of mayo but they end up staying to “hunt” for amazing deals. Clothing is a classic treasure hunt item (think about fast fashion brands like H&M or the single random gem buried in the racks at TJ Maxx).

• Store layout: Costco warehouses are designed in a racetrack style, with shelves on the outer perimeter and low tables in the center. This middle area is where most of the "treasure hunt" items are located including clothes, books, and toys. Most customers will inevitably make their way to this middle area, which allows for visibility to all other sections of the store and entices more shopping (like most grocery stores, Costco has meat and dairy in the back so every customer is forced to go through a mine field of mini-pizzas and beef teriyaki samples that’ll lead to more purchases you didn’t plan for).

In the long run, Costco clothes could play a strategic role in bridging the generation gap. One study found that the most common Costco shoppers are between the ages of 35 to 44, with the next most popular age group being those over 65.

Last month, Jelinek told CNBC that “more younger people” — referring to millennial and those born after — are signing up for memberships (I leeched on my parent’s membership until an age that I’m too embarrassed to type). I think the cult around Kirkland Signature clothes and the treasure hunt are actually helping to drive sign-ups among the younger demos.

Kirkland Signature clothes isn’t just about that dad drip. To wit: the search term for “costco clothing finds” has nearly 5B views on TikTok.

Further, Costco is looking to improve its e-commerce strategy, as it currently accounts for only 5% of its sales. For comparison, Walmart has an online business that makes up 13% of its sales (granted, it's a different business model). A growing cult clothing brand that appeals to younger folk seems to be one avenue to help expand the online channel.

A notable fact about the incoming CEO Ron Valchris is that he spent 2016 to 2022 as the Executive Vice President of Merchandising, a role that oversees the picking of in-store products. Here’s a related excerpt from Retail Leader in 2017:

Vachris is also part of the approval process for new Kirkland Signature items, but the buck stops with Jelinek, who personally signs off on every new item given the significance of the brand.

"We have to protect that brand because it is one of the largest in the United States," Jelinek says.

Vachris will soon be the final decider on that Kirkland Signature swag.

Whatever he picks, we know it’ll be a great deal.

Especially if Vachris channels his inner Jim Sinegal, whose second greatest quote of all time involves Costco clothing.

While speaking with MIT students in the early 2010s, Sinegal explained how Costco once negotiated a big discount on Calvin Klein jeans and why the retailer didn’t keep the extra margin.

“We pass the savings on to the customer, every time,” Sinegal said. “Do you know how tempting it is to make another $7 on a pair? But once you do it, it’s like taking heroin. You can’t stop.”

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Links and Memes

The future of podcasting: The Ringer’s Bill Simmons did a great 27-minute interview on the state of podcasts during a Bloomberg media conference. He thinks we are entering a new phase for the industry:

• Phase 0 (2007-2014): Simmons started his massive podcast in 2007 and this era is for the earliest adopters (Marc Maron and Joe Rogan both launched in 2009; Dan Carlin’s Hardcore History — the best podcast ever in my mind — launched in 2005).

• Phase 1 (2014-2018): The murder mystery podcast series Serial is a massive hit and the industry begins to see more highly-produced narrative podcasts.

• Phase 2 (2018-2023): Spotify gets into the game. The streaming app spends $1B on technology acquisitions and talent (including deals with Joe Rogan, The Ringer, Alex Cooper). A ton of money is wasted on celebrity deals (e.g. Harry and Meghan).

For Simmons, the shakeout from Phase 2 is that people now realize the model of “famous person starts a podcast” doesn’t guarantee anything. If a host isn’t putting in work — or the podcast is their 5th or 6th side hustle — it will fail. Simmons made $100m+ when Spotify acquired The Ringer, but he still obsessively watches sports for his podcast instead of mailing it in.

Quality always wins out and podcasting works well for hosts that come off as “your smart and funny friend that tells you interesting things at the bar” vibe, rather than just a famous person.

Simmons — who is also Spotify’s head of product innovation and monetization — is very bullish on the platform’s ability to make podcast advertising much more automated. It still blows my mind that radio ads do ~$15B a year while podcasts ad are at ~$2B a year.

AI bubble vs. Telecom bubble: The DotCom Bubble at the end of 1999 and early 2000 was actually a dual bubble including the massive build-out of telecommunications infrastructure (CAPEX reached $120 billion in 2000 dollars, or ~$213 billion in today’s dollars). At the time, the make-up of the telecom industry invited a lot of accounting shenanigans and created hall-of-fame shitshows like WorldCom and Enron (which had a wild deal with Blockbuster to do an early version of streaming…that went nowhere).

In a piece titled “Lessons from History: The Rise and Fall of the Telecom Bubble”, Fabricated Knowledge highlights how the current capital spend in AI is comparable to the telecom madness. But he also teases out three key differences: 1) Leverage (much more debt during the telecom boom); 2) barriers to entry in telecom were low (much lower than what is required to build a foundation model in AI); and 3) interest rates (the AI build-out is happening while rates are rising; what will happen if rates fall?).

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Some other baller links for you:

• **Bearly AI update**: The AI-powered research app I’m building just dropped a collaboration with LangChain that allows for remote execution of code (this makes it perfect for a code sandbox for agents, to allow for safe implementation of things like Code Interpreter). Check it out.

• Marty Scorsese: The legendary director just released his 6th collaboration with Leonardo DiCaprio (“Killers of the Flower Moon”). The Studio Binder YouTube channel has a 16-minute breakdown of how Scorsese directs his classic films including “Taxi Driver”, “Goodfellas” and “The Departed”

• Eminem turned 51: Here is an 8-minute story of how he met Dr. Dre for the first time. They recorded at the Dre’s home studio and Dre knew “within a few minutes” that Em was special and it was “magic”.

• Google pays Apple $20B a year to be the default search engine on iPhone. This 21-year deal is at the heart of the government’s antitrust case against Google.

• Superstar Economy: The NBA has a salary cap, which means the super superstars are underpaid. The Truehoop podcast tries to figure out the true value of Lebron James and Steph Curry.

• News in 2023: Last week, I talked about how the speed of war-time information has changed from telegraphs to smartphones. Here is a very good thread and discussion on why traditional newsrooms have been poorly equipped for the speed of social media in the past few years (example: most newsrooms rely on “trusted sources” for breaking news rather than examining Open Source Intelligence, which is readily available but requires more technical skills to understand).

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…and here them fire tweets / X posts:

Finally, enjoy this hilarious bit from comedian Sheng Wang.