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Showing posts with label economies of scale. Show all posts
Showing posts with label economies of scale. Show all posts

Monday 19 February 2024

Why Costco is so loved

Keeping customers, employees and investors happy is no mean feat writes The Economist

Customers line up to enter during the grand opening of a Costco Wholesale store in Kyle, Texas, USA.
image: getty images


In the nearly 40 years that The Economist has served up its Big Mac index, the price of the McDonald’s burger in America has more than tripled. In that same period the cost of another meaty treat—a hot-dog-and-drink combo at Costco—has remained steady at $1.50. Last year customers of the American big-box retailer devoured 200m of them. Richard Galanti, Costco’s longtime finance boss, once promised to keep the price frozen “for ever”.

Customers are not the only fans of Costco, as the outpouring of affection from Wall Street analysts after Mr Galanti announced his retirement on February 6th made clear. The firm’s share price is 430 times what it was when he took the job nearly four decades ago, compared with 25 times for the s&p 500 index of large companies. It has continued to outperform the market in recent years. What lies behind its enduring success?

Costco is the world’s third-biggest retailer, behind Walmart and Amazon. Though its sales are less than half of Walmart’s, its return on capital, at nearly 20%, is more than twice as high. Charlie Munger, a famed investor who served on Costco’s board from 1997 until his death last year, called it a “perfect damn company”. Mr Galanti, who describes Costco’s business model as “arrogantly simple”, says the company is guided by a simple idea—hook shoppers by offering high-quality products at the lowest prices. It does this by keeping markups low while charging a fixed membership fee and stocking fewer distinct products, all while treating its employees generously.

Start with margins. Most retailers boost profits by marking up prices. Not Costco. Its gross margins hover around 12%, compared with Walmart’s 24%. The company makes up the shortfall through its membership fees: customers pay $60 or more a year to shop at its stores. In 2023 fees from its 129m members netted $4.6bn, more than half of Costco’s operating profits.

Joe Feldman, an analyst at Telsey Advisory Group, a research firm, argues that the membership model creates a virtuous circle. The more members the company has, the greater its buying power, leading to better deals with suppliers, most of which are then passed on to its members. The fee also encourages customers to focus their spending at Costco, rather than shopping around. That seems to work; membership-renewal rates are upwards of 90%.

Next, consider the way the company manages its product lineup. Costco stores stock a limited selection of about 3,800 distinct items. Sam’s Club, Walmart’s Costco-like competitor, carries about 7,000. A Walmart superstore has around 120,000. Buying more from fewer suppliers gives the company even greater bargaining heft, lowering prices further. By limiting its range, Costco can better focus on maintaining quality. Less variety in stores helps it use space more efficiently: its sales per square foot are three times that of Walmart. And with fewer products, Costco turns over its wares almost twice as fast as usual for retailers, meaning less capital gets tied up in inventory. It has also expanded its own brand, Kirkland Signature, which now accounts for over a quarter of its sales, well above average for a retailer. Its margins on its own-brand products are about six percentage points higher than for brands such as Hershey or Kellogg’s.

Last, Costco stands out among retailers for how it treats its employees. Some 60% of retail employees leave their jobs each year. Staff turnover at Costco is just 8%; over a third of workers have been there for more than ten years. One reason for low attrition is pay. Its wages are higher than the industry average and it offers generous medical and retirement benefits. Another is career prospects. The company prefers to promote leaders from within. Although Mr Galanti’s successor has come from outside, the rest of Costco’s executive team has been with the company for more than 20 years. The late Mr Munger was confident that Costco had “a marvellous future”. Its customers could be enjoying $1.50 hot dogs for many years to come. 

Sunday 10 September 2023

A level Economics: How Chicago school economists reshaped American justice

From The Economist

In recent years the antitrust division of America’s Department of Justice has gone on a crusade against corporate mergers, filing a record number of complaints in an attempt to stop the biggest businesses from getting even bigger. With few exceptions, these efforts have been thwarted by the courts. That it is so hard to get a judge to intervene in business reflects the work of an institution known more for its free-market influence on economics than the law: the University of Chicago.

Fifty years ago this autumn Richard Posner, a federal judge and Chicago scholar, published his “Economic Analysis of Law”. Now in its 9th edition, the book set off an avalanche of ideas from Chicago school economists, including Gary Becker, Ronald Coase and Milton Friedman, which passed into the folios of America’s judges and lawyers. The “law-and-economics” movement made the courts more reasoned and rigorous. It also changed the verdicts judges handed out. Research has found that those exposed to its ideas are more opposed to regulators and less likely to enforce antitrust laws, and tend to impose prison terms more often and for longer.

Links between economics and the law have long been studied. In “Leviathan”, published in 1651, Thomas Hobbes wrote that secure property rights, which are needed for a system of economic exchange, are a legal fiction that emerged only with the modern state. By the late 19th century, legal fields that overlapped with economics, such as matters of taxation, were being analysed by economists.

With the arrival of the law-and-economics movement, every legal question was suddenly addressed in the context of the incentives of actors and the changes these produced. In “Crime and punishment: an economic approach” (1968), Becker argued that, rather than being a balancing-act between punishment and the opportunity for reform, sentences act mainly as a deterrent: the literal “price of crime”. Harsh sentences, he argued, reduce criminal activity in much the same way as high prices cut demand. With the caveat that a greater chance of arrest is a better deterrent than longer prison sentences, Becker’s theorising has since been borne out by decades of empirical evidence.

Too steep?

In the movement’s early days, “the legal academy paid little attention to our work”, recalls Guido Calabresi, a former dean of Yale Law School and another of the field’s founding fathers. Two things changed this. The first was Mr Posner’s bestselling textbook, in which he wrote that “it may be possible to deduce the basic formal characteristics of law itself from economic theory.” Mr Posner was a jurist, who wrote in a language familiar to other jurists. Yet he was also steeped in the economic insights of the Chicago school. His book successfully thrust the law-and-economics movement into the legal mainstream.

The second factor was a two-week programme called the Manne Economics Institute for Federal Judges, which ran from 1976 until 1998. This was funded by businesses and conservative foundations, and involved an all-expenses-paid stay at a beachside hotel in Miami. It was no holiday, however, even if those who went nicknamed the conference “Pareto in the Palms”. The curriculum was extremely demanding, taught by economists including Friedman and Paul Samuelson, both of whom had won Nobel prizes.

image: the economist

By the early 1990s nearly half the federal judiciary had spent a few weeks in Miami. Those who attended included two future justices on the Supreme Court: Clarence Thomas (an arch conservative) and Ruth Bader Ginsburg (his liberal counterpart). Ginsburg would later surprise colleagues by voting with the conservative majority on antitrust cases, applying the so-called “consumer welfare standard” championed by the Manne programme. This states that a corporate merger is anticompetitive only if it raises the price or reduces the quality of goods or services. Ginsburg wrote that the instruction she received in Miami “was far more intense than the Florida sun”.

In a paper under review by the Quarterly Journal of Economics, Elliot Ash of eth Zurich, Daniel Chen of Princeton University and Suresh Naidu of Columbia University treat the Manne programme as a natural experiment, comparing the decisions of every alumnus before and after their attendance at the conference. They then use an artificial-intelligence approach called “word embedding” to assess the language in judges’ opinions in more than a million circuit- and district- court cases.

The researchers find that federal judges were more likely to use terms such as “efficiency” and “market”, and less likely to use those such as “discharged” and “revoke”, after time spent in Miami. Manne alumni took what the authors characterised as the “conservative” stance on antitrust and other economic cases 30% more often in the years after attending. They also imposed prison sentences 5% more frequently and of 25% greater length. The effect became stronger still after 2005, when a Supreme Court decision gave federal judges greater discretion over sentencing.

That researchers are turning the unforgiving lens of economic analysis on law and economics itself is a promising trend. The dismal science has come a long way since the heyday of the Chicago school. Thanks in large part to the empiricism of behavioural economics, it is less wedded to abstractions like the perfectly rational actor. This has softened some of the Chicago school’s harsher edges. But it will nevertheless take time for judges to modify their approach. As Mr Ash notes: “The Chicago school economists may all be retired or dead, but Manne alumni continue to be active members of the judiciary.” In courtrooms across America, Mr Posner’s influence will live on for decades to come.

Sunday 23 July 2023

A Level Economics 98: The European Union

The European Union (EU) is a unique example of both a political and economic union. It is important to note that the EU's structure and level of integration differ significantly from other countries like the USA, China, and India.

  1. Political Union:

    • The EU is a political union in the sense that it aims to create a framework for cooperation and decision-making among its member states on various political matters. This includes setting common policies in areas such as trade, environment, immigration, security, and foreign affairs.

    • The EU has its own political institutions, such as the European Commission, the European Parliament, and the European Council, which work together to shape and implement EU policies.

    • Decision-making within the EU often involves complex negotiations and compromises among member states to accommodate their diverse interests and concerns.

    Comparison:


    • In contrast, the USA is a federal political union, where individual states have a degree of sovereignty, and powers are divided between the federal government and state governments. The federal government has authority over matters such as foreign policy, defense, and trade, while state governments have jurisdiction over local issues.

    • China operates as a unitary state with a strong central government that exercises significant control over regional governments. The Communist Party of China holds the ultimate authority and has decision-making power over key national policies and issues.

    • India is a federal political union similar to the USA, where powers are divided between the central government and state governments. The central government has authority over matters specified in the Union List, while state governments have authority over matters listed in the State List.

  2. Economic Union:


    • The EU is an economic union as well, with a focus on promoting economic integration and cooperation among its member states. This includes the creation of a single market, the adoption of a common currency (Eurozone countries), and the establishment of common economic policies.

    • The EU's single market allows for the free movement of goods, services, capital, and labor across member states, fostering economic growth and efficiency.

    • The Eurozone countries share a common currency, the euro, which is managed by the European Central Bank. This allows for easier trade and financial transactions within the Eurozone.

    Comparison:


    • The USA has a common currency, the US dollar, which is used across all states, contributing to economic integration and trade efficiency within the country.

    • China has a more centralized economic system, with a national currency, the Chinese yuan (Renminbi), and a strong central government that plays a significant role in economic planning and decision-making.

    • India operates with a common currency, the Indian rupee, across all states, facilitating economic transactions and trade within the country.

Overall, while the EU shares some similarities with other political and economic unions, its structure and level of integration are distinct, reflecting the diverse needs and interests of its member states. The EU's model of cooperation and governance may serve as a case study for other countries or regions seeking to enhance political and economic integration while respecting national sovereignty. However, each union operates within its unique political, cultural, and historical context, leading to differences in their organizational structures and functioning.

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Advantages of EU Membership:

  1. Access to a Large Market: EU membership provides access to a vast single market with over 500 million consumers, offering opportunities for trade and economic growth.


  2. Free Movement of Goods, Services, and Labor: EU membership allows for the free movement of goods, services, and people within the member states, promoting economic integration and labor mobility.


  3. Increased Foreign Direct Investment (FDI): Being part of the EU attracts higher levels of FDI due to the larger market and regulatory stability.


  4. Economic Growth and Development: EU membership has historically been associated with higher economic growth and development for member states.


  5. Common Currency (Eurozone): For Eurozone countries, using the euro as a common currency eliminates exchange rate risks and simplifies cross-border transactions.


  6. Shared Political Objectives: EU member states collaborate on various political issues, such as human rights, climate change, and regional security, enhancing their collective influence on the global stage.


  7. Regulatory Harmonization: EU regulations and standards create a level playing field for businesses across member states, promoting fair competition and consumer protection.

Disadvantages of EU Membership:

  1. Loss of Sovereignty: EU member states must comply with EU laws and regulations, which can result in a loss of national sovereignty in certain areas.


  2. Financial Contributions: Member states are required to contribute financially to the EU budget, which can be a burden for some countries, particularly net contributors.


  3. Bureaucracy and Decision-Making: The EU's decision-making process can be complex and time-consuming, leading to bureaucracy and delays in implementing policies.


  4. Regional Disparities: Some regions within member states may not benefit equally from EU membership, leading to regional economic disparities.


  5. Loss of Control over Monetary Policy (Eurozone): Eurozone countries lose the ability to control their individual monetary policies, as the European Central Bank sets the interest rates for the entire Eurozone.


  6. Migration and Security Concerns: Free movement of people can lead to concerns over immigration and security issues, especially during times of crisis.

Prospective Member Advantages:

  1. Economic Integration: Joining the EU provides access to a larger market and potential economic growth.


  2. Strengthened Political Ties: EU membership fosters stronger political ties and cooperation with other member states.

Prospective Member Disadvantages:

  1. Adoption of Acquis Communautaire: Prospective members must adopt EU laws and regulations, which can be challenging and require significant adjustments.


  2. Financial Contributions: New members will be required to make financial contributions to the EU budget.


  3. Harmonization of Policies: Prospective members must align their policies with EU standards and regulations.

Overall, the advantages and disadvantages of EU membership vary depending on the specific circumstances and objectives of each member state or prospective member. While EU membership offers numerous benefits, it also requires sacrifices and entails certain challenges that must be carefully considered and weighed by countries seeking to join or remain within the EU.

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The continuous expansion of the European Union (EU) can have both benefits and challenges for both existing members and new members. Here, we will evaluate these aspects:

Benefits for Existing Members:

  1. Economic Advantages: Enlargement increases the size of the EU's single market, leading to more significant trade opportunities and economies of scale. This can foster economic growth and enhance the competitiveness of existing member countries.


  2. Geopolitical Strength: A larger EU can have more influence on the global stage, allowing it to negotiate more effectively with other economic blocs and international organizations.


  3. Pooling Resources: With the inclusion of new members, the EU can pool resources, such as finances and expertise, to address common challenges like security, migration, and climate change.


  4. Cultural Exchange: Expanding the EU allows for cultural exchange and promotes understanding among different European nations, fostering greater unity and cooperation.

Challenges for Existing Members:

  1. Integration Challenges: As the EU expands, the process of integrating new members can be complex and may require significant efforts to harmonize laws, regulations, and economic policies.


  2. Financial Burden: The integration of new, often less developed, members may require financial contributions from existing member countries to support their economic development and convergence.


  3. Decision-Making Complexity: With more member states, reaching consensus on key policy issues may become more challenging, potentially slowing down decision-making processes.

Benefits for New Members:

  1. Economic Gains: Joining the EU can provide access to the single market, attracting foreign investments and boosting trade opportunities for new members.


  2. Political Stability: Membership in the EU offers a framework for political stability and democratic governance, which can be particularly valuable for countries with a history of instability.


  3. Institutional Support: New members gain access to various EU institutions, resources, and expertise, which can help them modernize and align with European standards.

Challenges for New Members:

  1. Convergence Challenges: New members may face economic challenges in meeting EU economic criteria, leading to the need for significant reforms and adjustments.


  2. Loss of Sovereignty: Membership in the EU requires adherence to EU laws and regulations, which may result in some loss of sovereignty for new members.


  3. Financial Obligations: New members must contribute financially to the EU's budget and may initially receive less in funding than they contribute.

Overall, the benefits and challenges of EU expansion depend on the specific circumstances of each country and the political will of both existing and new members to work together to achieve common goals. Careful consideration of the economic, political, and social factors is essential to ensure that the expansion is mutually beneficial and fosters further integration, stability, and prosperity for all member states.

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The Economic and Monetary Union (EMU):

The Economic and Monetary Union (EMU) is a core component of the European Union (EU) that aims to integrate the economies and monetary policies of its member countries. It was established to promote economic stability, facilitate trade and investment, and foster closer economic cooperation among its members.

Structure of the EMU:

  1. Single Currency: The most prominent feature of the EMU is the adoption of a single currency known as the euro. As of 2021, 19 out of the 27 EU member states have adopted the euro as their official currency.


  2. European Central Bank (ECB): The ECB is the central institution responsible for monetary policy within the eurozone. It is based in Frankfurt, Germany, and is tasked with maintaining price stability and supporting sustainable economic growth.


  3. Monetary Policy Coordination: Member countries participating in the EMU transfer their national monetary policymaking authority to the ECB. The ECB's primary objective is to keep inflation close to but below 2% over the medium term.


  4. Fiscal Policy Coordination: While fiscal policies (government spending and taxation) are mainly under the purview of individual member states, the EMU encourages coordination to ensure sound fiscal management and avoid excessive deficits.


  5. European Stability and Growth Pact (SGP): The SGP sets rules and guidelines for fiscal discipline within the eurozone. It requires member countries to maintain their budget deficits below 3% of GDP and government debt below 60% of GDP.

Functioning of the EMU:

The EMU operates on the principle of economic convergence, where member states aim to align their economic policies and structures to promote stability and balanced growth. Countries within the EMU are expected to pursue responsible fiscal policies, ensure price stability, and implement structural reforms to enhance competitiveness.

Benefits of the EMU:

  1. Price Stability: A single currency promotes price stability, reducing currency exchange risks and uncertainties for businesses and consumers.


  2. Enhanced Trade: The euro's adoption simplifies cross-border transactions, leading to increased trade and investment flows among member countries.


  3. Lower Transaction Costs: The elimination of currency conversion costs and exchange rate fluctuations benefits businesses engaged in trade within the eurozone.


  4. Monetary Integration: A unified monetary policy allows for effective management of monetary conditions and interest rates across the eurozone.

Challenges of the EMU:

  1. Divergent Economies: The eurozone comprises countries with different economic structures and levels of development, making it challenging to adopt a one-size-fits-all monetary policy.


  2. Fiscal Coordination: Limited fiscal coordination among member states can hinder effective responses to economic crises and asymmetric shocks.


  3. Sovereignty Concerns: Some member states may feel that transferring monetary policy authority to the ECB limits their ability to address specific domestic economic challenges.

Overall, the EMU represents a unique experiment in monetary integration and economic cooperation. While it offers several benefits, its success depends on effective coordination of fiscal and monetary policies, structural reforms, and efforts to address economic divergences among member states.