Charlie Munger and the Power of Costco

“I love everything about Costco.  I’m never going to sell a share.”----Charlie Munger

Table of Contents

Toggle

“I wish everything else in America was working as well as Costco does.  Think what a blessing that would be for all of us.”---Charlie Munger

“I believe Costco does more for civilization than the Rockefeller Foundation.  I think it’s a better place.  You get a bunch of very intelligent people sitting around trying to do good, I immediately get kind of suspicious and squirm in my seat.”---Charlie Munger

Warren Buffett has often said that he and his partner, Charlie Munger, never had an argument.

But they did sometimes disagree.

Though Berkshire Hathaway invested in Costco in 1999, they sold their shares, valued at $1.3 billion dollars, in 2020, worth perhaps $3 billion today.

Warren has acknowledged the sale was probably a mistake.

Charlie, meanwhile, became a director of Costco and remained one until his passing.  True to his pledge he, personally, never sold a share and was Costco’s second largest individual stockholder.

Warren and Charlie humorously parsed their views on Costco at a Berkshire Hathaway meeting:

And Charlie famously oft-repeated his belief that “Warren doesn’t like retailing.”

Retail is a difficult business: so many moving and changing parts.  Many great names---Sears, for one---have been wrecked upon the shoals of mercilessly changing tastes, technology and trends.

But Charlie saw how clear-eyed recognition of eternal verities of human nature and commerce could optimize retailing and grant the durable competitive advantages that an intelligent investor seeks.

Costco:  It’s Munger-ized!

Charlie Munger loved Costco and Costco loved him back.

Costco aligns with many of Charlie’s key prescriptions for commerce, finance and life:

I. Assemble A Bag Of Tricks

II. Find What Works And Repeat It: The Fundamental Algorithm

III. Establish Win-Win Relationships

IV. The Lollapalooza: Critical Mass Effects

I. A Bag of Tricks

Charlie Munger insisted he was “not a prodigy” and his success came, not through his formidable intelligence, but persistence and performing “a few simple tricks” that collectively “worked well.”

Witness a selection of Costco’s “simple tricks:”

1. The Club: limiting access to paid membership brings Costco more than just billions in fees. It’s a “cover charge” and a “sunk cost” that reduces shoplifting, encourages routine visits and large sales, attracting well-heeled big spenders.  (In my entire life I have observed but one Rolls-Royce vehicle publicly parked…at Costco.)  Wisely, membership fees are refunded to Executive Members in “cash back savings.”
2. Bulk: Costco sells bulk. Bulk is tough to steal and guarantees large sales.
3. Check In/Check Out: Membership cards are required for admission and receipts verified after checkout, discouraging pilferage.
4. Low Markups: low prices; profits are guaranteed by fees.
5. Prestige House Brand: Most house brands are second-rate, but not Costco’s Kirkland. Kirkland is quality, yet 15-20% cheaper than name brands and represents 30% of Costco sales.
6. Reduced Selection: People seek wide and varied choices but confronted with too many options they’re befuddled and may not buy at all. A few good choices are best for most people.  Think index funds, which totally delimit choice but bring great returns.  Charlie came around to endorsing index funds for employees at his final Daily Journal meeting.
7. Treasure Hunt: Costco’s products appear, disappear and relocate, encouraging the animal spirits of “scarcity demand.”
8. Big Parking: Costco parking lots are huge, exclusive, with extra-wide parking spots to prevent dings and facilitate loading.
9. Food Court: the eternal Costco $1.50 hot dog, the ultimate loss leader, has been prix fixe since 1985, a beacon of price stability in an inflationary world.
10. No Advertising, Ever: just positive word-of-mouth and flyers.
11. Own The Land: no rent hikes or agency costs.

II. Repeat What Works

Charlie’s two greatest heroes: Benjamin Franklin and Lee Kuan Yew.

We all learned of Ben Franklin in elementary school and, hopefully, greet him frequently on the hundred dollar bill.

Lee Kuan Yew, less well-known to Americans, was founder and first prime minister of the tiny island nation of Singapore.  Charlie thought him the single, greatest nation-builder in human history, creating a prosperous democracy out of a malarial swamp.

Lee Kuan Yew’s key concept and repeated instruction was:

 “Figure out what works and do it.”---Lee Kuan Yew

Charlie took this directive and distilled it to its essence:

“Repeat what works.”

then dubbed it:

“The Fundamental Algorithm of Life”

See “Charlie Munger and the Fundamental Algorithm of Life”.

Every “trick” Costco employs to optimize functionality and sales, once found, has been operationalized, repeated and never abandoned.

The Fundamental Algorithm is a wondrous thinking tool.  Defy it at your peril.

See “Charlie Goes Hollywood: Darryl F. Zanuck Meets The Fundamental Algorithm”.

III. Win-Win: “Is Everybody Happy?”

A century ago, one of America’s foremost entertainers, Ted Lewis, coined a catchphrase as sticky and memorable as any advertising jingle:

“Is everybody happy?”

Here’s Ted at the sunset of his career on The Ed Sullivan Show:

So Ted Lewis is perhaps the unsung and unknowing progenitor of Game Theory’s central thesis: that win-win relations, mutually benefiting all parties---when “everybody’s happy”---are more fulfilling, enduring and productive than any others.

Who wins with Costco?

1. Members: low prices, quality goods, easy access, friendly environment;
2. Shareholders: regular dividends, special dividends and market-beating returns;
3. Employees: Costco workers are smiling and happy: good pay and benefits---shareholding and retirement---merit-based advancement;
4. Management: managers and executives have risen through the ranks and know Costco bottom up and top down;
5. Public: Costco stores are good neighbors in good neighborhoods, welcoming new members;
6. Suppliers: reliable payment, bulk sales.

IV. The Lollapalooza: Critical Mass Effects

In his legendary 1995 Harvard lecture, “The Psychology of Human Misjudgment,” Charlie Munger listed no less than twenty-five cognitive biases that influence our thinking and introduced his “Lollapalooza:” the exponential effect when multiple biases combine and potentiate each other, creating a critical mass with explosive results.

Think of market bubbles and crashes, fads and popular manias.

Here’s Charlie at the Daily Journal meeting explaining the origin of his lollapalooza theory:

Is Costco a lollapalooza?

You bet it is.

But the exponential results of a lollapalooza are difficult for the human mind to anticipate or perceive.  As physicist, Albert Allen Bartlett, taught:

“The greatest shortcoming of the human race is our inability to understand the exponential function.”---Albert Allen Bartlett

See also, “The Great Exponential Blind Spot”.

Costco Addiction

By his own admission, Charlie Munger was “a total addict” where Costco is concerned, even as he decried addictions at large:

“Why play dice with something that can ruin your life forever?”---Charlie Munger

See also, “Tale of Two Charlies”.

While Charlie’s “Costco addiction” was philosophically and financially life-enhancing for him, the downside of “Costcomania” is hysterically portrayed on Charlie’s favorite comedy series, “Seinfeld,” as Kramer gets bit by the Costco bug:

Full disclosure: contented shareholder on dividend reinvestment since 2006 and, per Charlie’s example, never sold a share.