Latest / Boardroom Conversations with Fexingo: CEOs, Strategy, and Corporate Leadership Explained / How the Costco Board Protected the Employee Wage Model
Transcript
- Lucas: So last week Costco reported its May sales numbers — same-store sales up six point two percent excluding fuel and currency. Nobody was surprised. Luna: Right. Because that's basically been the story for the better part of two decades. But what's interesting to me is how much of that consistency traces back to a board decision in 2018. Lucas: Exactly. That's the moment I want to drill into. Because in 2018, Costco was under pressure from an activist investor group that held about three percent of the stock. Their argument was straightforward: Costco's wages were too high. Their average hourly rate was over twenty-two dollars at a time when Walmart was around fifteen, Target around thirteen. The activists wanted the board to push management to cut labor costs by at least ten percent. Luna: And the board said no. Which sounds obvious now, but at the time it was a real test. Because the activists had a decent narrative — 'shareholders are leaving money on the table.' Lucas: Yeah. And the board's response wasn't just a reflexive no. They actually put together a two-year study comparing Costco's model to every major retailer in North America. They looked at turnover costs, theft rates, productivity per employee hour. What they found was that Costco's turnover was about nine percent annually. Walmart's was around forty-four percent. Target's was around thirty-seven. The fully loaded cost of replacing a single hourly employee in retail is roughly four thousand dollars. Luna: So that math flips the argument. If you cut wages by ten percent and lose ten percent more workers, the savings disappear. Lucas: Exactly. The board presented those numbers at a 2019 investor day and basically said: we've modeled it, the activists are wrong, and we're not doing it. And the stock dropped three percent that day. But then it recovered over the next twelve months as same-store sales stayed strong. Luna: I want to talk about the board itself, because Costco's board composition is unusual. As of the most recent proxy, they have ten directors. Only one comes from a pure finance background. The rest are retail operators, supply chain veterans, and former executives from companies like Starbucks and Home Depot. Lucas: Right. And that's by design. Jim Sinegal, the co-founder and long-time CEO, structured the board to be what he called 'operationally literate.' He believed that a director who couldn't walk a warehouse floor and spot a stocking problem wasn't qualified to vote on labor strategy. So when the activists came in, the board had people who instinctively understood why a well-paid employee spots a pallet misplacement before it becomes a shrink issue. Luna: Shrink — theft and loss — is a huge cost in retail. The National Retail Federation puts average shrink around one point four percent of sales. Costco's is consistently under 0.3 percent. And a lot of that is because employees have skin in the game, they care enough to notice. Lucas: And the board saw that as a structural advantage, not a line item to cut. That's the distinction. Most boards, when an activist comes in, they commission a consultant, they do a quick benchmarking study, and they often cave on something to show they're responsive. Costco's board didn't cave. And I think that's partly because of who's on it. Luna: Let's talk about one specific director: Susan Decker. She joined the board in 2004. Former CFO of Yahoo, but also spent years at the helm of Berkshire Hathaway's insurance operations. She's the only director with a deep finance background. And she was the one who led the board's ad hoc committee on the wage study. Lucas: So the finance person on the board was the one who crunched the numbers and said 'the math supports keeping wages high.' That's a powerful counter to the activist narrative, because it's not just the operators saying it — it's the person who understands cost of capital and margin analysis. Luna: Exactly. And that's a lesson for other boards. You need diversity of expertise, but you also need people who can challenge each other's assumptions with data. If Decker had come back and said 'the model shows a ten percent wage cut adds two cents to EPS,' the board might have split. But she came back and said 'the model shows long-term value destruction.' Lucas: There's another layer here. Costco's governance structure includes something called a 'board observer' role for the founding family. Sinegal's son is on the board as a non-voting observer. That's unusual. But it means the family's philosophy — the 'pay people well and they'll stay' ethos — gets represented even without formal voting power. Luna: Some governance purists hate that. They say it blurs the line between management and the board. But in Costco's case, it seems to have provided continuity. Sinegal stepped down as CEO in 2011, but his influence on the board — through the people he appointed and the culture he built — persisted. Lucas: I think the real test came in 2024, actually. That's when a different activist group — this one more focused on executive compensation — filed a proxy proposal to tie CEO pay more tightly to same-store sales growth. The board opposed it, and the proposal got only thirty-two percent of shareholder votes. But the interesting thing is the board's reasoning: they argued that same-store sales alone didn't capture the full value the CEO was creating, especially around international expansion and e-commerce. Luna: And they won. But the vote was closer than in previous years. So there's an evolving tension: the board has to defend the high-wage model while also showing they're not ignoring shareholder returns. Lucas: And that's the balancing act. Costco's board has been remarkably consistent, but consistency can become rigidity. The question is whether they can adapt as the retail landscape changes. Amazon's grocery push, for example, is a direct threat to Costco's core. If the board gets too defensive of the existing model, they might miss the need to invest more aggressively in e-commerce fulfillment. Luna: So far, their record is strong. But I'd argue the next five years will be harder than the last five. Wage inflation is running three to four percent annually. The pharmacy business is under margin pressure. And international markets are becoming more competitive. Lucas: Yeah. And this is where the board's operational expertise becomes critical again. If you look at the directors' biographies, most have direct experience navigating margin compression. The Home Depot veteran on the board, for instance, lived through the 2008 housing crash. The Starbucks veteran dealt with the 2009 recession and the COVID recovery. So they've seen cycles. Luna: One thing I appreciate about Costco's board is how little drama there is. No leaked disputes, no sudden resignations. They seem to function as a real team. Lucas: That's partly because the board is smaller than average — ten directors versus a typical retail board of twelve to fourteen. Fewer egos, more focused conversation. And they meet in person eight times a year, which is above average for a company of Costco's size. They also hold a two-day strategy retreat every September. Luna: And speaking of teams, you know, this podcast is only possible because of listener support. If these conversations have moved your work forward in some small way, you can help keep them ad-free at buy me a coffee dot com slash fexingo. It's a simple way to say 'this is valuable' without any subscription pressure. Lucas: Yeah. And we really mean that. It keeps the show independent and lets us pick topics like this — deep dives into governance that would never fit a commercial template. So thank you to anyone who's contributed. It genuinely makes a difference. Luna: Alright, back to the boardroom. Let's talk about the 2025 proxy season, because there was a new development. Lucas: Yes. A shareholder proposal requesting the board to publish a report on the 'cost of low wages' — essentially asking them to quantify the benefits of the high-wage model publicly. The board opposed it, again, but this time they preemptively released a three-page white paper showing their internal data. It was a smart move — it defused the proposal, which got only twenty-eight percent support. Luna: So the board is actively communicating its philosophy. That's a shift from ten years ago, when they barely talked to investors outside of mandated filings. Lucas: And I think that's a sign of maturity. The board realized that if they don't tell their story, activists will frame it for them. By putting out the white paper, they controlled the narrative. They showed that the wage model isn't just a feel-good policy — it's a competitive advantage with measurable returns. Luna: What's the biggest risk you see for Costco's board in the next two to three years? Lucas: Succession. Craig Jelinek stepped down as CEO in 2023, and his successor, Ron Vachris, is a company lifer — he started as a forklift driver. That's great for culture continuity. But the board now has to oversee a CEO who's never been a public company CEO before. They need to provide the right level of support without micromanaging. Luna: And the board itself has some aging directors. The average tenure is about twelve years, which is above the S&P 500 average of around seven. The board has a mandatory retirement age of seventy-two, so a few directors are approaching that limit. Lucas: So there will be turnover. And that's a critical moment for governance. New directors need to be indoctrinated into the Costco philosophy without becoming yes-people. The board needs to replenish its operational expertise while also adding maybe some digital retail experience. Luna: It's a delicate balance. But if any board has shown it can manage that balance, it's this one. Lucas: I think the takeaway for other companies is: build a board that understands the business operationally, not just financially. And when an activist comes with a simple narrative, be willing to do the hard work of proving them wrong with data. Costco's board did that in 2018, and it's paid off for years. Luna: And for investors, the lesson is: look at who's on the board, not just what they say in the proxy. The composition tells you a lot about whether a company can withstand short-term pressure. Lucas: Alright, that's our look at the Costco boardroom. Next episode, we're going to examine a very different governance story — one about a board that couldn't say no.