The more I study investing, the less I reach for investing-specific books to read. Of course, you should read “The Classics” of Buffett, Graham, and Greenwald. But there comes the point when the 19th reading of Nick Sleep’s letters adds zero value to your investing capabilities.
Let’s return to the basics for a second. Shares of company stock represent fractional ownership in a physical business — a real business — with all its messiness and inconsistencies.
Examining the above definition at first principles, what books should we, as investors, spend most of our time reading? It’s not the “How-To” guides like Graham, Greenwald, and Greenblatt. Instead it’s the in-the-trenches stories of builders and leaders who took a few ingredients — like people, products, and strategies — and created wildly successful enterprises.
But we hesitate to read such books. There are no formulas, no numbers to plug into an Excel sheet. Instead, we learn precisely how random (and lucky) success is in business. And that scares us, as it should.
Yet it’s in these books that we gain the most significant investing insights. Insights that allow us to condense decades of learning into 200-300 pages.
One such book is Becoming Trader Joe, a memoir written by Trader Joe’s founder Joe Coulombe.
Trader Joe’s is a great case study with five main themes:
- Intensive Buying
- How To Set Prices
- Virtual Distribution
- Private Label Products
- Demand-Side vs. Supply-Side Retailing
By the end of this book review, you’ll understand each of the above lessons, add a few mental models to your toolkit, and leave a better investor.
I hope you enjoy the review as much as I enjoyed reading the book. Please buy a copy (no sponsorship) — also, one housekeeping note before you read. I’ll use both “Trader Joe’s” and “TJs” throughout the essay.
Alright, let’s get after it.
Intensive Buying: Obsessing Over The Product
Intensive Buying is the antithesis of how most large-chain grocery stores and retailers buy goods. As Coulombe notes, “The mass retailers, especially the supermarkets and drug chains, have been practicing eighteenth-century buying and merchandising programs.”
What do these 18th-century programs look like? Coulombe explains (emphasis mine):
“They [mass retailers, drug stores, etc.] take rigid, fixed positions based on heavily branded and advertised goods. Each week we’re treated to acres of advertising in which the chains honorably blow each other out of the trenches with Coca-Cola, Budweiser, Smirnoff, Anacin, Colgate, Pampers, Cheez Whiz, Folgers Coffee; or in which the chains dutifully survey each other’s prices on hundreds of brands, and declare victory on points.“
Coulombe consolidated the differences between Intensive Buying and the above with four key points. For example, Intensive Buying is not:
- Eliminating the middlemen
- Buying power
- Limited to branded closeouts and private label
So what is Intensive Buying? There are three critical aspects to an Intensive Buying program:
- Honor Thy Vendors
- Intense Intervention in Product Development
- Intense Legal and Financial Work
Let’s unpack each part.
Honor Thy Vendors
Vendors are the people that sell you products. They’re not competitors, nor are they enemies to pillage. Vendors are the most essential part of any retailing business.
Without vendors, you don’t have products to sell (save for own-brand items, of course). Coulombe went as far as to say that “vendors should be regarded as extensions of the retailer.” He went further in this stance, saying:
“Their [vendors] employees should be regarded almost as employees of the retailer. Concern for their welfare should be shown, because employee turnover at vendors sometimes can be more costly than turnover of your own employees.”
Coulombe’s advice contrasts with the Costco-like devotion to slashing vendors’ prices to a pulp. Coulombe knows the game he’s playing, though. It’s a multi-iterative Prisoner’s Dilemma game.
Buyers want long-term relationships with vendors, which changes how the buyer negotiates. How different would Trader Joe’s have acted with its vendors if it only played a one-iteration game?
Joe explained this idea in his 1977 Five Year Plan (emphasis mine):
“Buying, therefore, is not just a matter of trying to beat down suppliers on price. It is a creative exercise of developing alternatives.”
As philosopher John Michael Montgomery eloquently said, “Life’s a dance you learn as you go. Sometimes you lead, sometimes you follow.”
Sometimes Trader Joe’s can squeeze prices with its vendors. It also accepts less favorable prices in exchange for broader product assortment or differentiated product ideas.
Honoring Thy Vendors also requires that the retailer “Honor It’s Buyers.” If suppliers are one of the most critical parts of a retail business, the buyer is one of the most critical jobs in any retailer.
Coulombe was clear on honoring Trader Joe’s buyers (emphasis mine):
“Buyers should be well paid. Trader Joe’s had the highest-paid buying staff in grocery retailing … Most chains squeeze by with $50,000 buyers when they should be paying $150,000. Again, one of the basic distinctions of Trader Joe’s was its high rates of pay.”
Trader Joe’s paid well for great buying talent, which makes sense when you think about retailing’s first principles: Honor Thy Vendors & Honor Thy Buyers
Buyers at Trader Joe’s had one job: know everything they could about the products they buy and buy them. That’s it. Coulombe explained the one-dimensional role of a TJ’s buyer (emphasis mine):
“Buyers should buy, and be free of paperwork and routine reordering. Buyers need to be deeply knowledgeable about manufacturing, packaging, shipping, etc., but these aspects of vertical interference should be handled by assistants.”
Vendors are the backbone of businesses like Ollie’s Bargain Outlet (OLLI) or Five Below (FIVE). Stores that rely on differentiated product assortment to drive traffic and engagement. Without a great buyer, these stores can’t stock shelves with attractive merchandise. Without attractice merchandise, there’s no customer value proposition.
That leads us to the second aspect of Intensive Buying.
Intense Intervention in Product Development
Coulombe didn’t pay his buyers to be glorified order enterers. What Coulombe wanted was someone that knew the product better than anyone, someone that could spot trends other’s couldn’t see. The ability to see beyond the bulk order purchase.
Trader Joe’s coffee is a perfect example. Coulombe attributes Trader Joe’s success in coffee not from sourcing a specific product but in its discovery of nitrogen-flush packaging. Here’s how he explains it (emphasis mine):
“Based on our newfound product knowledge about coffees, we made the decision that we did not want to deal in ground, vacuum-packed coffees for two reasons. First, the grinding of the beans releases too much of the volatile compounds that give smell and flavor. Secondly, we discovered that ‘vacuum-packed’ is an illusion: if a true vacuum were drawn on those cans, they would collapse under atmospheric pressure.“
Armed with this knowledge about the vacuum-packed process, Trader Joe’s sold coffee beans whole or un-ground. A practice that most grocery stores abandoned during that time (the 1970s). Instead, Trader Joe’s sold coffee beans in paper bags. Then Doug Rauch had an idea (picking back up from the book):
“Instead of drawing a vacuum, [he] flushed the can with the inert gas nitrogen, driving out the oxygen.”
Trader Joe’s still uses this method to sell coffee beans today. However, the quirky thing about this packaging method was that not every bean fit in the can the same way. The company solved this issue because it possessed a deep understanding of all aspects of the product (manufacturing, packaging, etc.). The company packed the beans in different weights, explained the weight difference in its Fearless Flyer magazine, and customers loved it.
Coulombe also highlights the importance of Intense Intervention in Product Development through his story on glass bottles.
As Coulombe noted, “Some of our great values in fruit juices were generated by getting the glass containers for cheap.” Glass containers are one of the most expensive parts of selling fruit juices. Trader Joe’s leveraged its Intense Product Knowledge to buy glass bottles at “deep value” prices, which meant lower juice prices for its customers. Coulombe explains the process below (emphasis mine):
Let’s say that Sunsweet prune juice tries an odd-shaped container and then drops it. The leftover inventory gets closed out at bargain prices. We’d buy up these odd lots and ship them to our apple juice supplier. Since so much of the cost of fruit juice is in the glass container, we were able to reflect significant savings in the retail price.“
I love this example because it reeks of various “value investing” principles:
- Wait for a forced seller
- Buy at deeply discounted prices
- (Eventually) Profit
In Trader Joe’s case, profit was lower prices for its customers.
This brings us to the final leg in Trader Joe’s Intensive Buying Protocol.
Intense Legal & Financial Work
Are you noticing the theme throughout these last two pillars of Intensive Buying? Both share a common denominator: ruthless knowledge of all aspects of retail, so one can leverage it to their advantage.
Trader Joe’s leveraged its legal and financial knowledge to buy foreign products a bit differently from its peers. Coulombe explains (emphasis mine):
“All foreign vendors are willing to sell in USD, but they charge a risk premium for doing so. We assumed the foreign currency risk and squeezed their premium out of the price. We didn’t speculate, as soon as we issued a purchase order, we simply bought [whatever foreign currency] forward at whatever the same-day exchange rate was.”
Notice how everything Trader Joe’s does — from its Intense Product Knowledge to its Legal & Financial Work — revolves around one thing: lower prices for its customers.
We’ve talked a lot about prices so far. Which begs the question: How does Trader Joe’s set prices?
How To Set Prices The Trader Joe’s Way
Most retailers use gross margin targets to set prices, like 30% or something. Under this model, a retailer sets prices like this: If I buy good X from my supplier for $1.00, I must sell the product for at least $1.30. Unsurprisingly, Trader Joe’s does something different. Coulombe describes the Trader Joe’s approach below (emphasis mine):
“Our approach, when the buyers followed it, was to find out what the going price was for a given SKU and then undercut the market. At the same time, they were to consider how many dollars we made on each sale.“
One of my favorite Coulombe quotes revolves around this idea of cash over margin: “Margin doesn’t pay the bills, cash does.” What does he mean by that?
As Coulombe explained in the book (emphasis mine):
“At the time, I was willing to make only 13% margin on a $20 bottle of champagne, because that was a $2.60 profit. For a $2.00 item, however, I wanted to make a much greater percentage … The fact that we wound up with a 23% [margin] is irrelevant. What was relevant was that each SKU was a profit center after considering all the costs of handling it.“
It didn’t matter if you generated 13% or 30% on an item. What mattered was how much cash the business made from the sale. Again, it’s cash, not margins, that pay the bills.
Intensive Buying and a focus on cash margins are only as good as the distribution capabilities that bring goods to the store.
Virtual Distribution: You Know, For The Earthquakes
Trader Joe’s was growing like a weed due largely its intricate warehouse distribution system (DCs). The following paragraphs highlight Trader Joes’ mastery of various warehouse agreements and logistics systems to create a robust distribution system. One capable of meeting the company’s ever-growing product demand.
First, let’s address the amount of DCs. By 1977, Trader Joe’s had 18 DCs from which it shipped products to its store network. Why so many? According to Coulombe, it was due to earthquakes (emphasis mine):
“I [Coulombe] was partly responsible for our having so many warehouses: I was deeply concerned about earthquakes after the 1971 Sylmar quake, which not only knocked down some warehouses, but knocked down so many freeway overpasses that it was impossible to get trucks in or out of some places.”
The more warehouses he had, the better Coulombe slept. But this caused many logistical challenges. Let’s start with frozen foods.
Trader Joe’s has a gigantic assortment of frozen foods, but it wasn’t always that way. In 1977, Coulombe struggled to support its frozen food distribution due to low volumes, explaining:
“I had little hope that we could create our own stable of frozen products and create a frozen distribution system, because our sales were so small. Furthermore, I projected that electrical costs would continue to go through the roof.”
At this time, Coulombe contemplated removing all frozen food cases to make room for more room-temp and refrigerated products.
So what changed? A more efficient distribution system. Coulombe’s compadres Leroy and Doug devised a plan, back to the book (emphasis mine):
“Leroy and Doug worked out a system of warehousing frozen products in a public warehouse in Pasadena that needed business, then shipping frozen products in Styrofoam chests on the same trucks that delivered nuts and dried fruits and other products.“
Notice how Trader Joe’s used adversity (lack of frozen food volume) to devise a clever distribution solution. Trader Joe’s solved its distribution problem by shipping frozen products and nuts and dried fruits together — saving the company time and money.
Milk and juices are further examples of innovative distribution.
Here’s Coulombe explaining the power of combining both fresh juices with milk to create one massively advantaged distribution system (emphasis mine):
“Since milk has to be delivered much more frequently than cheese, however, we needed still more physical volume. That’s when we stopped squeezing orange juice in the stores, and went to fresh juices squeezed in a central plant. Our volume in fresh juice was so high … that the combined milk-juice program could be put in place in 1986.“
There’s a clear theme with Trader Joe’s distribution strategy. Find ways to drive more volume that one wouldn’t otherwise consider maximizing logistics cost savings.
But there was still the fear of earthquakes — and the web of eighteen warehouses. It wasn’t until 1987 that Trader Joe’s finally consolidated its DCs. Coulombe explains how one man, John Shields, convinced Coulombe to reduce (emphasis mine):
“[John] immediately did a great job of untangling knots in our distribution system — he even talked me out of my earthquake fears and we began consolidating the eighteen warehouses into one.“
I love this book becauses the importance of things like distribution that often go unnoticed on Wall Street. Maybe there’s something to @Post_Markets‘ soap-box speeches on the powers of advantaged distribution.
Let’s pivot and discuss another critical aspect of many retailers’ business strategies: Private Label Products.
Private Label: Make A Concerted Effort
I’m glad Coulombe took the time to discuss private label products in retailing for two reasons. First, investors love private label products. It’s “glory” for a retailer to leverage its brand by offering its own-branded products. As such, companies are quick to tout their private label offering. Don’t believe me? Scan any significant retailer’s investor presentation — it’s there.
Let’s see what Trader Joe thought about the private label business.
Trader Joe’s cut its teeth in private label during its “Whole Earth Harry” days — a time where Trader Joe’s focused exclusively on healthy foods. The company used its world-class knowledge of wine and other specialty foods to enter the private label space.
Coulombe’s Guiding Principle for Trader Joe’s private label business was simple: No private label products for the sake of having a private label. This principle was contrary even in the Whole Earth Harry days. Coulombe explained the reasoning (emphasis mine):
“This is 100% contrary to the policy of supermarkets. The supermarkets try to have a private label copy of every branded product, which they usually sell for less, but in these days of double coupons, ‘customer loyalty programs’, and God knows what else — who can tell?“
Trader Joe’s took a different approach. If supermarkets were machine gunners, Trader Joe’s was a sniper. The company intentionally crafted private label offerings for its customers, like the below corn example (emphasis mine):
“The most extreme example was Trader Joe’s Vintage Dated Canned Corn. This corn, grown in a specific field in Idaho, isolated so it wouldn’t be cross-pollinated from other fields, was the best in the world … Each year the label bore the date of that harvest, and when that was gone, that was it, until next year.“
This is the antithesis of the supermarket model of “find a product, slap your brand on it, and sell it cheaper.” Another example of private label selection was the 1982 bakery product stoppage (emphasis mine):
“Even when we dropped all branded bakery products in 1982, we did not introduce a Trader Joe’s ‘Balloon loaf’ of white bread, nor hamburger buns, nor hot dog buns. We simply did without these products.“
The above example begs the question: What did they private label, and their criteria? Trader Joe’s used six “themes” in its private label production (with examples from the book):
- Wine Merchandising: Pineapple from the island of Maui, Concord grapes from the 1981 harvest
- Obvious Health-Food Appeals: Molasses without sulfur, Prunes without preservations
- Medical News: Solder-free cans, Vanilla extract without alcohol, low sodium baking powder
- Ecological Appeals: Albacore caught on long lines
- Rarity: Cold pressed peanut oil, Eighteen-month-old Longhorn cheese
- Gourmet: Unfiltered apple cider vinegar, Handmade tamales, Handmade berry pies
Notice the trend again? Everything Trader Joe’s does come back to differentiation and value-add. Trader Joe’s only made private label products that thought it could bring differentiation and add value to the consumer’s experience.
Our final section summarizes Trader Joe’s key concepts while bifurcating them into two categories: Demand Side Retailing and Supply Side Retailing.
Demand & Supply-Side Retailing
Coulombe wrote Demand Side/Supply Side Retailing to “get a sense of what it is like to run a business day in, day out, as I did for thirty years.” Think of it as a distilled version of Coulombe’s lessons on what retailers control and the entities they must obey. Let’s start on the Demand Side.
Demand Side Retailing
Coulombe offered a few comments on the “obvious promises made by retailers to customers” about product assortment. We’ll examine a few below.
Biggest or Most Complete Variety in Town
Coulombe’s Take: “One of the biggest operational issues for limited-SKU retailers like Trader Joe’s is: What SKUs do you drop to make room for new ones?”
What Trader Joe’s Did: “Mostly we did it on the basis of dollar value of sales.”
Coulombe notes that the company “made no effort to have a complete assortment, which was one of the hardest concepts to put across to the troops.” This makes sense when you consider Coulombe’s maxim that every SKU should be profitable.
Exclusively at Our Stores
Coulombe’s Take: “This proved to be a fool’s errand, since the exclusives were honored in the breach, and I was glad to get out of that rat race as soon as Fair Trade ended.”
Exclusivity is problematic in a mostly-commoditized world like grocery retailing. Trader Joe’s would, however, use its private-label offerings to add some exclusivity.
Positive Negatives included selling products without MSGs, animal testing, along with other health-conscious agendas. Coulombe admitted that Trader Joe’s “restored to [Positive Negatives] daily.”
Then there are Coulombe’s thoughts on Pricing. We already know a few things about Trader Joe’s pricing, like how every SKU must be profitable and the company focuses on cash, not gross margins. Coulombe further noted that “We never change our prices. No shell games.” He also commented on pricing products versus the competition (emphasis mine):
“You should price a product where you think it should be in terms of the market and stick with it. We never cut a price to meet a competitor. If we had done our job of Intensive Buying correctly, and a competitor undercut us, that was their decision.”
I love that above quote. Note how Coulombe stresses first principles with Intensive Buying. Whether it’s real estate, stocks or merchandise — you make your money on the buy.
There were also a few final notes on pricing. Trader Joe’s doesn’t make closeout sales. The reason? You train your customers to wait for a sale. Additionally, there are no special discounts for senior citizens. I love Coulombe’s rationale here:
“Giving discounts to people over sixty is, to borrow a phrase from Charlie Munger, ‘a type of dementia I can’t even classify.'”
Next, we’ll dissect Supply Side Retailing.
Supply Side Retailing
There are eight Supply Side debtors which every retailer must obey. Think of the Supply Side of Retailing as things that happen to you (the store) or things that aren’t directly in your control. They are:
There are two categories of Government within Supply Side Retailing: Less Regulated and More Regulated. Coulombe explains the different types of businesses in each category (emphasis mine):
“Among businesses that are relatively free of government regulations are bookstores, apparel stores, hardware stores, music stores, appliance stores, etc. Grocery stores, by contrast, are heavily impacted by state laws and regulations (milk, alcohol, weights and measures), and local laws and regulations: health departments; building departments, whose rules may conflict with the health departments; and zoning.”
But don’t tell Elizabeth Warren that.
Businesses have systems for everything, whether they concretely define it or not. Sometimes these unspoken systems waste time and money because, well, “we’ve always done it that way.” Coulombe asks one question to combat such unspoken time/money sucks: “Why do we do what we do in this specific way? Better yet, why do we do it at all?”
These are also great questions to ask management when conducting investment research. Answers to the above questions will provide valuable insights into how that management team thinks about the innards of their business.
Non-merchandise vendors include any company or contractor that fills a need for a business. Coulombe references trash companies, radio stations (advertising), and utility companies.
Additionally, he includes truck drivers since Trader Joe’s outsourced its logistics to third-party contractors. Coulombe would routinely keep tabs on non-merchandise vendors, as he explains:
“Since we owned no trucks, no warehouses, etc., I asked our people to keep track of the outsourced drivers and to do their best to see that our contractors were paid reasonable wages with reasonable working conditions.”
While we’ve covered merchandise vending in our Intensive Buying segment, Coulombe used this chapter to offer examples of vendor relationships that went wrong.
One example involved cork pullers. Coulombe once bought a large cork pullers he found in a Hoffritz store. Trader Joe’s slashed the price of the puller and sold out. They went to reorder the product, but it never came. I’ll let Coulombe take it from here (emphasis mine):
“We didn’t get sore, we got even. There was nothing patentable about the product. I knew a couple of engineers … turned them loose on it, and broke the price permanently on that design of cork puller.”
Illegal? Nope. Ruthless and savvy? Yes.
Another example is Jarlsberg cheese. Trader Joe’s charged $3.49 for the cheese while supermarkets sold the same product for $6.00. The difference? Advertising allowances. Coulombe highlights this distinction, saying:
“Because supermarkets insisted on advertising allowances, which were credited to the ad budget; cash discounts, which were credited to revenue, etc. The apparent cost was inflated by all these accounting decisions.”
There are two types of landlords (according to Coulombe):
- Landlords who have financing in place for a new building or already have existing space. These landlords want to maximize rent or get tenants who can draw traffic to maximize revenue from the shopping center.
- Landlords who need a strong tenant on a long-term lease to secure financing for the property.
Coulombe also explained where Trader Joe’s fell in the landlord department (emphasis mine):
“Trader Joe’s is able to drive hard bargains partially from its willingness to take existing structures, and party because of its strong Demand Side programs. Also, Trader Joe’s has no need for co-tenants.“
Here’s Coulombe’s take, “I mention [investment bankers] here only because top management people of publicly traded companies spend an inordinate amount of time with investment bankers, to the detriment of the real business.”
I like that.
Coulombe was the controlling shareholder of Trader Joe’s. As such, he ran “scared, too scared.” This caution was because “every dime I had was in the company.” That’s skin in the game. Find management teams like that.
Employee payroll is a relatively small expense in most grocery stores. Trader Joe’s, unsurprisingly, did things differently. The company paid higher-than-average wages for its workers.
The goal was simple: attract better talent with higher salaries, so they work hard and don’t leave. And it worked. Coulombe stressed throughout the book that labor turnover was one of the highest expenses one could incur.
Trader Joe’s is an incredible business worthy of study. It’s a business you wish were publicly traded. Coulombe created a grocery store that played by its own rules. The company paid its workers higher than any grocery store. It thought deliberately about its private label business. It solved distribution challenges with innovation and creativity.
Most importantly, Trader Joe’s put the right product in front of the right customer, right when they needed it. The company created its language and cult-like following through its creative advertising campaigns.
I hope you enjoyed this book review and learned a few things you can take to your next investment opportunity. Please read the book for yourself. And while you’re at it, shop at your local Trader Joe’s store the next time you need groceries.