Priced to grow: How Costco got started

    The Coscto founders' bootstrapping days involved canceled credit cards and wooing major vendors one by one.

    As told to Lenora Chu

    (Fortune Small Business) -- Jim Sinegal was a former Price Club executive. Jeffrey Brotman was a lawyer who had returned from a trip to Paris with a vision of importing a retail concept the French embraced. In 1983 they opened the first Costco, in Seattle.

    Today the company operates more than 550 warehouses worldwide, employs 140,000 workers and generates $70 billion in annual sales. Fortune Small Business met with Sinegal, 73, and Brotman, 66, at Costco headquarters in Issaquah, Wash. to learn about the company's early days. Their stories are combined here.

    Where did you get the idea for Costco (COST, Fortune 500)?

    BROTMAN: At the time, most U.S. grocery chains sold overpriced goods. I had visited Europe and seen what the French called "hypermarkets," a combination of discount supermarket and department store. I thought the concept would work well in the U.S., so I called around to retail contacts and asked them to list executives who could run such a business. Jim was on most lists. I cold-called him one day and flew to California to meet him.

    SINEGAL: We planned to clone Price Club and launch in the Northwest because it was one of the least competitive U.S. markets. Later we merged with Price Club, became Price Costco for about a year, and eventually restored the Costco name.

    How did you finance the business?

    BROTMAN: Initially with our own funds and credit cards. We were both all-in. If we failed, we'd be broke.

    In 1983 Jim and I went to a hardware show in Las Vegas. By then we had hired buyers, who were using our credit cards to check in. But the bank had canceled the cards, so they were denied entrance. They had worked with us for only a month and were probably wondering whether we'd make it. I thought we'd lose half of them, but they stayed.

    SINEGAL: We eventually raised enough money to open three warehouses that year.

    BROTMAN: Most of the money was our own and from friends and acquaintances. We raised what we thought was all we'd ever need: $7.5 million.

    SINEGAL: We received checks totaling $11 million. Because the offering documents had been drafted to reflect a $7.5 million shareholder investment, we had to either start over with new documents or return $3.5 million. We chose the latter, but used investment bankers to help us raise money after that.

    BROTMAN: Even once we had money, Jim and I drew a relatively modest salary -- $75,000 per year -- for a long time. [In 2008 each drew a salary of $350,000 plus an $80,000 bonus. Each also received stock and option awards in excess of $4 million.]

    In the early days, 70% of your customers were business owners, as opposed to 55% today. What did you offer those entrepreneurs that they couldn't get elsewhere?

    SINEGAL: Back then a small business might have to go to five or six places to get what it needed -- office supplies, food, electronics, for example. Our model provided for most of those needs in one stop.

    What was that first year like?

    SINEGAL: The crowds weren't overwhelming at first, but business built up. In Seattle, the first few weeks we were open, sales grew at a weekly rate of 25%. Within 10 weeks we hit $1.4 million in weekly sales. After opening that first warehouse in Seattle, in September 1983, we opened in Portland, Ore. and Spokane later that year.

    BROTMAN: We worked almost constantly. Fortunately our wives worked with us, so we weren't totally separated from family. But we didn't see our kids. Jim and I were probably on the road almost every day for 10 years. It was a tough grind.

    How did you get manufacturers to distribute through Costco?

    BROTMAN: Many wouldn't sell to us, period. But fairly early on we demonstrated our ability to be the best merchant out there -- better than the Wal-Marts (WMT, Fortune 500) and Sam's Clubs of the world. We convinced manufacturers one by one. When Jim met with Sony (SNE) about five years ago, the Sony executives said they would never sell to us. Today we're one of the largest retailers of Sony products.

    As we grew and became such a large distribution channel, it got harder for key vendors to ignore us. And in tough times like today, most manufacturers are happy to have customers like us -- who pay their bills.

    What were your early growth projections?

    SINEGAL: The original business plan called for eventual growth to about 12 Costcos, primarily in the Northwest, and maybe $80 million in sales per store. We thought we'd become a $1 billion company and make a nice return for our shareholders. We hit the $1 billion mark in our third year of operation.

    BROTMAN: To a certain extent, scale was forced upon us by outside events. When Wal-Mart announced it was going into the discount warehouse business, we had to compete and grow quickly.

    SINEGAL: We were fortunate in that the first three units we opened succeeded, we were able to get the products we wanted to sell, and we had funding. We started our business back when venture capital was available.

    How is the recession affecting business?

    SINEGAL: U.S. sales are flat, which is better than what most retailers can say, and international sales are down 9% when converted to U.S. dollars. Our attitude has always been that the best companies thrive and build market share during tough times. If they offer a great product and great value, they become even more important to the consumer.