Do you love going on a good old Costco run, grabbing bulk items at extremely low prices, and maybe some hot dogs to go? Once upon a time, people thought that Costco was crazy – charging people to enter their stores? Huh?! There was no way that was going to work. Well, as you know, it did. But how exactly? Well, here are 10 Ways Costco Became A Massive “Members Only” Retailer.
10. A Little Of Costco’s History
In 1954, an attorney by the name of Sol Price inherited a vacant airport hanger in San Diego. He did what anybody would do: stock up on wholesale jewelry, furniture, and liquor, and launched Fedmart, a warehouse-style store where people could pay a $2 entrance fee to have access to his deals. Back then, an idea like that was considered downright crazy, but Sol didn’t care. He sold Fedmart in 1975, and by that time, it had grown into a $350 million-per-year, 40 location chain. He wasn’t done, though, because just a year later, he launched Price Club, a one-stop-shop that offered, well, everything. Sol had a protege named Jim Sinegal, who started out as a bagger in Fedmart. Sol took him under his wing, and by the early 80s, Sinegal was ready to branch out on his own. In September of 1983, the world was changed forever when the first Costco was launched in Seattle. It was modeled on Sol’s business principles and, against all odds, was immensely successful. Actually, in just a decade, Costco grew so much that it became a threat to Price Club, so the owners agreed to a merger. For a brief period in history, Costco was known as ‘PriceCostCo.’ However, it was eventually rebranded as ‘Costco,’ and Sinegal took the lead. Today, Costco is one of the world’s largest retailers, with over 770 locations, nearly 250,000 employees, and plenty of business practices that others can learn from.
9. Saving Your Money
What sets Costco apart from other retailers is that the company genuinely wants people to save money. Because of their immense buying power, they’re able to get discount deals with vendors, which leads to more customer savings! When retailers buy things from vendors, they tend to up the price by at least 25%-50%, making it more expensive for the people buying these items. However, Costco caps its markups at 14% for brand-name items and 15% for its in-house Kirkland brands – even items such as wine, which is notorious for its 200% to 300% markups everywhere else. And while their highest markup is 15%, the majority of things at Costco are only marked up by 11%! So, for example, if Costco spends $100 on an item, they’ll sell it back to you for $111, whereas a grocery store might sell it back to you for a minimum of $125. Because Costco buys in such large volumes, its purchase price is a lot lower than its competitors. Taking the low markups into consideration, it’s nearly impossible to beat their prices. While Costco’s prices are so impossibly low, they barely break even on their merchandise sales, and despite pressure from investors over the years, Costco refuses to boost their markup. That’s how committed they are to saving their customer’s money. So, while other places are constantly thinking about how to sell things at inflated prices, Costco is constantly thinking about how to make things more affordable for you.
8. Membership Fees
Costco is one of the only retailers that ask people to pay to shop in their stores. The company runs on a “subscription business model,” which means that if you want access to their bulk goods and crazy low prices, you need to be prepared to pay an annual fee. That being said, they definitely make up for the membership cost by offering their customers lower prices for their goods. Plus, we can’t forget about the free samples. Those are pretty great, too. In 2019, Costco sold $152.7 billion worth of merchandise. Their margin – meaning how much money they made from sales – was around 11%, which, compared to Walmart’s 24%, means they didn’t make all that much. But Costco has a secret weapon: they don’t really make money by selling things; they make money through their membership fees. In 2019, Costco made $3.35 billion from membership fees alone, which was a 7% increase from the previous year. In total, they made $3.66 billion. So, when places like Walmart need to worry about a decline in sales that would lead to fewer profits, Costco doesn’t have to worry about that one bit. Their profits remain in the hands of the people, quite literally, as well as their ability to convince people to pay either $60 a year for its Everyday Value membership or $120 for the Gold Star Executive status.
7. Fewer Choices Makes More Sense
In most of the stores that you visit on a regular basis, there’s a lot to choose from. When you walk down the aisles, there are often hundreds upon hundreds of different brands. And that can be great if you’re looking for variety. But Costco does things a little differently; it acts as a bulk curator for its customers. The average Costco stocks just 3,700 units at any given moment. For comparison, this is less than 1/10th of the number of items most supermarkets keep in stock, which ranges from forty thousand to fifty thousand items. Your average corner store, evidently, has less than this, but still a good amount of different items to choose from. Costco, on the other hand, only provides one or two brands in any given category. Because of how well Costco knows their customers, they can figure out what they’re most likely to want and limit their choices. By doing this, the company solves the paradox of choice – something that happens when a customer experiences stress and delayed decision-making due to an abundance of options. Like at a sushi place where the menu is 6 pages long, and you can’t decide which of the 20 different types of salmon rolls to get. Stocking fewer items means there’s less selection, which also means there’s less labor. As we all know, more labor means more money that the company has to spend. On top of this, even though Costco stocks fewer items, it sells what it does have in huge quantities. We all know that Costco is notorious for its bulky wares. This is because they understand it makes more sense for their customers to be paying $400 once a month instead of $100 once a week because it saves time, resources, and a lot of trips to the store.
6. Costco Cares About Your Wallet
Because Costco stocks a smaller inventory, it spends a lot of time choosing which vendors it wants to work with. When the company finds a product it wants to sell, it often spends months working closely with the vendor and its factories to reduce the price for its customers, as well as increase the quality of the product! One example is a toy that would usually retail for around $100 in other stores. Even though Costco could have bought it wholesale at $50 and sold it to its customers at $60, they decided to take extra steps to ensure its customers were getting a good price. Over a period of months, the company worked closely with the vendor and its factory to redesign the toy from the beginning, examining the production process to find ways to cut costs. The end result? They managed to get the vendor to reduce the price by 50% – and Costco sold it for $30. The thing is, if they’d just sold it at $60 right off the bat, they would’ve been making the exact same amount of money when selling it for $30. They didn’t need to take the time to reduce costs, but they did because they care about their shoppers. Another example of this is when they took a circular container of cashews and redesigned it to be square shaped. Because more cashew containers could now fit on a pallet, this reduced the number of shipments by 24,000 pallets per year, making it cheaper for you and me!
5. Well-Treated Employees
Despite being deemed as essential workers, retail workers are among America’s lower-paid employees. The average salary of a retail worker in America is $10 per hour, which isn’t nearly enough to cover the cost of living. What’s worse is that they rarely get full benefits, and they’re often viewed as expendable, with turnover rates as high as 65%. However, Costco is different. They understand that it’s much better to retain happy employees and pay them a livable wage instead of firing and rehiring them all the time. The average pay of Costco’s 245,000 workers is an astounding $21 per hour, which is double the national retail average. Moreover, 88% of Costco’s employees receive company-sponsored health insurance! This means, of course, that the company has some of the highest retention rates in the industry, and for good reason. Not only is the employee retention rate high, but the customer retention rate is also a whopping 85%. This extremely stable base of Costco members is largely due to its lower prices, and that helps keep the company’s profitability consistent over the years. Jim Sinegal once said in an interview that he didn’t see why an employee shouldn’t earn enough to buy a house or have a health plan for the family. We have to wonder, why isn’t this the approach of all retail employers? It worked out for Costco; surely, this could work out for other companies.
4. Costco Sticks To Its Values
Since the day Costco opened, investors have complained that the company’s been “too generous” to its customers and employees. By too generous, they mean the company has been dedicated to giving its employees a living wage and trying to get good prices for its customers. In fact, Costco investors are constantly calling for higher markups on goods, steeper prices for the customers, and reduced benefits for workers. Why? In short, greed. Maximizing shareholder value by hiking prices, laying off employees, and cutting corners are ways to get more money to the investors and fewer deals to the customers. In the last 30 years, the amount of profits going to stockholders has jumped from 50% to 86%. This investor-first standpoint is one that many public companies stand by, but Costco is different. They’ve stuck by their values and their policies, and they’ve shown people that there is enough room to make money and still treat people well. Plus, their policies actually do work: since 2000, their stock has gone up 347%, and it shows no signs of stopping. When Sinegal started Costco, he wanted to build a company that would last. It seems, through all of his crazy policies, he’s done just that.
3. No Advertising Budget
Most retailers spend huge amounts of money on advertising and marketing that’ll attract customers to their stores. For example, Walmart spends about 0.5% of its revenue on marketing, which rounds up to around $2.4 billion, making it one of the largest advertisers in the world. Target also spends a lot of money on marketing, more than 2% of its revenue. Costco, on the other hand, spends zero. It has no advertising budget, though it does send mailers to prospective members, as well as coupons to those who are already part of the Costco club. So, how are they successful despite not having any form of traditional advertising? The first one is obvious. The idea is a Costco product sells itself. When you become a member, the fantastic prices and quality of the items seems too good to be true, not to mention that other traditional retailers can’t match Costco, price-wise. Secondly, because most of their revenue comes from membership fees, it doesn’t make much sense to try to get them to visit the store more often, as it wouldn’t really affect their profits. And if Costco were to spend 0.5% of its revenue on marketing like Walmart, it would wipe out 17% of the company’s operating profit. If it were to spend 2% like Target, it would be much more, nearly 70%, so overall it’s just not worth it.
2. Strategic Mindset
Because it has no advertising and requires a paid membership card to gain entry, Costco has to think of ways to attract and then retain customers. Over the years, they’ve figured out a few ways to do this. The first is giving customers a reason to return to their stores. On top of that, they want as many customers to return as possible, which means they need a diverse array of reasons to return: selling low-priced, high-quality items is a given, but they also have earn-back membership fees, which means that returning customers can get even more savings by returning to Costco. They also have iconic items that draw people to their stores, the two most notable being their Hot Dogs and the Rotisserie Chicken, both at fantastically low prices. Lastly, they have strong product guarantees and full refunds. Oh, and who can forget the free samples? Let’s be real; the thing drawing in most people is probably the free samples. The second thing is that they give their customers reasons to spend more money which, obviously, helps their bottom line. They do this by selling things in larger sizes (the bulk items that Costco is famous for), offering executive memberships with added benefits (a 2% annual purchase rebate, for example), and even going so far as to partner with American Express to provide a credit card that rewards more spending at Costco!
1. Costco’s Limitations
While there are many great things about Costco’s business model, we have to admit that there are some flaws and limitations to it. For example, because most items are only available in bulk, the company is promoting high volume consumption. You can’t just get one tube of toothpaste; you have to get a five-pack. While this is great for larger families, it can be detrimental to single-person homes. It also has a very limited array of goods and services. While this was designed to make the shopping experience easier, it can be downside for some of the pickier shoppers out there. Finally, Costco’s main weakness is also the thing that makes it so unique: its membership-only warehouse club retail business model. While it encourages people to buy at Costco, it also limits the number of total customers while also making non-member consumers feel unwelcome. These are all things that might make someone shake their head and decide to find the nearest Walmart instead. However, for those who do take the membership plunge, Costco really is a sea of deals.