Costco Wholesale Corp. (COST), the members-only, big box discount retailer, charges $60 for it's lowest level membership, the Costco Gold Star membership (as of 2020). This may seem like steep cost to buy things, but Costco uses a subscription model of business for three reasons. Costco members can also upgrade to the $120 Executive subscription, which includes additional savings, perks and benefits as well as cash back on qualified purchases.

Key Takeaways

  • Costco has a business model that depends heavily on repeat shoppers buying and renewing memberships.
  • By selling memberships, Costco can sell products at deep discounts that barely cover costs.
  • Still, membership revenue continues to grow and contributes a significant portion of Costco's bottom line.

Loyalty

American grocery competition is intense. With several large supermarkets, Wal-Mart Stores, Inc. (WMT) Supercenters, Target Corp. (TGT), Sam’s Club, BJ’s Wholesale Club, and a variety of neighborhood groceries and farmer’s markets, Americans have lots of choice about where to spend their weekly food budget.

Psychology plays a part in the success of the subscription business model. First, by requiring membership, Costco shoppers belong to a private club. Additionally, the fee motivates action: the money's been spent; best to take advantage of the membership.

This thinking gives Costco its most powerful advantage: customers become loyal to the store. The customers remember having paid a membership fee and are more likely to visit Costco than a non-member would be likely to visit supermarket X – shoppers are less likely to shop at a variety of stores.

Reducing Shrinkage

Costco has found a way to deter theft in its stores: charge people to shop. It's unlikely that shoplifters will spend $60 a year for the opportunity to steal. Costco noted in a recent financial report that the company's theft rate was “well below those of typical discount operations” and credits this in good portion to its membership fees.

Income Stream

In the volatile world that is the grocery business, Costco has a way to ensure a steady source of income: membership fees. In fiscal year 2019, the company's revenue from membership fees was $3.35 billion, up 8% over the previous year.

Revenues from membership fees are great. Aside from a few minutes of an employee’s time, plus the cost of the card and subsequent promotional mailings, managing membership isn't too costly. As such, Costco’s billions of dollars in membership fee revenue is almost entirely profit.

When you consider that 2019 operating income was just short of $4.75 billion, you can see why the company needs membership fees to stay in business.

The Bottom Line

Costco has consistently low prices with a strong consumer following. With the company expanding both domestically and internationally, as well as profits increasing year over year and its sophisticated logistics network, the company looks poised to become a retail giant that rivals Wal-Mart. Many Americans believe that Costco has membership fees solely for the cash they provide, but direct profit is only one of the three reasons.