Numerous critics say prices at Costco Wholesale Corp. (COST), the members-only, big box discount retailer, aren't competitive – and recently, the retailer raised its fees for the first time since 2011. The newest fees are $60 per year for a Gold Star membership.
But Costco uses a subscription model of business for three reasons.
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.
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 notes, in its 2014 financial report, that the company's theft rate is “well below those of typical discount operations” and credits it to membership fees.
In the volatile world that is the grocery business, Costco has a way to ensure a steady source of income: membership fees. In 2017, the company's 90.3 million members worldwide brought in $2.6 billion in membership fees.
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 $2.6 billion in membership fee revenue is almost entirely profit.
When you consider that in 2016, Costco’s operating income was only $3.6 billion, you can see why the company needs membership fees to stay in business. Thankfully, its membership numbers keep growing: they were up 8% in 2014, 6% in 2015 and 9% in 2016. The company is likely to not only maintain, but to increase its revenue and profit in the coming years.
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.