Costco Wholesale (COST), the members-only big-box discount retailer, charges $60 annually for its lowest level membership, the Gold Star. For $120 per year, Executive membership offers additional savings, perks and benefits, as well as cash back on qualified purchases. These fees may seem steep, but Costco relies on a subscription model for three reasons.

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. BJ’s Wholesale Club and Sam's Club offer direct competition for Costco. In addition, consumers can choose among Sam's Club parent Walmart Stores (WMT), Target (TGT) and a variety of neighborhood groceries and farmers' markets.

Psychology plays a part in the success of the subscription model. Membership means Costco shoppers belong to a "private" club. Also, the fee motivates action: the money's been spent, so it's best to use the club's advantages.

This thinking gives Costco its most powerful advantage: customers become loyal to the store. Having paid the fee, members are more likely to visit Costco than a non-membership store that confers no special benefits.

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. By controlling entrances and exits in addition to the membership format, Costco believes its shrinkage is "well below those of typical retail operations."

Income Stream

In the volatile world that is the grocery business, membership fees provide a stable source of income. In the company's fiscal year 2019, revenue from membership fees grew 7% to $3.35 billion. When you consider that net income was $3.66 billion, you can see why the company relies on membership fees to stay in business.

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.

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 Walmart. Many Americans believe that Costco has membership fees solely for the cash they provide, but direct profit is only one of the three reasons.