Latest / Business Strategy Talks with Fexingo: Competitive Advantage, Market Positioning, and Growth Planning / How Costco Builds a Moat on Membership and Operational Efficiency
Transcript
- Lucas: Let's talk about a retailer that seems to break every rule in the book. Costco pays its workers nearly 20 dollars an hour, caps its gross margin at roughly 14 percent, and yet it's one of the most profitable companies in American retail. Luna: And you can barely walk through the aisles on a Saturday. The parking lot alone is chaos. So how does that math work? Lucas: It comes down to the membership model. Costco essentially makes its profit from the annual fee, not from the stuff it sells. In fiscal 2025, membership fees brought in about 4.6 billion dollars. Their net income was around 6.3 billion. So roughly three-quarters of net profit comes straight from those fees. Luna: Wait, so the merchandise is almost a loss leader? They're barely making money on the physical goods? Lucas: Exactly. They intentionally price everything so low that they only cover costs plus a tiny margin — enough to keep the lights on, but not enough to generate real profit. The profit engine is the membership. And once you pay that 60 or 120 dollars a year, you feel compelled to shop there to 'get your money's worth.' That behavioral lock-in is a huge part of the moat. Luna: It's almost like a gym membership. You pay upfront and then you feel guilty if you don't go. But with groceries. Lucas: Right. Except people actually show up. Costco's renewal rate in the US and Canada is over 90 percent. Globally, it's around 87 percent. Those numbers have been stable for years. That's the moat — a recurring revenue stream that customers willingly pay because they believe they're saving more than the fee costs. Luna: But Amazon has free shipping, lower prices on many items, and infinite selection. Why doesn't that eat into Costco's moat? Lucas: It's a fair question, and Costco has actually leaned into its physical-store advantage rather than trying to beat Amazon online. The treasure hunt experience — that's the term Costco uses internally. They constantly rotate a limited selection of high-end, unexpected items: a 2,000-dollar piano next to a 5-dollar rotisserie chicken. You can't replicate that serendipity in a search bar. Luna: And the rotisserie chicken is a loss leader, right? I think they've kept it at 4.99 for a decade. Lucas: Since 2009. And they lose money on every single one. But it drives foot traffic, and once you're in the store, you buy the chicken and then wander into the electronics section. The average Costco shopper spends about 150 dollars per visit, and they visit roughly twice a month. Luna: So the chicken brings you in, but the membership fee is where they actually make money. And the low prices on everything else keep you renewing. It's a virtuous cycle. Lucas: Precisely. And that cycle has a powerful feedback loop: because they have such loyal, high-volume customers, they can negotiate aggressively with suppliers. They buy in massive quantities and demand the lowest possible price. Suppliers know that if they lose a Costco slot, they lose access to millions of households. So Costco's bargaining power only grows. Luna: I've heard they also limit the number of SKUs — like, deliberately carry only about 4,000 products compared to a typical supermarket's 40,000. That seems counterintuitive for driving sales. Lucas: But it's brilliant operationally. Fewer SKUs means less inventory complexity, faster turnover, and better buying power on each item. They can offer a single brand of olive oil at a price nobody else can match because they're buying ten times the volume of a regular grocery chain. That efficiency is a moat in itself. Luna: It also makes the treasure hunt work. If you see a good deal on something at Costco, you buy it then because you know it might not be there next week. There's a scarcity element. Lucas: Exactly. And that scarcity triggers impulse purchases. The average Costco shopper buys something they didn't plan to about 40 percent of the time. That's a stat I saw in their investor materials a few years back. Compare that to a typical supermarket, where impulse buys are maybe 20 percent. Luna: Okay, but there's another angle here: Costco pays its workers incredibly well. And that is not typical for retail. How does that fit into the moat? Lucas: It's actually a core part of the strategy. Costco's turnover rate is around 13 percent for employees who have been there more than a year. The retail industry average is over 60 percent. Low turnover means they save massively on hiring and training costs. And experienced employees provide better customer service, which drives more loyalty. It's a virtuous cycle within the virtuous cycle. Luna: But paying 20 dollars an hour is expensive. How do they offset that when their margins are already so thin? Lucas: They offset it with higher productivity per employee. Because they have fewer SKUs and a simpler warehouse layout, each employee handles more volume. Costco generates about 650,000 dollars in sales per employee. Walmart, by comparison, does about 250,000 per employee. So Costco's labor cost as a percentage of revenue is actually lower than many competitors. Luna: That's a really clean example of how a moat isn't just one thing. It's this whole system — pricing, membership, employee pay, store design, product selection — all reinforcing each other. Lucas: It's a system, exactly. And it's hard to copy because you can't just pick one element. You need the whole flywheel. If a competitor tried to match Costco's pricing without the membership fees, they'd bleed cash. If they tried to match the wages without the productivity, margins would collapse. If they tried to limit SKUs without the buying power, customers would leave. Luna: Speaking of the system, there's a fascinating detail about how they handle Kirkland Signature. Their private label now accounts for about 30 percent of sales. And they use it strategically to keep national brands honest. Lucas: Right. Kirkland Signature is often made by the same manufacturers as the national brands. Costco can say to a supplier like Procter & Gamble: 'If you don't give us your best price, we'll put Kirkland on a product that's 20 percent cheaper.' That leverage is enormous. And because Costco has such high trust with shoppers, Kirkland is seen as a quality brand, not a generic. Luna: Plus, they guarantee everything. You can return a half-eaten jar of Kirkland peanut butter and they'll refund it. That builds trust. Lucas: Which feeds back into the membership renewal. The return policy is famously generous, but they rarely have to honor it because their quality control is so good. It's another example of a policy that sounds expensive but actually pays for itself in loyalty. Luna: So when someone says Costco is just a warehouse store, they're really missing the point. The moat is in the business model itself. Lucas: You know, I think that's worth a small sidebar. If these conversations have moved your work forward in some small way — maybe helped you spot a moat in your own industry or think differently about pricing — honestly, if today was worth a coffee to you, that's the link: buy me a coffee dot com slash fexingo. It's not a big ask, just a way for listeners to keep the show ad-free and independent. Luna: I love that. It's exactly the kind of low-pressure, high-trust ask that Costco would appreciate. Lucas: There you go. And speaking of trust, let's get back to the numbers. One more thing I want to highlight: Costco's capital expenditure is very disciplined. They build warehouses, not fancy stores. A typical Costco costs about 50 million to build and open, and they aim to recoup that within two to three years. That's a remarkably fast payback period for a retailer. Luna: And they don't advertise. No TV ads, no digital marketing. Word of mouth is their only channel. Lucas: Which saves them about 2 percent of revenue that most retailers spend on marketing. That goes straight into lower prices or higher wages. It's another layer of the moat — they've built a brand so strong that people actively want to tell their friends about it. The day a new Costco opens, there's a line around the block. Luna: So what's the biggest threat to the moat? If I'm an investor, what keeps me up at night? Luna: But the delivery model undermines the impulse buys, right? If you order online, you lose the serendipity. Lucas: True. But they're careful to keep the online selection smaller and to charge a premium for delivery. They want the physical store to remain the primary experience. And so far, it's working. Same-store sales growth has been consistently in the 5 to 8 percent range, even as e-commerce grows overall. Luna: Another threat could be a recession. If household budgets tighten, that 60-dollar membership might get cut. Lucas: Ironically, recessions actually tend to help Costco. During the 2008 financial crisis, their membership renewal rates actually went up. Because when people are pinching pennies, they want the best deal. Costco's value proposition becomes even more compelling. And since they sell a lot of staples — food, toilet paper, gasoline — demand is relatively inelastic. Luna: Gasoline is a big one. They have gas stations at almost every location, and they price it below market. It's another loss leader that drives traffic. Lucas: Exactly. They lose money on gas, but it brings you to the store three times a month instead of two. And while you're there, you grab a rotisserie chicken and a 50-inch TV. The gas pump is the gateway. Luna: So the moat is really a collection of these interconnected tactics — membership, treasure hunt, Kirkland, employee pay, gas, the chicken — all reinforcing each other. And each one is hard to replicate in isolation. Lucas: That's the key insight. A moat isn't a single patent or a single data advantage. It's a system where every element makes the others stronger. Costco has built one of the most durable systems in retail, and it's been doing it the same way for 40 years. That consistency itself is a moat. Luna: It's a good reminder that you don't need to be the flashiest or the most disruptive. Sometimes the strongest moat is just doing the basics exceptionally well, and never stopping. Lucas: And never compromising on the model. Costco has had plenty of opportunities to raise prices or cut wages to boost short-term profits. They've resisted every time. That discipline is rare, and it's probably the hardest part of the moat to copy. Luna: So if you're building a business, the lesson might be: find your membership-style recurring revenue, create a treasure-hunt element that brings people back, and build a system where every part supports the whole. Easier said than done, but Costco proves it's possible. Lucas: Absolutely. And they also prove that treating your employees well and your customers well can be a competitive advantage, not a cost. That's a powerful takeaway for any founder or strategist listening. Luna: Great episode. I'm craving a hot dog now. Lucas: With that 1.50-dollar soda. Still the same price since 1985. That's a moat I can get behind.