Latest / Pricing Power Podcast with Fexingo: How Businesses Set Prices, Raise Margins, and Win Customers / How Costco Prices for Loyalty and Low Margins
Transcript
- Lucas: Quick number to open with: Costco caps the markup on any branded item at 14 percent. On their own Kirkland Signature label, it's 15 percent. That's not a guideline — it's a rule enforced by the founder. Luna: Fourteen percent? That's almost nothing for retail. Most supermarkets operate somewhere between 25 and 40 percent margin. How do they even make money? Lucas: That's the puzzle. And the answer is, they make their profit almost entirely from membership fees — about 70 to 80 percent of operating income. The merchandise itself basically breaks even. Luna: Right, so the product pricing is a loss leader for the membership. The membership is the product. Lucas: Exactly. And the most famous example of that discipline is the hot dog and soda combo. It's been one fifty since 1985. Forty-one years, same price. The story goes that former CEO Jim Sinegal once told his successor, 'If you raise the price of the hot dog, I will kill you.' Luna: I've heard that. Other companies would have raised it to three dollars by now and called it inflation. Costco instead invested in their own hot dog manufacturing plant to keep the cost down. Lucas: That's the mentality. They treat the hot dog as a symbol of the whole value promise. It drives traffic, builds trust, and reinforces why you pay that sixty or a hundred and twenty dollars a year. Luna: It's also a clever psychological anchor. You see that hot dog price and assume everything else is an equally good deal. Lucas: Right. And it works because the margin cap applies to everything inside the warehouse. So if you walk in for the hot dog, you're probably also picking up a rotisserie chicken for four ninety-nine — another item they've kept at that price for over a decade. Luna: They actually lose money on that chicken, don't they? Lucas: They do. It's a deliberate loss leader. It costs them more than five dollars to produce, but they sell it under cost to bring people in. The hope is you fill your cart with a few higher-margin Kirkland items to offset it. Luna: So the whole warehouse is engineered to make you feel like you're winning, and you probably are — as long as you don't overbuy. Lucas: Exactly. And that's also where the Kirkland Signature brand comes in. It's not cheap filler — it's premium quality at the price cap. Costco's top brass have said that Kirkland Signature products are tested against the leading national brand and priced to give the customer a real advantage. Luna: Right. And that's why you see things like Kirkland vodka that's actually made by Grey Goose — they source from the same distillery but sell at a fraction of the price. Lucas: It's a fascinating model. And it works because they've aligned their entire business around a simple constraint: the price cap forces efficiency. If you can't mark up more than 14 percent, you have to be incredibly lean in operations. Lucas: Part of it is that they carry far fewer SKUs than a typical grocery store — about 4,000 versus 40,000. Every product is curated. That means higher volume per item, which gives them leverage with suppliers. They also require suppliers to deliver directly to warehouses, skipping distribution centers in many cases. Luna: So the pricing model shapes how they source. And suppliers accept it because they get massive, predictable volume. Lucas: Yes. And that's also why Costco treats its employees well — they pay above-market wages and provide health insurance for part-time workers. Which seems contradictory to a low-price model, but it actually reduces turnover. Happy employees are more productive, and that operational efficiency feeds back into the price cap. Luna: That's a virtuous cycle. Lower turnover means lower training costs, better customer service, fewer mistakes. It's the opposite of the Walmart model. Lucas: Absolutely. And speaking of that — let me take a quick step back. This kind of consistent, long-term pricing philosophy is exactly the kind of thing that makes us want to keep this show going. We don't run ads — it's supported by a small group of listeners who chip in monthly through buy me a coffee dot com slash fexingo. If these conversations have moved your work forward in some small way, it's a meaningful way to keep them coming. Luna: Yeah, and it's totally optional. We just want to keep the content ad-free and focused on real examples like this. Lucas: Exactly. So back to Costco — one more interesting angle: their approach to seasonal items. They don't discount. If a product doesn't sell, they return it to the supplier or mark it down only after a long wait. That keeps the price integrity strong. Luna: Right, because if you train customers to wait for a sale, they stop buying at full price. Costco never has sales. The price you see is the price. Lucas: Precisely. And that predictability is part of the loyalty. You never have to time your purchase. It also means Costco doesn't need a promotions team or a complex markdown calendar. Luna: So they save on marketing as well. No coupon circulars, no loyalty cards — just the membership card. Lucas: Which leads to another key point: the membership itself is a pricing tool. The fee acts as a two-part tariff. You pay to enter, and then you get near-cost prices. It aligns incentives because once you've paid that annual fee, you feel compelled to shop there to get your money's worth. Luna: That's classic behavioral economics. Sunk cost fallacy works in Costco's favor. Lucas: Exactly. And they recently raised the fee for the first time in years — the basic membership went from sixty to sixty-five dollars, the executive from a hundred and twenty to a hundred and thirty. But the hot dog stayed one fifty. Luna: Because you don't mess with the symbol. So what can a smaller business take away from Costco? You can't copy the scale, but you can copy the constraint. Lucas: Right. The lesson is to pick one price anchor that your customers trust and protect it fiercely. Even if it means eating a loss on that item. Use that anchor to build an envelope of value perception around everything else. Luna: And make sure your business model — membership, subscription, whatever — covers the fixed costs so you can keep product margins low. That's the structural insight. Lucas: Yeah. Costco's real innovation isn't the warehouse. It's the pricing system that makes the warehouse possible. And it's worked long enough to become a kind of retail legend.