Latest / The Operator's Manual with Fexingo: Daily Decisions, Tactical Wins, and Business Execution / How Costco Pays Its Workers More and Profits More
Transcript
- Lucas: You know that moment when you walk into Costco and you think, 'Okay, I'm paying a membership fee, and the prices still feel too good to be true'? Luna: Every single time. I walk out with a five-dollar rotisserie chicken and a forty-dollar sweatshirt I didn't plan to buy. Lucas: Right. And that's the puzzle. How does a retailer pay its warehouse workers an average of thirty-one dollars an hour — almost double what Sam's Club pays — and still sell a hot dog and soda for one fifty? That's been the same price since 1985. Luna: Thirty-one dollars an hour is wild. I think the federal minimum wage is still seven twenty-five. Lucas: Exactly. And Costco's not some boutique grocer in a wealthy zip code. It's a warehouse club competing head to head with Walmart and Amazon. So the conventional business logic says: if you pay more, your prices go up or your margins shrink. Costco proves that's false. And the reason is entirely operational. Luna: Alright, walk me through the mechanics. How does paying more actually save them money? Lucas: Let me start with turnover. The average retailer in the U.S. loses about sixty percent of its hourly workers every year. Costco's annual turnover among employees who've been there at least a year is under six percent. That's not a typo. Six percent. Luna: So they keep people. And keeping people means you don't have to constantly hire and train new ones. Lucas: Exactly. The cost of recruiting, onboarding, and training a new warehouse employee runs somewhere between four and seven thousand dollars. If you have a thousand employees and you lose six hundred of them a year like a typical retailer, that's two to four million dollars just in churn costs. Costco, with the same headcount, is replacing sixty people. That's maybe three hundred thousand dollars. Luna: So the higher wage pays for itself partly through reduced hiring costs. Lucas: Partly. But there's a bigger effect. A long-tenured employee knows the warehouse. They know where the flat-screen TVs are, they know how to stack the pallets so the forklift can reach them, they know which items need to be rotated first. That knowledge translates directly into faster inventory turns. Costco turns its inventory about twelve times a year. Walmart does about eight. Target is around six. Luna: Twelve turns a year means stuff moves through the warehouse in about a month. Lucas: Less than that. Roughly thirty days from receiving to the customer's trunk. And when inventory moves that fast, you don't need as much warehouse space. You don't need as much working capital tied up in goods sitting on shelves. And you have a much lower risk of getting stuck with out-of-season product that you have to mark down. Luna: Markdowns are a huge profit killer in retail. I've seen numbers that say department stores lose thirty to forty percent of margin on clearance. Lucas: Costco essentially avoids that. They don't run clearance racks. They don't have sales events. Their pricing model is what they call 'treasure hunt' — they bring in limited quantities of high-demand items, and once they're gone, they're gone. That creates urgency, but it also means they're almost never discounting stale inventory. Luna: Wait, if they don't have sales, how do they move the stuff that doesn't sell? Lucas: They don't buy it in the first place. And that's the crucial operational discipline. Costco stocks about thirty-seven hundred SKUs. A typical Walmart supercenter carries over a hundred thousand. By limiting selection, Costco buyers can be incredibly precise about what they bring in. They buy in massive volume, negotiate hard, and they put every item on a tight performance standard. If a product doesn't turn fast enough, it's delisted. Luna: So the employee turnover, the inventory turns, the SKU count — they're all connected. Lucas: They form a feedback loop. High wages attract better workers. Better workers stay longer and learn the system. Experienced workers handle inventory faster and smarter. Faster inventory turns mean less capital tied up and fewer markdowns. Fewer markdowns mean higher gross margins despite low prices. And those higher margins pay for the high wages. Luna: I want to check something. Costco's gross margin is typically around twelve to thirteen percent. Walmart is about twenty-five percent. So Costco actually makes less per item? Lucas: Per item, yes. But because they turn inventory so fast, the return on that inventory investment is actually higher. There's a metric called GMROI — gross margin return on investment. Costco's GMROI is around one hundred fifty percent. For most retailers, it's closer to eighty or ninety percent. So even though their markup is thin, the velocity makes up for it many times over. Luna: And the employee piece — does the high wage show up in the price? I mean, labor is a big cost. Lucas: Labor is about ten percent of Costco's revenue. For Walmart, it's about eleven percent. So Costco is actually more efficient in labor as a share of sales, despite paying more per hour. That's the productivity effect. A Costco employee generates about six hundred thousand dollars in annual sales. A Sam's Club employee generates about four hundred thousand. So Costco gets fifty percent more revenue per worker. Luna: Because they're not just stocking shelves — they're moving pallets, operating forklifts, managing the flow. Lucas: And there's one more piece: shrinkage. Shrinkage — theft, damage, administrative errors — runs about one and a half percent of sales for the average U.S. retailer. Costco's shrinkage is reported to be around two-tenths of a percent. Almost negligible. Luna: How? Is it the membership model? Because you have to scan your card to get in? Lucas: That helps. But the bigger factor is employee engagement. When workers are paid well and treated well, they're less likely to steal and more likely to prevent theft. Costco also intentionally understaffs a bit — they want employees busy, visible, and interacting with customers. An empty aisle is an invitation. Luna: So the whole operating model is consistent. High wages, low turnover, high productivity, low shrinkage, fast turns, thin margins that still generate great returns. It's a system. Lucas: It's a system that most competitors can't replicate because they're locked into a different set of assumptions. If you're Walmart, you've built your whole supply chain around massive distribution centers and thousands of SKUs. You can't just cut your SKU count to thirty-seven hundred overnight. Your suppliers, your logistics, your shelf-space algorithms — all designed for variety. Luna: So Costco's advantage is structural, not just a matter of choice. Lucas: Exactly. The high-wage strategy works because everything else is aligned. If you just raised wages without changing the inventory model or the SKU count, you'd crush your margins. Costco's founder, Jim Sinegal, used to say, 'We try to pay our people enough so they can afford to shop here.' That's not a platitude. It's an operational principle. Luna: And that principle has made Costco one of the most consistently profitable retailers in history. Their same-store sales growth has beaten Walmart and Target almost every year for the past decade. Lucas: It's also worth noting that Costco's membership fees — about sixty dollars a year for a basic membership — contribute about seventy percent of their operating profit. That's not a side business. It's a deliberate structural choice that lets them keep product margins razor-thin. Luna: So the real product isn't the goods — it's the access to the pricing. Lucas: Right. And that's a hard thing to copy because it requires customers to pay before they buy. Most retailers can't get away with that. Costco can because the value proposition is so clear. Luna: You know, it reminds me of something I read about Patagonia — they also pay above market and have incredibly low turnover. Their repair program actually drives customer loyalty and reduces returns. Different industry, same kind of flywheel. Lucas: That's a good parallel. And you see the pattern in a few other companies — In-N-Out Burger pays their entry-level workers well above fast-food averages and has turnover rates below twenty percent in an industry that's often over a hundred percent. But retail is where the numbers are most stark because the margins are so thin. Luna: So what's the one thing a small business owner could take from this? Say you run a local grocery store or a hardware store. You can't copy Costco's SKU count or membership model. Lucas: The principle that applies universally is: don't treat labor as a cost to minimize. Treat it as a driver of productivity. If you pay enough to attract and keep good people, and you give them the tools and autonomy to move fast, you can often offset the higher wage with better execution. Start by measuring turnover cost. Most small operators don't know what it costs them to replace a cashier or a stocker. Once you calculate that, the math often shifts. Luna: And the inventory piece — think about what you actually need to stock. Are you carrying a hundred shades of paint when only ten sell? That's capital sitting on a shelf. Lucas: Exactly. Every SKU has a carrying cost. The more you have, the more you have to discount to move. Costco's discipline is saying no to most products. That's hard because suppliers offer deals, and customers ask for variety. But saying no is a competitive advantage if it lets you excel at the few things you do carry. Luna: It's almost a minimalist approach to retail. Lucas: It is. And it works because it's backed by data and operational rigor, not just intuition. Costco knows exactly how fast each pallet moves, and if it doesn't hit the target, it's gone. That's a level of discipline most companies lack. Luna: If these operational insights have helped you think differently about your own business, there's a simple way to support the show and keep it ad-free. It's a small gesture, but it makes a difference. Lucas: Yeah, listeners can head to buy me a coffee dot com slash fexingo. That's it. No subscription, no perks, just a way to say this podcast is worth the time. And honestly, it's what keeps us going. Luna: We don't run ads, so listener support is really the engine here. If today's episode gave you one concrete idea, that's enough. Lucas: Alright, back to Costco. One last number that ties it all together: Costco's employee productivity is about two hundred thousand dollars more per person than its closest warehouse competitor. That gap is the payoff for building a system where high wages and operational excellence reinforce each other. It's not magic. It's just really hard to execute. Luna: And that's why most retailers can't do it. The system has to be designed from the ground up. Lucas: Next time you're pushing a giant cart through a Costco warehouse, take a second to watch how the employees move. They're not rushing, but they're efficient. They know where everything is. They're not standing around waiting for a manager. That's the visible sign of an invisible system. Luna: And you can buy a hot dog for a buck fifty. Still. Lucas: Still. That's the real test. If they can keep that price for forty-one years, the system is working.