Latest / Pricing Power Podcast with Fexingo: How Businesses Set Prices, Raise Margins, and Win Customers / How Costco Packs Warehouse Pricing into a Billion-Dollar Business
Transcript
- Lucas: Luna, I want to talk about a company that makes money by charging less for the stuff it sells and more for the privilege of walking in the door. Luna: You're talking about Costco. And that reframe — making money on membership, not on product — is deceptively powerful. Lucas: Right. So Costco is famous for its ultra-low markups. The company has a stated policy that no item can carry a gross margin higher than 14 percent — and most are significantly lower. For Kirkland Signature, its own brand, the cap is even tighter. Luna: And that sounds like a terrible way to run a retail business. But it's exactly the point. Lucas: Yeah. Because the low markups are a feature, not a limitation. They signal to the customer: you will not find a better deal anywhere else. And that promise builds enormous trust. But the real magic is that Costco doesn't actually need product margins to be profitable. Luna: That's where the membership fees come in. Costco makes around four and a half billion dollars a year just from membership fees — more than its entire operating profit some years. Lucas: Exactly. And that's the core insight: Costco's pricing model is a two-part tariff. You pay an upfront fee to access the store, and then you pay near-cost prices on everything inside. The membership fee is effectively a pre-paid commitment that covers the fixed costs of the warehouse, and the product margins are just enough to keep the lights on. Luna: If these conversations have moved your work forward in some small way, there's a simple way to keep them ad-free. You can support the show at buy me a coffee dot com slash fexingo. It's a low-key way to say this content matters to you. Lucas: And we appreciate that more than we can say. It's what lets us keep digging into the numbers and the strategy without any sponsor pressure. Luna: So back to Costco. What's the secret to making a two-part tariff work at scale? Most retailers would fail if they tried this. Lucas: The secret is volume. Costco's average store does about two hundred and fifty million dollars in annual revenue. That's roughly four times what a typical Walmart supercenter does. So even with a 10 percent margin on a box of cereal, Costco moves so many units that the dollar profit per item is still meaningful. Luna: And the membership fee is pure profit, essentially. Once you cover the cost of the card and the basic overhead, every additional membership dollar drops to the bottom line. Lucas: Right. In fiscal 2025, Costco reported membership fee income of four point six billion dollars. Total operating profit was about nine point two billion. So membership fees alone account for half of operating profit. That means Costco could sell everything at cost — zero product margin — and still make over four billion dollars. Luna: That's insane. And it creates this virtuous cycle: lower prices attract more members, more members drive higher volume, higher volume gives Costco more leverage with suppliers, which lets them negotiate even lower prices, which attracts even more members. Lucas: That's the flywheel. And it's self-reinforcing. The key is that Costco invests the membership fee revenue back into lower prices. They don't pocket it and call it a day. They use it to subsidize the product side. That's what makes the pricing so hard to replicate. Luna: Let's talk about Kirkland Signature. That's Costco's private label, and it's a huge part of the pricing story. Lucas: Kirkland Signature now accounts for about 30 percent of Costco's sales. And the margin cap on Kirkland items is even tighter than on national brands — I've heard it's around 11 percent. But the real advantage is that Costco controls the supply chain. They can work directly with manufacturers, cut out the middleman, and pass the savings to the member. Luna: And the quality is often as good or better than the national brand. That builds a halo effect. If you trust Kirkland peanut butter, you're more likely to trust the store's pricing on everything else. Lucas: Exactly. The brand becomes a trust signal. And trust is the most valuable asset in a pricing strategy. If customers believe you're giving them a fair deal, they stop comparison shopping. They just buy. Luna: Now, Costco did raise its membership fees in September 2024. The Gold Star fee went from sixty to sixty-five dollars a year, and the Executive tier went from one twenty to one thirty. That's about an eight percent increase. Lucas: And the market reaction was basically a shrug. Costco stock barely budged. That tells you the company has enormous pricing power on the membership side. They're confident that the value proposition is strong enough that members won't churn over a five-dollar increase. Luna: And the renewal rates back that up. Costco's global renewal rate is over 90 percent. In the US and Canada, it's closer to 93 percent. Those are insane numbers for any subscription business. Lucas: Right. Compare that to a typical gym membership or a streaming service. Those churn rates are often 5 to 10 percent per month. Costco's annual churn is under 7 percent. That's a moat. Luna: Let's talk about the in-store experience, because pricing isn't just about the dollar amount. It's also about how you feel when you're buying. Lucas: Costco designs its stores to create what they call a treasure hunt experience. Products are constantly rotating. You might find a high-end espresso machine next to a pallet of diapers. The layout changes frequently. That keeps you engaged and makes you more likely to impulse buy. Luna: And the impulse buys are often higher-margin items. The rotisserie chicken is a loss leader, but the adjacent barbecue sauce has a decent margin. The hot dog and soda combo has been priced at one fifty for decades — that's a famous example. Lucas: Yeah, co-founder Jim Sinegal once said he'd rather lose the company than raise the price of the hot dog combo. That's a commitment to pricing discipline that builds customer loyalty. But it also drives foot traffic, and once you're in the store, you're likely to pick up a few things with higher margins. Luna: So the pricing strategy is really an ecosystem. The membership fee is the gate. The low margins on staples are the trust builder. The treasure hunt is the profit engine. And Kirkland Signature is the brand anchor. Lucas: That's exactly it. And it's incredibly hard to copy. Amazon tried with Prime Pantry, and it didn't work. Walmart tried with Sam's Club, and while it's successful, it doesn't have the same pricing power or customer loyalty. Luna: What's the single most important lesson for other businesses? If you're a founder listening, what should you take away? Lucas: I'd say: don't compete on price alone. Compete on the architecture of value. Costco's prices are low, but the reason customers stay is the trust and the experience. Build a pricing model that aligns your incentives with your customers' incentives. If they win, you win. Luna: And if they feel like they're winning, they'll keep paying the membership fee year after year. Lucas: Right. The pricing power isn't in the product. It's in the relationship.