Latest / Pricing Power Podcast with Fexingo: How Businesses Set Prices, Raise Margins, and Win Customers / How Costco Prices Membership for Retail Dominance
Transcript
- Lucas: So Costco made about seventy billion dollars in revenue last fiscal year. And here's the wild part — almost all of their operating profit came from membership fees, not from selling stuff. Luna: Wait, so the hot dogs and the rotisserie chickens and the giant tubs of peanut butter are basically just a loss leader for the membership? Lucas: Pretty much. Costco's model is the inverse of a traditional retailer. Walmart or Target make their profit on the spread between what they pay for goods and what they sell them for. Costco caps that spread at roughly twelve percent gross margin — and that's a hard cap, it's in their corporate DNA. Luna: Twelve percent. That's incredibly thin. Most grocery chains run around twenty-five to thirty. Lucas: Exactly. So by design, Costco's merchandise business is barely profitable. But they collect about four point five billion dollars a year in membership fees. That's pure profit after covering the cost of running their warehouses. In fiscal twenty-twenty-five, membership fee income was roughly equal to their entire operating income. Luna: So the membership fee is the real product. The stuff in the warehouse is just the marketing. Lucas: That's exactly how former CEO Jim Sinegal described it. He said the membership fee is not a revenue stream — it's a commitment device. When you pay sixty dollars a year for a Gold Star membership, or a hundred twenty for Executive, you're psychologically invested. You need to shop there enough to justify the fee. Luna: That's the loyalty flywheel in action. The more you pay upfront, the more you feel compelled to return. Lucas: And the low margins ensure that when you do return, the deals are genuinely good. Costco's average markup on a branded item is about eleven percent. Compare that to a department store that might mark up apparel forty percent or more. The value proposition is undeniable. Luna: But how do they keep those margins so low when rents, wages, and transportation costs keep rising? Lucas: Two big levers. First, they sell in massive volumes. A Costco warehouse averages about a hundred seventy million dollars in annual sales — that's roughly four times the average Walmart supercenter. Their inventory turnover is incredibly fast, so they can negotiate aggressively with suppliers. Luna: Second lever? Lucas: The treasure-hunt effect. Costco constantly rotates a portion of its inventory — seasonal items, electronics, luxury goods that show up once and then disappear. That creates urgency. Shoppers know that if they see a Vitamix blender at a deep discount today, it might be gone tomorrow. So they buy more, and they come more frequently. Luna: And that frequency reinforces the membership value. It's a virtuous cycle. Lucas: Right. And it's also why Costco has one of the highest customer retention rates in retail. Their renewal rate in the US and Canada is over ninety-two percent. Globally, it's about ninety percent. That means once someone joins, they almost never leave. Luna: Ninety-two percent renewal. That's staggering. Most subscription businesses would kill for those numbers. Lucas: And they keep raising the fee. Costco last raised its US membership fee in June of twenty-twenty-four — Gold Star went from sixty to sixty-five dollars, Executive from a hundred twenty to a hundred thirty. That's about an eight percent increase. And what happened? Renewal rates barely budged. Customers grumbled for a week and then moved on. Luna: Because the value is still there. Even at sixty-five dollars, you're getting access to some of the best prices in retail. Lucas: And Costco's pricing power is so strong that suppliers accept razor-thin margins just to be in the warehouse. For many consumer brands, a Costco placement is like a seal of approval. It signals volume and credibility. Luna: But doesn't that create tension? If Costco is forcing suppliers to keep prices low, they might push back. Lucas: Some do. But Costco is willing to delist products if a supplier won't play ball. They've done it with Coca-Cola and Kraft in the past. And they have their own brand, Kirkland Signature, which gives them enormous leverage. Kirkland now accounts for about twenty-five percent of Costco's sales and growing. Luna: Kirkland is fascinating because it's not just a generic alternative — it's often made by the same manufacturers as the national brands. I've heard that Kirkland vodka is basically Grey Goose. Lucas: The story goes that Kirkland vodka is produced at the same distillery in France. But Costco sells a one-point-seven-five-liter bottle for about twenty dollars, while Grey Goose for the same size is fifty or more. The quality is comparable, but the price is dramatically lower. Luna: That sort of thing builds immense trust with customers. They know Costco isn't trying to gouge them on anything. Lucas: And that trust is what lets Costco maintain its pricing discipline even when inflation spikes. In twenty-twenty-one and twenty-twenty-two, when most retailers were passing on cost increases immediately, Costco held the line on many items. They absorbed some of the margin compression because they knew the membership fee would cover the difference. Luna: So the membership fee acts as a shock absorber. It gives them strategic flexibility that traditional retailers don't have. Lucas: Exactly. And that's why Costco's stock has outperformed the S&P 500 retail index by a wide margin over the past decade. The market rewards that stability and pricing power. Luna: Okay, but there's a downside, right? Low margins mean low earnings per share relative to revenue. And if membership growth ever stalls, the whole model wobbles. Lucas: That's the risk. Costco needs to keep adding new members faster than it loses old ones. In mature markets like the US, that gets harder over time. But they've been expanding internationally — they have warehouses in Japan, South Korea, Australia, and Europe. And in many of those markets, the model is still in its early growth phase. Luna: Plus, they've been testing new formats. I read about Costco opening smaller-format stores in China and some urban US locations. Is that a hedge against membership saturation? Lucas: It could be. The traditional warehouse requires a lot of space and a car to get there. Smaller formats in dense cities could tap into a new demographic — people who want the Costco value but don't live in the suburbs. Luna: But the treasure-hunt effect might not translate as well in a smaller store with less inventory rotation. Lucas: That's the open question. Costco's magic is partly about scale and surprise. Shrink the space, and you might dilute the experience. But if any retailer can figure it out, it's probably Costco. Luna: You know, this episode reminds me of something I've been thinking about — how much these conversations actually help me in my own work. I often find myself applying these pricing frameworks to my day job. Lucas: I hear that from listeners too. And honestly, if today's episode moved your thinking forward even a little, the best way to keep this show ad-free and independent is through listener support. There's a link at buy me a coffee dot com slash fexingo. It's a small way to say this content matters to you. Luna: Yeah, we love making this podcast, and knowing it's valued keeps us going. No pressure, just if it's worth a coffee to you. Lucas: So back to Costco's pricing power — one other angle I find really clever is how they use the Executive membership to lock in high-spending customers. For a hundred thirty dollars a year, you get two percent back on almost everything you buy, up to a thousand dollars in rewards. The average Executive member spends about three thousand dollars a year at Costco, so they get sixty dollars back — essentially cutting the net fee in half. Luna: That's brilliant. It makes the upgrade feel like a no-brainer for frequent shoppers, and it deepens their loyalty even further. Lucas: And it gives Costco a huge data advantage. With Executive members, they can track purchase patterns and tailor inventory. They know exactly which products to stock in which warehouses based on local demand. Luna: So the pricing model isn't just about revenue — it's a data-generating machine that improves the entire operation. Lucas: That's the hidden layer. The membership fee creates a direct financial incentive for Costco to keep prices low and quality high. If they ever cheated on that promise, members would leave. But because they don't, the model is self-reinforcing. Luna: It's almost like a cooperative. Members vote with their wallets every year. Lucas: And the board knows that. Any major pricing misstep could trigger a wave of non-renewals. That discipline is baked into the corporate culture. Luna: So what can other businesses learn from Costco's approach? Obviously not every company can run a membership model. Lucas: The bigger lesson is about aligning your pricing model with customer incentives. Costco's fee structure ensures that the company and the customer are on the same side — both want low prices and high quality. When you can align those interests, you build lasting loyalty. Luna: And the treasure-hunt element adds a layer of excitement that keeps people coming back even when they don't need anything specific. Lucas: Exactly. It's a reminder that pricing isn't just a number on a tag — it's a statement about your relationship with the customer. Costco's pricing says 'we're in this together,' and that's a powerful message.