Latest / Pricing Power Podcast with Fexingo: How Businesses Set Prices, Raise Margins, and Win Customers / How Costco Keeps Its Hot Dog at $1.50
Transcript
- Lucas: Let's start with a number that hasn't changed in over forty years: one dollar and fifty cents. Luna: The Costco hot dog and soda combo. I think I've seen it mentioned in a dozen viral tweets, but it's real. Lucas: It's real. And it's become a kind of urban legend in the pricing world because it's survived through two major recessions, double-digit inflation in 2021 and 2022, supply chain chaos, and labor cost increases. Most companies would have bumped the price to $1.75 or $2.00 by now. Costco didn't. Luna: And they sell about 200 million of these combos a year. So it's not a trivial item — it's a big piece of their food court operations. Lucas: Right. And there's a famous story about Jim Sinegal, the co-founder, who supposedly told a manager who suggested raising the price: 'If you raise the price of the hot dog, I will kill you.' That's probably apocryphal, but it captures the attitude. The hot dog is sacred. Luna: So what's the strategy here? Is it just a loss leader that brings people into the store? Lucas: Partly. But it's more interesting than that. The hot dog is a signal. It tells the customer: 'We are on your side. We will fight to keep prices low, even on the most visible item.' Think about it — you can't hide a hot dog price. It's on a giant menu board. Every member sees it. If they raised it to $1.75, the news would be everywhere. The backlash would erode trust. Luna: That's the brand trust argument. But there's a hard math side too. Costco makes its money on memberships — about two-thirds of their operating profit comes from membership fees. The hot dog is an investment in keeping that membership renewal rate above ninety percent. Lucas: Exactly. The renewal rate is around ninety-two percent in North America. That's insanely high. And the average member spends about $2,500 a year at Costco. If the hot dog keeps one in a hundred members from cancelling, it pays for itself many times over. Luna: But how do they keep the cost down? Beef prices have doubled in some years. Buns, mustard, ketchup — all more expensive. Lucas: They vertically integrated. Costco owns its own chicken farms for rotisserie chickens. For the hot dog, they built their own hot dog plant in Traverse City, Michigan, in the 1990s. They also own the ketchup and mustard supply chain through their own condiment production. They control the cost from the raw material to the final product. That gives them pricing power — not to raise prices, but to hold them flat. Luna: So they're using vertical integration as a pricing strategy. That's a different kind of power than, say, a premium brand that can just raise prices because customers expect quality. Lucas: Totally different. And there's another layer — the fixed-price commitment becomes a competitive moat. No other retailer can copy the $1.50 hot dog and make money. They don't have the scale, the supply chain, or the membership model to subsidize it. So Costco owns that price point forever. Luna: That reminds me of a study I read — the 'price image' effect. If a store has a few items that are famously cheap, customers assume everything else is also a good deal, even if some items are priced at market rate. The hot dog anchors the perception of the whole store. Lucas: That's exactly it. Behavioral economists call it the 'halo effect' of pricing. Costco's other margins are actually quite thin — they cap markups at around fourteen percent on most items. But the hot dog is the extreme example. It's a loss leader that also shapes the entire brand narrative. Luna: And they've been consistent with it even when it's been tested. In 2018, when beef prices spiked, there were rumors Costco might switch to a smaller hot dog or a different recipe. They didn't. They absorbed the cost. Lucas: That's the moment that made me want to do this episode. Because most businesses, when costs go up, they pass it along. That's normal. Costco's decision to take the hit is unusual. It tells you something about their time horizon. They're not optimizing for this quarter's food court margin. They're optimizing for a member relationship that lasts twenty years. Luna: If today's episode was useful to you and you want to keep it ad-free, buy me a coffee dot com slash fexingo helps. Lucas: Yeah, it really does. Okay, so back to Costco — there's a lesson here for any business that sells a subscription or a recurring relationship. The most price-sensitive item isn't always the one with the highest dollar value. It's the one that's most visible and most comparable. If you can hold that price steady, you build a trust asset that's hard to replicate. Luna: So what about the other side? Are there companies that tried this and failed? Lucas: Plenty. One example is the 'dollar menu' at fast food chains. McDonald's, Wendy's, Burger King all tried to hold a $1 price point on certain items. But they didn't have the supply chain control or the subsidy model. Eventually, they had to raise prices or shrink portions. The dollar menu became the 'value menu' at $1.29, then $1.49. It eroded trust because customers noticed. Luna: So the key is having a structural advantage that lets you maintain the price, not just a marketing decision. Lucas: Right. Costco's advantage is the membership fee, the vertical integration, and the scale. Without those, a fixed-price promise is just a promise you'll eventually break. Luna: And now they're testing something new — some locations have introduced a $1.50 Polish sausage or a bratwurst. Same price, different product. They're expanding the line without breaking the price point. Lucas: That's smart. It keeps the food court fresh without undermining the anchor price. The hot dog stays at $1.50, but now there's variety. I think we'll see more of that. Luna: I want to ask about the future. With inflation still above the Federal Reserve's target in mid-2026, and food costs up another three percent year-over-year, can Costco keep this going for another decade? Lucas: I think so, but it will require more vertical integration. They're already building more supply chain infrastructure — a new chicken farm in Nebraska, a new bakery in Colorado. They're doubling down on the model. And as long as membership revenue grows, they have room. The hot dog cost them an estimated $30 to $40 million in lost profit last year. But membership income was over $4 billion. It's a rounding error. Luna: So the hot dog isn't really about the hot dog. It's a symbol of a pricing philosophy. Lucas: Exactly. And that philosophy — 'we will find a way to give you this price, forever' — is a competitive advantage that's almost impossible to copy. You can't just decide to have a $1.50 hot dog. You have to build the entire business around it. Luna: It reminds me of something Warren Buffett said about pricing power: 'The single most important decision in evaluating a business is pricing power.' Costco's pricing power is the ability to not raise prices. Lucas: That's a great way to put it. Most companies think of pricing power as the ability to charge more. Costco's is the ability to charge the same, forever. It's a different kind of strength.