As a savvy shopper and student of the retail industry, I‘ve long been fascinated by Costco‘s singular business model. No company in the world does quite what Costco does, and none do it nearly as well. With a fanatically loyal customer base, an unmatched value proposition, and a growth story for the ages, Costco is the retailer that every other retailer wants to be. But how did a nondescript warehouse store hawking bulk-sized mayonnaise jars become an international juggernaut with over $200 billion in sales? Let‘s pull back the curtain on Costco‘s winning strategy.
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Membership Mastery
The core of the Costco way is its membership model. Costco is really two businesses in one—a membership club and a discount retailer. The basic Gold Star membership costs $60 per year and grants access to all Costco locations and the Costco.com site. An Executive membership, at $120 per year, offers additional benefits like 2% cashback on Costco purchases and discounts on services like check printing and identity protection. Business memberships are available at both tiers with additional perks.
Costco makes the vast majority of its profits on membership fees, not retail sales. While margins on product sales are razor thin, membership fees flow almost entirely to the bottom line. Membership fee income topped $3.9 billion in 2022, compared to total company profit of $5.8 billion (Costco 2022 Annual Report). In other words, membership fees account for more than two thirds of Costco‘s profit in a typical year. No wonder Costco execs call memberships "the most important thing we do."
Costco‘s renewal rates are the envy of the industry—over 90% in the U.S. and Canada (Costco Q4 2022 Earnings Call). The membership model creates stickiness and loyalty that traditional retailers can only dream of. Once a customer pays for a membership, they are invested in getting their money‘s worth by shopping at Costco as much as possible. The more they shop, the more value they perceive in their membership. It‘s a virtuous flywheel that competitors have found impossible to match.
Demographic Dominance
So who are these devoted Costco members? Costco‘s core customer base is surprisingly upscale. The average Costco member is college educated, owns a home and earns over $100,000 per year (Numerator Intelligence). Nearly a third have annual incomes over $150,000.
| Costco Member Demographics | |
|---|---|
| Median Age | 50.5 |
| Gender | 49% Male / 51% Female |
| Median Income | $100,000+ |
| Education | 48% College Degree+ |
| Homeownership | 73% |
Source: Numerator Intelligence
This highly desirable demographic is attracted to Costco‘s unique mix of quality and value. Walk into any Costco and you‘ll see BMWs and Mercedes sprinkled throughout the parking lot. Where else can you pick up a Prada handbag along with a pallet of paper towels?
Costco knows its customers and caters to their preferences. You won‘t find many bargain basem*nt brands at Costco. Instead, the merchandising skews heavily towards premium brands, organic foods, and high-end electronics and appliances. "Costco is a curator of quality," says Timothy Campbell, a senior analyst at Kantar Retail. Costco is pickier about what it sells than any other store.
The Kirkland Powerhouse
Perhaps nothing exemplifies Costco‘s quality-first approach better than its Kirkland Signature private label. Kirkland Signature is a powerhouse in its own right, with annual sales of over $50 billion. That‘s bigger than the total revenue of Kraft-Heinz, Colgate, or Mattel (CNN).
But Kirkland Signature is no ordinary store brand. Costco goes to extraordinary lengths to make KS products as good or better than national brands at a fraction of the price. It partners directly with many of the world‘s top manufacturers to create Kirkland products. For example, Kirkland Signature batteries are made by Duracell, KS vodka is made by Grey Goose, and KS golf balls are made by Titleist (MoneyWise). This unmatched combination of quality and value has earned Kirkland a fiercely loyal following. Over 30% of Costco members say they shop at Costco specifically for the Kirkland brand (CNN).
As a longtime Costco member, I can personally attest to the lure of Kirkland. Why buy Oreos when the Kirkland cookies taste just as good (maybe better) at half the price? Kirkland products are the main reason my annual Costco journeys have steadily increased from a few visits to over 30 per year. I challenge anyone to do a blind taste test between Kirkland and national brand products. You‘ll be shocked how many "ties" you wind up with. With Kirkland Signature, Costco has achieved the holy grail of retail—a private brand customers are actually proud to buy.
Efficiency Obsession
Private label quality is just one way Costco keeps costs down and passes value to the customer. Costco‘s entire business model is built around ruthless efficiency. As a frequent shopper, I‘m always struck by the Spartan nature of Costco warehouses. There are no window displays, mannequins, or fancy fixtures. 60 percent of merchandise is still on the pallet it was shipped on. The sales floor does double duty as storage space—excess inventory is simply stacked on steel racks above the shopping floor.
This bare-bones approach enables Costco to achieve incredible sales per square foot, inventory turnover, and labor productivity. Costco captures over $1,600 of sales per square foot, nearly double that of Walmart or Target (Retail Dive). Inventory turns over before Costco has to pay suppliers, creating "float" that Costco can invest. And with a self-service model, Costco generates over $700,000 of sales per employee, again multiples higher than competitors (Cascadia Strategy).
All these efficiencies add up to cold, hard cash. As one retail analyst put it to me, "Costco basically mints money." Costco‘s gross margins of around 13% are less than half that of Walmart or Target (Costco 2022 Annual Report). But its steady membership fee income and rock-bottom costs mean Costco‘s profit margins and return on equity are consistently higher than other large retailers.
A Winning Formula
Put it all together and you have a business model that prints cash as reliably as the U.S. Mint. Over the last decade, Costco‘s sales have grown at a 8% compound annual growth rate while profits have increased a whopping 12% per year (Costco 2022 Annual Report).
| Costco 10-Year Financials | 2013 | 2022 | CAGR |
|---|---|---|---|
| Revenue | $105.2B | $196.4B | 8.0% |
| Operating Income | $3.1B | $7.8B | 12.2% |
| Number of Warehouses | 638 | 841 | 3.1% |
| Total Cardholders | 72.6M | 118.9M | 6.4% |
Source: Costco 2022 Annual Report
This phenomenal growth isn‘t due to complex financial engineering or unsustainable expansion. It‘s the product of a simple business model executed to perfection, year after year. By relentlessly focusing on quality, value, and efficiency, Costco makes its members happy and generates boatloads of cash in the process. It forgoes short-term profits to build long-term value. In an era of retailers chasing the latest fads, Costco‘s consistency is its greatest strength.
Not that Costco is resting on its laurels. To keep growing, Costco will need to attract the next generation of shoppers. E-commerce remains an opportunity and a challenge—Costco.com is growing rapidly but only represents about 7% of sales (Costco Q4 2022 Earnings Call). Capturing younger, digital natives without cannibalizing store sales will require deft management. International markets, with just 16% of locations today, offer another avenue for growth.
But Costco isn‘t about to abandon a formula that has served it so well for so long. "If we keep our eye on the ball: keep prices down, keep providing good value and quality to our members, and keep paying our employees better, we think we have a pretty good future ahead of us," says CEO Craig Jelinek (Cascadia Strategy). I couldn‘t agree more. As retail continues to evolve at a breakneck pace, Costco‘s future appears as solid as that 20-pound turkey in my oversized shopping cart.
