How Costco's Unique Business Model Resulted In Global Success

How Costco's Unique Business Model Resulted In Global Success

In this strategy study, we’ll take a look at how Costco pioneered the business model, what elements make it as successful as it is, and why it allows Costco to do things other retailers simply can’t or won’t do.

Costco is the third biggest retail player in the world - behind only Walmart and Amazon. Yet there is something very unusual about the retail giant. Costco makes way less money per a sold product compared to other retail stores. 

The company’s average gross profit margin in 2020 was only 11.2%. That’s way lower than your average retailer gross margin that ranges from 20% all the way to 50% for department stores. E.g. Walmart’s average margin in 2020 was 24.1%. In fact, Costco even loses about $40 million a year on their $5 roasted chickens alone.

It also doesn’t have nearly as many stores as other big retailers, yet it outperforms everyone but Walmart. Costco has “only” 803 stores around the world, while Walmart has 11,443 stores, Schwarz Group, which is behind Lidl and Kaufland, has 12,500 stores, Kroger has nearly 2,080 stores and Target has 1,897 stores.

So how can Costco be so successful?

After all, the company boasts:

  • $163.22 billion net sales in 2020
  • 9% increase in annual sales from 2019 to 2020
  • 273,000 employees
  • Stores in 12 countries
  • 100+ million worldwide members
  • A 91% membership renewal rate in the U.S. and Canada and an 88% renewal rate worldwide

Members - that’s Costco’s secret. Their warehouse retail stores are membership-only and that’s the foundation of their extremely successful business model.

Costco’s story is a masterclass of thinking outside the box and creating win-win scenarios which satisfy customers and employees while achieving the company’s business goals.

It all begins with a warehouse club

Costco’s story begins with Price Club which was founded in 1976 by Sol Price and his son Robert Price. The store introduced a brand new concept - a retail warehouse club. In order to shop there, you had to be a member.

At first, Price Club was limited exclusively to business members, who could purchase a wide range of supplies and wholesale items. But after a while, it opened up its membership to employees of local businesses, non-profit organizations, and government. 

One of the people who were instrumental in fine-tuning the new warehouse club concept was Jim Sinegal, the executive vice-president of merchandising, distribution, and marketing. He was previously employed by Sol Price and was familiar with the Price Club business model.

Seven years after the first Price Club store, Sinegal used his expertise to co-found Costco Wholesale with Jeff Brotman, and together they opened the first warehouse in Seattle, Washington in 1983.

In 1993, Costco and Price Club agreed to merge operations since Costco's business model and size were similar to those of Price Club, which made the merger more natural for both companies.

Costco has transformed the retail world as the world's first membership warehouse club for the wider public which accepted non-business members. While the idea of charging people to shop in your store seemed very bold and was not followed by any of the retail giants, it proved to be the right move. It allowed Costco more efficient buying and operating practices while giving the members access to unmatched savings.

Costco’s operating philosophy has always been simple: 

Keep costs down and pass the savings on to our members.

People loved the concept, which resulted in Costco’s meteoric rise. By the end of 1984, 200,000 people held Costco memberships and Costco soon became the first company ever to grow from zero to $3 billion in sales in less than six years since its inception.

The annual membership of Costco’s first Seattle store back in 1983 was $25. The cost of a membership nowadays is $60, which is around the same as it was back in 1983 once adjusted to inflation. 

Costco’s memberships graphCostco’s membership trend

In 1993, Price Club and Costco merged into Price Costco and thus created the world's most successful warehouse club. In 1999 the name of the company was changed to Costco Wholesale Corporation and remained as such until this day.

Key takeaway #1: thoughtful innovation pays off

Costco’s innovative membership model paid off because it offered members substantial benefits that offset the initial membership price. At the same time, it provided Costco with an additional source of income that fielded its growth.

A successful global expansion

Before Costco's international expansion, there was quite some doubt whether the innovative Costco retailing strategies would result in success outside the United States. 

Target's exit from Canada in 2015, Tesco's shutdown of its U.S. Fresh and Easy chain, and Walmart's store closings in Brazil in 2016 show that being successful on the global market is not given even for the biggest retail players.

However, Costco's expansion, which began in 2013, succeeded in ways that Target, Walmart, and Tesco failed to achieve. 

By March 2021, Costco is present in 11 countries outside the US and Puerto Rico.

Costco membership sign ups in the first 8 to 12 weeks of a new store opening overseas are generally 10 times greater than at Costco store openings in the United States. Additionally, the company’s international membership renewal rate was 88% at the end of 2020.

While many other retail chains open international locations as a defensive strategy in order to shore up declining sales, Costco isn't compensating for domestic weakness. Costco's international expansion came in the middle of high profits in the U.S. market, allowing the company to focus on a long-term international strategy and to test if its business model would be well-received in other markets.

And talk about great reception! In 2017, before Costco opened its doors in Iceland, one out of eight Icelanders had already signed up for membership. On the opening day, search-and-rescue teams were deployed to manage the crowds.

Perhaps even more impressive is Costco’s opening of its first store in mainland China in Shanghai in 2019. On an opening day, 139,000 people got their Costco membership. The store even had to close early on the first day due to traffic jams caused by crowds of shoppers and three-hour wait times just to park.

Key takeaway #2: universally understood benefits drive global expansion

Costco’s operating philosophy “Keep costs down and pass the savings on to our members” proved to be universal regardless of nation, race or religion. Its business model is appealing no matter the country. 

Now let’s see what exactly makes Costco’s business model so successful.

Understanding Costco’s business model

The basics

Costco’s mission is “to continually provide members with quality goods and services at the lowest possible prices. 

This mission statement is directly linked to its business model and strategy. It emphasizes quality and cost leadership, which are two factors that top consumer’s priority charts. While they might seem mutually exclusive, Costco is known for both.

Costco is primarily a big-box store. Such stores achieve economies of scale by focusing on large sales volumes and are meant to be a one-stop shop for customers. Establishments like Costco took “the one-stop shop” bit a step further and don’t offer just groceries and store products, but also a food court, optical services, gas stations, tire garages, or photo processing services. 

Big-box stores typically carry items in extra-large sizes and lure customers with the promise of saving by buying in bulk. Costco is no exception - real bargains can be had by purchasing bulk non-perishable items or items with long shelf life.

As a result, Costco’s generic strategy is cost leadership. 

This strategy entails maintaining the lowest prices possible and is used by many retail giants. However, Costco’s strategy incorporates the warehouse club membership business model, which differentiates it from other retailers and enables Costco to offer lower prices than its competitors.

Costco is so effective because its revenue is broadly divided into two streams:

  • Product sales, which is revenue from all the sales of goods and services through all Costco’s channels.
  • Membership fees, which is revenue from Gold Star, Business and Executive memberships to customers worldwide.

This is a very basic overview of Costco’s general business model. Now let’s go into more details and look at some specific elements - starting with the core of the business model, Costco’s membership.

Costco’s membership

As said, Costco uses a membership-only warehouse club business model, which means consumers pay a membership fee to access the low-cost products available at Costco stores.

Each member is entitled to issue a free supplementary card to someone living in the same household or to a fellow staff member working in the same company. Non-members may accompany members, but only members are allowed to purchase products in stores. In 2020, Costco had a total of 58.1 million paid members and 105.5 million cardholders.

Costco has two tiers of membership – basic and executive plans for consumers and businesses. Basic plans cost $60 per year, while Executive plans cost $120 per year.

Executive members get an annual 2% cashback on their purchases (up to $1,000 per year). This makes executive membership an enticing offer for people who often shop at Costco and there’s plenty of them. In fact, 39% of members pay $120 for the Gold Star Executive membership.

Costco membership costs
These membership fees actually represent the majority of Costco's operating profit. Yes, Costco makes most of its money by selling access to affordable products and not by selling those products.

In 2019, Costco made $3.35 billion from membership fees, an increase of 7% from the previous year. Its entire net income for the year was $3.66 billion.

Costco’s membership is also a powerful play on the human psyche. Once a customer pays the membership fee, it treats it like a sunk cost. The investment has been made and now it is time to get value from it. Because of that, customers will make additional trips to Costco to make sure they get value from their investment. 

While other retailers need to worry that a decline in same-store sales will lead to collapsing profits, Costco doesn’t really face this problem. Its profits are mostly dependent on its memberships, which are getting renewed on an extremely high basis (91% in the US and 88% internationally).

Obviously, such high renewal rates aren’t a coincidence. Costco does reinvest the membership fees into low prices for customers and by doing so ensures that everyone wins. We’ll talk more about product prices later on, but now let’s see what kind of people Costco wants for its members.

Target market: suburban homeowners

From the very beginning, Costco targeted relatively affluent and college-educated customers who would understand the value of membership.

A typical Costco shopper is an upper-middle or upper socioeconomic class and has an income of about $93,000 a year. 

But if Costco employs a cost leadership strategy, why does it target relatively wealthy people? Well, while all shoppers like a bargain, Costco’s customers also have the means to buy in bulk, which is the only way one can buy most products Costco stocks.

While the price of an individual product generally is the lowest around, shoppers usually have to buy at least a three-pack, which means that the average transaction total is quite high.

That also explains why the vast majority of Costco stores are located in affluent suburban areas both in the U.S. and around the world. It’s hard to make the most of a Costco membership if you’re renting a small flat as it takes a lot of space to store bulk purchases. That’s why a typical shopper is a suburban homeowner.

Speaking of buying and selling in bulk - that is also an important part of Costco’s business model.

Bulk purchasing

Product quality is a crucial aspect that Costco focuses on for driving growth and maintaining customer loyalty.

Instead of selling a hundred thousand different products as most other retailers, Costco’s merchandise is limited to under 4,000 items (for comparison, Walmart sells over 142,000 SKUs in each of its supercenters). This allows Costco’s procurement team to rigorously screen each product in order to provide the best quality and the best price to members. Each item Costco sells is meticulously selected. As a result, consumers don’t suffer from choice paralysis and can always rely on Costco for selling quality products.

Because of the lower number of options, each option has a higher perceived quality and is more likely to sell, which allows Costco to order more stock and thus lower the product’s price. Remember that Costco is selling most products in bulk packaging, so shoppers can’t buy just one cereal box but have to get 5 or them - which complements Costco’s ordering model.

Costco also sources its products directly from manufacturers which eliminates intermediaries and further lower prices for the customers.

By selling products in bulk Costco entices customers to buy large quantities of items. The perception of getting a deal often negates the fact that one may not even need all the products. Customers believe they're saving more money by spending more money, which leads them to spend more in the long run. 

According to Perfect Price’s research from 2015, customers spend by far the most money per shopping trip when visiting Costco compared to other retailers.

Here are the top 10 stores where customers spend the most per shopping trip:

  1. Costco, $136 
  2. Sam’s Club, $81 (similar membership model)
  3. Target, $62
  4. HEB, $59
  5. Stop & Shop, $56
  6. Wal-Mart, $55
  7. Meijer, $54
  8. Whole Foods, $54
  9. Trader Joe’s, $50
  10. Kroger, $50 

There’s another part of Costco’s business model we haven’t mentioned yet that makes big purchases less risky.

Best in class refund policy

Costco has a very liberal return policy where customers can return almost anything they have purchased at any time. Even their membership.

On Costco’s website it says: 

“We are committed to providing quality and value on the products we sell with a risk-free 100% satisfaction guarantee on both your membership and merchandise.” 

Having such a liberal return policy is almost necessary if you want to entice shoppers to try new products which they can only buy in bulk. If you know you can return anything if you don’t like the first product in the box of ten, you’ll be much more inclined to buy something new.

And yes, members can also claim a refund on their memberships at any time if they are not satisfied with the service, which means anyone can try shopping at Costco risk-free.

There was even a case of a woman who successfully returned a Christmas tree 10 days after Christmas because the tree was dead.

Efficient inventory management and warehouse design

From a logistics standpoint, Costco is one of the most efficient retailers in the world. This is because of two factors: inventory management and warehouse design.

Costco uses its warehouse-style stores as retail and storage spaces in one. It utilizes cross-docking, which means that products from a supplier or a manufacturing plant are distributed directly to the retail chain with marginal to no handling or storage time, which reduces inventory management costs and storage space costs.

Costco also displays goods in their shipping pallets, instead of arranging individual items on shelves, which further reduces inventory costs.

Costco’s warehouses are strategically designed to make restocking as easy as possible. Warehouse design allows forklifts to restock the store, which also makes it easier to rotate seasonal products and enables the treasure-hunt experience. This purposeful design saves both time and costs.

The combination of impeccable inventory management and warehouse design also allows Costco to utilize the just-in-time stocking principle, which is a management strategy that has a company receive goods as close as possible to when they are actually needed.

Once you combine everything mentioned thus far in this chapter, you can see why Costco can cut prices even lower and pass on the savings to their members, thus attracting more membership sign-ups and directly increasing their bottom line.

However, their store design serves yet another purpose.

“Costco doesn’t use any fancy decor or lighting, instead, they make sure that their store resembles a warehouse with exposed beams, pallets, and simple metal shelving,” says Mark Ortiz, a marketing expert and founder of Reviewing This. “This is smart because it tricks the consumer into believing that they are purchasing goods at low prices. Logically, you would think, less money spent on decor equals less overhead cost equals the opportunity to lower your prices.”

The warehouse design is a part of “the Costco Experience”, which Costco is famous for, which shouldn’t be neglected when talking about their business model. Let’s see what the famed experience is all about.

The Costco experience and Costco culture

Shopping at Costco is often called “The Costco experience”.

As offering superior customer experience is the key to customer loyalty, Costco does its best to be an experience in itself. By putting customers first in every choice and innovation, Costco continues to build its loyal customer base 

Consumers go crazy for a deal, and Costco has designed its entire strategy around this core tenet. A good deal “feels like winning,” says Bob Nelson, the senior vice president of financial planning and investor relations at Costco. And Costco would like their members to feel like they’re always winning, even if this means resisting the urge to raise prices and increase profits.

James Sinegal, Costco’s co-founder and former CEO, once talked about how once Costco was selling Calvin Klein men’s jeans for $29.99 a pair. The pants were selling faster than Costco could stock them, and when he bought another shipment for $22.99 per pair, it was ultra-tempting to charge more. However, Costco stayed true to their philosophy of passing the savings to their members and sold the jeans for $22.99 per pair.

Making sure that the customers get the best deal at Costco is an integral part of Costco’s culture.

Besides providing an exceptional shopping experience, Costco is also famous for an employee-focused organizational culture, which we’ll explore later. 

The combination of cost, generous return policy, and satisfied employees resulted in a shopping experience that many customers get addicted to.

It was believed at the company that culture is not the most important thing, but the only way forward. Costco saw promoting its core values as the only recipe for success. Maintaining integrity, passion, motivation, and customer trust is what enables Costco to outdo its competitors.

Shopping features aside, there is something more to Costco that cultivates such a loyal customer base.

"Costco relaxes my soul," says John, the founder of the I love Costco blog. 

"I do love that everyone at Costco appears to be relaxed humans," says Ellinger. "I love overhearing a weird personal conversation between two employees unloading a box and knowing that Costco is a safe space for people to just be people."

Costco also has great food courts which drive visits on their own. And they offer amazing deals, which are even losing them money in some cases.

We already mentioned the $5 roasted chicken, but there’s also the famous hot dog and soda combo for $1.50. It still costs the same as in 1985 when it was introduced and that is a big part of its almost mythical status among Costco’s members. Yes, Costco could make a lot of money by raising the price, but it’s much more valuable if they let it serve as a reminder of Costco culture every time a customer decides to grab a hot dog after a shopping trip.

All this helped the company build an outstanding image among its customers and it’s apparent that it leads to more sales year after year.

Key takeaway #3: do everything you can to fulfill your promises

Costco promises to pass savings to their members and to continually provide members with quality goods and services at the lowest possible prices. Costco also wants to offer a customer experience that makes it stand apart from the rest of the retailers.

In order to realize its vision, the company uses many innovative approaches which resulted in an excellent brand image over the years.

But does Costco’s strategy produce results? How successful is its business model been during the last few years?

Well, the company has financially outperformed over a series of years, with a consistent growth pattern. There was an increase in revenue in 2019, which was an 8% increase over the previous year, and 2020 was even better, with a further increase of 9%.

Costco revenue graphSource: Costco annual report

How Costco’s business model allows the company to excel

Lower margins, lower prices, high value

Offering quality products at the lowest prices is as much a part of Costco’s business model as the result of it.

According to Craig Jelinek, Costco's CEO and Director: 

"Costco is able to offer lower prices and better values by eliminating virtually all the frills and costs historically associated with conventional wholesalers and retailers, including salespeople, fancy buildings, delivery, billing and accounts receivable. We run a tight operation with extremely low overhead which enables us to pass on dramatic savings to our members." 

Unlike most other retailers, Costco’s membership model allows them to focus on strategies for making products cheaper for customers, rather than trying to increase revenue by finding ways to make customers pay more.

Because of its limited range of products, Costco can stay committed to delivering high-quality items at the lowest prices. Because of its efficient inventory management system and constant revenue from membership fees, Costco can keep its gross profit margins lower than most other retailers. Low margins result in cheaper products as Costco passes the savings to their members. 

Kirkland Signature: one of the most trusted private-label brands

When it comes to affordable yet quality products, Costco’s own private-label brand, Kirkland Signature, deserves its own chapter.

In 1995 Costco began the Kirkland Signature. Its mission was to create an item of the same or better quality than the leading brand at a lower price and do so by controlling every element of the item’s creation, including packaging and transportation. 

Costco claims that Kirkland Signature products are high-quality goods at simply excellent prices and openly invites customers to compare any Kirkland Signature product with its brand-name counterpart. The store’s return policy basically guarantees Kirkland’s quality.

Costco prices Kirkland Signature items according to its philosophy and that’s why they are always cheaper than their brand-name equivalents, often by more than 20%.

It’s no surprise that nowadays Kirkland products account for roughly 25% of Costco’s sales and shoppers can find them in virtually any category, from groceries to household products and clothing.

"I am not sure there is another [private-label] brand that has established this level of trust," says Timothy Campbell, a senior analyst at Kantar Consulting.

The success of Kirkland Signature is possible because of Costco’s business model as they have direct contact with lots of manufacturers and their members trust them that they will only choose and offer quality products.

In return, Kirkland Signature has become one of the top reasons that customers are so loyal to Costco. Creating such a strong store brand shows that Costco cares about its customers and wants them to have great products at a great price.

A lot of Kirkland products are actually manufactured under a private label by name-brands just for Costco. 

Select varieties of Kirkland Signature Coffee are actually roasted by Starbucks Coffee Company, Kirkland Signature dry dog and cat foods are made by Diamond Pet Food and Craig Jelinek, Costco’s CEO, said in an interview that Kirkland Signature Batteries are made by Duracell. 

There are many other examples and in each case, Kirkland products are cheaper than their brand-name counterparts.

The treasure hunt experience

If you’ve ever spoken with a Costco member, you’ve probably heard them brag about their latest find at our warehouse. Costco calls those products treasure hunt items, and they’re offered in various departments throughout the year. 

They’re there to make the customers feel the thrill of discovery. The aisles at Costco aren’t labeled, which tempts shoppers to walk down each one. That makes them more likely to encounter what Costco calls its “treasures.” 

“Treasures” make up 25% of Costco’s inventory and they are items that make shopping an adventure. When customers turn the corner they might suddenly find the luxury “surprise” of the week. It’s often something one would expect in upscale department stores, but certainly not in Costco. Surprises like Waterford Crystal, Coach handbags, Omega watches, Andrew Marc, Calvin Klein, Adidas, Chanel, Prada handbags and many more are offered at incredibly low prices. Other treasures include electronics, appliances and other less frequently purchased finds at extremely good prices. These products appear on Costco’s shelves one day, but are gone the next. 

That uncertainty creates a sense of urgency, and means that Costco shoppers don't just buy a pack of gum on impulse - they buy an 80" 3D television or a whole box of fine wine.

The company refers to this strategy as “treasure hunting,” in which Costco shoppers must navigate through the entire warehouse in search of exciting deals and unbelievable bargains. And they know some of the things they can find as they receive a pamphlet filled with coupons and irresistible deals as soon as they walk into the warehouse.

Every Costco warehouse is purposely designed with the necessities at the back of the store, meaning customers have to walk through the rotating items and sales to get their most-needed products and groceries. 

The treasure hunt atmosphere is also a safeguard against online competitors as customers have to go into a Costco store to see what is new and exciting. 

One would think that unlabeled isles, rotating inventory and purposely longer shopping trips would bother customers, but in the case of Costco, it’s quite the opposite. It’s all a part of the famed Costco experience and members enjoy it as they feel that’s how they get the most value for their membership. Instead of a run-of-the-mill grocery trip, Costco becomes an adventure that loyal customers are obsessed with.

Setting up the adventure is made possible by Costco’s inventory management and warehouse design which enables the store to quickly and efficiently rotate merchandise and allows them to grab the best deals their procurement team can find.

The treasure hunt experience is once again something that is enabled by Costco’s business model and at the same time a part of it. It’s also another factor that contributes to Costco’s extremely high customer retention rate.

Customer loyalty

Most consumers take pride in being a Costco member and the company’s high level of customer loyalty is no secret.

The emphasis Costco places on excellent customer experience and the value to their members results in an extremely high membership renewal rate - 91% in the US and Canada and 88% on the global market

Costco’s number of cardholders has also been steadily growing - there were 76.4 million cardholders in 2014 and the number rose to 105.5 million cardholders in 2020. Around 60 million of them are paying members as each member gets an additional card for their household. These numbers are what makes Costco’s customer retention rate even more impressive.

But Costco’s members aren’t just loyal, some of them are obsessed with the Costco experience. There are websites and blogs solely devoted to people talking about the warehouse. Some of them, like Costco Insider, have huge followings as they review recent deals at the store.

A blog dedicated to the Costco experienceA blog dedicated to the Costco experience

This stable base of members who are making repeat purchases throughout the year is the result of Costco’s business model. There’s another very interesting thing Costco does or rather doesn’t do, in order to keep their profits higher and prices lower.

No advertising

Costco spends next to nothing on advertising and has no official advertising budget. It does send targeted emails to prospective members, email coupons and offers to existing members, but that’s negligible. Considering the huge sums of money most retailers spent to bring customers into their stores, that’s a really unorthodox approach.

How can Costco completely shun traditional advertising and still be successful? There are two reasons.

First, Costco has a product that sells itself. The membership offers great value to those who shop regularly at Costco, and because they’re excited about the deals they get, they spread the word.

Costco’s focus on customer satisfaction helped them create a strong brand and nowadays it’s safe to say that their reputation precedes them and that most of their target market has at least heard of Costco.

Second, spending on marketing to get existing members to shop more wouldn't really help Costco’s bottom line as membership fees are the real driver of profits. You might think that spending heavily to gain more members would make sense, but when you look at the numbers it actually doesn’t.

Spending just 0.5% of its revenue on marketing would wipe out 17% of the company's operating profit. If Costco was to spend 2% of revenue on advertising, as Target does, it would erase nearly 70% of their operating profit. The number of new members they’d get couldn’t possibly cover that loss, so it’s just not worth it.

Costco’s membership model allows them to focus on improving every aspect of the experience that leads to customer loyalty and inevitable word-of-mouth recommendations instead of spending on traditional marketing campaigns. This is one of the company’s core strengths as almost no other retailer can afford to pretty much ignore advertising.

Instead of investing in ads, Costco invests in something that much more directly impacts their members’ experience - their employees.

Higher wages and great employee benefits

Costco is often recognized as being much more employee-focused than other Fortune 500 companies. By offering higher wages and top-notch health benefits, the company has created a workplace culture that attracts positive, high-energy, talented employees.

Costco’s objective is to have motivated employees and reduce the employee turnover rate. And it succeeded as Costco's annual employee turnover is 13% while the industry turnover is believed to be well above 20% annually. The company also cultivates most of its leaders through internal leadership development, which presents an opportunity for professional growth and development.

Costco fosters a culture that is built on employee empowerment. It invests in its employees in order to improve operations and drive profits. Employees are recognized as an asset for the company as they are the ones driving the competitive advantage in the physical retail landscape. Costco doesn’t only provide them with good wages and health benefits but also promotes cultural diversity and inclusion.

This inclusive organizational culture and HRM practices have resulted in extreme popularity along with a strong social image - driving more and more loyal customers into the stores.

Apart from that, the focus of Costco has been on a company culture that promotes constructive criticism, and the philosophy has been ‘leading from the floor’, which means there’s much less micromanagement than in many other similar jobs.

Of course one of the biggest draws is a higher wage, so let’s take a closer look at it.

In early 2019, Costco raised its minimum hourly pay to $15. Its average hourly pay in 2019 was about $17.60 an hour, compared to about $10.88 on average for retailers, according to Payscale. When you add healthcare benefits, you get arguably the best job package in the retail sector.

According to Forbes surveys, Costco is consistently among the 5 top employees on America’s Best Large Employers chart. In 2017, it was even ranked as #1, and in 2021, it is ranked as #4.

How can Costco afford these higher wages and great benefits? Once again, it’s all thanks to its business model. In fact, Costco always had a much higher revenue per employee than other big retailers.

The average Costco employee generates nearly triple the revenue produced by the average Wal-Mart and Target employee and the latest results show, Costco is ranked #1 for revenue per employer in the retail sector, the wholesale industry as well as the general market!

Highly paid, motivated and happy employees help customers enjoy a consistently good shopping experience. That plays a large part when it comes to membership renewal and ensures that Costco’s customers keep coming back. In the end, that’s what matters the most.

Key takeaway #4: create more win-win scenarios

Once Costco became super successful it could’ve become stagnant and enjoy the fruits of its business model. However, that’s not what happened. The company created the Kirkland Signature brand, they raised their employee’s minimal wage again and again and always looked to improve their treasure hunting experience. It offered new products, services, and experiences that benefited its customers and in turn benefits the company as well. Most of them were possible only because of their business model and quickly became a part of it.

Evolving and innovating

Costco is a shining example of how very successful an innovative business model can be and how it can create an environment where everybody wins.

Almost everything we discussed in this study is thought-thru and purposeful innovation - from Costco’s membership model to its warehouse store design. 

Despite its success (or because of it?) Costco never stopped evolving. It expanded its offering to services such as gas stations, pharmacies, beauty salons and travel agencies which generated about 16% of the company’s $166 billion in revenue in 2020. 

It added a food court and if it weren't considered a retailer, Costco would be #14 on the list of the largest pizza chains in the U.S in 2018. They cannot be easily implemented by e-commerce giants like Amazon and as such make Costco more “future-proof” than many other retailers.

Let’s take a look at two interesting examples of how Costco evolved some aspects of its business and what might be in store for the company in the future.

The art of free samples

Free samples in stores are anything new or groundbreaking, but there’s no brand that’s as strongly associated with them as Costco. 

The company took the promotional activity to the next level and people have been known to tour the sample tables at Costco stores for a free lunch, acquired piecemeal. There are even personal finance and food bloggers who’ve encouraged the practice

There are shopper blogs about favorite sample options, and some say the samples are their main reason for coming into the store.

Of course, free samples boost sales of certain products (in some cases even up to 2,000%), but Costco knows that they also can make the store a fun place to be.

Consider this - Penn Jillette, from the famous magic act Penn & Teller, has even taken his dates to Costco to enjoy free samples on more than one occasion. And he’s surely not the only one.

However, samples don’t just make Costco’s store more appealing, they operate on a more subconscious level as well. As author Robert Cialdini writes in his best-selling book Influence, the Psychology of Persuasion: “One of the most potent of the weapons of influence around us is the rule for reciprocation. The rule says that we should try to repay, in kind, what another person has provided us.”

This means that customers feel a stronger urge to buy something after they sample it and that creates a potent combination for Costco. Even if people come to their stores because trying samples is fun, a variety of psychological mechanisms kick in, compelling them to buy more products over a longer period of time.

The curious case of Costco and e-commerce

Costco actually entered the e-commerce world in 1998, which shows that they were again quick to evolve and try something new. However, online shopping never became a substantial part of its business model.

As for most other companies, the COVID-19 pandemic changed that to a certain extent. Costco’s e-commerce sales grew 50% in 2020 and were up 76% year-over-year in Costco’s most recent quarter.

Costco definitely upped their e-commerce game and also started selling their products via Instacart, which had to hire 300,000 new staff to accommodate the surge in shopping delivery.

Costco now also offers same-day delivery service to its customers located within a 20 minute vicinity. 

While Costco evolved its e-commerce activities, it hadn’t quite recreated the unique in-store experience online. And the interesting thing is, perhaps it doesn’t need to.

Costco’s online margins aren’t as good as their in-store sales and even as foot traffic slowed at some of its competitors, Costco saw their members spending more in stores during the pandemic. That’s why the company opened 16 new warehouses even in 2020.

“Ultimately, we still want our members to come into the warehouse,” CFO Richard Galanti said during a December 2020 earnings call. “When they come in, they see the items and they are more likely to buy some of those items.”

When you think about it, it’s apparent why Costco is more resistant to the rising e-commerce threat. Their members give them a stable income and treat their fees as a cost that makes them come to the store. Costco entices them with the services they offer and the treasure hunting experience which can’t really be replicated. Customers genuinely enjoy being there and they buy in bulk, which means they don’t have to visit the store that often if they don’t want to.

So in the case of e-commerce, it’s not that Costco wouldn’t be willing to further evolve, it just doesn’t make a lot of business sense for them at that very moment.

This already shows that there are some unusual strengths when it comes to Costco’s business model, which means it’s high time to look at Costco’s SWOT analysis.

Key takeaway #5: innovate to evolve - when it makes sense

Costco’s whole business model and the above examples show that they are ready to evolve and go all-in when they see an opportunity that can improve the Costco experience and is in line with their mission. However, their e-commerce situation also shows that sometimes they go against the flow when it seems to make sense for their business. While they might need to improve and evolve their e-commerce in the future, right now they rather focus on bringing their members back to the store. The lesson here is - don’t innovate just to innovate, but think through what the results are going to be.

Costco’s SWOT analysis

While there’s certainly a lot to love when it comes to Costco and its business model, there are always things that could be improved. As the SWOT analysis is going to recap a lot of what you already read in this study.

Strengths

Membership business model

Costco’s membership fees enable Costco to better predict their income, cut prices and ensure customers have an incentive to shop at the store. 

Loyal customer base

Membership card renewal rates of 91% in the US and 88% worldwide show that Costco has an extremely loyal customer base in an industry where it’s very easy to switch brands and retailers. 

Low prices, high quality

Costco’s strategy of stocking high-quality items, which are sold in bulk-size at low-profit margins entices their target customers to become Costco members and to buy more products during their shopping trip. Their own Kirkland Signature brand is also a result of Costco’s philosophy to offer the highest quality products at the lowest price.

Selling in bulk

Costco can keep their margins low because they sell more of the same product compared to other retailers. It significantly increases how much money customers spend during one trip to Costco.

Low operation costs

Costco’s inventory management, warehouse store design and selling in bulk directly from transport pallets keep overhead costs low. 

Passing savings to customers

Costco is not reliant on making huge profit margins in sales and can therefore pass the savings to customers, which encourages loyalty and entices new members.

No advertising

Costco doesn’t rely on ads to sell their products and doesn’t need to spend huge amounts of money on ad campaigns, which allows them to keep their prices lower than their competitors. Their strong brand name and word of mouth are enough to bring in new members.

High paying retail jobs with generous benefits

Costco takes care of their employees which translates into a better customer experience for their members. Satisfied and motivated employees do a better job and are less likely to leave which results in a low turnover rate.

Flexible inventory

Costco rotates their inventory faster than other retailers which enables them to make the most out of the best deals on the market (e.g. by buying the surplus stock at the lowest prices) and create a treasure hunting experience.

Eco-friendly

Costco’s eco-friendly approach focuses on four main objectives:

  • Creating proper waste management systems
  • Significantly reducing their carbon footprint
  • Changing how they package designs
  • Improving energy management systems in warehouses

This is important for eco-conscious shoppers, which a lot of their target customers are.

Weaknesses

Limited product selection

While this is a plus for some, it’s indisputable that Costco offers much fewer choices than other retailers and that customers often can’t find more “exotic” products. Therefore, Costco is unable to attract a wider customer base, who want a bigger selection of products in smaller quantities.

Cumbersome transportation and storage

Buying in bulk can be very difficult for people living in cities and storing these products can be tough if a customer doesn’t own a house. 

Aging customer base

Costco has an aging problem. It is mostly attributed to its lack of digital advertising and limited e-commerce. A lot of younger people prefer a quick shopping experience or an online shopping spree, which is not something Costco is known for.

Long lines at the checkout

That’s the biggest complaint of Costco members, which Costco is trying to address with self-service lanes at selected locations.

Wasted food

As consumers are becoming more eco-conscious, it’s starting to bother them that a lot of food from Costco goes uneaten as there’s just too much of it in the one big package the store offers.

Opportunities

Online presence and e-commerce 

Although we said Costco might not need e-commerce as much as other retailers, it’s still an opportunity they can explore to attract new members and increase their revenue.

Social media

Costco could tap into new markets by using social media and social advertising for a fraction of the cost of traditional advertising. Currently, they have 0 tweets on their Twitter accounts and are lacking behind the competition on Facebook.

Global expansion

Costco has shown it can successfully enter new markets, which are an opportunity to further expand. China especially represents a huge opportunity after the success of Costco’s first Shanghai store. 

Threats

Reputational damage

Costco relies on its strong brand name more than other retailers and therefore has to retain a strong reputation. Product recalls can seriously damage Costco’s image of a store that provides quality items. Instances such as a rotisserie chicken salad recall in November 2015 due to the outbreak of E. Coli toxin where 19 people were infected make Costco less attractive to potential members.

Data security 

Costco gathers and hands over its customers’ and employees’ information to a third-party cloud service for safekeeping. In an era where people are more and more conscious of cybersecurity, any incident can create a major problem for the company.

Competition and digitalization

A lot of Costco’s competitors are ahead of them when it comes to e-commerce and digital services. While this might not be a problem yet it does represent a threat in the long run if Costco doesn’t evolve and starts losing younger potential members to their competitors.

Final thoughts & key takeaways

Costco has become one of the top retailers by sticking to its core philosophy and values. The company is based on a promise that they’ll pass their savings to their members and that they will offer the highest quality products at the lowest possible prices. If they fail to deliver on their promise, they’ll refund your money.

Costco’s unwavering commitment to do what they feel is the right thing for their members, their employees, their suppliers and their communities has created a Costco culture and a strong brand with a strong social image. That’s quite an achievement for a retail company that primarily employs a cost leadership strategy.

Recap: Growth by the numbers

Year

2020

2015

Number of stores

803 warehouses

698 warehouses

Industry market share

15,35%

 

Number of employees

273,000

205,000

Net sales

163.22 billion USD

113.66 billion USD

 

The ultimate list of strategic takeaways:

  • Cost-leadership market approach

Because of its limited range of products, Costco can stay committed to delivering high-quality items at the lowest prices. And because of its efficient inventory management system and constant revenue from membership fees, Costco can keep its gross profit margins lower than most other retailers.

With this cost-leadership strategy, Costco’s managed to successfully expand beyond the US market and achieve enviable year-over-year growth. 

  • Create value and build experience

From treasure hunts to everyday deals, Costco makes sure that everyone gets the most bang for their buck in all product categories. It is not reliant on making huge profit margins in sales and can therefore pass the savings to customers, which encourages loyalty and entices new members.

  • Optimize the supply chain management - the lesson of ownership and flexibility

With Costco’s business model, cost-optimization is everything. But to ensure the best possible experience, the quality of products mustn’t be sacrificed. Costco achieved this by rotating their inventory faster than other retailers which enables them to make the most out of the best deals on the market. They also introduced their own brand where they own the whole production process - Kirkland Signature.

Costco’s innovative business model and practices allow it to:

  • Offer premium merchandise and exclusives extras at the lowest prices.
  • Ensure customer satisfaction and loyalty.
  • Take better care of their employees.
  • Spend no money on advertising, but let their brand image and word of mouth do the work instead.
  • Create a customer-centric experience that revolves around their members.

As a result, a lot of customers are crazy about Costco. They love the company and have fun going to their stores. It’s not just a shopping trip, it’s a Costco experience - an adventure where members look forward to what treasures they might find. 

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