Unpacking The Costco Membership Model

GM! It's Thursday, March 23rd - Today, we're unpacking the strategy behind Costco's money-printing membership model which boasts over 66M members. It's so effective that new startups are using it to create the next dominant company in their industry.

- Callum

FEATURE

Unpacking Costco's Membership Model

I am one of 66,900,000 Costco members.

Together, we helped Costco generate over $222.7B in sales last year.

This sounds like a lot (and it is), but most people don't realize that Costco doesn't make its money from selling you a 10lb bucket of cream cheese.

The money is in the memberships and Costco has perfected the model.

So How Does Costco Work?

If the sun touches it, Costco probably sells it - Foot long hot dogs, gas, engagement rings, car tires, and a new BBQ. They've got you.

But unlike other retailers that sell their goods for a 25-50% markup, Costco has an average markup of only 11%. Its goal is to have the cheapest prices possible.

They do that in a few ways:

Capped Markups: Markups on national brands are capped at 14%, and this is a rule they do not break.

• A few years ago, Costco sold Calvin Klein jeans for $29 a pair, $20 less than almost anywhere else. After a change in its purchasing deal, Costco was able to get the jeans for cheaper. Instead of keeping the extra profit, they lowered the jeans’ price to $22.

Bulk Curator: Costco optimizes affordability for consumers by providing 12- quality brands in bulk for any given category.

• Costco does extensive research on each of its goods and will even work with vendors to re-engineer products from the bottom up to better suit their customers’ needs.

• Limiting options reduces operational costs, as a forklift takes products right from the delivery truck to pallets on the store floor– there are no workers stocking shelves.

The commitment to low prices is so strong that they don't spend money on marketing. Low prices do the marketing for them.

So how much do they actually make from $222.7B in sales? About $2B.

The Membership Model Is The Cash Cow

Costco generated $5.8B in profit last year, with 70%+ of that profit ($4.2B) coming from membership dues.

Every year, over 66M members pay Costco anywhere between $60-$120/yr for the privilege of shopping at their stores.

In the U.S. there’s a 91% membership renewal rate.

How Can You Use This Playbook?

It turns out, the membership model is repeatable. E-commerce store Italic has tailored the Costco business model to their online fashion marketplace.

Italic partners with high-end clothing manufacturers who produce clothing for top luxury brands around the world.

Just like Costco, Italic shoppers must pay a $60 membership fee to gain access to their catalog of unlabeled goods with low markups, enabling them to sell a $1,075 cashmere sweater, for $150.

This model is simple, but not easy. Here's how to think about it:

• Built A Honeypot: You need to identify a category of goods with high-repeat purchase rates and obsess over low prices. Think of consumer staples like clothing, food, transportation, healthcare, etc. This can also be done in B2B businesses. The prices should be so impressive, that you don't need to invest in marketing - word of mouth will carry the business. For example, diapers (high repeat purchase).

• Launch A Membership Plan: The combination of high repeat purchase rates and low prices make a membership a no-brainer for the right type of customer. If you can't win on price, then don't use this model.

• Let The Flywheel Spin: Over time, you'll build up a reputation as the lowest-cost option. Even as sales grow, stick to low prices like it's your religion (because is it).

• Layer In New Products: Begin to layer complementary products to your catalogue. If I'm selling diapers, I could try other baby products & supplies (Wipes, toys, food, etc). This will reinforce the value of the membership.

I hope you enjoyed this read!

Callum

Fun Fact: Billionaire investor Charlie Munger of Berkshire Hathaway believes in having a concentrated portfolio, and for that reason, he only has three stocks in his personal portfolio, and 75% of the shares he owns are in Costco.

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