How Costco Wholesale Keeps Members Coming Back

The key to keeping Costco's business rolling is keeping its members happy. It doesn't take much.

Feb 6, 2014 at 12:05PM

There is little better in the business world than a captive audience. Not literally (brands would likely take a heavy hit if they forcibly locked people in the store); we're talking metaphorically here. As we speak, Costco Wholesale (NASDAQ:COST) is sitting on close to 75 million members in its club -- that's a captive audience.

For the uninitiated, Costco's membership program gives cardholders access to the company's warehouse retail locations and cheap prices. Memberships range from the personal level up to business class, and the recurring income drives a large portion of Costco's operation. To keep customers happy, Costco must consistently offer low prices, which means low margins, which would mean weak income if it weren't for the happy consumers paying for memberships. It's a beautiful circle, and here's how Costco keeps it rolling.

Keep the punters happy
Everyone has a favorite little thing that they pick up from the store more often than not. Maybe you grab a cookie at the grocery store, or buy batteries whenever they're on sale, or just pick up a pack of gum when you buy gas. Costco has built an empire founded on the idea that those things keep us happy and coming back for more.

As an example, take Costco's famous rotisserie chicken. Right now, the Boston Market near me sells half a chicken for $8.59. That doesn't seem too bad. You can feed a few people on half a chicken and some sides. Now look at Costco -- a whole chicken is $4.99. Costco could be losing money on those chickens, and with poultry costs rising, it probably is, but that's not the point. The point is that the little things like cheap chicken make for return customers. Costco's current membership renewal rate is more than 90% in the U.S. and 87% globally.

Costco also makes coming into the store a different experience every time. The company drops special sales in unexpected places, so shoppers have a reason to browse every aisle looking for hidden values. That has helped the business fight off online competitors that can't offer the same experience.

Wall Street's Costco anxiety
Not everyone loves Costco's strategy. By selling low, Costco takes short-term hits on revenue and comparable-store sales, and that makes some analysts unhappy. Last quarter was especially unsettling, as Costco cut deeper, missing forecasts for revenue and income. Of course, today the company bounced back with a strong showing over January. 

For serious investors, Costco continues to be a long-term investment. The company is built around an extended vision, which involves growing its membership base by keeping shoppers happy. That means taking little hits in the short term to make the long term work. This year looks set to be another good one for Costco, especially if January is a glimpse of things to come.

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Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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