For the first time in more than five years, Costco (COST +0.82%) has hiked its membership fees in the United States and Canada.
The increases are relatively modest. A basic Gold Star membership has gone up by $5 to $60 per year. The higher-end Executive membership, which formerly cost $110 a year, will now cost $120, but holders will be able to get 2% cash back up to $1,000 instead of the previous $750 limit.
Those are reasonable increases given how long it has been since the warehouse club has raised prices. Members will be charged the new fee when it's time to renew their annual membership, and many won't even notice that the cost has gone up.
Shopping at a Costco requires a membership. Image source: Costco.
This is important for Costco
Most retailers derive most of their profit from the markup they add to the price of goods and services they sell. Costco does not follow that model. Instead, the chain earns about 75% of its profits from membership fees.
Basically, Costco keeps its markups low in order to entice people to join by giving them low prices. That's a model that has produced steady increases in membership and consistent same-store sales growth.
What does the increase mean to the bottom line?
Increasing membership fees does help Costco, but it's by no means an immediate major gain. In addition, the company has historically put the extra money it earns by raising rates into keeping prices low, according to CFO Rich Galanti speaking during the second-quarter earnings call, which was transcribed by Seeking Alpha.
During that call, Galanti also explained that the impact of the increase would take almost two years to hit. That's because each month it books one-12th of the revenue from customers who renew that month. That means revenue from June renewals will be completely accounted for the following May, while May renewals won't be completely counted until April 2019.
"The full P&L impact of these increases will be over a 23-month time line, such that the last group of members to be billed at these new levels will be next May of 2018, with a booking if you will, of those $5 and $10 increases being recorded over that month, and its succeeding 11 months, i.e., 23 months out," Galanti explained.
How will this impact Costco?
While the accounting for the cost increase may be a bit challenging, the end result is a strong positive for the company. Over the next year, the "fee increases will impact around 35 million members, roughly half of them Executive Members," according to Costco's second-quarter earnings release.
Over the long term, about 90% of Costco members renew each year. That means that 31.5 million members would pay the higher fees, broken down to 15.75 million paying $5 more for Gold Star and 15.75 million paying $10 more for Executive.
That would mean that on a cash basis, Costco will take in an extra $88.75 million from Gold Star renewals and another $177.5 million from Executive members in the next 12 months . Of course, on top of that, the chain will collect the higher fees from any new members signing up.
Costco handled this well
While nobody likes paying more, Costco's customers can't be very upset about such a small increase after more than five years. By not being aggressive and asking for so little, the warehouse club should be able to inch its profits up (albeit over the long timetable detailed above) without angering its users.
That's very important because Costco members have been incredibly loyal making the chain one of the few not negatively impacted by the jump in digital spending. This was a price increase, but it was one handled as gingerly as possible, which means it's not likely to materially impact renewal rates.
