Everyone has a favorite Costco (NASDAQ:COST) item. Some love the four-pound bags of Kirkland trail mix; others can't make a trip to the warehouse retailer without getting a $1.50 hot dog and soda combo in the food court. 

No matter the product, it seems Costco manages to give its customers exceptional value on pretty much every item in the store. That's great for customers, but investors might wonder: "OK, but how does this company actually make money, then?"

We're here to answer that question with a video from our YouTube channel! (A full transcript follows the video.)

 

Editor's note: The paid members count in the video is in thousands. 

Narrator: You might think that Costco is your average retailer... but it's not.

The "everything in bulk" store sells cleaning supplies, jeans, pet food, and anything in-between, but Costco doesn't actually make much money on the merchandise it sells.

In this video, we're going to break down exactly where the cash really comes from for Costco.

According to the company's 2018 results, it sold $138 billion in merchandise -- that's a lot of Kirkland brand trail mix and discount prescription glasses.

The products they sold cost the company $123 billion, leaving $15 billion for the business.

BUT WAIT! We also have to account for all the company's retail employees, pallet trucks, and store overhead expenses that enable Costco to sell those goods and give away those sweet, sweet free samples.

All those costs combined totaled nearly $14B.

So we've got:

  • Sales of $138 billion.
  • Cost of goods sold of $123 billion.
  • And selling, general, and administrative costs of $14 billion.

That leaves us with just $1 billion dollars... but the company reported over $3 billion in net income for the year. So where's the extra money coming from?

Costco's real source of income: its memberships.

In order to shop at Costco, you need to be a member, and annual membership costs either $60 or $120, depending on the benefits an individual or business chooses.

Those membership fees add up over time: In the company's 2018 results, they said they collected $3.1 billion in membership fees.

A huge chunk of this revenue flows directly down to the company's bottom line because memberships are relatively cheap to create -- all the company needs to do is give people a card, maintain a tracking system, and occasionally provide some customer service. All told, that's a much higher-margin business than selling products to consumers, even at regular retail prices.

If you look over the past few years, you'll see Costco's net income tracks pretty closely to the revenue it brings in from membership fees. This revenue from membership fees is what allows the company to offer customers the marked-down prices and cheap private-label goods they've come to expect.

It also means that, while merchandise sales matter for the company, the metrics that Wall Street tends to care about are mostly related to Costco's member base.

When the company reports earnings, investors want to see the company continue to add members, and over the past few years, it has. And the members the company brings in are generally pretty satisfied with what they're paying for. Costco maintains a member-renewal rate of around 90%.

Satisfied members keep the money consistently flowing in, and it helps insulate Costco from the creeping competition of e-commerce. The membership model has helped Costco earn the "Amazon-proof" label, and kept the company's brick-and-mortar business thriving, even as online sales make up a larger portion of U.S. retail.

Membership fees -- it's how Costco actually makes money.

Thanks for watching this video -- if you have a company you'd like to see us break down, mention it in the comments section below [on Youtube], and be sure to like the video and subscribe to get more videos like this one from The Motley Fool.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.