When you look at the earnings statement of most retailers, there's just one item at the top, labeled sales or revenue. Costco Wholesale (COST -0.39%) has two items listed on the revenue front, and this completely changes the way investors should be looking at the company's performance.
Here's why Costco's sales are less important than you might think.
The top line
The income statement is a key tool for investors as they analyze a company's performance. Normally, the revenue part of the story (the top line) is pretty simple.
For a retailer like Costco, you would expect that figure to show the dollar value of what it sold during a quarter or year. That figure is indeed there, just like it would be for any other retailer. But along with that number is another one, labeled membership fees. Together they make up total revenue.
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Membership fees exist because Costco is a club store. Customers pay an annual fee for the privilege of shopping at the retailer's stores. The membership-fee total is dwarfed by the value of product sales, so it would be easy to overlook its importance.
However, merchandise costs along with selling, general, and administrative (SG&A) costs are almost all tied to the running of the retail stores. Which means that the membership fees are mostly pure profit. The importance of this becomes clear when you look at some actual numbers.
In the third quarter of its fiscal 2023, Costco sold $52.6 billion worth of merchandise and brought in just over $1 billion in membership fees, producing total revenue of roughly $53.6 billion. Merchandise costs totaled $47.2 billion and SG&A expenses were about $4.8 billion, so the direct costs of running the business totaled $52 billion, almost as much as the revenue brought in from product sales.
So the operating income of nearly $1.7 billion was largely supported by membership fees, which at $1 billion were nearly 60% of operating income.
Yes, the revenue brought in from product sales is important, but membership fees are more important -- and more consistent over time given the membership renewal rate of 90% and higher. If you are following Costco, membership fees are a number you need to pay particular attention to in your assessment.
Real-world impact
Clearly, membership fees play an important role in Costco's financial performance. But they also have a material impact on how the company runs its business. Simply put, keeping members happy is very, very important.
That shows up in simple ways, like the company's long-standing hot dog and soda deal, which has remained $1.50 despite rapidly rising inflation. Or the rotisserie chicken that is cheaper than buying a chicken and cooking it on your own.
And these are just examples of a bigger trend in the business, which is a keen focus on keeping costs extra low. The membership fees mean that Costco can survive with lower margins than its peers. And it uses that to its advantage, which, in turn, keeps members happy and coming back for more.
The company also made a unique decision during the pandemic, when supply chains were upended. In order to ensure it was able to keep its shelves filled with goods, Costco started to transport its own products, by directly chartering ships.
That was an added expense, but it helped keep its customers happy (empty shelves do not lead to happy shoppers). Now that supply chains are back to normal, the company has stepped out of this investment.
While the $298 million charge taken in the fiscal third quarter of 2022 to account for exiting its ship charters was a negative, the overall benefit of stepping in to keep its supply chain moving was probably worth a lot more.
While that $298 million is just under 30% of the $1 billion the company brought in from membership fees in the quarter, you have to consider it relative to the multiple quarters over which Costco benefited from having full shelves. This isn't a decision that many other retailers could have -- and perhaps would have -- made. And it all boils down to membership and those membership fees.
Doing things differently
So membership fees are vital to watch at Costco from a profit perspective. But they also materially alter the way the company goes about operating its retail business.
From a vigilant focus on low prices to adjusting to a unique crisis in a way that keeps members coming through the doors, the membership fees Costco collects are much more important than their dollar value (compared to product sales) might at first suggest.
