If you shop at Costco (NASDAQ:COST), then you've likely seen its employees make their way through the lines of waiting customers in an effort to upgrade regular members to its executive membership program. It's an important task for the nation's second-largest retailer, as an executive membership costs $110 per year relative to the standard rate of $55 per year for a gold star member. But is upgrading beneficial for customers?
In other words, is a Costco executive membership worth an extra $55 a year? The answer is: It depends.
The primary benefit of an executive membership is that, once a year, Costco will reimburse you for 2% of the amount you spent at the warehouse chain over the past 12 months. Thus, the issue boils down to whether or not the potential savings will more than offset the added $55.
In most cases, it will. I say that because all it takes is a total of $3,000 spent at Costco over the course of a year to translate into $60 worth of savings. On a monthly basis, that equates to $250 in purchases -- which, speaking from experience, is enough to cover about one and a half trips to Costco for a family of four. If you spend more than that, as you can see in the chart below, your savings can grow to a maximum of $750 per year.
Despite the obvious opportunity to save in excess of $55 a year, it's tempting to think that Costco must benefit financially from the added membership fees associated with up-selling customers from gold star status to the executive membership. At first glance at least, this is true, as Costco's profit derives not from merchandise sales, but rather from membership fees. In the most recent quarter, membership fees accounted for $584 million, equating to 2.29% of Costco's net merchandise sales. Costco's net income, meanwhile, was only $516 million, or just 2.03%.
On top of this, as the company's chief financial officer Richard Galanti recently pointed out, Costco's executive members "shop more frequently and buy more" on each visit. Consequently, while they currently make up only 36% of Costco's member base, executive members account for approximately two-thirds of the company's overall sales.
Importantly, however, the link between profits and upselling executive memberships is more nuanced than this. I say that because, while it does indeed generate higher fees and thus profit for the chain of membership warehouses, it simultaneously reduces Costco's margins and thus profitability. In the latest quarter, for instance, the 2% discount offered to executive members translated into a drop of six basis points in its gross margin (that is, hundredths of a percent) on a year-over-year basis.
"This is good," Galanti said. "It is the 2% reward feature, which reduces sales and the fact is that as more members switch to executive member, we think that's good for us long term."
In sum, the answer to the question of whether or not a Costco executive membership is worth the extra $55 a year seems to be yes -- at least from the perspective of many customers. Assuming you spend roughly $3,000 or more a year at the chain's locations, then upgrading will be to your financial advantage.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Apple and Costco Wholesale. The Motley Fool owns shares of Apple and 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.