Just when you thought there was nothing new under the sun -- or at least in the world of big-box retailing -- Motley Fool Stock Advisor pick Costco (NYSE:COST) today unveiled a plan to offer health insurance to holders of its "Executive Membership" at 34 stores in Los Angeles and Orange Counties.
For anyone unfamiliar with an "Executive Membership," here's how it works. An ordinary Joe like you or I can only buy stuff at a warehouse club such as Costco, Wal-Mart's (NYSE:WMT) Sam's Club, or BJ's (NYSE:BJ) if we purchase a membership. There are two membership levels. Costco's garden-variety membership runs $45 per year and lets you shop at the store. Several years ago, Costco added an Executive membership at $100 per year. The pricier version offers additional discounts on long-distance phone service, overnight delivery, and auto financing, among others.
Since the beginning of the warehouse club business in the 1970's, membership income has been these retailers' primary profit. Last year, Costco raked in 69% of its pretax profit, or $961 million, from membership fees. Any changes these companies make in the structure of their membership are big doings.
Sam's Club and BJ's quickly followed suit with their own $100 premium membership plans. But none of the club operators could find a way to put real value in the pricier fee until Costco added a 2% rebate. In short order, Costco's membership income began to take off. It's not hard to understand why once you look at the economics. The upgrade costs $55; with a 2% rebate, you pay for it with $2,750 of annual purchases, assuming you don't take advantage of the other benefits.
Why is this a good deal for Costco? Because there are only so many loyal warehouse club shoppers around, and the best ones spend more than $2,750 a year. Costco gave up some margin on these customers, but they locked in the loyalty of their very best shoppers -- not a bad thing in a retail world that grows more crowded every day. BJ's has since added a similar 2% rebate to their premium membership. For some reason, Sam's Club has never jumped on this bandwagon.
So what about health insurance? Costco's program is targeted to people who cannot get group insurance, such as the jobless or owners of small businesses. The program will start as just a pilot in Los Angeles and Orange counties, but it could expand to the entire state of California by year's end. With 1.5 million Executive members in California, Costco has a sizable pool of existing customers to serve. The plan will offer two types of policies from PacifiCare Health Systems of Cypress, California. Costco isn't disclosing premiums, but it estimates that members could save as much as 20% on coverage. In my experience with Costco, it doesn't offer new products or services to members unless they are a significant value.
For investors, this is just another sign of Costco's commitment to providing value. Insurance is not an easy business to get into, and with regulations that differ from state to state, it's hard to say whether the program could go nationwide. But a well-tailored health insurance deal, offered at attractive rates in certain key states, could make Costco even more attractive to its core customers. Chalk up another potential win for this cream-of-the-crop retailer.
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Fool contributor Timothy M. Otte surveys the retail scene from Atlanta, and welcomes comments on his articles. He owns shares of Wal-Mart, but none of the other companies mentioned in this article. The Fool has a disclosure policy.
