Costco's 'Outrageous' Price Move Actually Makes Perfect Sense

Members have gotten angry at a recent change the warehouse club has made, but they're getting things wrong.

Costco has a well-earned reputation for offering low prices and good value. That's something that extends throughout every area of its business. Whether you buy the ingredients to make dinner, a trip to a theme park, or a new set of tires, you expect (and even assume) that the price will be low relative to what you might pay somewhere else.

In some ways, Costco (COST) - Get Free Report has taken this proposition to its breaking point, focusing more on arbitrary historic price points rather than delivering value relative to its rivals. That's what has happened with two very public food items the chain sells -- its $1.50 hot dog combo and its $4.99 rotisserie chicken.

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Costco holds those prices (even though it almost certainly loses money selling full chickens for $4.99 each) because it's good public relations. Members certainly appreciate it, and during times of rising prices -- which the United States has experienced for the past couple of years -- the chain gets a good story to tell in every earnings call.

The problem is that price is not value. A hot and a soda for $1.50 offers both a low price and a high value, but that does not mean a pricier item can't be a good value.

Costco Customers Angry Over New Sandwich

"Costco's New Sandwich Has the Internet Outraged"

"Costco's $9.99 Roast Beef Sandwich Sparks Outrage Among Price-Conscious Shoppers"

Those are both real headlines from actual stories that detail people expressing anger that Costco has started selling a $9.99 roast beef sandwich in its food court at select locations. These stories are filled with people expressing anger that the chain's new sandwich costs so much more than its hot dog combo and really anything else on the menu.

In reality, while it's pretty much always possible to aggregate a story showing how mad people are about pretty much any change a popular company makes, there's nothing even sort of outrageous about selling a roast beef sandwich for $9.99. That's a reasonable price if Costco has opted for even reasonable quality ingredients.

Perhaps consumers have been tricked by Arby's selling its self-described roast beef sandwiches in 2 for $6 specials, but that's a fast-food outlier that's not the standard. New England roast beef chain Kelly's, a sort of standard-bearer for that region's tradition of fresh-sliced roast beef sandwiches costs $9.75, according to its website.

New England Roast Beef, another local favorite, charges $13.99 for its classic take on a roast beef sandwich.

Costco Understands That Price Isn't Value

You can sell a roast beef sandwich for $5. Arby's does that every day, but no person who enjoys a fresh-cut deli-style take on that classic sandwich thinks the two are equitable.

Costco could, for example, offer a lobster roll and a glass of wine for $9.99. That would be a low price, but it's probably not a good value when you consider the cost of decent, or even good, ingredients.

The warehouse club focuses on bringing good values to its members relative to what its rivals offer. It's not about price, but about how the chain compares to its rivals. CFO Richard Galanti explained how the chain maintains its value proposition for members during his comments during Costco's second-quarter earnings call. 

"Our locations do weekly comp shops of 100 to 150 key items, all directly competitive items and then a variety of other our direct competitors and other limited comp shops against other forms of traditional retail where the gap of competitiveness is much greater. But at the end of the day, our relative level of competitiveness in our view is as strong as it's ever been," he said. 

Price isn't value.

Costco's "outrageous" $9.99 roast beef could be an excellent value, or it could be terrible, but the quality of the sandwich will determine that not what the chain charges for it.