Costco's Secret to Keeping Prices Lower Than Its Competitors

The warehouse club has built its business on low prices and has managed to (mostly) hold the line despite rising costs and inflation. Here's how.

Costco (COST) - Get Free Report has built its business around delivering value to members. That sounds simple, but when your entire business hinges upon customers renewing their memberships because they believe they're getting a good deal, keeping prices low becomes pretty much the only thing that matters.

The retailer has used its purchasing power as part of that equation. It has a huge reach and only sells limited SKUs which allows it to buy in massive quantities. Doing that allows its vendors to save on packaging and basically squeeze every penny of value out of whatever items Costco buys.

That's an advantage Amazon (AMZN) - Get Free Report and Walmart (WMT) - Get Free Report have as well due to their massive size, but pretty much every other retailer can't compete on that level. The warehouse club, however, has another edge that allows it to offset rising costs and higher prices.

Costco's CFO talked about this pricing advantage during the chain's first-quarter earnings call.

Value, Not Price Is the Key for Costco

While low prices are important, Costco's goal is actually offering a good value compared to Amazon, Walmart, Target (TGT) - Get Free Report, and your local grocery chain. That means the warehouse club does not have to make every item as cheap as possible. Instead, it can use products with a higher margin that are still priced at a good value compared to its rivals to allow it to take a smaller margin on other items.

Gas has been a key area where the company uses that strategy. It offers members a price per gallon that's usually the cheapest in the market, but it's not as cheap as it could be for good reason, according to Galanti.  

"As it relates to gas, for several quarters now, even beyond a year ago, we talked about the gas profitability for us, and we believe our competitors -- other big chains of gas stations have made more in gas. And certainly, that's helped us use some of that to continue to hold prices where we can on some things," the CFO said.

Costco Uses Every Advantage

Galanti shared in the previous quarter's earnings call that when the Costco makes more money on gas while prices are falling. That's not something he can be sure will be true going forward. 

"Who knows what the new normal is? What we know is that not only is gas more profitable than it has been in the past, and like I said the same thing a year ago, will that change at some point? Maybe. We don't know," he shared.

The CFO, however, made it clear that Costco gas has been a profit center and that allows the company to hold the line on prices in other areas by absorbing some price increases and not passing them on to members. 

"So, right now, it's good. And by the way, as we've mentioned a couple of times, we've seen strong gallon sales, and we're still taking market share. [While] U.S. gallon sales are generally close to flat, we're up in the 10% to 15% range in gallons," he shared.

Gas doesn't just create profits that can be used to offset increases in other areas, it also drives most members to shop at the warehouse club.

"So, we're driving people into the parking lot. And the fact that gallons of gas are profitable, that there's just a little bit more for us as well. So, that's helped us. There's always things that are going to help us, and there's always going to be puts and takes," Galanti added.