One Huge Thing People Get Wrong About Costco

The warehouse club helps members save money, but that's not the entire story.

Costco  (COST) - Get Free Report has an incredibly loyal customer base, for a variety of reasons.

First, the warehouse club offers low prices by keeping its product count limited and squeezing vendors for the best deals possible. Costco buys at huge volumes, so it can push its partners to keep lowering their prices by offering them massive orders that enable them to produce goods more efficiently.

Second, Costco members get the treasure-hunt aspect of shopping at the chain's warehouses. On a given day you never know exactly what might be there, and you may leave with a kayak, a book, a winter jacket, or a tub of candy you never expected to buy. 

Even if you don't purchase many of these items, it's still fun to see what the chain has on offer, and there's a clear entertainment value to being a member.

Lastly, Costco offers members the idea of savings. It's sort of like being a member of a gym. If you quit, there's no chance you will get in shape, but if you keep your membership, healthier days might be ahead. For Costco members, the same idea applies. They might not go as often as they should, but they keep their memberships because they are inexpensive and offer the promise of savings.

Costco does not care which type of member, or combination of the three, you are. The company's business isn't selling goods; it's selling memberships. That's the secret that the chain makes no effort to hide and that the stock market seems to miss.

Here's Why Costco Offers Low Prices   

Costco reported its November sales on the last day of the month, and while the numbers were strong, Wall Street expected more, and the company's share price fell. This is one of those cases where market sentiment has nothing to do with how a company performs.

Sales are not Costco's most important metric or even a very important one. A big drop in sales might show that the warehouse club's members are dissatisfied and that could lead them to not renew. A smaller-than-expected gain hardly sends that signal. 

Costco "reported net sales of $19.17 billion for the retail month of November, the four weeks ended Nov. 27, 2022, an increase of 5.7% from $18.13 billion last year. For the 12-week first quarter ended Nov. 20, 2022, the company reported net sales of $53.44 billion, an increase of 8.1% from $49.42 billion last year," the company reported.

Analysts may not like those numbers, but the figures don't reflect the health of the chain or customer satisfaction with their memberships. Costco customers may be spending a little less than expected, but it's hard to imagine that the chain will see its retention rates drop or new memberships slow down.

Costco uses low prices as a way to get people to join and keep them as members. The warehouse club does not really care if members shop more or less, as more than two-thirds of the chain's profit comes from membership fees, not selling thin-margin goods.

This Is Costco's Key Business Metric

Costco wants people to join its warehouse clubs and receive enough benefit from that memberships that they renew and remain members. That's why the company's key metric is renewal rates, not sales, and those numbers have been stellar. Chief Financial Officer Richard Galanti outlined the latest numbers during the chain's fourth-quarter-earnings call.

"At Q4 end, our U.S. and Canada renewal rate came in at 92.6%, which is 0.3 percentage point higher from 16 weeks earlier at Q3 end when we were at 92.3%. And our worldwide renewal rate came in at the end of the fiscal year at 90.4%, up 0.4 percentage point from Q3 end when it was 90%," he said.

Those numbers have always hovered around 90% and climbed during the pandemic, when Costco became a more essential retailer to its members. The chain has also steadily grown its membership base.

"In terms of the number of member households and cardholders, at Q4 end, we ended the fourth quarter with 65.8 million paid household members and 118.9 million cardholders, both up 6.5% from a year earlier," Galanti said. "And that 6.5% increase in number of members and cardholders is on about -- just under a 3% increase in the number of locations."

Costco closed the year with 29.1 million of its premium $120-a-year executive memberships, an increase of 1.2 million, or 74,000 per week, during the 16 weeks since third-quarter end.

"Executive members now represent over 44% of our members and just under 72% of our worldwide sales," the CFO added.

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