How does Costco, with an annual fee of 60 yuan, lock in hundreds of millions of members?

As the world's second largest retailer, how did Costco achieve such commercial success? This article explores Costco's business model and membership system, analyzes its business strategy, and hopes to inspire you.

Costco, the world's largest chain of membership warehouse supermarkets, is a retail giant founded in 1983. Since its inception, it has been committed to providing the market with high-quality goods at low prices. In the process of development, Costco has almost never shown signs of decline and has been on a path of steady growth. It is currently the world's second largest retailer after Walmart.

It is precisely because of this that Costco has been praised by countless bigwigs: Amazon founder Bezos regards it as "the retailer most worth learning from" , and Warren Buffett's buddy Charlie Munger calls it " the company that most wants to be taken to the grave" ; in China, Costco has captured many fans such as Lei Jun, Fu Sheng, and Huang Zheng.

Today, we will explore Costco's business model and how it makes 3.5 billion through annual membership fees. Whether you are an entrepreneur, product manager or marketer, you can get valuable information.

Without further ado, let’s get straight into the main text.

1. Costco’s Business Achievements

According to incomplete statistics from Xinmo, as of April this year, Costco had a total of 17 offline stores in China, most of which were located in Taiwan.

Since the successful opening of the store in Minhang District, Shanghai in 2019, Costco's layout in South China and East China seems to have pressed the accelerator: the country's first membership service flagship store will be built in Nanjing Jiangning High-tech Zone, and its headquarters will be located in Shenzhen, just like its competitor Sam's parent company Walmart.

Costco's charm, of course, comes from its unique business model and operating philosophy: as a representative player in the membership-based warehousing field, it is famous for its membership model, low prices, few SKUs, strong bargaining power and high turnover .

1. Beautiful business data

Annual sales exceed US$110 billion, and the number of members exceeds 88 million (2017 financial report data). In the past five years, the number of the company's stores has maintained rapid expansion, and operating income and net profit attributable to shareholders have basically maintained steady growth, with the year-on-year growth rate of operating income remaining at around 5%.

Comparison data between Costco and Walmart (Top 1 retailer):

• Net profit margin: Costco is 2.2% (financial report at the end of 2018), Walmart is about 1.3% (financial report in February 2019).
• Inventory turnover rate: Costco's inventory cycle is only 29.5 days, while Walmart's is 42 days (nearly 5 years).
• Single-store sales: $170 million, Walmart's is $43 million.
• Single-store profit: US$3 million, about twice that of Walmart.

2. Excellent business model

The retail formats in the United States mainly include: large shopping malls, factory direct sales centers (such as the outlets that are more familiar to Chinese people), department stores (such as Macy's), comprehensive supermarkets (such as Walmart), mass-market warehouse membership stores (such as Costco) and specialty supermarkets (such as Whole Foods Market).

Costco is a typical mass-market warehouse membership store format and is also the leader in this format, with Sam's Club being the second.

The beautiful business data is supported by the business model, which has 6 core competitive advantages:

1) Membership system

Customers need to pay to become Costco members, there is no such thing as free membership.

Carefully design member-exclusive benefits, such as exclusive prices/discounts, exclusive products, and exclusive services, so that members have a high order frequency and high average order price.

The loyalty of paid members is extremely high, and the churn rate is very low. When consumers become paid members, they will fill in a lot of relevant information as required, which is more serious than filling in the information of free members. Member data is the top priority for business analysis and marketing.

2) Few but good SKUs

The total number of SKUs is less than four thousand. Generally speaking, the number of SKUs in supermarkets is around 40,000, and the number of SKUs in shopping malls is around 100,000.

While ensuring high product quality, low SKU also reduces consumers' decision-making costs, increases single product sales, and creates single product scale advantages.

Abandoning the long-tail products of traditional supermarkets, they not only occupy inventory and working capital, but also bring greater losses. The huge sales volume of a small number of categories has improved Costco's upstream bargaining power and turnover efficiency , further reducing the sales cost of goods, which is conducive to maintaining a low price advantage.

3) Warehouse and mass merchandising

Large-package sales bring about a scale effect in sales, similar to wholesale, significantly increasing single-time sales and the circulation of goods.

In 2020, Costco's inventory turnover rate was as low as 29.35 days, which is better than those of leading supermarket companies in Europe, the United States and China.

4) Strictly control gross profit margin

Because the paid membership mechanism has recovered funds in advance, and the large-scale purchase of a small number of items has lowered costs, Costco is able to maintain a high net profit margin while strictly controlling the gross profit margin. Costco has two strict regulations:

• First, the gross profit margin of all goods shall not exceed 14%. If it exceeds this figure, it must be reported to the CEO and then approved by the board of directors.
• Second, when it comes to external suppliers, if the price elsewhere is lower than Costco’s, its products will never appear on Costco’s shelves again.

Under these two regulations, Costco is able to control its gross profit margin at around 12%-13% (the gross profit margin of general supermarkets is 15%-25%), creating Costco's image of high-quality goods at low prices.

5) Target customer group: middle class

Costco targets middle-class families, who have stable spending power, pay attention to the price-performance ratio of goods, and regularly purchase daily necessities needed by the family.

Moreover, according to data from the U.S. Census Bureau, middle-class families account for 21.67% of the U.S. population, which means that Costco's target user market is 21.67% of the U.S. population.

6) Private label

The core competitiveness of the market segment comes from own brands. If you sell other people's brands and products, the supply chain is in the hands of others, and you have no say (although Walmart and Costco have gained the right to speak through large-scale procurement, the final decision is still in the hands of others). In a situation where anyone can sell, due to competition, the room for price increase is limited, costs cannot be controlled, and the supply chain cannot be optimized, it is difficult to guarantee profits.

Costco established its own brand Kirkland Signature in 1995, focusing on snack foods, frozen fresh food, cleaning products and health products. Although Kirkland accounts for less than 7% of SKUs, its revenue contribution rate is as high as 25%.

3. Super giants supported by membership fees (earning 3.5 billion in membership fees a year)

Judging from the financial report data, because Costco sells large packages, the average customer order value is around US$130-140, which is far higher than that of other retail peers.

In fiscal year 2020, Costco's total sales reached $166.8 billion, a year-on-year increase of 9.2%, of which membership fees reached $3.54 billion. The final net profit reached $4 billion , a year-on-year increase of 9.4%. Judging from the numbers, membership fees are almost the same as net profit.

In other words, the sales of goods and services are just a flow that covers the administrative expenses (note that there is no "sales/marketing expenses" item in Costco's financial report), and every consumer contributes to Costco's year-end profit the moment he or she renews his or her membership card .

2. Analysis of Costco’s Membership System

As of August 2021, Costco has more than 106 million members worldwide - 58.1 million of which are paid members and the rest are affiliate members.

Costco's low prices and selection of products have cultivated a large number of loyal customers, and its excellent reputation continues to attract new members. From 2006 to 2017, the number of members increased from 47.7 million to 90.3 million (including family card members), and the renewal rate of members has also been increasing, from 86% to 90% , and customer loyalty is very high.

1. Costco membership categories and benefits

Not only the benefits of low-price shopping, but also the additional service benefits increase membership stickiness, making members more willing to introduce it to people around them after renewing their membership.

2. Costco membership operation strategy

The essence of the membership system: an operational means to promote user retention, activity and even new user acquisition through identity recognition . In addition to promoting continued user activity and new user acquisition, a well-designed membership system can even, to a certain extent, become a contributor to platform revenue.

The membership system supports Costco's growth logic:

1) Growth Flywheel:

2) RARRA growth model:

Based on the growth flywheel and RARRA growth model, Costco's membership operation strategy is ready to emerge for reference:

3. The secret of Costco’s membership system

• Lower the trust threshold (price anchor for membership fees).
• Maintain high stickiness (entertainment, spreadability).
• Seize the user’s mind (the core differentiation of the brand).
• Establish a closed value loop (value management throughout the user lifecycle).

3. Final Thoughts

Break through competitive barriers and achieve amazing revenue growth through a membership model.

In the AIGC era, if companies want to stand out in the fiercely competitive market, establishing a membership model is an effective business strategy. By understanding user needs, providing personalized services and unique membership benefits, companies can enhance user loyalty and achieve sustained revenue growth.

The above is all the content of this issue of "How Costco locks in hundreds of millions of members". Next time I would like to talk to you about growth experiences such as increasing average order value through membership upgrades, so stay tuned!