Costco Business Model Explained: The Things That Led to Its Success

Costco is one of the most popular US multinational corporations, praising itself with almost 850 warehouses all over the globe. Out of those locations, over 580 are based in the US. Today, Costco occupies fifth place as one of the largest retailers worldwide.

Its business model is highly successful, and the brand’s recognition goes through the roof. It’s no longer humble as it was in the beginning.

Their focus is on providing customers with affordable yet good-quality products. At the moment, business-wise, Costco plans to maintain its current international position in the retail market. Below, I will detail Costco’s business model, its strengths and opportunities, and more in this Costco Business Model Explained guide.

Key Takeaways 

• Costco’s business model relies on budget-friendly shopping that helps the company maintain its competitive edge. Its operations function on membership-based warehouses;
• The retailer is known for offering more employee benefits and better wages compared to many of its competitors;
• Its plans revolve around minding climate change and doing something about it, expanding the business even more, and supporting local suppliers.

Costco’s Brief Business History

Let’s see Costco’s history timeline. The company appeared on the market in 1983. Everyone knows it as Costco, but its legal name is Costco Wholesale Corporation.

Beginnings

The company’s first warehouse was opened in 1983 in Seattle. Costco had two co-founders: Jeffrey Brotman and Jim Sinegal. Brotman was an attorney, but he was part of a retailing-specialized family. Sinegal, on the other hand, worked in wholesale distribution.

Costco’s history goes several years before the first warehouse. In ’76, the first Price Club supermarket appeared. Later, in 1993, the two companies merged, followed by a name change in 1997. So, Costco went from Price/Costco to Costco Companies Inc. The retailer went public in 1985 and then, in 1987, moved its Seattle-based headquarters to Kirkland.

The company’s current name was established in 1999. The merger with Price went quite smoothly due to their similar business models.

Growth and Development

After opening more stores across the United States, Costco went international. It expanded its operations in other countries, including Australia, Canada, Mexico, the Far East, and Europe.

From one store in 1983, Costco managed to grow to 22 warehouses by ’86. So, its development was quick and impressive. In ’87, the company created a bakery department and even had a hot dog stand. Costco’s Optical Labs are then launched, but the company’s management decides to shut down its Mid-West division. So, instead, it focused on the West and East costs.

In 1989, Costco already had 46 operational warehouses, being the third most successful US business in terms of profits. By ’92, the retailer launched its 100th warehouse. The first Asian Costco appeared two years later in Seoul, Korea.

The growth is dazzling if you consider that the 200th point of sale opened in ’95. In 1999, Costco created a special order kiosk, and the company’s Travel Business appeared the following year.

Costco Home completed the business’s assets and diversity in 2003.

Longevity

Both Costco’s expansion and popularity, as well as its business model diversification, continued to boom. By 2005, Costco Travel managed to book more than 57,000 vacation packages. Your typical Costco store generated around $130 million in sales in 2007. The same year, Fortune Magazine called the company a highly admired business.

Over 90 million people were Costco Members in 2017. As of 2022, that number exceeded 118 million. So, the company relies a lot on its customers’ loyalty.

Costco Business Model Explained – How Does It Work?

Costco’s business model is straightforward; they want to meet their customers’ needs by selling quality goods that aren’t expensive. Hence, the clients will save money due to the retailer’s low prices. One thing through which Costco differentiates itself from the competition is its bulk-sized warehouses.

• Mission – Costco’s mission statement is to offer its clients low-cost yet good-quality services and products. At the same time, it wants to serve all these clients effectively while remaining one of the largest retailers on the globe;
• Value proposition – Costco’s values are offering low prices and good products. Also, it focuses on respecting its suppliers and obeying local laws and regulations. Finally, it’s taking care of both its employees, members, and partners;
• Selling channels – the retailer relies on the single-step distribution method to sell its goods. This approach enables Costco to sell its inventory completely and gain revenue before paying its suppliers.

Costco Business Strategy

The company markets a wide range of US-branded items and private-label goods. I will group them into the following categories:

• Dry foods and groceries;
• Cleaning supplies;
• Snacks and beverages;
• Garden and patio furniture;
• Appliances and electronics;
• Fresh meat and bakery goods;
• Pharmacy products;
• Fuel;
• Health and beauty items. 

Generally speaking, the company’s strategy is cost leadership.

Still, the company’s overall strategy was to become appealing to affluent customers. So, Costco’s main clients are those who are looking not just for discounted prices but also for a customer-friendly shopping environment. Although Costco generates significant revenue, it has a less diverse product range than other retailers.

By comparison, Costco is less of a traditional retailer because it bases its operations on membership fees. Moreover, it focuses on selling products in bulk. As a result, it has an excellent budget reputation, but, honestly, you wouldn’t find the best pricing deals all the time.

Focusing on quality is another part of Costco’s business strategy. This is a valuable part of its growth tactic. Even though the product range could be more diverse, the quality is outstanding. Due to this and other additional factors, the membership’s retention rates are exceptional.

Maintaining a solid reputation is also what Costco focuses on. Rather than spending a lot of money on advertising, Costco does its best to build its ethics, collaboration, and customer service. For instance, the wages are higher here than at Walmart.

At Costco, investing in technology and developing an agile supply chain is also essential. Through new technologies, the retailer improved customer satisfaction and convenience. They have digitalized many of their services through cloud technologies.

Costco’s distribution management has made the business significantly more successful. Its lean supply chain keeps operational costs low. Each warehouse holds around 3700 items. Moreover, the company, just like Walmart, eliminated the middleman.

Costco’s Business Pillars

I will further detail each of Costco’s business pillars.

Client Filtering

The company relies on its subscription model, discouraging low-income clients from paying the fee and becoming members. That’s why the retailer has a higher spend per shopping trip.

A Loyal Culture

One of the most supportive customer and employee bases in the world is at Costco. Their clients are happy and loyal, while their staff is satisfied with the benefits it receives. Hence, they dare to take the initiative when needed. As a result, Costco’s devoted culture has boosted employee productivity and one of the highest client retention rates in the industry.

Suppliers’ Independence

The retailer thrives even without a large product variety due to its more exclusive customer base. That derives from the business’ membership model. Therefore, Costco can afford to be picky when choosing its suppliers, which further increases the company’s negotiating power. All this process makes me think of a domino effect.

Cheap Designs

Operating costs are maintained low due to the warehouses’ simple and industrial design. They prefer to invest their profits in other things, such as reputation, image, and client retention, rather than spending it all on store design.

Operations – How Costco Gains Its Money

Since its launch, the retailer has expanded its investment channels, leading to a more diverse income stream. The primary revenue rate comes from selling discounted in-bulk products. But there are also other sources of income.

Membership Fees

Unlike conventional warehouses, Costco requires clients first to become members. Only then can you achieve good bargaining leverage. In addition, Costco has a tier system, so you may see a variation in its membership fees. These fees account for over 2% of Costco’s annual income.

Merchandise Sales Volume

Over 90% of the retailer’s revenue comes from sales of SKUs (store-keeping units). With just 3700 items in any of its warehouses at all times, the company can exceed $150 billion in yearly income.

eCommerce Offers

In 2001, the company launched its online shop and has gained much popularity since then. Costco’s members and clients can benefit from the retailer’s low prices without visiting its physical warehouses. Hence, increased convenience!

Home Programs

Costco offers many home installation services, from flooring and carpeting to countertops and HVAC. This part of the business represents a valuable income stream for the retailer.

Auto Sales Program

Nowadays, Costco collaborates with over 3000 auto dealerships. Through this program, customers can purchase either new or second-hand vehicles. Besides the low prices, clients can also benefit from extra value-added perks that Costco offers.

Key Partners

Costco’s partners are all important. I’m talking about its suppliers, branding companies, technology businesses, non-profit programs, credit partnerships, and payment solution providers. 

The most notable eCommerce delivery partners are Instacart and Google Shopping. Other valuable partners are gas stations, travel companies, optical clinics, pharmacies, and hearing aid centers. 

As for its credit services, Costco signed a deal with Visa and Citibank. This bank issues all Costco cards. Moreover, every time a client uses a Visa card to pay for a Costo purchase, the retailer earns a royalty.

Financial Performance

In 2022, the retailer saw significant profit margins, with a revenue of over $4 billion. A Costco client spends around $136 on one shopping trip. That’s higher than Walmart’s Sam’s Club. The retailer’s market capitalization was more than $203 billion in 2022. The company’s return on equity hit the mark of 28%.

By 2023, Costco’s net sales for 26 weeks were over $116 billion. That represented a considerable increase from the previous year’s $108 billion. In percentage, there was a boost of 7.1%.

See also: Walmart Business Model

Customer Segments

Costco’s main clients are baby boomers and millennials, among others. To cater to millennials’ needs, the retailer developed its innovative technology. Besides individuals, Costco also has small businesses among its regular customers. So, it has penetrated B2C (business to client) and B2B (business to business) market niches.

Unlike Walmart, Costco has affluent clients and middle-class individuals attracted by the retailer’s significant discounts. The brand is a client-centric one. So, it relies a lot on its members. Costco provides two membership types:

• Gold Star – this membership category includes individual clients who want to save money by buying low-cost items;
• Business – this membership option targets small and medium-sized companies. These businesses are outlets through which Costco resells its goods. Business-licensed individuals or company owners can also benefit from the business membership.

All clients, individuals, and businesses can also opt for Executive membership. This alternative allows you to collect points and gain rewards. These points increase with every purchase or transaction you make at Costco. It’s an excellent way to boost customer loyalty and retention.

Costco’s Services

I am impressed with Costco’s various services. Here are a few details about each of them.

Costco Travel

The retailer’s members based in either the US or Canada can benefit from Costco’s vacation packages. You could travel to Hawaii, Europe, Mexico, Las Vegas, South Pacific, and other amazing places as a member.

Concierge Service

Costco’s concierge service is free for those customers who buy electronics. The staff offers valuable insights regarding the use, installation, and setup processes. This further decreases the rate of product returns.

Costco Optical

The company’s optical service is one of the largest in the US. So you can benefit from a consultation whether or not you’re a Costco member. Still, only members can receive a prescription.

Costco Insurance

Costco has signed an agreement with Connect. Together, they provide customers with home, auto, and even umbrella insurance.

Food Service

At Costco, you’ll find fresh, dry, packaged, frozen foods, and more. You’ll even see hot dog carts at the company’s warehouses. With Costco, the sky’s the limit regarding its available foods: beverages, yogurt, ice cream, pizza, sandwiches, and so many other items.

Audiobook App

Costco began selling audiobooks in 2021. You can also buy a mobile app to listen to these audiobooks. The app is available for download on both iOS and Android devices. However, only Costco members can gain access to those materials. For them, the app is free.

Costco’s Customer Relations

Costco’s client engagement is high, and that’s because of all its effective customer support systems. You can contact the company through several channels:

• DM or comments on social media;
• Emails;
• Through its self-service platform, but that’s available only in specific areas;
• In-person sale support;
• Via Costco’s membership warehouse club.

Marketing Strategy

Instead of relieving on traditional advertising, Costco focuses on its membership club. This system is less risky and more profitable. Also, clients get more benefits from it since they love low prices. Those unhappy with their purchases can even receive a full refund.

Secondly, Costco perfects its inventory management, high-volume sales, and private-label branding. These are the company’s essential pieces that led to its success.

Costco Marketing Mix

Let’s dig deeper into Costco’s marketing mix.

Product:

• Large amounts of popular and low-cost products;
• High value delivered to customers;
• A wide range of available goods – appliances, groceries, electronics, toys, beauty items, furniture, fitness gear, optical services, etc.;
• Frequently changing inventory;
• Seasonal products;
• Costco’s private label – Kirkland Signature.

Placement:

• Physical stores – warehouses;
• The company’s mobile app;
• Costco’s online shopping platform;
• Doorstep delivery service;

Promotion:

• Personal selling;
• Sales promotion;
• Public relations – press releases, Costco’s monthly publication, etc.;
• Direct marketing – email and newsletters;
• Zero advertising;
• Branding image and reputation through donations.

Price:

• Low margins;
• High value;
• Low price tags;
• Annual member fees;
• Coupons and discounts;
• Special promotions and offers;
• High-low pricing strategy – helping clients save money;
• Market-focused approach.

Future Plans

• Building a larger membership base;
• Continuing to sell in bulk while keeping prices low. Boosting shopping frequency;
• Opening over 20 new stores all over the globe;
• Planning to spend around $4 billion on its new warehouses.

SWOT Analysis

It’s time to see some of Costco’s strengths and weaknesses and the market factors that could impact the company.

Strengths

• Competitive edge through its membership model;
• No money spent on advertising;
• Appealing low price tags;
• A wide range of goods;
• Quick inventory turnover;
• High sales – leading to low operational costs.

Weaknesses

• The largest market segment in North America – so there’s a dependence on that segment;
• Non-members feel unwelcome and are reluctant to buy at Costco;
• Limited product selection – some competitors, including Walmart, offer a larger mix of goods.

Opportunities

• Entering new markets, including developing Asian countries;
• Attracting younger clients;
• Expanding its online store’s coverage;
• Increasing its product variety.

Threats

• Labor and transport costs;
• New and strong competitors like retail businesses that focus on the same approach – membership-only warehouses;
• Economic slowdown;
• Other retailers’ aggressive marketing;
• Stronger eCommerce competitors.

Main Competitors

Among Costco’s main competitors are Sam’s Club, Amazon, Walmart, and Target.

Walmart

• Walmart is a better choice for non-grocery purchases;
• Just like Costco, it has competitive prices;
• Walmart provides a broader product selection;
• Costco offers greater employee perks;
• Self-checkout is better at Walmart.

Target

• It was created in 1902;
• Most of its market is within the US;
• Costco is better if you want to buy allergy meds, alcoholic beverages, sodas, and furniture;
• Target is better if you purchase packaged foods such as hot cocoa powder, books, beauty products, and OTC meds.

Sam’s Club

• Both companies have similar business approaches;
• Sam’s Club is, however, a Walmart subsidiary, while Costco is publicly traded;
• Costco has higher membership fees but lower price tags;
• Sam’s Club owns more physical locations within the US, while Costco is larger globally.

Amazon

• In terms of value, Walmart wins;
• Amazon’s client satisfaction is not as good as Costco’s;
• Amazon is a better choice if you want to buy individual products, not bulk;
• Costco wins by having a generous money-back return policy.

FAQs

Bottom Line

Costco’s business model has proven itself unique, leading to its global success. As a warehouse retailer, Costco is profitable and highly viable. Its business approach leads to many advantages that give strong competitive leverage.

Still, to maintain its long-term viability and success, Costco should address every market threat it faces. The company’s profitability might increase through oversea expansion. But, they must include that objective in their business strategy.

Let’s look closely at what Costco does in terms of business strategies. We can see its transparency, great partnership and networks, and speedy customer service. All these are essential values for the retailer. It’s a win-win situation for all since they benefit everyone, from customers to employees and Costco’s stakeholders.

Recommended reads:

• Walmart Competitors Analysis
• Amazon Competitors Analysis
• Service Value Chain Explained
• Costco Competitors Analysis : 6 Strongest Competitors

Resources:

• https://www.britannica.com/topic/Costco
• https://fourweekmba.com/costco-business-model/
• https://www.theibfr.com/download/ijmmr/2010-ijmmr/IJMMR-V3N3-2010-6.pdf
• https://www.forbes.com/sites/andriacheng/2020/09/24/costco-earnings-shows-it-still-remains-in-a-league-of-its-own/
• https://www.cnbc.com/2019/05/22/hooked-how-costco-turns-customers-into-fanatics.html
• https://edition.cnn.com/2021/10/27/business/costco-minimum-wage/index.html
• https://www.businessinsider.com/costco-vs-walmart-vs-aldi-review-prices-grocery-shopping-photos-2022-3
• https://pestleanalysis.com/costco-business-model/
• https://www.entrepreneur.com/finance/costco-vs-amazon-an-end-of-the-year-showdown/440783
• https://www.entrepreneur.com/business-news/costco-is-opening-24-new-stores-this-year/440788

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Alexandra Gavrilescu

Alexandra Gavrilescu knows how important success is, which is why she’s dedicated herself to helping other people find it. The single most important thing in her life is helping other people accomplish their dreams, which is why she spends all of her time learning about digital marketing. As she’s constantly refreshing her skills and the knowledge she understands, she’s here to help you learn new skills, grow, and succeed.

Whether you want to know more about marketing funnels or use eCommerce platforms in your company's best interest, Alexandra will unravel all those elements of the digital marketing industry. She's also an expert on topics such as social media, search engine optimization, and email marketing.

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