The Costco Membership Model That Prints Money
Costco sold $254 billion worth of products in fiscal 2024. The company generated $9.3 billion in operating profit. Membership
Costco sold $254 billion worth of products in fiscal 2024. The company generated $9.3 billion in operating profit. Membership fees account for less than 2% of total revenue but generate over half of that operating profit. This is how the Costco membership model prints money.
137 million people pay Costco an annual fee for the privilege of buying products. Those membership fees cost Costco essentially nothing to collect, creating profit margins of 66% against the retailer’s bottom line. While competitors fight over razor-thin retail margins, Costco built a business where the entry fee generates more profit than selling hundreds of billions in merchandise.
How It Started
The Costco membership model didn’t start at Costco. It began in 1976 when Sol Price opened Price Club in San Diego, charging customers an annual fee for access to a warehouse selling products at near-wholesale prices. The experiment nearly failed. In its first year, Price Club lost $750,000. Price had limited membership to businesses only. When he opened it to household consumers, the business turned profitable.
Jim Sinegal watched this transformation while working at Price Club. In 1983, he opened the first Costco in Seattle with the same model. By 1993, Price Club and Costco merged, creating the company that now operates 914 warehouses globally.
How The Numbers Work
The Costco membership model operates on counterintuitive mathematics. Fiscal 2024 numbers reveal the mechanism. Total revenue reached $254.5 billion. Of that, $249.6 billion came from merchandise sales. Membership fees contributed $4.8 billion, less than 2% of revenue. On the surface, membership appears insignificant.
The surface view misses the point entirely. Costco generated $9.3 billion in total operating income in fiscal 2024. Membership fees provided over half that profit. The merchandise that generated $249.6 billion in sales? It produced less operating profit than the nearly free money collected from membership fees.
The disparity exists because of Costco’s pricing strategy. The company caps markups at 14% for branded items and 15% for its private label Kirkland Signature products. Compare this to traditional retail markups of 25% to 50%. Costco’s gross margin hovers around 13%. Net profit margin on merchandise sits at roughly 2.9%. The company barely profits from product sales.
This is intentional. If Costco raised prices to increase merchandise margins, it would risk destroying the value proposition that keeps members renewing. The 90% membership renewal rate globally, 93% in the U.S. and Canada, proves customers perceive extreme value. Members spend an average of $3,000 annually at Costco. That spending happens because products cost less than elsewhere.
The Costco membership model creates a virtuous cycle. Low prices drive high spending. High spending from millions of members generates massive purchasing power. Massive purchasing power allows Costco to negotiate better supplier prices. Better supplier prices enable even lower retail prices. Lower retail prices justify the membership fee. The cycle reinforces itself.
What You’re Actually Paying For
When someone pays $65 for a Gold Star membership or $130 for an Executive membership, they’re not buying access to a store. They’re buying into an economic mechanism designed to deliver value that exceeds the fee. Executive members receive 2% cash back on purchases, capped at $1,250 annually. To hit that cap, a member spends $62,500 at Costco in a year. Many do.
The Costco membership model transforms customer psychology. Paying an upfront fee creates sunk cost commitment. Members feel compelled to shop at Costco enough to justify the fee. This drives repeat visits and higher basket sizes. The average Costco shopper visits 2.7 times per month, far higher than typical grocery store frequency.
Membership also creates exclusivity without elitism. Costco’s no-frills warehouses with concrete floors, pallet-stacked merchandise, and minimal decor communicate value over luxury. The membership requirement signals this isn’t for casual browsers. It’s for committed shoppers willing to buy in bulk to maximize savings. This attracts customers who spend more per trip.
The fee structure has evolved carefully. In 1983, Costco’s first Seattle warehouse charged $25 annually for membership. Adjusted for inflation, that’s roughly equivalent to today’s $65 fee. Costco has raised prices minimally over four decades, maintaining accessibility while slowly growing fee revenue through membership growth rather than aggressive price increases.
September 2024 marked the first fee increase in seven years. Gold Star and Business memberships rose from $60 to $65. Executive memberships increased from $120 to $130, with the cashback reward cap rising from $1,000 to $1,250. This change affected 52 million memberships. The impact on fiscal 2025 revenue will be substantial, adding hundreds of millions in nearly pure profit.
Why Competitors Can’t Copy This
The Costco membership model looks simple enough to replicate. Charge an annual fee, sell products at minimal markup, profit from memberships rather than merchandise. Several competitors have tried. Sam’s Club, owned by Walmart, operates 600 warehouses using a similar model. BJ’s Wholesale Club has 244 locations on the East Coast. Both struggle to match Costco’s execution.
The difficulty lies in discipline. Costco enforces strict pricing rules that require saying no to easy profit. When suppliers offer promotional allowances or vendor rebates, most retailers pocket the difference. Costco passes savings to members. This builds trust but sacrifices immediate profit. Most companies cannot resist the temptation to optimize short-term margins.
Costco carries only 4,000 SKUs in a typical warehouse, one-tenth the variety of an average supermarket. This limited selection enables incredible purchasing power. When Costco commits to a product, it buys massive volumes, securing discounts other retailers cannot match. The trade-off is selection. Members accept limited choices in exchange for lower prices.
The warehouse format itself requires commitment. Costco’s average warehouse is 140,000 square feet. Real estate costs are enormous. The no-frills presentation keeps construction costs lower than traditional retail, but the scale demands locations where land is available and affordable. This limits expansion opportunities in dense urban areas.
Employee compensation represents another barrier. Costco pays significantly above retail average wages and provides generous benefits. This creates low turnover and high employee satisfaction, reducing training costs and improving customer service. But it requires accepting higher labor costs than competitors. Most retailers optimize labor as a variable cost. Costco treats employees as long-term investments.
The combination of factors creates a moat. Competitors can copy individual elements but struggle to execute the entire system. The Costco membership model works because every component reinforces the others. Remove one piece and the structure weakens.
The Kirkland Signature Multiplier
Private label Kirkland Signature products account for 30% of Costco’s sales, roughly $75 billion annually in fiscal 2024. This isn’t just a product line. It’s a strategic weapon that makes the Costco membership model even more profitable.
Kirkland Signature launched in 1995. The name comes from Kirkland, Washington, where Costco’s headquarters were located at the time. Previous retailers changed private label names depending on product type. Costco assigned Kirkland Signature across all categories, building brand recognition and trust.
The private label strategy serves multiple purposes. First, Kirkland products cost 10% to 30% less than national brand equivalents while maintaining equal or better quality. This reinforces Costco’s value proposition. Second, Kirkland carries higher margins than branded products while still costing less than competitors’ prices. Third, private label products cannot be comparison shopped elsewhere, eliminating price transparency that erodes margins on national brands.
Members trust Kirkland Signature because Costco’s reputation depends on it. If Kirkland quality declines, membership renewals suffer. This incentive alignment ensures Costco maintains high standards. The brand has expanded into premium categories, with Kirkland Signature vodka competing favorably with Grey Goose and Kirkland almonds outselling Blue Diamond.
Kirkland’s success demonstrates how the Costco membership model creates flexibility. Most retailers need branded products to attract traffic. Costco can prioritize private label because members are already committed through the fee. This shifts power dynamics with suppliers. Costco doesn’t need to carry every brand. Brands need Costco’s volume. This negotiating leverage results in better terms.
The Business Model Other CEOs Dream About
Charlie Munger, Warren Buffett’s longtime business partner, called Costco “one of the most admirable capitalistic institutions in the world.” The admiration stems from understanding what the Costco membership model achieves that most businesses cannot.
First, Costco generates predictable, recurring revenue. Membership fees provide a base of $4.8 billion annually with minimal associated costs. This cash flow is largely independent of economic cycles. Even in recessions, members continue renewing because Costco’s value proposition strengthens when budgets tighten.
Second, the model aligns company and customer interests perfectly. Costco profits when members perceive value and renew. This requires relentlessly low prices and high quality. Most retail businesses face conflicts between maximizing profit and delivering value. The Costco membership model resolves this by extracting profit from fees rather than markups.
Third, the membership base creates a data goldmine. Costco knows exactly what each member purchases. This information shapes merchandising decisions, optimizes inventory, and identifies trends before they’re obvious to competitors. The membership card that seems like a simple access token is actually a tracking mechanism providing competitive intelligence.
Fourth, members become brand advocates. Paying for membership creates psychological ownership. Members defend Costco in conversations, recommend it to friends, and feel pride in their membership status. This word-of-mouth marketing costs nothing and outperforms paid advertising. Costco famously runs no traditional advertising. The business model itself is the marketing.
When The Model Shows Cracks
The Costco membership model faces challenges that the pure financials obscure. Fiscal 2024 revenue growth slowed to 5%, the lowest in nine years. Membership fee growth also decelerated to 5.4%, a record low for the period measured. These numbers suggest market saturation in core regions.
E-commerce presents a particular challenge. Online sales grew 18.9% in Q4 fiscal 2024, but this is down from over 20% growth in the previous quarter. The warehouse experience is central to Costco’s appeal. The treasure hunt of walking aisles and discovering unexpected products cannot be replicated online. Free samples, rotisserie chickens, and the food court experience drive foot traffic. Online orders miss these elements.
The membership increase in September 2024, while modest, tested customer tolerance. Some members complained publicly. Costco’s strategy has been to raise fees infrequently and by small amounts, keeping price increases below inflation. However, $130 for Executive membership approaches a threshold where price sensitivity may increase. The company cannot simply raise fees indefinitely to grow revenue.
International expansion offers growth opportunities but with complications. Costco operates 914 warehouses globally, with 85% in North America. Asian and European markets present different consumer behaviors, supplier relationships, and regulatory environments. The membership model translates but requires adaptation. Growth in China, where Costco has seven warehouses, shows promise but happens slowly.
What Entrepreneurs Can Learn
The Costco membership model offers lessons applicable far beyond retail. First, find ways to separate revenue from transactional friction. Costco collects membership fees upfront, then focuses on delivering value without worrying about maximizing profit on each sale. Software-as-a-service companies understand this. Subscription models create predictable revenue while aligning success with customer retention rather than extraction.
Second, discipline matters more than cleverness. Costco’s 14% markup cap seems simple. Maintaining that discipline when easy profit opportunities appear requires organizational culture that few companies achieve. The temptation to make exceptions, to optimize just this once, undermines the system. Costco resists.
Third, scale enables advantages that create self-reinforcing loops. Costco’s purchasing power comes from massive volume, which enables lower prices, which drives membership growth, which increases purchasing power. Entrepreneurs should identify similar loops where getting bigger makes you better at getting bigger.
Fourth, long-term thinking beats quarterly optimization. Costco invests in employee wages and member value at the expense of short-term margins. This approach requires patient capital and leadership willing to resist pressure for immediate profit maximization. Public markets increasingly reward this patience when companies can demonstrate the long-term payoff.
Fifth, simple business models executed flawlessly beat complex strategies executed poorly. The Costco membership model is not intellectually complicated. The complexity lies in execution across 914 warehouses with hundreds of thousands of employees while maintaining standards and resisting profit optimization.
What’s Next
The Costco membership model faces market saturation in North America. Growth must come from international expansion, increased spending per member, or raising fees. The September 2024 fee increase will boost revenue substantially, but Costco cannot raise fees frequently without risking the value perception that drives renewals.
The company has added stricter membership verification, requiring QR code scans at warehouse entrances. This cracks down on membership sharing and potentially converts shared users into paying members. Food court access is now restricted to members only.
E-commerce presents challenges. Online sales grew 18.9% in Q4 fiscal 2024, but the warehouse experience drives Costco’s appeal. The treasure hunt of walking aisles, free samples, rotisserie chickens, and the food court cannot be replicated online.
For 48 years, the model has withstood recessions, competition, and changing consumer behavior. The $4.8 billion in fiscal 2024 membership revenue proves the value proposition still works. Members continue believing that paying the fee saves them more than it costs.
