What we can learn from Costco's promotion strategy

May 20, 2021
Henry Bewicke
Promotions Advisor
Min to read

Costco is probably the world’s biggest and most well known ‘warehouse club’. In fact, it sits among the likes of Walmart and Amazon as one of the largest retailers in the world.

Even though Costco’s business model is pretty simple (membership-only wholesale retail), it uses a number of interesting promotional techniques to drive sales and customer retention.

This makes it an interesting case study for us in the field of promotions. In this blog post, we’ll analyse Costco’s promotion strategy and explain how the techniques they use could help your business too.

But first, let’s take a look at Costco’s business model.

What is Costco’s business model?

Costco, along with a number of other wholesale retailers, operates under the ‘warehouse club’ business model. This model is closely linked to the ‘cash and carry’ model.

While there are some small differences between these two models, the general approach can be summarized as follows:

  • A warehouse club / cash and carry sells a variety of wholesale items directly to their members from a warehouse / big box store
  • The customer base consists of a mixture of individual customers and small business owners
  • Customers go to the warehouse / store, purchase goods at wholesales prices, and then transport them back home themselves

In this sense, warehouse club / cash and carry stores are effectively the same as supermarkets, except they sell products in bulk at wholesale prices.

This model differs slightly from standard wholesale retail because customers pay for goods on the spot and transport them home themselves, instead of receiving an invoice upon delivery.

Now let's look at the promotional techniques Costco employs.

Costco’s membership system

Costco is well-known for its membership system. If you want to take advantage of its low prices and exclusive own-brand products, you have to pay an annual membership fee. Your only other option is to use a Costco Cash gift card (which has to be purchased by a member in the first place).

Costco has a range of four different membership options:

  • Gold Star ($60)
  • Gold Star Executive ($120)
  • Business ($60)
  • Business Executive ($120)

To put it simply, standard Gold Star membership allows you to shop in Costco stores. Meanwhile, Business membership allows members to purchase goods for resale. Then you have Executive versions of Gold Star membership and Business membership, which offer 2% rewards (cashback) on most products, alongside other benefits.

It's a straightforward concept, but membership is one of Costco’s core marketing strategies. It serves a number of different purposes:

1. It’s an important source of income

In 2019, membership fees totaled $3.35 billion. While that’s a small portion of the business’s overall revenue ($152.7 billion), it accounts for the vast majority of its net income ($3.65 billion).

When Costco’s business model relies so heavily on low margins, it needs to maintain low prices to stay competitive. Rather than using membership fees to increase profits, it uses them to keep prices as low as possible for the consumer.

“If you take [money from membership fees] and put it back into lower prices, it begins to feed on itself.” - Sol Price, founder of Costco predecessor, Price Club

2. It helps give an air of exclusivity

Unlike normal supermarkets, where anyone can come and shop, Costco uses paid membership to market itself and add an air of exclusivity to its brand. You see the same technique being used in many different industries.

As Costco primarily targets more affluent shoppers who will spend many hundreds of dollars in one visit, exclusivity is an important selling point. In fact, Costco spends practically nothing on advertising. It uses its brand as its main marketing tool. And you can probably argue it’s the main reason for the business’s success.

3. It helps the business upsell

Costco has two different membership levels (standard and Executive) for normal and business customers. Executive-level membership is twice the price of standard membership, but it offers 2% pre-tax cashback on purchases (up to $50,000) every year.

This adds a clear incentive for customers to spend more. After spending $6,000, customers will recoup their membership fee. This cashback rewards system is an important driver of customer loyalty, sales, and brand recognition for Costco.  

4. It helps combat shoplifting 

Because Coscto operates on such tight margins, reducing shrinkage as much as possible is essential. Costco’s ‘shrinkage’ rates (the amount of money lost to shoplifting, employee theft, etc.) are about 1/10th the average for other retailers.

While there are many factors that influence shrinkage, Costco itself says that membership plays an important role. That’s because it allows the business to vet the kind of customers that enter its stores.

One of the most telling stats about Costco membership is the roughly 90% renewal rate across all markets. The brand even offers a refund if customers are unsatisfied with their membership, which makes this renewal rate even more impressive.

Similarities with loyalty programs

In many ways, Costco’s paid membership strategy serves a similar purpose to loyalty programs. The promise of rewards and additional incentives encourages buying and other actions from customers.

Specifically, its membership strategy can be likened to a tiered paid loyalty program. Customers get the immediate benefit of reduced prices, and they can upgrade their membership to get cashback on the money they’ve spent over the year.

This is part of the reason why Costco has:

Costco’s pricing strategy

As we've already mentioned, pricing is another key part of Costco’s wider business strategy. Why is it so important? Because the customers pay their membership fees knowing that they can buy what they want cheaper at Costco than pretty much anywhere else. This is great for brand awareness.

Costco prices products at 14-15% markup above costs. This gives it an average profit margin of just 2%, and positions the brand firmly within the wholesale market. The reason Costco is able to offer such low prices is because it sells products in bulk. That’s why the brand has become synonymous with oversized items and enormous warehouses.

Not only does selling in bulk allow Costco to list lower prices, it also increases their average order size. Customers may not realistically need a 3,000 foot / 914 meter roll of plastic wrap, or a 10 pound / 4.5 kilogram ‘God Bless America’ cake. But these are the kinds of things you find at Costco. And, in addition to being high quality, it’s the wholesale prices that suddenly make these items attractive to customers.

Ultimately, low prices are a fundamental pillar of the warehouse club / cash and carry model. When asked about his recipe for success, Sol Price, the founder of Costco predecessor, Price Club, said the following:

“My ‘secret’ is so simple that I’m reluctant to speak openly about it for fear of appearing stupid. I sell things as cheaply as I can.”

Similarities with product bundling

In many ways you can draw similarities between wholesale / bulk pricing and product bundling. Both techniques aim to increase average order value by selling multiple items together. While wholesale isn’t really a viable option for many businesses, product bundling is applicable in pretty much any industry. So, take inspiration from Costco, and think about ways you could use product bundling to help your business.

Additional incentives

Low prices aren’t the only thing Costco uses to get customers through its doors. The brand is famous for some additional incentives that it has established as an important part of its brand:

Costco’s free samples

Employees hand out free samples of various edible products from the warehouse shelves every day. Costco sees these free samples as an important part of the shopping experience. And, if customers try something that they like, they’re more likely to buy it.

Costco food court

Costco is perhaps even more famous for its food court. The star menu item is a quarter pound hot dog and refillable drink for just $1.50. The price of the hot dog has remained the same since 1985. And, unsurprisingly, this hot dog deal is a loss-leader for the business. This means that it loses a bit of money on every one of the 120 million hot dogs it sells each year.

The same goes for Costco’s rotisserie chickens, another of the brand’s most popular items. It sells more than 90 million $4.99 rotisserie chickens each year, totalling a $30-$40 million loss. These chickens are such an important part of Costco's promotion strategy that it opened its own $450 million chicken plant in Nebraska to streamline costs. But, again, it all comes down to giving customers what they want, and ultimately increasing brand loyalty.

Costco gasoline

Costco’s final big incentive is gasoline. Rather than being a loss-leader, it sells its gasoline at a small profit. This still makes Costco gasoline one of the cheapest options on the market, and another key reason many customers pay for their membership.

Does Costco’s approach translate well to other businesses?

Costco’s promotional strategy is specifically tailored to its niche within the wholesale club / cash and carry sector. As a result, it doesn’t necessarily translate that well to other businesses.

However, lots of the underlying strategy behind Costco’s promotional techniques can be applied to other industries and businesses. As we've already mentioned, there are some clear strategic similarities between Costco's paid membership system and loyalty programs. The same goes for its wholesale pricing and bundle deals, and its extra incentives and giveaway items.

When it comes to implementing similar promotion strategies in your own business, start off with a clear plan. You should know what you’re trying to achieve, and what business objectives you’re working towards. You can then adapt many of the underlying techniques and ideas used by big businesses to your own.

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So, to recap

Costco uses a number of marketing techniques and promotion strategies to increase its customer base and sell more products:

  • Paid membership gives an air of exclusivity to Costco's brand, while also helping reduce losses from shoplifting
  • Costco's low prices and small margins help it keep customers coming back time and time again
  • Additional incentives, like hot food and gasoline, are another big draw for Costco customers

While these promotional techniques aren't applicable to every business, the underlying concepts behind them are highly transferable.

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