This Is Exactly How Costco’s Business Model Works
Costco sells a very specific kind of product: value — in the form of deals, bargains and low prices. 7–11 sells convenience, in the form of quick snacks and drinks. Amazon sells variety and speed (not literally though, last I checked). Trader Joe’s sells vibes. Six Flags sells thrills. Get the idea?
Some companies design their business model around the exploitation or manipulation of its customers: Think late fees and data mining, for example. At Costco, everyone is on the same team. Costco makes the system the enemy. By that, I mean the company attacks any inefficiencies within its supply chain that increase operating costs. Then, it passes down the savings to members.
So here’s how Costco works: First, you pay a year’s membership fee upfront. Next, it’s Costco’s turn to provide the value that it promises. Costco can afford to offer better prices than competing chains because the majority of its annual profit comes from membership fees. But things do not stop there.
Costco’s every decision is a means of providing better deals to members. Here’s an example: A few years ago, Costco re-engineered the shape of a container of nuts so more of them could be stocked on storage pallets. As a result, Costco saved 26,000 pallets per year. Costco then used the money it saved to lower the price of the nuts. Naturally, members bought more nuts. When members bought more nuts, the food company that sold the nuts to Costco was very happy and wanted to keep selling its product at Costco. Because of this, Costco had more negotiating power with the food company. Costco leveraged its position and bought more nuts from the food company, but at an even cheaper price. Then, Costco sold those nuts to its members for a cheaper price. Customers bought more nuts and renewed their memberships. The cycle continues for every product, at every Costco warehouse around the world.
By now, Costco has a reputation and companies are desperate to get their products inside the warehouses. Basically, Costco doesn’t have to suck-up to the food distributors; Costco has to suck-up to its members. And Costco is okay with this, because its members paid their membership fees in advance.
Costco’s business model is masterfully designed. Everyone wins! Well, everyone except the environment. But that’s a different story.