Why Costco is Cheaper than Amazon - YouTube

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Every October, thousands of dead strip malls, Blockbusters, and Radioshacks crawl out of

their graves and spring to life with orange signs.

While Halloween spending has steadily grown in recent years, the number of pop-up stores

has absolutely exploded.

Companies like Party City and Spirit Halloween have no trouble finding empty 50, 60,000 square-foot

buildings in the middle of town.

For that, they have to thank the so-called Retail Apocalypse.

In the last three years alone, Sears lost 142 of its stores, Toys-R-Us filed for bankruptcy,

J.C. Penney lost about 200, Payless ShoeSource closed all 2,000, and RadioShack, about a

thousand.

The obvious question is Why? and the obvious answer is Amazon.

But not exactly.

It’s not retail stores that are dying.

All these brands have something in common: they suck - usually because they failed to

adapt.

Sears tried to do everything and ended up doing everything… terribly,

J.C. Penney forgot its customers,

and Toys-R-Us thought the internet was a fad.

Millennials didn’t “kill” your business, they stopped putting up with its 18th-century

practices.

Other companies are thriving, like Ross, Lush, Aldi and Dollar General.

One, specifically, Costco - succeeds against all odds not by copying Amazon but doing almost

the opposite.

While both sell just about everything - from food, to tires, vacations, and lawnmowers,

Costco’s strategy could hardly be more different, and that’s exactly why Amazon should be

paying attention.

Most grocery stores - cheap, premium, big, and small - have the same basic strategy.

They know everyone buys milk, eggs, bread, and bananas, and almost everyone knows what

they cost.

So they lure customers in with cheap prices for these staples, even at a loss, and then

profit from their large volume, repeat business.

Costco is no different, with its five dollar rotisserie chicken and bargain gas stations,

which usually attract long lines.

But unlike almost all of its competitors, Costco’s deals aren’t aimed at the general

public.

While the average grocery store does anything to get you in the door, Costco charges you.

You won’t even be allowed inside without a membership, which starts at $60 a year,

or $120 for Gold Star Executive.

This, like Amazon Prime, triggers a sunk-cost fallacy.

Once you’ve already paid the 60, $120, you feel invested - why shop around when you already

have Prime?

By not using it, you think, you’re just wasting money.

Soon, you stop comparing prices and automatically go to Amazon.

But what’s really genius about Costco’s membership is that it’s mandatory.

Amazon users will self-sort - each individually calculating whether buying Prime will save

them enough money to be worth it.

This does create loyalty but doesn’t fundamentally change the company’s business model.

Costco, on the other hand, makes 75% of its money from membership fees.

Membership isn’t its loyalty program.

Membership is its business model.

In 2018, Costco had 94 million members, a little less than Prime’s 100 million, despite

having only 700 stores around the world.

That’s significantly more than cheaper, digital subscriptions like Apple’s Music’s

60 million or Hulu’s 25, and yet 90% renew each year.

Why?

Because its prices are so, ridiculously low.

Not because it’s a charity or makes money from more expensive items while you’re already

there, but because it’s incentives are aligned with yours.

Its first priority is getting its customers to renew their membership - which means impressing

them time after time with low prices and high quality.

Raising prices would only generate a few cents today and cost the company $60 next year.

That’s why it has a self-imposed rule: No item can be marked up more than 15%, or 14%

for branded items, giving it an overall average markup of 11%, far lower than Walmart’s

24%, 30 across all supermarkets, or Home Depot’s 35.

Almost everything about its stores is designed to accomplish this goal.

True to its name, Costco stores are, in every sense of the word, warehouses - there is no

”back-room”.

Instead, forklifts move pallets of products directly onto store shelves.

There are no fancy decorations and aisles deliberately feel crowded - basically the

opposite of an Apple store.

But for as big as its warehouses are, their selection is surprisingly sparse.

Your neighborhood supermarket will sell, on average, about 30,000 unique items, a Walmart

Supercenter, 140,000, but Costco, only about 4,000.

Many of its stores have a gas station, pharmacy, hearing aid center, optometrist, photo processing

center, tire garage, liquor store, and food court, but for each “kind” of item, there

will usually be only one or two choices.

Rather than paralyzing shoppers with an endless row of similar brands, Costco offers large

quantities of whatever it considers the highest quality.

Not only does this make shopping and stocking shelves simpler, but it gives Costco immense

buying power, and by extension, immense negotiating leverage with its suppliers.

Companies want so badly to be the one or two choices at Costco, they’ll lower prices

and work to adapt their product to its needs.

At one point, for example, Costco reengineered a container of cashews so it could fit more

in the same space, ultimately saving 24,000 pallets a year - money it passed onto the

customer.

If Costco is unsatisfied with a product, it just creates its own.

Its store brand, Kirkland Signature, accounts for about 25% of its annual sales and has

a reputation for being high quality.

The other major ingredient to Costco’s success is the way it encourages high spending.

Because getting around the store is so confusing, you have no choice but to wander through most

of the aisles.

The large quantities attract business owners, who makeup just over one third of its total

members, but account for two-thirds of its sales.

The $60 up-front fee, meanwhile, selects for an affluent demographic, with an average household

income of nearly $100,000.

And that’s the genius of Costco: it turns nearly every seeming obstacle into a competitive

advantage.

Its membership fee should make acquiring new customers fatally difficult.

Instead, it creates loyal, deep-pocketed patrons who praise the company for its free samples,

generous return policy, and, of course, low prices.

Its cost-saving warehouse layout should confuse and annoy shoppers.

Instead, it makes them feel like deal-hunters, much the same way IKEA’s do-it-yourself

model makes its customers proud of their work.

It’s a winning formula that’s now being exported to 13 countries, including, as of

this year, China.

Its grand opening in Shanghai was so busy that the store had to temporarily close for

safety.

Ultimately, Costco will never be as big or exciting as Amazon, and that’s largely why

it’s so adored.

Shareholders love it as a solid low-risk, predictable long-term investment.

And its customers can feel good about its low prices knowing they don’t come at the

expense of workers.

While Amazon ruthlessly sacrifices everything for lower prices, Costco sees its employees

as a crucial ingredient to its success.

The average wage of all 245,000 workers is $21 an hour, double the U.S. retail average.

It also gives better health insurance and retirement benefits, which Costco is rewarded

for with employees three times more productive.

In an era of overvalued startups, reckless desire for growth, and questionable business

practices, Costco is something else entirely: refreshingly boring.

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