Until recently, Costco charged US$16.99 for a 24-pack of San Pellegrino. Now, that same item retails for US$14.99—a 12% reduction.
Sparkling water isn’t the only product looking cheaper at Costco these days. During a quarterly earnings call in March, Chief Financial Officer Richard Galanti seemed to signal an inflection point when he rattled off a variety of goods for which prices were being lowered: Kirkland batteries (from US$17.99 down to US$15.99) and reading glasses (US$18.99 to US$16.99), as well as sporting goods and lawn-care products. A bag of frozen fruit was even reduced by US$4. Plus, there was a more subtle clue about the direction of retail pricing: inflation was mentioned just seven times on the call, compared with 35 times during the March 2023 earnings call. (As for the recent trade disruptions in the Panama Canal and Red Sea, management said this hadn’t pushed up prices because of the long-term nature of shipping contracts.)
Costco’s results for the quarter were healthy, but they also contained signs that industry dynamics are beginning to shift. For example, given that overall inflation was flat across the retailer’s product categories, growth in same-store sales was dependent on increased customer traffic.
Shifting Dynamics
As inflation moderated in early 2024, increased traffic to Costco’s stores was the source of same-store sales growth
Source: Company filings
To be sure, the US Federal Reserve’s battle with inflation is continuing. A Commerce Department report last week showed that the central bank’s preferred inflation gauge unexpectedly reaccelerated in March, throwing into question the interest-rate cuts that were projected for later in the year, as well as providing a more complicated backdrop for Costco’s pricing strategy.
As consumer prices surged the last few years, Costco thrived by offering relative discounts. Its Kirkland Signature private-label products tend to be at least 20% cheaper than national brands, and at the height of inflation, Kirkland’s market penetration increased by 2%. One item in particular has become a symbol of Costco savings: its iconic food court hot dog. Even after inflation on food set multidecade records in 2022, the hot-dog-and-soda combo still costs just US$1.50, the same price it’s been since 1985.
Costco has an advantage in setting prices because of its limited assortment of products. Each store carries only about 4,000 stock-keeping units, or SKUs—the scannable barcodes assigned to each type of product. In contrast, SKUs at other big-box retailers, such as Target and Walmart, can number in the tens of thousands. By purchasing fewer products in enormous quantities, Costco’s purchasing power often exceeds that of its rivals, which enables it to set lower prices than the market.
“We always want to be the first out there trying to lower prices,” Galanti said in March. But if the economic environment is such that other retailers begin to lower prices, competition may increase.
The prospect of rising competition leaves investors to wonder if that’s why Costco seems hesitant to raise membership fees. Only members can shop at Costco’s warehouses, and the fee to be a member has traditionally gone up every five to six years. However, the last increase was nearly seven years ago in June 2017, suggesting the retailer is overdue for another bump. Currently, the two membership options cost US$60 and US$120 a year.
Last May, Galanti said that he felt “very good” about the ability to increase membership fees without hurting renewal rates or signups. But it’s easier to raise prices when prices in general are going up, and harder to do if inflation moderates. During the recent earnings call, Galanti was vague about the company’s plans, adding only that the decision for when to raise fees doesn’t involve “some big analytical formula.”
In the meantime, other retailers have introduced optional membership programs to encourage shoppers to spend more money with them. In 2020, Walmart launched Walmart+, a plan that costs US$98 a year and includes free shipping and delivery, fuel savings, and access to the Paramount+ streaming-TV service. In April, Target introduced a similar program called Target Circle 360; for US$99 a year, users save on speedy shipping and are given an extra 30 days to make returns. There’s also Amazon Prime, a US$139-a-year subscription with shipping and digital-entertainment perks. For shoppers looking to buy in bulk, one of Costco’s closest rivals is BJ’s Wholesale Club, which similarly requires customers to become members and pay either US$55 or US$110 a year.
Despite the myriad in-store and online shopping competitors, Costco members remain especially loyal. About 93% in the US and Canada, and 90.5% worldwide, renewed as of the latest quarter, with both rates essentially unchanged from a year ago.
Loyal Shoppers
As Costco’s membership base has grown, the proportion renewing their plans has remained consistent
Source: Company filings
Over time, international renewal rates should also build to near North America’s levels. That’s because many of its locations abroad are still new. In China alone, the company has opened six stores since 2019 to much initial fanfare (the grand opening of the first location drew such large crowds that it had to close early for the day). New stores initially attract consumers who are curious about Costco but don’t necessarily live nearby or plan to remain members. Therefore, it can take time for the customer base to stabilize.
While Costco remains a high-quality company, the stock’s rally this year—partly due to high expectations for its expansion in China—has caused the valuation to become stretched relative to its growth prospects. The business is a steady grower, with revenue set to climb by mid-to-high single digits over the long term, yet as it grows it passes on savings to customers, which means margins shouldn’t change much. As competition increases and the company prepares to raise membership fees, investors will watch closely for any change to its membership growth. ∎