The Cult of Costco

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S1: This ad free podcast is part of your slate plus membership.

S2: Hello and welcome to sleep.

S3: Money, food, the whole mini season devoted to the economics of food and the food industry and everything associated with food.

S4: And boy, do we have the perfect episode to kick off this series. It is Costco, obviously in the news right now because everyone is storming it to stock up on whatever they need in the home bunkers. There is one man who understands Costco better than anyone else around here. That man is Zack Crockett. Hey, how you doing, Felix? Tell me about yourself. Who are you and how did you find out all about Costco?

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S5: Yes. So I’m a reporter at the Hustle, a business and tech newsletter. Costco is just this weird, fascinating place that in many ways breaks all the rules of retail. You can pay a twenty seven pound bucket of mac and cheese, a casket, a dollar fifty hotdog and a life insurance policy items sit in these wooden pallets, in these dark unmarked aisles. The brand selection is super limited and you pay $60 just to get in the door. So I’m just wondering how this all makes sense.

S4: We will find out. Coming up on Slate, Money, Food. So, Zach, what proportion of Costco members do you think have been just like rushing to Costco to stock up on everything as they start panicking about Corona virus?

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S1: This is something, you know, if you spend a lot of time on Twitter online, you’re going to see people jousting over the toilet paper rolls. The panic buying, empty shelves, all the pictures. I have to say, though, I think that is a relatively small proportion of the Costco customers at large. Most Costco customers are families who buy these big bulk orders or, you know, just people in the suburbs stocking up on stuff. You see these retail arbitrage guys going in and buying big bulk packages of stuff and reselling it on Amazon for a profit. And you also see, you know, the doomsday community going full scale on on their Costco binges lately, buying out the toilet paper aisle and so forth.

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S6: But I think that’s actually just a relatively small portion of what’s going on right now, because this is one of the things which I find super fascinating about Costco, which you are an expert in and which is one of the most amazing businesses in America, is that people don’t actually go there very often.

S7: Right.

S8: The whole business model is basically that you have some monster suburban, you know, SUV, tank type vehicle and you drive it into the parking lot of Costco and then you go and you do some massive shopping, buy pallets full of goods, and then you load them into into the SUV or your pickup truck or whatever, and you drive them into a four car garage and you just let them sit there and you can basically live off your garage for the next like three months until you have to rinse and repeat.

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S9: If I got that right, because I mean, I live in Manhattan, I don’t really understand that. That’s pretty much it.

S1: I mean, the first thing you have to understand is most of these stores are in suburban areas. The average Costco shopper is pretty well off. Like we’re talking like a hundred K. So for a discount store, that’s that’s pretty high. And, you know, you have to have the space to store this stuff. Like you said, but very much by design. The average Costco shopper probably only goes in once a month compared to, you know, the average supermarket shopper goes in once a week. So that is very much by design. That also comes with an economic benefit to Costco. You know, the less a customer has to go shop, that’s less resources for the store, less restocking resources, less cashier resources, less people taking up space in the parking lots. It’s just a more efficient operation, which is very core to their model.

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S4: It is super efficient, right. The typical supermarket, you know, a pallet of goods will come in and then they will spend a huge amount of effort unpacking everything. And so everyone can buy these bottles of shampoo individually or something. And then at Costco, people, they all just buy a dozen bottles of shampoo at a time. And then they know who thinks that it makes sense to buy a dozen bottles, which I at a time. But people do that, right?

S1: Yeah. I mean, look like you walk into one of these stores and it’s it’s really the antique store in every way. It’s like the ugliest place in the world. You’ve got these bare concrete floors. There’s no signage. You there’s these giant pallets. There’s forklift operators just zooming by you as you’re buying your rotisserie chicken, you know, and actually, shockingly, it’s actually expensive for Costco to design their stores that way. It costs about 80 million dollars per store just because they’re so large. But all of this minimal operation, it’s both by design and it ultimately it streamlines the operations, makes things a little bit cheaper for consumers. But it’s also kind of just experience all in this weird way.

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S6: I was wondering about that. How much of that is theater? How much of that is is is like putting on a show of being cheap as opposed to actually being efficient?

S1: Some of it is absolutely a show. Costco is is some weird form of capitalistic theater. And in some ways, it’s Jim Senegal. The founder and CEO of Costco who stepped down in 2012, has admitted as much. But to be fair, some of it is practical and operational. I would say actually most of it is bringing things in on the pallet by forklift reduces the backlog of stuff they have in store rooms. It reduces touch costs, which essentially there’s this idea in retail that any time an employee has to touch a good, it adds to the cost. And Costco has very low touch costs. It’s coming straight off the truck and basically going right into the store. There’s no fancy displays that you might see in Whole Foods. There’s no stocking little cans on shelves. You see what you get.

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S4: And they have a. Like super high and steaks and lobsters and thousand dollar bottles of wine, then that kind of stuff as well. Right. They they’re trying to be all things to all people.

S1: Yeah. I mean, you can walk into a Costco and you can buy an 18 karat white gold diamond necklace for five hundred thousand dollars. You can buy a 72 pound wheel of of parmesan cheese. You can buy what?

S4: And then sell it for real, Zellie? Who the hell buys a 72 pound wheel apartment? I mean, that’s that restaurateurs. Are they getting are they shopping at Costco?

S1: You know, it’s funny you ask that because the original premise of Costco was supposed to be kind of this B2B model that sold to other restaurant tours and food operators. You know, it goes all the way back to the 50s with So Price, who started this store called Fed Mart, which eventually became the Price Club. One of his employees was Jim Senegal. He broke off and started Costco. But over time, they realized this this business to business model selling to restaurant tours wasn’t working. The business only really works when they opened it up to individual people who kind of had this sudden novelty of going in and seeing these crates for themselves. It’s a great question. Who the hell buys this 72 pound thing of cheese, right? I don’t actually know. I’ve never seen any. I’m a Costco customer myself. I go in there. God knows who buys that. But someone does out there and they have an incentive to sell anything on their shelf because they’re they’re incredibly selective about what they do sell.

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S4: So this is a bit like Trader Joe’s, right? They have a very low number of schools, as it’s known, the actual items that they sell.

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S1: Yes. So the average supermarket you’re looking at 40 or 50 thousand SKUs. At Walmart, you’re looking at one hundred thousand. Costco has thirty seven hundred SKUs. They’re incredibly selective. Very small number of items. Relatively, you know, in any given category, you’re only going to have one or two selections rather than like fifteen or twenty. It’s very low skew, very high volume. So, you know, you’re not going to buy one jar of tomato sauce. You’re going to buy a six pack. You’re going to buy a 40 pack of toilet paper. You’re going to buy, you know, a seven pound tub of Nutella. That’s the kind of volume we’re talking about here.

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S4: It does raise the question, though, if they only have three and a half thousand SKUs and each one is very carefully picked out because, you know, they’ve managed to negotiate some great deal with the manufacturer and they know that it hits the sweet spot. How on earth they manage to wind up with a 72 pound wheel of Parmesan like it’s like. Is that really in the top three and a half thousand things that anyone wants?

S1: That’s a great question. I mean, someone out there is buying these seven pound type of Marcella’s. And, you know, a lot of a lot of big families will stock up. I think one interesting thing you just raised is, you know, right now, if Corona virus solve all of this panic buying, we’re seeing it Costco to some small level. I don’t want to say they’re contributing to that, but by design, they are stockpiling store in some small way. Right. Like a family is going to go in there maybe once a month and buy enough rations to last them a month. You know that the prepping community, for instance, loves Costco. Costco once at one time sold a six thousand dollar doomsday kit that gave you rations that would last you like four years dehydrated meats and such. So if you go on these doomsday communities, like these bunker communities, which are very active right now online, you’ll see a lot of discussion about Costco.

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S7: I mean, in terms of this like stocking up mindset, it seems to me that this is really it’s not just a prep her and doomsday thing. I mean, although that’s happening right now, it’s actually deeply embedded in the entire Costco business model.

S4: I have this mental model of, you know, we used to live in villages and there would be the fishmonger and the green grocer and the butcher and the pharmacist and the, you know, all the rest of it. And you would go from one to the next with your shopping bags and you’d like buy from each one than you. And then you do the same thing the next day. And that would be like a daily thing. And you could and you could do it all with a couple of tote bags over each arm. And then when things became much more suburban, that model changed to exactly what you were talking about, which was the weekly shop at the supermarket. And in order to do a weekly shop at the supermarket in the fridge. But you also need quite a big fridge to fit a week’s worth of food. And then you also needed a bunch of other storage for the non-perishable foods and whatnot.

S7: And the the service that a bunch of those old village stores were doing was we will stock all of these things in stock for you.

S8: And then when you need them, you can come and buy them. And then with the rise of the supermarket, that balance changed. And it’s like, well, we will just sell you a bunch of stuff once a week and then you will stock it in your own home. And then when you need it, you will go and find it on the third shelf in the in the garage. Yeah. And then that just got turbo charged by Costco. But the amount of just sheer square footage and freezer space that you need in order to be a Costco member seems to be a deeply American thing.

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S1: This is the ultimate mutation of what you just talked about. It’s. I mean, Costco has 114 million square feet of retail space. It’s almost unfathomable. But this is almost all the way down. They’ve taken the model all the way down the chain where they’ve almost eliminated a part of that supply chain process where they’re you know, they’re they’ll even skip this distribution process sometimes and take this crate straight from manufacturers to stores. So it’s giving consumers a taste of that back end process of retail. And in the process, it actually does make things a little bit cheaper in some ways.

S4: Or I mean, it kind of it’s somewhere almost back towards like the wholesale end of the of the chain rather than the retail end of the chain. And it’s done on this subscription basis where you have to buy a membership.

S8: And so in a weird way, like what you’re doing when you’re buying that membership is your, you know, paying rent on this million square foot warehouse where you can just walk in and buy whatever you need in bulk. I don’t know what the best way to think about this membership with the membership like a lock in thing was what we asked for paying the membership thing when you feel that you need to go back.

S1: Yeah, it’s it’s a sunk cost fallacy. You know, you pay this this upfront cost of. $60 just to get access to the store. You’re already in the hole before you’ve even started shopping. So, you know, there’s this frantic mindset like I have to recoup that $60. People often walk into Costco with the idea that they’re going to do 50, 60 hour shopping trip and they’ll walk out with like seven hundred dollars worth of stuff. But the membership fee is interesting, the subscription model grocery store. If you look at Costco’s annual reports and their numbers, you know, they have about 150 billion dollars in sales every year. Their cost of goods on that is one hundred and thirty two million. So their profit margin, their margin on their sales is only about 11 percent. They really make the bulk of their profits on those membership fees, which amount to about three billion dollars a year. That 11 percent margin they make on on that stuff. They actually sell, you know, these 72 pound things that cheese, that eleven percent margin goes to cover their operation costs. So, you know, there are stores that put it keeping the lights on their employees. And really they’re the bulk of their profit comes from those membership fees that they charge, which they charge on a variety of levels. But most people get what’s called the gold membership, which is just 60 bucks, gets you access in the store and kind of gives you a free pass to to buy whatever the hell you want in there.

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S10: They also had a very lucrative deal with American Express for a long time. Right. And I know that my Amex was like those big headlines when Amex lost that deal. And yeah, and that makes us, at least according to The Wall Street Journal, went into full on panic mode to try and get all of the small businesses back when they lost the Costco card, because they were like, that’s like a backbone of because you had small businesses who had that cut. They would spend, you know, seven figures often. Right. On those goods.

S1: Yeah. I don’t know too much about the numbers behind that, but yeah, that is like a royalty model. They’ll get kind of a percentage royalty from from the sales. And yeah, you know, you do have the the the executive tier cardholders going in and spending 70 pick your some six figure sums but for a time at least and possibly still at it. That is a big part of their models. Well, well.

S7: So what all of you see is that the basic individual tiers, the 60 bucks a year. Right. Mm hmm. And then and then it goes up. You get cheaper prices. What do you get if you spend more than you get?

S1: You know, the 120 executive tier, I think is you get a percentage back if you get 2 percent back or something. So it really only makes sense. We spend a lot. But look, you know, they have 53 million paying cardholders and the bulk of them are those standard 60 are, you know, everyday suburban families going in there.

S4: And who else does this? Wal-Mart has like a version of this, right?

S1: Wal-Mart has Sam’s Club, which Sam Walton, the founder of. Well, he started Sam’s Club as a way to compete with the Price Club, which is Costco’s predecessor. Costco actually merged with the Price Club in the 90s to compete with Sam’s Club because they were such a big threat. And for for a while, there are price Costco. And then they kind of just rebranded into Costco over time. But the other you know, there’s other players in this space who operate on a very similar model. I think the thing that distinguishes Costco from some of the other players is they’ve always had a mentality of putting their employees or their customers over profits. I don’t want to sound like a a proselytizer of Costco, but they they’ve proven it time and time again. They play pay their employees well. Their shareholders often get angry that they don’t increase their margin caps on their on the goods that they sell. And they have a good track record of treating their customers employees while passing down this.

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S7: Any savings they get to people who actually go and shop in their store and the employees are well paid and they have much less turnover than the Wal-Marts of this world.

S1: Yeah. There’s there’s an economic benefit for Costco that for treating employees well to the average turnover rate in retail at large, it’s 65 percent. The average pay is like ten bucks an hour. A Costco, they have a much higher retention rate of employees over time. They pay them about twenty one dollars an hour on average. And, you know, they give them things like health sponsored benefits. They have a union with sixteen thousand members. They have a good track record of treating employees well.

S10: So the other big question I had about Costco is if you’re only going there once a month, how do you deal with perishable food? Who is perishable food? Not really a big part of what Costco sells.

S1: They do sell quite a bit of perishable food. I think what what you’re tapping into is it’s a huge debate whether or not you save. Money shopping at Costco. That’s a question everyone asks, like, do you actually save money shopping at Costco, buying all its bulk stuff? And if if you look at the per unit costs, you for sure you save money, think things are cheaper, they do a lot to drive down those costs for you. But if you look at food waste, that’s a big problem with buying in bulk. If you factor in the amount of food that customers are probably wasting when they’re doing these big bowl purchases, the value add of shopping at Costco does decrease. Food waste is a big problem. I mean, Costco’s bulk principles extend to its produce and you know, each buy 24 pack of apples or whatever. I would I would hope that the majority of people who are buying those things are have really big families or just eat a lot of apples.

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S6: But say you come, but you can’t go in there and buy like free apples.

S1: I don’t think so. No. You’re looking at like 18 to 24. If you want a muffin, you’ve got to buy 12. You know, the exception is like their food courts. You can go go wild and buy a single hotdog for a dollar fifty at the food court, but off their shelves. You got to go big if you’re if you’re going into a Costco. And that’s sometimes probably means more food waste if you’re not a responsible consumer or just non-food.

S7: Sort of. I can easily imagine that if you buy a dozen bottles of shampoo, that’s a lot of people will not actually wind up using all those bowls of shampoo for whatever reason.

S1: Yeah, although I’m sure that the people who stocked up on, you know, like 10 packs a hand sanitizer, pretty happy about it now.

S7: So let me ask you the big question of the moment right now, which is toilet paper. Of all the things ex ante, if you told me that was going to be a pandemic crisis and people were going to wind up stocking up on essentials. But there’s one item in particular that is going to wind up getting sold out of every single market and every single superstore. And I’d be like, well, obviously, that’s going to be Tylenol, right? Well, that’s going to be Gates retail. That’s going to be whatever they need when they get sick. Well, I got know what? I would have me probably smoke since soap seems to be the number one weapon in this in this war and maybe people that it’s looking up.

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S9: No, none of that is toilet paper. Is there any do you understand this weird thing?

S7: How is it toilet paper? Everyone is suddenly got hung up on.

S11: It really is an it’s an unlikely golden asset of our times. Really. It’s I don’t know how the focus became on toilet paper. I will tell you, there is a history of this. This whole thing actually kind of reminds me of back in 1973, Samir listeners might remember the oil embargo. There was a market dip and there was a toilet paper panic in 1973. And the means of transmission back then that stoked the panic was not the Internet. It was. I think Johnny Carson made a joke on a TV show about there being a shortage of toilet paper based on some governmental report that hinted that there might be slightly less paper and Americans kind of collectively lost their minds, flooded the toilet paper market. Every store was sold out for for a few weeks. And that’s kind of what we’re simply seeing now. It’s everything you’re hearing from from manufacturers is telling us that there actually isn’t a shortage. There’s nothing to worry about. Yesterday, The New York Times, there is an article to the effect of there’s plenty of food in America. People don’t worry, the supply chains are functioning perfectly fine. I even saw a video on Twitter yesterday of this toilet paper employee in a big manufacturing facility driving around in a forklift, laughing maniacally at these at these mountains of toilet paper. And he was just saying, see, everyone there? There’s plenty of toilet paper. Calm down, calm down. The problem, I think is customers are are lining up for as long as two hours before Costco opens. They’re storming in there and jousting over these 40 packs. But, you know, it’s interesting, Costco. Costco is unique role in this toilet paper situation. Toilet paper is actually one of if not their best selling product in the entire store. You sell a billion rolls a year. They actually employ full time toilet paper engineers to test things like tensile strength, cross direction, the loft in thickness, and they even use a spectral automata to measure the whiteness of the toilet paper. So they put a lot of effort into the Kirkland brand toilet paper, and that’s their own brand is Kirkland. They’re their private label brand that accounts for about 30 percent of their sales. But yeah. You know, it is interesting that that toilet paper has become the focus of our of our panic buying.

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S4: I do think it’s self-fulfilling and a lot of ways that it could have been the thing. But then one’s for whatever reason, like a couple live, as you say, tweets went viral and Johnny Carson went on the television or whatever.

S6: Everyone started thinking toilet paper. Started buying toilet paper just because everyone was buying toilet paper and there’s no actual other reason for that. And it could have been zapping it, too. Exactly. But it’s happening even with even the Costco people. People are going to Costco maybe twice a month. No, that’s that’s the point. I have seen the videos of people like, as you say, lining up outside Costco with empty shopping carts before Gavin opens to get in there like some kind of weird Black Friday situation.

S1: Yeah, yeah. I mean, the lines are there. The lines are there. I went to a Costco yesterday and there’s plenty of food there. I mean, you know, the shelves are well stocked, but for sure, they’re out of a few things. You go you go a few hours into the day and they’re gonna be out of t’py. It’s not necessarily because there’s a shortage. It’s it’s more just that, you know, people are lining up, they’re storming in there. They’re putting as much as they can fit in their cart. I think Costco. I’m not 100 percent certain, but I think they are starting to institute some some caps, a rationing, toilet paper rationing.

S9: Exactly. And yeah, I me a hundred rolls of toilet paper.

S1: Yeah. I think I think the last ration I heard was that you could only buy two packs, but that’s still 80 rolls of TV. So I’d say it’s going to last you a while if you’re lucky.

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S6: What what have I missed. What’s the what’s the big crazy thing about Costco? Me being an urbanite.

S1: I don’t even comprehend or understand what one interesting thing we could mention is Costco is extremely selective about who it works with. Anyone who works with Costco is going to be in for for a hard time. They’re gonna get pushed to bring down the cost of their products. Costco will even work directly with people who make things to help bring these costs down. There is one story I heard wants about, you know, this teddy bear company wanted to sell their bears and Costco and the retail price was like 100 bucks and they were willing to sell them to Costco for $50 each at this bulk price. But Costco really was intent about selling these berries for twenty nine bucks in their store. So they worked for like months with this teddy bear company to reduce the costs way down like 40 percent. So they could sell these things for twenty nine bucks and they would have made the same profit margin if they had sold them for $60. All that time and effort to drive down the price optimistically, I think it was mostly for the consumers benefit of their stores. They know that people come in there to find good deals and they want to stay true to that. But it did remind me, hearing that story of a perfect counter that I once heard from someone else. I once interviewed Robert Crandall, who is the president of the ex president of American Airlines, and he told me a story about how back in the 80s he took one olive off of every person’s salad on the airplane, back when they serve food on planes. And that saved the company. Forty thousand dollars a year, just taking out one olive off the salad. And in that case, an executive made a move that saved the company money at the consumer’s expense. Costco often will do the opposite. They’ll make a move to reduce the costs, but they’ll pass the saving generally down the chain instead of hoarding it at the top level.

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S6: Yeah, the name has been going through my head. This whole conversation is IKEA like it seems to be like it’s exactly the same model, right? You just have massive warehouses, super low prices. But Costco does seem to have a lot more consumer loyalty than IKEA. Those people really like is a pleasant place like whereas there’s nothing worse in the world. Was thinking like it.

S1: People are obsessed with Costco. I mean, there there are like forums. I mean, if it’s out of control, part of the whole membership model isn’t just a source of revenue. It’s creating this cult of frugality. People like to share their stories about how much money they save at Costco. And like I said before, the average Costco customer is pretty well off, but they’re also incredibly frugal. They’re almost like, you know, a Silicon Valley engineer who makes two hundred thousand a year who insists on only owning four t shirts. It’s like that’s kind of typical got Costco customer, but which they bought to Costco, which they probably bought at Costco or Sam’s Club. Yeah, but yeah, there’s a total cult of frugality to the membership model that works in their benefit as well.

S4: Zack Crockett, thank you for bringing us up to speed on Costco. And we will put the link in the show notes as well for your amazing piece on Chick-Fil-A, which we didn’t have to get to.

S3: But that is a whole other insanely amazing and kind of unique business model. Thank you very much for being with us on Slate. Money, food was fun. Thanks, Felix.