Hooked

How Costco uses $5 rotisserie chickens and free samples to turn customers into fanatics

A woman pushes a cart while shopping at a Costco Wholesale Corp. store in Hackensack, New Jersey.
Ron Antonelli | Bloomberg | Getty Images

Around the world, there are 94 million people who have a Costco membership card. Celebrities have them: Chrissy Metz of NBC's "This Is Us" is an executive member "because we buy a lot of toilet paper," she says.

There are Instagram accounts devoted to Costco, such as @costcodeals, and websites, such as CostcoInsider.com.

Costco has even become a travel destination — one fan says she has been to 70 Costco stores during her travels. And at least one couple got married at Costco.

This level of enthusiasm for a grocery store may seem odd to some — unless you're a Costco shopper.

Chrissy Metz of NBC's "This Is Us" shows off her Costco membership card
CNBC

"Some of their customer base is absolutely addicted to Costco — absolutely addicted to the experience and the brands and the thrill of going to Costco," Patricia Hong, partner at the global management consulting firm A.T. Kearney, tells CNBC Make It.

And that is by design — inspiring obsession is all part of Costco's playbook. Costco gets you hooked with everything from psychological tricks to the layout of the store and its extreme value.

Membership feels exclusive

To shop at Costco's warehouse-like stores — which sell everything from food and toiletries in bulk to clothes, electronics and diamond rings — you have to buy an annual membership for either $60 (household or business) or $120 (executive).

That makes the store feel "a little exclusive" and thereby more appealing, says Paco Underhill, author of "Why We Buy: The Science of Shopping." You have to be a part of the "club" to even enter.

But more than that, there's a psychological aspect: Since membership fees are a "sunk cost," consumers try to justify it mentally, which results in them shopping more frequently and buying more products each trip, according to Kusum Ailawadi, author of a 2017 study on club shopping.

"You'll say ... I'm going to make sure I get my money's worth by shopping in the club store every chance I get," Ailawadi told KTLA.

As Underhill says, the membership card "vibrates" (metaphorically) in your wallet.

"I have spoken to people that go and drop into a Costco three, four times a week," Hong tells CNBC Make It.

Of course, not everyone believes the membership fee is exclusive, or even worth it, and it may not be if you don't shop at Costco regularly, if you live alone, have little space to store bulk-sized items or are unable to resist impulse buys.

Still, the company says it has a 90% renewal rate in the U.S. and Canada and 51.6 million paying memberships (each of which can have multiple cardholders).

"They have a very loyal membership base," Hong says.

Everybody loves a deal

Consumers go crazy for a deal, and Costco has designed its entire strategy around this core tenet — even if it means resisting the urge to raise prices and increase profits.

A good deal "feels like winning," says Bob Nelson, the senior vice president of financial planning and investor relations at Costco. "Would you rather win or lose?"

Value is the driving force behind Costco's sales strategy, according to Nelson: "The definition of value for us is highest quality, lowest price and best member service."

Part of that equation is that Costco is "an item business," according to Nelson. Every item on its warehouse shelves is meant to be the best in its category. That means there are only between 3,700 and 3,800 items for sale per warehouse, Nelson says. By comparison, a Walmart supercenter sells 142,000 different items, according to Walmart's website.

VIDEO9:1509:15
How Costco's $1.50 hot dogs and free samples helped rake in billions

"Every item has to hold its own," says Nelson. "Part of our secret sauce is our buyers are good at going out there and pre-selecting the best items."

Another factor is price. For example, two 48-ounce jars of Skippy creamy peanut butter bought from Costco online cost $11.49, or $0.12 per ounce). Meanwhile, one 16.3-ounce jar bought on Amazon Fresh and delivered in New York City costs $3.19, or $0.20 per ounce. And an October 2017 price comparison by J.P. Morgan found Costco prices to be 58% cheaper than Whole Foods prices.

Products that are manifestations of Costco's value ethos have become cult favorites people return for, like its $4.99 rotisserie chicken and $29.99 sheet cake that serves 48 people (the value and quality of which was even hat-tipped by gourmet food magazine Bon Appetit).

"Are there things that we could raise the price on potentially and sell just as many items? Maybe," says Nelson. "If we took a widget or something and changed the price from $10.99 to $13.99 could we sell just as many of them...? Possibly. ... But our DNA is figuring out what is the lowest price that we think we can sell it to you at and make a fair return."

James Sinegal, the founder of Costco and its CEO until he retired in 2011, spoke at a Massachusetts Institute of Technology course in May 2018 about selling Calvin Klein men's jeans for $29.99 a pair. The pants were selling faster than Costco could stock them, and when he bought another shipment for $22.99 per pair, it was ultra-tempting to charge more.

"We pass the savings on to the customer, every time," Sinegal told MIT students. "Do you know how tempting it is to make another $7 on a pair? But once you do it, it's like taking heroin. You can't stop."

Of course, some say its value at a low cost comes at price: Costco's popular Kirkland Signature brand, for example, is meant to be inexpensive while also high quality, but certain of the line's products, like its paper goods, have been criticized for their poor sustainability.

And though selling in bulk means less packaging in many cases, according to the company, it also means things like apples that are often not packaged, are packaged in plastic.

Costco has made efforts to be more sustainable in many areas like its seafood, however, and according to Costco's website, the brand "will continue to adapt" alongside its efforts to "remain a low-cost and efficient business operator."

As for service, Costco aims to make the user experience seamless. Take, for example, its generous return policy: Item five years old? No receipt? No problem. There are some restrictions, like electronics have to be returned within 90 days from the date that the member received the merchandise, but otherwise it's mostly a no-questions-asked return policy.

In fact, according to one California Costco shopper, the woman on line in front of him successfully returned a Christmas tree "because it's dead" on Jan. 4.

Shopping at Costco is a journey

Going to Costco is more than just a grocery run; the map for shopping there is strategic to draw customers in, keep them there and ultimately make more sales.

It all begins with the store layout: Necessities are placed toward the back of the store. That requires shoppers to pass by everything else — all the fun and impulse buy items like computers and televisions to get to the milk and produce.

The Costco warehouse in Epping, Australia, shortly after opening.
Costco Wholesale

Along the way, shoppers can drink and eat Costco's famous unlimited samples and even get the occasional free massage. This not only makes the experience enjoyable, but free food has the effect of making you "a much less disciplined shopper," says Underhill, and freebies actually boost sales.

Costco shoppers can also expect to find the unexpected. "People come back to Costco stores for the thrill of the treasure hunt," Hong says.

In addition to staples such as its Kirkland Signature brand toilet paper (30 rolls of two-ply tissue cost $18.99 online), Costco has an ever-rotating lineup of surprise deals — like designer Marc Jacobs, Coach and Rebecca Minkoff bags around the holidays — which keeps customers hunting.

Costco is nostalgic

Costco first opened in 1983 in Seattle and has "built its franchise with an older American affluent consumer," largely the baby boomer generation, Underhill tells CNBC Make It. In 2017, the most recent year Costco has data for, the average household income of the Costco member was $92,236.

And because it is so popular with baby boomers, (those born between about 1946 and 1964), it has now become nostalgic to their children and grandchildren, aka millennials.

"I've spoken to a few consumers that have started their relationship with Costco not so long ago and several of them recall the Costco experience with their families — shopping trips, eating in the food court, items at home — and so for them to now go back and have their own membership also almost becomes a rite of passage," says Hong.

Costco plays on the nostalgia because it's great branding: Take for instance, Costco's $1.50 Kirkland hot dog and Pepsi soda combo that has been available at that price since 1985, which industry tracker Winsight Grocery Business calls "Costco's secret weapon."

"It's legacy. Look at all the people talking about it. ... It's one of the things we are known for," says Nelson.

In fact, that's why it has the same price it did in 1985; Costco makes "very little money" on the combo deal, Nelson says, but "we get so much more mileage out of it than we would by raising the price to $1.60 and making a few more million dollars."

Costco's increasing investment in the e-commerce space is also playing well with younger shoppers, Hong says.

How it all boosts Costco's bottom line

In fiscal year 2018 Costco had net sales of $138.4 billion (an increase of 9.7% from 2017), revenue from membership fees of $3.1 billion (an increase of 10.1%) and profits of $3.1 billion (an increase of 17%), according to the company's annual report.

The enjoyable experience and value for its prices — not to mention its bulk sales ("They make money getting you to buy 10 pounds of coffee rather than two," Underhill says) — results in the average spend per visit at Costco being between $130 and $140, according to Nelson (which includes money spent at the pharmacy, gas station and main store).

That's more than shoppers spend per trip at other stores. For example, an analysis of money spent per trip by Perfect Price based on credit card transactions in May and June 2015 found shoppers average $136 per trip at Costco, $81 at Sam's Club, $62 at Target, $55 at Wal-Mart, $54 at Whole Foods, $50 at Trader Joe's and $50 at Kroger.

And Costco boosts its bottom line by saving on costs. It has exceptional relationships with suppliers, says Hong, so it gets competitive prices on goods. And once the product is in the warehouse, operational costs are bare-bones; goods are sold from the pallets they arrive on (instead of employees taking the time to stack each item individually), for example.

Costco also makes money via its membership fees, but more importantly that revenue "allows us to be a bit sharper on price than we would be if we didn't receive that," Nelson says.

"Costco does a really good job hiring" too, says Underhill.

The company pays well. In March, Costco announced it raised starting wages to $15 an hour. And about two-thirds of the company's selling and general administrative expenses go to employee labor and benefits. "It's just good business," Nelson says. For example, turnover, which is expensive for a business, is relatively low, Costco says.

Fundamentally, Costco's business strategy — low prices and thin margins on high-quality products — is what makes customers ravenous for the experience. And that makes the company billions.

"The thing that is uniquely different about us is we want to find the best items out there and sell it to you at the fair price, and a fair price to us is just make a fair return," Nelson says.

— Video by Emma Fierberg

Disclosure: NBCUniversal is the parent company of CNBC.

See also:

Ex-Apple exec Guy Kawasaki: I want a product that will make me 'wait like a fool outside an Apple store'

Google execs reveal secrets to success they got from Silicon Valley's 'trillion dollar' business coach

Amazon's Jeff Bezos: Why success depends on not being efficient sometimes

VIDEO17:0917:09
'This Is Us' star Chrissy Metz on being broke, Warren Buffett and Costco

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