Costco Makes Almost Zero Profit on Merchandise: The Membership Model That Defies Retail Economics

Costco Wholesale reported $254 billion in net sales in fiscal 2024, making it the third-largest retailer in the United States behind Walmart and Amazon. The company operates approximately 890 warehouses globally and maintains a renewal rate of approximately 93% among its 130+ million cardholders. These are impressive numbers. The extraordinary number is what Costco earns from selling merchandise: essentially nothing.

Costco's gross margin on merchandise is approximately 11% — roughly half of Walmart's (~24%) and a third of Target's (~28%). After covering warehouse operating expenses (labor, occupancy, utilities, shrinkage), Costco's profit from merchandise operations is near zero. The company's actual profit — over $7 billion in annual operating income — comes almost entirely from membership fees: the $65 (Gold Star) or $130 (Executive) annual fee that each household pays for the privilege of shopping at Costco. Membership fee revenue was approximately $4.8 billion in fiscal 2024, with the remainder of operating income coming from ancillary services (pharmacy, optical, food court, gas stations).

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Why It Works

Costco's model works because the membership fee creates a self-selecting customer base with a pre-committed economic incentive to consolidate spending. A member who has paid $65-$130 for the right to shop at Costco is motivated to maximize the value of that membership by purchasing as much as possible at Costco's low prices. This concentration of spending gives Costco enormous purchasing leverage with suppliers — it can demand (and receive) lower wholesale costs because it sells massive quantities of each SKU through a limited number of warehouses.

The limited SKU strategy reinforces this cycle. Costco carries approximately 4,000 SKUs compared to 30,000-100,000 at a typical supermarket and 100,000+ at Walmart. By offering fewer choices per category, Costco concentrates volume on each item, which enables it to negotiate lower costs, which enables it to offer lower prices, which justifies the membership fee. The model is circular: low prices justify the fee, the fee creates committed shoppers, committed shoppers concentrate volume, concentrated volume enables lower costs, lower costs enable lower prices.

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The Hot Dog as Strategy

Costco's $1.50 hot dog and soda combo — unchanged since 1985 — is not a loss leader in the traditional sense. It is a brand statement: an artifact that communicates Costco's commitment to value in a way that no advertising campaign could. The hot dog combo costs Costco money on every sale. Its purpose is to reinforce the member's belief that Costco is relentlessly focused on providing value — a belief that justifies the membership renewal and the concentrated spending behavior that funds Costco's actual profit. The hot dog is not a product. It is a trust mechanism.