TLDR:
- Costco utilizes the loss leader strategy, in that they sell their food court items for a price lower than it costs to produce. They’re essentially losing money by running their food court.
- However, they embrace it. To keep costs low, they began to produce their own hot dog meat for their $1.50 hot dog, with CEO Craig Jelinek promising that no matter what, it’ll always cost $1.50.
- “We drive sales, not a margin company.” This utilizes the Halo effect, where the low food court prices help create a positive image in the mind of the consumer and drive them to make an unplanned purchase under the guise of believing that they won’t find a better deal elsewhere.
- “We [Costco] have a responsibility to figure out how little we can make off of a product instead of how much we can make off a product.” They are in the volume business, so they want to sell as much as they can. One way they achieve this is with their Kirkland Signature brand, which isn’t a cheap alternative, but rather meant to be a competitor to the mainstream by providing the same quality at a lower price.
- “With low prices, you generate a lot of volume, and when you generate a lot of volume, you generate cash.” If cash is king throughout the world, then for Costco, volume is king.
Why Costco’s profit margin is lovin’ it more than McDonald’s
When you think of Costco, you probably first think of its food court. A $1.50 for their iconic quarter-pound hot dog, $1.99 for an 18’’ pizza slice, and their chicken bake.
You’ve probably thought, “How can they keep prices that low?”
So what if I told you that with those prices, they’re able to compete with major fast food chains such as McDonald’s?
That’s right, Costco’s food court actually helps Costco generate more profit than McDonald’s.
By losing money.
You’re probably scratching your head now, but here’s how.
Costco purposely loses money with its food court items by selling them for less than it costs to produce, known as the loss leader strategy.
So every time you’re enjoying that $1.50 hot dog, Costco is actually losing money by selling it.
But they don’t care. In fact, they embrace it.
Since it was first founded in 1976, Costco has been selling its hot dog for $1.50.
To make this possible, in 2009, they began producing their own hot dogs by bringing production in-house at its location after their Kosher suppliers started to run low on meat.
Along with that, they purchase their buns, ketchup, and mustard for lower prices.
In spite of rising inflation, especially during the COVID pandemic, the hot dog was still $1.50.
It's the promise of CEO Craig Jelinek, that no matter what’s going on in the world, their hot dog will always be $1.50.
This highlights the mission statement of Costco, one that you’ll hear Jelinek say in all his interviews: “We’re not a margin company, we’re a volume company.”
He has also said “We drive sales, not a margin company”, and keeping prices this low at the food court shows that.
The food court prices also take advantage of the Halo effect, in which the very low prices make the consumer create a positive image of the brand in their head.
And if they’re eating in the food court, chances are they might make an unplanned purchase, firmly believing that they won’t get a better deal anywhere else.
This brings us to our main point.
Unlike McDonald’s, Costco doesn’t only sell food. It's primarily a wholesale retail company, which is why it is possible for it to operate its food court using the loss leader strategy.
In an interview with Yahoo Finance last year, Jelinek says that they don’t make a lot of margins and that their goal is to sell “high-quality goods at a great value.”
And Costco doesn’t only cater to the average American demographic, they cater to all classes.
On average, Costco sells its products for up to about 13% in markup, which allows them to sell a $2300-$2400 wine for under a markup of $2000 (an example used by Jelinek).
Jelinek says that because they are in the volume business, want to sell a lot, and aren’t in the margin business, “we have a responsibility to figure out how little we can make off of a product instead of how much we can make off a product.”
One way they do this is with their Kirkland Signature brand, which isn’t your typical cheaper off-brand alternative, its objective is to be better or equal to the quality of mainstream brands and at the same time be the cheaper alternative.
In an interview with CNBC in 2020, Jelinek says that they truly want consumers to believe that they won’t find better deals anywhere else, and the Kirkland Signature brand is a key part of achieving that goal.
During the same interview, he says that “with low prices, you generate a lot of volume, and when you generate a lot of volume, you generate cash.”
If cash is king throughout the world, then for Costco, volume is king.
And volume is how they have been able to rake in more profit than McDonald’s.
So far in 2023, Costco’s market cap stands at $261.82B, well above McDonald’s current market cap of $204.94B.
Jelinek also goes on to say that if you want to figure out how to lower the prices, you have to lower your expenses. The lower your expenses, the more efficient you become and the more they can lower prices.
And that’s why Costco’s food court is more profitable than McDonald’s.