Higher gas prices drive members to Costco, which generally has the cheapest gas in most markets.“Clubs like Costco and BJ’s use gas as a ‘loss leader’ to attract new customers and get more foot traffic into their stores,” according to Investing.com.That’s the accepted logic for low gas prices — they drive in-store traffic, which the website further spelled out.“Why sell gas at a razor-thin margin? Because that helps get people in the door, and justifies the cost of their membership. Customers who notice the savings they receive on gas are more likely to venture into the warehouse for higher-margin goods, especially when economic sentiment is poor, and consumers are worried about stretching their dollars,” Investing.com added.That’s an accepted narrative, but it’s not actually what’s happening, because just like Costco makes a very low margin on gas sales, it also sells items in its warehouses at similar low margins.More gas sales don’t change Costco’s trafficCostco CFO Gary Millerchip shared how Costco’s record gas volume in the third quarter impacted its in-store traffic.”I would say that, generally speaking, a little less than half of our members are visiting the warehouse when they visit the gas station. I would not say we have seen a dramatic change when you look at our results in the third quarter around traffic overall as a result of that. We think partly because a lot of members are increasing their frequency,” he said during the Q3 earnings call.Millerchip said that many members have visited more often to “top up” their tanks due to uncertainty over future prices. Most of those customers, he said, don’t increase how often they actually go inside.More Costco:Costco made several changes to get members to its warehouses moreCostco drops a surprising new exclusive snackCostco solves major frustration for membersSelling gas, however, does drive the one thing Costco cares most deeply about.”We do think over time, it is a great way to build loyalty when we look at our members that are engaged in gas with us, they are generally visiting more frequently overall,” Millerchip added. “They are spending more with us overall, and they are also renewing at a higher rate. So we do think it is a good healthy barometer of long term growth for the business as we continue to drive engagement in gas.”
Costco’s gas stations are for members only.Shutterstock
Renewal is Costco’s magic wordCostco isn’t trying to drive members into its warehouse, clubs; it’s trying to drive them to renew their membership.”Their revenue is from membership. I mean they do care if you enter the warehouse or you won’t keep renewing, but they value and want that annual recurring revenue from membership,” RTMNexus CEO Dominick Miserandino told TheStreet. Most retailers, at least the ones that don’t sell memberships, need to make higher margins than what Costco charges.Economics professor Alan Gin from the University of San Diego believes the motivation for Costco’s aggressive gas price strategy has to do with how Costco makes its money.“The bulk of their profits come from memberships,” he told ABC News.Costco reported membership fee income of $1.37 billion, an increase of $133 million or 10.7% year over year, according to its third-quarter earnings call.”In other words, Costco probably couldn’t operate the way it does if anyone could shop in its stores for free. The membership fees stir the drink and make Costco profitable,” wrote The Motley Fool’s Justin Pope.Membership fees are essentially all profit. That allows the chain to operate its warehouse clubs, gas stations, and online sales on thinner margins than its rivals.”The way membership fees drive Costco’s bottom line means the entire company can grow earnings faster by growing membership fees than by selling more merchandise,” he added.Costco isn’t a store in the traditional sense. It’s a club that sells things in order to get people to join and members to renew. That’s a fundamentally different model than most retailers, and it does not depend upon driving people into its stores.Related: Amazon challenges Costco with July 4 gas savings deal