Business Over Easy
Businesses and industries, simplified and served weekly.
Main Course
Club Costco: The $65 Cover Charge
Costco isn’t making a ton of money from you buying groceries or stopping for a $1.50 hot dog on your way out the door. Costco certainly wants you buying things once you’re inside, but squeezing the biggest possible profit out of every item isn’t its main concern. What Costco really cares about is that $65 membership fee you pay once per year, and keeping you happy enough to pay it again next year.
I can smell the hot dogs from here.
Walking into Costco is an experience in itself. A pilgrimage of ultimate consumerism. They scan your membership card as if you’re accessing a top-secret facility. Upon being granted access, you’re instantly greeted by concrete and industrial shelving as far as the eye can see. TVs, jewelry, and cell phone salespeople catch your eye first. You then see a tent for a family of five, a grill cabana, and a 15-foot pool inflatable rising above the fray, a monolith to Costco’s endless offerings. Oh look, they’re having a sale on khakis!
Pushing further, you’re greeted by a labyrinth of bulk goods; peanut butter, wet wipes, olive oil. A kind older woman offers you a sample of cheese tortellini while someone walks by with a 10-foot tube of ground beef. There’s a 20-person line waiting for $4.99 rotisserie chickens.
With the sheer volume of stuff going on inside any Costco at any given second, it’s not exactly a surprise that the grocery goliath sold close to $270 billion worth of merchandise in 2025 (Costco Annual Report). It’s a well-oiled machine in every sense of the phrase. It may not surprise you either that Costco also pulled in about $5.3 billion in 2025 from membership fees alone, with customers more than willing to pay for access in return for savings on groceries and household items.
What may surprise you is just how critical that $5.3 billion is to its bottom line.
Crack It Open
Costco brings in hordes of customers by offering something that typically makes zero sense for retailers and grocers: selling its products at prices remarkably close to cost. This means Costco’s merchandise business operates on unusually thin margins compared with most retailers.
According to Costco’s 2025 10-K filing, the company generated $30.02 billion in gross profit from its $269.9 billion in net sales. Subtract its $24.97 billion in selling, general, and administrative expenses (essentially many of the overhead costs of running the business), and you’re left with a little over $5.06 billion before membership fees come into the picture.
Then comes the “cover charge.”
Costco collected another $5.32 billion in membership fees during the year.
That number is pretty insane for a couple of reasons. Membership fees represented less than 2% of Costco’s total revenue in 2025, yet that $5.32 billion was equivalent to roughly 51% of the company’s entire $10.38 billion in operating income.
Operating Income: the money left from running its core business before interest and taxes are taken out.
In other words, Costco sold nearly $270 billion worth of merchandise, and the comparatively tiny fee customers pay just for the privilege of walking through the door was equal to more than half of its total operating income.
For most retailers, operating with merchandise margins this thin would leave very little room for error.
The crazy thing about Costco, however, is that it isn’t trying to maximize the profit it extracts from every sale. The $4.99 rotisserie chickens, the $1.50 hot dogs, and all the groceries that seem cheaper than anywhere else you’ve seen?
Those are the sales pitch.
Your membership fee is the real product.
Everything you love about Costco is designed to make that yearly membership feel worth paying for again next year, and every year after that. Costco has this down to a science. In 2025, it reported a membership renewal rate of 92.3% in the US and Canada.
Why is it so laser-focused on collecting your yearly membership fee instead of squeezing more profit out of the $350 you seem to spend every time you walk in? Membership fees don’t require Costco to buy pallets, stock shelves, or predict inventory, making them an attractive (and fairly straightforward) source of recurring revenue.
It makes sense why so many aspects of shopping there seem a little too good to be true. Everything inside is part of the sales pitch to the customer paying for access.
Costco doesn’t just need you to shop there.
It needs you to believe the fee is worth paying again next year.
Costco and nightclubs are also pretty similar in that I usually walk out of both having spent a lot more money than I planned to.
It may help to think of Costco like a nightclub.
A nightclub generates its income in two ways: through the cover charge at the door, and the drinks that you buy once you’re inside. Nightclubs will offer cheap drinks or run specials all night in order to draw people in. This creates a line of people at the velvet rope willing to pay a fee at the door for the opportunity to go inside and get cheap drinks and a fantastic evening.
The profit margin on the drinks inside (or groceries and other goods in Costco’s case) isn’t necessarily as important to the nightclub, because it’s already collected a chunk of your money at the door. Costco and the hot nightclub downtown don’t operate all that differently, except the customers probably wear more leather to one than the other.
The thing about nightclubs is that the cover charge only works if people believe the party is good inside. If customers hear that the drinks are still expensive and the party is lame, they aren’t going to pay the cover to get in, and they will probably tell their friends to stay away. Costco knows that it has to keep prices extremely low, or customers aren’t going to keep renewing memberships.
Costco has a loyal, satisfied customer base that keeps the money coming in. Because of the effort to keep customers happy, there can be little room for error.
High dependency on membership renewals. Because Costco operates on unusually thin merchandise margins, even a small drop in renewal rates or resistance to future price hikes can hit profit a lot harder than it would at a “normal” retailer.
Competition can be fierce. Sam’s Club (Walmart) and BJ’s Wholesale both run a pretty similar playbook, offering access to bulk savings in exchange for a fee. Amazon and Walmart+ are both chasing the same “pay for access” customer base with more of a focus on convenience.
Thin margins leave little room for error. Tariffs, supply chain disruptions, or rising wages can squeeze margins even thinner. There isn’t much room for Costco to pass through higher costs without undercutting its low-price reputation.
The low-price reputation has to be defended. The entire membership sales pitch rests on Costco staying meaningfully cheaper than the competition. If competitors get cheaper, or Costco’s fees rise, the advantage could erode quickly.
Costco is a titan in the retail space. What makes its business model so effective at creating (and keeping) paying members?
Recurring, highly predictable revenue. The membership fees are paid up front, once a year, whether customers set foot in the store once or fifty times. Costco receives that cash regardless of how much members spend in the store.
Insane renewal rates. Over 92% of US and Canadian members renew every year. Once someone joins, they almost never leave, which makes membership revenue extremely predictable.
Low prices stifle competition. By intentionally keeping its margins thin, Costco builds the reputation that it’s hard to compete with. Other retailers without a subscription model aren’t able to come close to offering the same prices.
The cycle feeds itself. Lower prices bring in more paying members. More members mean more buying and negotiating power for Costco with its suppliers. This allows for even lower prices from those suppliers. The cycle keeps on moving, and membership fees fund the whole thing.
Finishing Up
Costco operates more like a subscription service than a traditional grocery store or retail chain, but this is the exact advantage that sets it apart. It goes to great lengths to make sure customers are happy and renewing memberships; nearly everything beyond that helps make sure you want to pay for it next year too.
Short Stack
$269.9 billion: Costco’s net merchandise sales in 2025.
$5.3 billion: Costco’s revenue from membership fees.
51%: Costco’s membership fee revenue as a percentage of its 2025 operating income.
$65-$130: Costco’s annual membership fee.
92.3%: the rate of members across the US and Canada who renewed their membership in 2025.
Source
What’s Your Order?
Do you see any issues in the future that would keep Costco from maintaining the same rate of membership renewals in the future? Hit reply and let me know!
We want to hear from you!
Got a business model that confuses you? Reply to this email! It might just be next week’s issue.
Until next time,
Brandon
Business Over Easy