Midday Report: Costco's Membership Fees, Low Prices a Magic Formula

Produced by Drew Trachtenberg

With consumers pinching pennies, why are so many people willing to pay just for the right to shop at one chain?

Costco (COST), it seems, has found a magic formula.

Most of its customers pay $55 a year in membership fees. With that they buy the right to shop in big warehouses, with no décor to speak of. But they also get cheap prices, on everything from socks and paper towels to steaks and garage doors. The company limits its price mark-up on everything to no more than 15 percent. That's created loyal customers who keep coming back -- and paying that membership fee.

In fact, Costco collected $528 million in membership fees last quarter, accounting for most of its profit. Overall, net rose 39 percent from a year ago, beating Wall Street expectations.

This combination of guaranteed revenue from membership fees and high sales volume has generated consistent growth. Costco's main competitors are Wal-Mart (WMT) owned Sam's Club and BJ's Wholesale, and analysts say Costco has outperformed them in terms of sales growth and productivity.

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Costco also does a good job of controlling costs. Many of its stores use solar energy to power their electrical needs. And even though they pay their workers a bit more than most retailers, they have less turnover, which also helps the bottom line.

Costco's stock rose two percent this morning, but it's been pretty flat this year, despite the double-digit gains for the overall market. Longer term, Costco has fared pretty well: Its shares are up about 15 percent over the past year, and up about 70 percent over three years.

Costco is not without critics. It was sued last month by high-end jewelry retailer Tiffany (TIF), which claims that Costco was selling counterfeit Tiffany diamonds rings. Costco also sells some high-end art, and there have been questions about the authenticity of some of those pieces as well.