Brad Ferris does a lengthy analysis of Costco’s business model in this post, and he makes it clear that despite Costco’s low prices on many items, their business model is not centered around competing on price, which makes COST a more attractive company to own stock in:
Have you ever asked yourself the question, “How can I come into Costco for just milk & walk out spending $65?” Milk never costs $65 and in fact is likely the lowest margin item sold in Costco. The reason you walk out of Costco spending more than your intended $4 is because of how strategic management is utilized and the business’ ability to understand customer behavior.
Say you go to Costco for a bag of milk on your way home from work. At every Costco there is only ever one entrance and one exit for all customers. You are greeted by one or more employees on the way in and at least one on the way out. Immediately as you enter the warehouse you’re required to display your exclusive membership card and are immediately handed a coupon pamphlet of various discounted products. You then have to navigate the same landscape that is duplicated hundreds of times at every other Costco warehouse in North America. In order to get to the milk (located at the far back corner) you have to navigate your way through consumer electronics, home appliances, clothing, automotive, books, games and home accessories.
These are all high-margin items; the percentage markup from the manufacturer cost is higher than other products. Located at the rear and far side of the warehouse are food and household perishables which are lower margin and generally more frequently purchased items. These lower margin items are placed strategically opposite the entrance & exit because Costco wants you to browse, investigate, sample and spend more time in their stores in the hopes you’ll find something you want, need or decide to try. You then navigate the rest of the store back towards the checkout and are advertised to for supplementary business such as credit cards, small business loans, auto & home insurance, business telephone, check printing & real estate/mortgage services along your exit.
Everyone that’s ever entered a Costco knows full well that they’re not going to leave just with the low-price staples they pretend are the only reasons to shop there. In fact, I would say that many people justify buying the other random but attractive items by thinking of the few cents they saved on the staple items. It goes like this “I just saved 3 cents on milk, with that money I saved I can buy this pair of jeans, too. I have been needing a couple new pairs of jeans. Maybe I’ll buy two.”