How warehouse stores make money

Last week, I listened to an old episode of NPR's Planet Money podcast. In this 15-minute installment about “anti-stores”, the hosts look at businesses like Price Club and Costco. What makes them different? How have they succeeded by re-writing the rules of retail?

“It used to be if you ran a store, you wanted to make it easy for your customers,” the hosts say during the intro. “PriceClub and Costco went in the opposite direction. They made shopping harder.” Yet, it worked. “Today, Costco alone sells more stuff every year than Amazon — by far.”

How Warehouse Stores Make Money

Here are some examples of how warehouse stores go against conventional wisdom:

  • When you join a warehouse club, you pay a membership fee. It's not much — maybe $40 or $50 per year — but it's something, and it puts you in the hole from the start. You feel motivated to spend in order to recoup your “investment”.
  • Regular retail stores have signage to help customers find what they need. Warehouse stores, on the other hand, intentionally do away with signs because it encourages people to wander the aisles. As they wander, they're more likely to find other things to buy. (Seriously, this is a deliberate design decision!)
  • Warehouse stores often sell in bulk, which gives the consumer the illusion that they're saving money. (And they are saving money — if they use everything they purchase instead of letting it go to waste.) But bulk sales also help the store. Their goal is to have people shop infrequently. The less people come, the less the business needs to spend on overhead.
  • A normal store offers a wide selection; warehouse stores offer limited selection. “When you have more selection, you have more labor,” notes Robert Price, founder of Price Club. Plus, you have to store the backstock, which costs money.

And why does Costco only accept Visa credit cards? Because they've struck an exclusive deal with the Visa payment network that saves them a ginormous amount of money. (Seriously, it's huge.)

Online Shopping Gets a Piece of the Action

With the advent of online shopping, businesses like Amazon are taking the lessons from warehouse stores and building upon them.

When you buy something online, for example, much of the purchase price goes to shipping and handling — even if you don't know it. When you pay $99/year for Amazon Prime to get “free shipping”, you're still paying for shipping. The cost is embedded in each item's price.

Knowing this, you can see how certain Amazon business practices make sense.

  • Lots of little things are “add-on” items at Amazon. You can't order them on their own, but instead have to buy $25 of other stuff before you can place an “add-on” item in your cart. Otherwise, there's no way for Amazon to recoup their labor costs.
  • I'm a big fan of Amazon's “subscribe and save” program, which lets me receive one monthly shipment of items I use often (such as multivitamins, coffee, and dog food). When you subscribe to enough items, you get a big discount: 15%. That's a win for me, but it's also a win for Amazon because they're able to do one big order instead of several small ones.
  • Recently, Amazon has introduced delayed shipping. When you place an order, you're given the option of delaying shipment for a few days or a few weeks. If you do, you get a credit to your account. Again, this is a win for me and it's a win for Amazon, who can then wait to fulfill the shipment the next time I order something.

This episode of Planet Money reminded me a lot of the book Why We Buy: The Science of Shopping [my review], which describes all of the many, subtle ways stores manipulate customers into buying more.

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Karen Klinedinst
Karen Klinedinst

I love my neighborhood hardware store, where I can go up to the counter and ask for what I need. Then they go in the back and get the item and bring it to the check-out counter where I proceed to pay for it. I have no desire or time to wander through a big warehouse looking for something, and finding other things to buy that I didn’t intend to. So, I might pay more per item in my neighborhood hardware store; but, I will never walk out of there with things I never intended to purchase.

Jon
Jon

We use Amazon wishlist to put things on Amazon that we wish to buy. Then we use purse.io to purchase those items and get a 15% discount (about 12% or so after fees). Since we don’t really purchase that much it works out pretty well. We put about $300 into bitcoin for this purpose and didn’t buy all the stuff we were planning on purchasing. Since then we haven’t really paid for anything since the price of bitcoin has gone up so much. Also, we use costco to get eggs, tortillas, bacon/sausage on a regular basis since we have for… Read more »

Kate
Kate

I would love a more in-depth take on if it’s beneficial and where that line would be in using these stores or special memberships. I listened to the episode awhile ago and felt somewhat annoyed at how Costco is designed to make me spend more, and stand in lines that never seem to end. I only joined this year, but may not renew until I find a real true reason to keep shopping there outside of finding good sales at other stores. Some things I may miss, like their dog food for my dogs, but other things I won’t like… Read more »

Bonnie
Bonnie

Agreed! Would love to hear more of JD’s thoughts on why/if these types of stores are a good value. I’m going back and forth on whether I want to renew my Costco membership, too. When I had a baby in diapers who drank formula, Sam’s/Costco was 200 percent worth it for us. Now that she’s out of that stage, I’m not so sure the membership fee is worth it. Also I got the serious hard sell for the Executive Membership, which I fell for and didn’t need (and which doesn’t offer the same perk as Sam’s Plus, which is special… Read more »

Ron Cameron
Ron Cameron

The Executive Membership is a slam dunk: If your increased rebate doesn’t at LEAST equal the extra cost of the membership, tell them and they’ll give you the difference. It was obnoxious to have them incessantly try to sell me on it until one employee finally told me the above detail. I’ve never had to do it, but it just depends on how much yo spend. Also, make sure you check out Costco.com – they have WAAAY more there than in-store. As for “feeling annoyed at how Costco is designed to make me spend more”, all stores do that. Costco… Read more »

Bonnie
Bonnie

Thanks for the counterpoint, Ron. Since this is my first year as a Costco member, I don’t understand how the rebate works. Do you have to go in person when your card expires and then they look it up and see if you paid enough in? Or do they just mail you a check? That’s just not clear to me. I do wish they would consider the earlier hours for Exec Members, but I suppose that the later opening hours might be part of the benefits of working there. I was there on Saturday and spent only $100 and considered… Read more »

Ron Cameron
Ron Cameron

They’ll automatically mail you a “check” that you can cash at customer service. If you see it and say “Hey, that’s only $23.47!” go to that same customer service and they’ll pay the difference. At least that was their system 5-10 years ago 🙂

Regarding hours, I’m always impressed (and occasionally annoyed) that they’re really open a minimal amount of time, especially around the holidays. I think long ago they had extended hours for Executive Members, but that was before I was a weekly customer.

TS
TS

Not disagreeing with some of the points made, but I think the answer is – it depends on how you manage it. My wife and I live within 20 minute drive from 2 Costco stores and mostly buy: produce, fruit, paper products, sparkling water, occasional jar of pickles, kimchi, cheese, dog food, occasional pork ternderloin and pork belly (for curing bacon). The only waste we have from the trips is pickle jars and the cardboard box, and we use it at least once more during the week when we pick up local CSA share. Discarded cuts of produce goes to… Read more »

Michael
Michael

This is where I am. In fact I belong to both Costco (2 miles away) and BJs (about 5 miles). While they are both very easy to overspend at, they definitely have advantages. The main one is gas. If you have a warehouse club nearby, you will probably make up the membership cost on gas alone. Looking at my gasbuddy app right now, Costco and BJs are both $.28 cheaper than the other stations in the area. For me, as Costco is on my way to work, that is absolutely worth the membership alone. I also purchase almost all my… Read more »

Money Beagle
Money Beagle

I have heard that Costco basically breaks even on selling merchandise, but that their profits basically come from the membership fees.

Bonnie
Bonnie

Which must be why they REALLY push the Executive Membership (see my comment above), to the point of obnoxiousness.

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