Why Costco Delays Price Hikes on Muffins
Delaying the inevitable is rarely an admired tactic, but Costco
does just that when it comes to raising select food prices in an inflationary
period.
On a conference call last week for its second quarter ended Feb. 13,
management noted that although overall gross margins in the quarter grew to
12.6 percent from 12.5 percent year-over-year, fresh foods were down 10 basis
points, primarily due to commodities price inflation. On the call, Richard
Galanti, the club’s chief financial officer, said fresh foods’ margin dip reflected
the fact that Costco tends "to hold pricing as long as we can," particularly
on key small business items, as well as some items in the food court, bakery
and the deli.
As an example, Mr. Galanti pointed to a 15-pack of muffins costing
$5.49. He said Costco sells a "heck of a lot of those to restaurants and
businesses and convenience stores" for resale. To support those small
business members, Costco is willing to realize lower margins for several weeks
or a few months before finally bringing prices up 30 cents to 50 cents to get
back to regular margin.
"That’s not a competitive issue other than we want to protect the prices
to the members who are buying these items," said Mr. Galanti.
The fact
that the 15-pack muffin package has held that price seemingly "forever" also
leads to the delayed price increase. In that same manner, despite rises in
the cost of cheese and other ingredients that have impacted the profitability
of pizza, Costco isn’t planning on soon changing its $10-for-an-18-inch-pie
deal, or $1.99 a slice, in its food court.
Mr. Galanti also noted that Costco is also
able to hold prices on certain items because overall margins "have been
quite good" partly due to
its decision to change its electronics returns policy two years ago. Vendors
are supplying some promotional support in the form of enabling additional buys
at the old price for a limited period. Costco’s strong private label assortments
also provides some leverage in price negotiations.
Nonetheless, Mr. Galanti
said with inflation continuing in the low- to mid-single digits range in fresh
foods and in the low-single digit range in food and sundries, Costco has been
passing along price increases on most items, particularly traditional supermarket
items such as tin foil, paper goods and cereals. And with inflation appearing
likely to only increase over the year, the chain will inevitably have to raise
prices across the board.
"Ultimately, you’ve got to pass on cost increases, but we want to hold
in longer and particularly on those business items like the 15 packs of muffins," said
Mr. Galanti.
- Costco Wholesale Corporation Reports Second Quarter and Year-to-Date Operating
Results for Fiscal Year 2011, and February Sales Results – Costco Wholesale
Corporation - Costco Wholesale Management Discusses Q2 2011 Results – Earnings Call Transcript – Seeking
Alpha - On the Call: Costco’s CFO on passing along costs – Bloomberg Businessweek
- Costco, BJ’s Post Solid Results Aided By Membership – The Wall
Street Journal
Discussion Questions
Discussion Questions: What do you think of Costco’s move to selectively delay price increases? What should guide any decisions around the timing and extent of price increases in inflationary periods?
Costco has a well deserved reputation for looking out for its members, especially in terms of price. They are notorious for keeping margins slim, and kicking out vendors where there is a pricing or value issue – i.e. Coke (back in), Apple (not). I think members realize that Costco works hard to keep prices low and value high, and they reward that accordingly. There are other things that they don’t do so well, but consumers are by and large willing to overlook those.
Let’s applaud Costco for their ongoing support of the small business market. Yes, they are a large part of Costco’s business and they realize the need to assist them in any way they can. Great job Costco.
I think it’s great. Many are raising their prices in advance of actual cost increases, I mean seriously, look at the price of gas and oil. No supply disruptions have occurred yet. It’s just piggishness,
Good job Costco. Makes me want to go buy some massive quantities of something!
Well – this move will certainly drive shoppers to pick through the aisles for good deals. That’s smart – taking advantage of a marketplace negative & turning it into a business opportunity. Good for them.
The customer segment valuation in this example is interesting (i.e., “particularly on business items”). It makes a lot of sense economically. Costco’s business customers must spend a lot more on average than consumers do. Yet the product margins are the same, so individual business customers must be far more profitable. This gives a way of investing in the more valuable segment, but without price discriminating on a customer basis.
Of course, this same approach (price investments targeted to segments through products) is relevant much more broadly in retail. But I’m not sure holding off on taking price is the right way for many retailers outside the club sector to handle it.
Let’s see, Costco pays and treats its employees better than most, and really does seem to have the best interests of its customers in mind. Hmmm … anyone surprised then that they continually perform so well?
Retail isn’t rocket science (although the IT folks would like us to believe that it is). More retailers should follow Costco’s lead on both employee and customer relations.
Costco’s delay in raising prices on select products during inflationary times is because they know it’s smart business, good merchandising, top notch PR — and Costco can afford to do it because they generate strong sales per square foot. Costco has its act together.
Eight to ten percent consistent same store sales growth. I wonder? Do they know their customer? Do they know how to create real loyalty? As Captain Jack Ross said, “These are the facts, and they are undisputed”. Consistent same store sales growth. Its a fact. Their strategies are directed towards that and they win – consistently. No magic act. No misdirection.
This is an important story as the effects of cotton and other commodity price increases begin to manifest. Taking a literalist, item-for-item price perspective (my price increases so yours will as well) is old school, particularly for multi-category retailers. The key phrase is “overall margins.” Costco gets it that they are managing a portfolio, not a single position.
I wonder what Costco’s Galanti charges for tin foil. Is it cheaper than aluminum foil? If so, our family could save some money.
In “Pretty Woman,” Richard Gere asks Julia Roberts what happens after the hero “climbs up and rescues” the girl, and she responds, “She rescues him right back.” It’s the same with Costco. Costco is loyal to its members, and the members are loyal right back.
We continually refer to consumers who purchase in Costco stores as customers. They aren’t. As Al McClain pointed out, they’re members. And that’s precisely why Scanner referenced loyalty in the Costco/member relationship. Costco is loyal to members and members are loyal right back. And clearly Costco has identified several items that are brightest on its members’ loyalty radar. Essentially, Galanti is saying that a static price for muffins leads to a static price for muffins. That is, because a price increase has been delayed for “forever,” it will continue to be delayed. It must make sense to Costco, because it seems to be effective.
To today’s question, we must take into account that there are different pricing dynamic rules for member/consumers as opposed to customer/consumers. Costco has taken upon itself a merchant responsibility in their relationship with members that goes far deeper and is far more accountable than typical retailer-shopper transactions. Thus, price policies for Costco in inflationary periods will not apply to other types of stores. The timing and extent of Costco’s price increases depend most upon member feedback and satisfaction, unlike any other style of retailing.
All this positive feedback is very gratifying. I work for Costco and am responsible for getting today’s topic on the racks in a large enough supply to increase sales. All I know is that our muffins are the most time consuming part of our day, it commodities prices are increasing our company would rather take a hit on our margins than upset our members. They are the driving force of our company, happy members keep signing up.I don’t think it’s any more complicated than that. Great feedback everyone.
All pricing should be selective. A good merchant understands the marketplace and prices their products accordingly. A good PR agency never misses the opportunity to leverage a positive story. In this case, Costco is running on all cylinders.