When 2% of Revenue Drives 50% of Profit

Today, I’m digging into Costco (COST). I've written about them before, but I wanted to revisit it.

Specifically, I wanted to focus on their membership model.

Only ~2% of Costco’s ~$275B in revenue comes from memberships, but that small slice makes up just over half of operating income. The entire model leans on those renewals as their membership has nearly a 100% gross margin.

This is a relatively popular story in the business world, but Costco's membership model directly influenced what is now the membership model behind Amazon Prime.

In 2001, Costco founder Jim Sinegal had coffee with Jeff Bezos. He walked him through Costco’s simple model: customer value, razor-thin margins, and a membership model that creates loyalty and cash flow. That conversation pushed Bezos to rethink Amazon’s strategy and ultimately inspired the creation of Amazon Prime.

Here’s what else stands out about Costco:

• Kirkland has grown into a powerhouse. At roughly $86B in annual sales, it functions like a brand-within-a-brand that strengthens Costco’s leverage with suppliers.

• Their margins appear weak compared to most other companies that I've looked at (3.8% operating margin), but that’s intentional. The whole system is built around volume and tight process control.

• Cash position is strong. Costco sits on nearly $10B more in cash than debt.

• They barely advertise. The product, pricing, and in-store experience do the heavy lifting.

Costco has one of the highest NOOB scores of all the companies I've reviewed at a 3.7. They are impressive.

But there are a couple of things that weren’t so rosy:

• Their digital experience still trails Amazon and Walmart. The reluctance to lean into online convenience is a growing vulnerability.

• The recent membership fee hike raises expectations. If the shopping experience slips even a little, that trust can erode quickly.

In the businesses I'm working on, I'm actually gonna lean away from the membership model given that I think there is plenty of fatigue around memberships and subscriptions. But combining razor-thin margins with a 100% margin via a membership has obviously done great things for Costco.

With that, I'll see you tomorrow.

Nick

TL;DR

• Costco runs a global membership warehouse chain where merchandise margins are intentionally tiny and the real profits come from recurring membership fees.

• Revenue is huge (~$275B TTM) but operating margins sit around 3.8%, which forces operational discipline at every level.

• The machine works because Costco uses scale, trust, and minimal SKU variety to negotiate incredible prices and move product fast.

• Entrepreneurs can learn from the membership-first model, the power of one unbeatable value anchor, the focus on process, and the strategic use of private label.

The 30,000-Foot View

Costco operates 900+ membership-only warehouse clubs selling a curated selection of food, general merchandise, services, and gasoline. The business model is simple: keep margins razor thin, move absurd quantities, and let membership fees subsidize low prices.

Key stats:

• Market cap: ~$405B

• Revenue: ~$275B TTM

• Gross margin: ~11.1%

• Operating margin: ~3.8%

• Net income: ~$8.1B

• Employees: ~341,000

Company History

• 1976: Sol Price launches Price Club.

• 1983: First Costco opens.

• 1985: IPO.

• 1993: Merges with Price Club.

• 1995: Launches Kirkland Signature.

• 2012: Craig Jelinek becomes CEO.

• 2024: Ron Vachris becomes CEO.

• 2024–2025: Major membership updates and fee hike.

Show Me the Money

Key financial features:

• ~2% of Costco's revenue comes from membership fees, but those fees represent just over 50% of operating income

• Impressive revenue and gross profit increases over the last few years

• Costco operates with ~ $9.6B net cash.

• Capex rising but well covered by cash flow.

Financial Data

The N.O.O.B. Nine — Competitive Powers

The Nerd Out on Business Nine is made up of Hamliton Helmer's famous "7 Powers" of competitive advantage (Scale Economies, Network Economies, Counter-Positioning, Switching Costs, Branding, Cornered Resource, and Process Power) combined with two of my own (Data Flywheel and Distribution Advantage).

Average Score: 3.7/5 - Strong moat driven by scale and process, not customer lock-in. Hard to attack head-on but possible to flank in digital or niche service models.

Memorable Marketing

1. The $1.50 Hot Dog Combo

• Symbol of value discipline.

• Drives loyalty and traffic.

2. Kirkland Signature

• Single private label across categories.

• Outperforms national brands.

3. Membership Flywheel

• Strong recurring revenue.

• Executive rewards drive upgrades.

4. Executive Early Hours

• Helps relieve congestion.

• Drives Executive tier adoption.

AI Uses & Opportunities

• Current: Inventory forecasting, supply chain, shrink control.

• Future: Churn prediction, dynamic staffing, AI-led product discovery, vendor scoring.

Bumps in the Road

• Labor negotiation pressures.

• Fee hike increases expectations.

• Thin margins leave little cushion.

• Kirkland quality missteps are amplified.

• Digital experience lags major competitors.

Your Swipe File

• Build recurring revenue.

• Anchor trust with exceptional value.

• Simplify assortment.

• Use private label strategically.

• Treat process as strategy.

• Guard culture as you scale.

• Do not copy Costco pricing without Costco scale.