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- Retailers' profits are seeing a pinch as inflation cools — and in some categories, even reverses.
- For Costco, raising membership fees can offset some of that deflationary bite.
- The wholesale club prides itself on ultra-low markups, and membership fees help it do that.
Consumer prices cooled significantly in the past month, with some categories ticking into reverse as inflation was nearly flat.
A fall in prices (known as deflation) can put a pinch on retailers' profits as they must offer better promotions and discounts to keep shoppers coming back.
For Costco, deflation tends to come a bit earlier, since the company prides itself on adhering to an ultra-low markup strategy that leaves less room for experimentation than a traditional retailer might have when prices are falling. (Given its size and buying power, Costco is credited with helping prices come down too.)
In periods of normal inflation, Costco prefers to make more money by simply selling more stuff: "We're a top line company, we want to drive sales," former CFO Richard Galanti was fond of saying.
But Costco also makes a lot of money from the membership fees it charges to gain access to its ultra-low prices. In fact, fees represented around two-thirds of the company's profits last quarter.
As grocery prices remain flat or tick down, those fees will offset some of the deflationary bite Costco faces this year.
When Costco is looking for more fee revenue, its preference is ordinarily to simply sell more memberships (which it has been doing aggressively for the past year).
The other option is to raise the price of the membership — a move the company resisted until this week when it announced the basic membership would go up by $5 in September for the first time in seven years. Executive memberships will increase by $10.
With 52 million paid memberships affected by the move, that translates to roughly $390 million of additional revenue per year, which the company says will be largely reinvested into the business.
As CNBC's Jim Cramer noted, "Management said it wasn't going to raise its membership fee until they saw inflation under control."
While Cramer pointed out the company's statements that it didn't want to add further pressure to members' wallets during high inflation, Costco's business model shows it stands to benefit from the timing of this hike. Plus, it's an option that few other retailers have.
So what does it mean for US households' grocery bills that Costco chose to pull this financial lever? It could be that the years-long run of rising prices is finally nearing an end.