With almost 700 warehouses worldwide and over $100 billion in revenue last year, Costco has shown that it can survive in a retail industry overcome by e-commerce. Costco is able to continue to draw its 40+ million household memberships back to its store for the promise of steep discounts. The business model and operating model of Costco are singularly focus on one theme, cost savings.
A subscription business model is not unique to Costco. However, this type of business model allows Costco to pass on cost savings to its members. Costco charges it’s members $55 a year to have access to the incredible savings that lie inside the warehouse-like stores and at their gas pumps. This subscription fee accounted for $785 million in sales for the fourth quarter and flows directly to the bottom line of the company’s profitability. Because of membership revenues, Costco does not have to make a large margin on the products it sells. Costco’s average gross margin is about 10%, while Walmart’s is around 25%. This cost savings is given directly to its customers which they believe more than compensates for the price of membership. Renewal rates for membership are roughly 85%.
Economies of Scale
Costco buys products in bulk orders from suppliers at low prices because suppliers are able to spread their fixed costs over more units. Prices are pushed down even further due to competition between suppliers. Costco has a limited number of stock keeping units, which limits the amount of brand competition in the aisle. Therefore, suppliers bid down their prices to obtain the coveted space within Costco. Customers, attracted by the extremely low prices, purchase their items in bulk quantities as well moving massive volumes of products through Costco. Furthermore, Gasoline is a very unique product that Costco provides which also benefits from economies of scale. Traditional gas stations have limited storage capacity and can not purchase in wholesale quantities. Costco, on the other hand, can buy enough gas in bulk at wholesale prices for its network of self-service stations in the US and Canada and sell it to customers at a discount.
Another cost saving measure of Costco is to invest in its employees. Employee turnover is costly for a business due to lost productivity and finding, hiring, and training new employees. Costco pays high wages, $43,000/year average, almost twice the industry average. They also provide comprehensive benefits, health insurance, retirement programs, and gym memberships. In 2014, employee turnover was only 5%. Costco can afford this high compensation because employees are so productive with 3x the revenue per employee as Walmart. Employee productivity is also increased due to the limited SKU’s in their spartan-like warehouses. 
Costco’s business model is clearly in line with the operating model. Both are focused on utilizing economies of scale for their suppliers and consumers. The subscriber model allows Costco to keep its margin razor thing, so customers can benefit from the cost savings. Furthermore, Costco’s emphasis on employee retention demonstrates the value of human capital in an organization while still keeping costs low and productivity high.