Costco has built its business model around being super efficient in order to keep its prices low. That's why the warehouse club has such a limited selection of items.
It can magnify its buying power by selling fewer items. If the chain wants to sell ketchup, it can go to Heinz and make a massive purchase of a single bottle size rather than splitting up that order between different sizes and packaging.
That enables the vendor to lower its prices because it can refine its manufacturing process and make a better deal on ingredients and packaging because of the huge volume. Basically, Costco (COST) -) has made a negative — a limited selection — into a positive because it helps the chain offer lower prices.
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Rivals like Walmart and Kroger offer complete grocery lines, which limits their buying power compared with the warehouse club. It's not that either chain has high prices, but Costco has been the most aggressive retailer when it comes to keeping prices down because it makes most of its profit (about two-thirds) from membership sales, not what it sells in its warehouse clubs.
Selling in huge volume has also given Costco another edge where it can both pad its bottom line and sell at a cheaper price than not just Walmart and Kroger but every player in the space.
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Costco has a massive gas advantage
Costco sells gas at most of its warehouse clubs only for members. Its prices are usually lower than those at any other gas stations in the markets it serves, which makes it worthwhile for members to drive to their local store even if it's not the closest gas station.
Kroger (KR) -) operates 1,000 gas stations in 16 states. Walmart operates stations in partnership with Murphy's at many stores; runs its own stations in some locations, and runs some at BJ's Wholesale Club.
Costco, however, has a big edge over its rivals because of the sheer volume of gasoline it sells. CFO Richard Galanti discussed this point during Costco's fiscal-fourth-quarter-earnings call.
He explained that the warehouse club turns over the gas at its stations on a nearly daily basis, while its rivals may take a week or longer for that to happen. That means that as prices go up Costco makes less on gas, but as prices drop the chain makes more.
Costco can afford to make less as prices go up, which keeps it competitive.
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Costco can take thinner margins
Galanti often talks about how Costco monitors its key rivals' prices. That means that sometimes if Kroger, Walmart, Target and other rivals raise prices, the warehouse club can do the same while also being a market leader on price.
That applies to gas pricing as well.
"Everybody seems to be wanting to make more in gas, which allows us, in our view, to make a little more and still be even more profitable," he said.
"We've seen our competitive spread versus our direct competitors at every location, on average, improve over the last couple of years to now be in the — I want to say the $0.30 range per gallon. Thirty is the average, which is up. It's an average, and it can range from 10 to 45."
Galanti has long made clear that Costco will sometimes sacrifice profit in order to maintain value for members.
"At the end of the day, we feel good about our competitive position. It's increased and we're still quite profitable, down a little bit from a year ago, but nonetheless quite profitable," he added.
