Costco Wholesale Corporation's Biggest Win in 2016 So Far

By Markets Fool.com

People do not like change.

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People get angry when social media websites alter their layouts or when a store moves around its merchandise. Even in this day and age of digital video recorders, when many people record their favorite television programs to watch later, ratings for a show generally go down when its time slot shifts.

But when a change will ultimately be better for a store and its consumers, then it simply becomes a matter of managing the transition well.

For Costco (NASDAQ: COST), it needed to make a change to its credit card provider to get a better deal for itself and its customers. The warehouse club had to negotiate with providers other than the incumbent American Express (NYSE: AXP), and opening the door to another card company winning the business meant change was possible.

Citigroup (NYSE: C) ultimately won Costco's business, meaning its loyalty reward program members would see their American Express cards replaced with Visa (NYSE: V) cards. That's a difficult swap to make, and after a rocky first few days, the company made the switch in impressive fashion.

Costco managed a difficult situation well with its credit card change. Image source: author.

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This was not an easy change

In switching from American Express to Visa, Costco -- which has not released the exact terms of the deal -- likely lowered the fees it pays the card issuer. In a February research note, BMO Capital Markets analysts wrote that they "estimate the savings from lower interchange fees could amount to $110 million to $220 million," as reported byThe Street.

In addition, Costco members got better perks. The new card, like the old one, has no fee but requires holders pay the warehouse club's $55 annual membership charge. It gives cardholders more cash back on gas purchases: 4% on the first $7,000 spent in a year compared to 3% on the first $4,000 under the old card. It also increases cash back to 3% onrestaurant and eligible travel purchases (up from 2% with the old card), while returning 2% cash back on all Costco purchases (up from 1%), and 1% on everything else (like the old card).

The challenge for Costco was both pulling off the logistics of a massive card switch, but also countering the fact that people feel pretty strongly about American Express.

"People do tend to be pretty brand loyal and hold onto their credit cards for a long time," Matt Schulz, a senior industry analyst for credit card website CreditCards.com told MarketWatch. "And AmEx, more than any credit card issuer has cultivated that sort of brand loyalty over the years."

Costco managed to overcome that loyalty, at least partly because its customers largely feel the same way about the warehouse club.

Bumps on the road

The actual credit card switch did not happen without problems. In part, that was because Costco took a rip-the-bandage-off approach to the process. On June 19, the chain accepted American Express cards, and then on June 20, it only accepted Visa and its former American Express loyalty card became nothing but a useless piece of plastic.

That abruptness resulted in short-term disarray leading to some 1.5 million calls to Citigroup, according to Citigroup spokesperson Jennifer Bombardier. "With any conversion of this magnitude and a brand this beloved, call volumes were unprecedented," she acknowledged in an email interview with The Motley Fool.

She also noted that longer-than-desired wait times were addressed quickly. She explained that most of the calls were regarding "card activation, payment queries, online setup and things of that nature. Not complaints." She added that the call volume quickly decreased and that, as of July 20, one month after the switch, call wait times had gone way down, along with the volume. In addition, because new Costco rewards cards had not been offered since November 2015, Bombardier noted that pent-up demand was high.

Costco deserves credit

While problems were inevitable with a switch this large, Costco deserves credit for making a relatively smooth transition. The chain won't report Q3 sales numbers until Sept. 29, but its most recent monthly sales report, which includes a full month post-credit-card-change, shows encouraging results.

July sales excluding gas were flat in the United States year over year, but 2016 had one less day in the reporting period than the previous year. That extra day negatively impacted U.S. sales by 3.5%, according to the sales report.

So, despite an initial rocky road and some other bumps along the way, Costco mostly pulled off a massive change without hurting its sales. In the long run, this switch benefits the company and its consumers so the short-term pain, while unpleasant, pays off in the long run.

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Daniel Kline has no position in any stocks mentioned. He will not miss the Olympics. The Motley Fool owns shares of and recommends Costco Wholesale and Visa. The Motley Fool recommends American Express. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.