Costco Knows Its Perfect Customer

By Daniel B. Kline Markets Fool.com

Costco (NASDAQ: COST) has a perfect member who spends more money while adding increased profit to the chain's bottom line. The company's CFO, Richard Galanti, laid out exactly what makes up the warehouse club's ideal customer in its Q1 2017 earnings call. He explained how different types of members spend at the chain, and he detailed the payment method used by consumers who generally spend more.

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More of these perfect customers would clearly benefit Costco and the chain has been adding members who fit at least part of the criteria. Going forward, these customers could become even more important to the company as everything that makes someone more loyal to the Costco brand is another thing keeping them away from online retailers, other warehouse clubs, and discount chains.

Costco understands its customer base very well. Image source: author.

What make the perfect Costco customer?

During the earnings call, which was transcribed by Seeking Alpha (registration required), Galanti noted that the company was not ready to say if people using its new Visa (NYSE: V) rewards credit card spend more than those who used its previous American Express rewards card. What he would say is that "irrespective of what credit card it is whether it's a co-branded or rewards card for an airline or hotel. Generally, we find the people on credit card spend more than by cash or check or debit."

That's probably true with many, if not most, retailers, but the CFO shared one more thing. He explained that the company also found that people with Executive Memberships -- the one that costs double the basic $55 annual fee, but come with 2% cash back on most purchases -- spend more than those who do not have them.

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"So the trifecta if you will is when they are not only a member, but they're an Executive Member and they use the co-branded card," he said. "Lots of incentives for loyalty and for spend and for capacity of the spend. And so that's what we try to do. It's not as hard of a sell as you might expect."

The numbers are growing

Costco has added 1 million new credit card rewards program members since switching to Visa in June. It also added 348,000 new Executive Members in Q1. The company does not report how many users hit the "trifecta" where they are not just members, but Executive Members who also have the Visa rewards card. But, it's clear from Galanti's comments that getting a customer to sign up for either loyalty plan likely drives business.

"Executive Members are a little over a third of our base and a little bit more than two-thirds of our sales where Executive memberships are offered," Galanti said.

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This makes sense

The loyalty rewards can pile up if a customer is both an Executive Member and a Visa rewards card holder. If the customer pays with his or her Visa, he or she will be able to double dip -- saving 4% on their purchase. It's easy to see how that would entice people to spend more, and increase their loyalty to Costco.

And, since Costco makes about 75% of its revenue from membership fees, a "trifecta" customer not only pays $110 versus $55, he or she should be more likely to renew. The "trifecta" customers are good for Costco, but it's a two-way relationship. Their loyalty is because in exchange for committing to the warehouse club more deeply they get a very good deal with meaningful discounts.

This is a type of relationship that makes sense for heavy Costco users. Having an Executive Membership and a Visa reward card pays off for the member and the company.

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Daniel Kline has no position in any stocks mentioned. He is going to let his Costco membership expire for geographic reasons. The Motley Fool owns shares of and recommends Costco Wholesale and Visa. The Motley Fool recommends American Express. The Motley Fool has a disclosure policy.