Costco Is Raising Its Membership Fees (You Knew It Was Coming!)

By Adam Levine-Weinberg Markets Fool.com

Every five or six years, Costco Wholesale (NASDAQ: COST) raises its membership fees. For the U.S. and Canada, the last increase was implemented in November 2011. As a result, investors -- and savvy Costco customers -- have been expecting the company to raise its membership fees sometime in 2017.

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On Thursday afternoon, Costco confirmed that it will raise its membership fees in the U.S. and Canada by about 9% this year, with the increase going into effect on June 1. Let's take a look at what this means for investors and Costco members.

Another modest increase

Today, a standard Gold Star membership at Costco costs $55 per year, as does a business membership. The executive membership costs $110 per year and offers various additional perks, including a 2% cash back reward on purchases, with a maximum annual reward of $750.

On June 1, the prices for these membership tiers will rise 9% to $60 and $120, respectively. The highest-spending Costco members will benefit, though, as the maximum annual reward for executive members will rise to $1,000. (That said, you'd have to spend $50,000 a year at Costco to rack up a cash back reward of that size.)

Costco will raise its membership fees in the U.S. and Canada in June. Image source: Costco Wholesale.

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Costco has moved at a very deliberate pace in raising its membership fees. A $5-$10 increase isn't going to break the bank for many Costco members, given that the average customer there has a six-figure income. As a result, there shouldn't be a big change in renewal rates, which have hovered in the 90%-91% range in the U.S. and Canada recently.

The fee increase should drive faster profit growth (temporarily)

Costco is unusual among retailers in that membership fees account for the vast majority of its income. Its actual warehouse operations barely turn a profit.

In fiscal 2016, membership fee income reached $2.65 billion at Costco, representing 72% of its $3.67 billion in operating income. Just a few years earlier, a full 75% of Costco's operating income came from membership fees.

To some extent, this modest shift in the source of Costco's profits has been driven by gross margin improvements. But it also has to do with the fact that Costco hasn't raised its membership fees in the U.S. and Canada recently.

Costco has stated that the fee increases will affect about 35 million members, roughly half of whom are executive members. Based on those figures, the membership fee increase should add more than $250 million to Costco's operating income when fully rolled out, assuming there is no major change in renewal rates. This would boost operating income by nearly 7%.

The increase will take a while to show up

For Costco shoppers whose memberships expire in June and beyond, the impact of this price hike will be immediate: They will have to fork over an extra $5 or $10. Costco will see a corresponding immediate bump in its cash flow.

However, the impact to Costco's earnings results will be more gradual. Accounting rules don't allow Costco to book membership fees as revenue at the time of payment. Instead, that revenue is spread over the one-year period that the membership covers.

Thus, Costco won't see the full benefit of the fee increase on its profitability until June 2018, when all of its members will have paid the increased membership fee. There will be a minimal impact on Costco's profitability in the current fiscal year (which ends in early September). The biggest gains will come in the second half of fiscal 2018.

Members shouldn't mind

Based on Costco's recent pattern of raising its membership fee by $5 (or $10 for executive members) every five or six years, the cost of a membership has been increasing at an annual rate of less than 2%. This is an extremely fair arrangement for customers, especially considering the savings that Costco offers relative to most other retailers.

That's a big reason why Costco gets some of the highest marks for customer satisfaction among retailers. In the long run, this customer-focused approach has been great for Costco as well, helping it become the second-largest American retailer and driving huge gains for shareholders.

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Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale. The Motley Fool has a disclosure policy.