Side Business is Big Business at Costco Wholesale Corporation

By Fool.com

Ranked by worldwide annual sales, Costco is a distant second to retailing king Wal-Mart, but the warehouse giant is second to nobody when it comes to sales velocity.

Costco moved $100 billion of merchandise through its 475 U.S. stores last year. Yes, Wal-Mart booked almost triple that sales figure. But it took the megaretailer 10 times the number of stores to do it.

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Big businessA significant chunk of Costco's hefty volume comes from businesses other than its bread-and-butter grocery and sundries sales. In fact, side businesses such as gasoline, food court, and pharmacy, accounted for $19 billion of global revenue in 2014 -- 17% of all sales.

If judged as a stand-alone company, the ancillary businesses would rank at No. 144 in the Fortune 500, just ahead of Goodyear Tire & Rubber.

Source: Costco.

Costco operates these noncore divisions with the aim of expanding its product selection and boosting the frequency of subscriber shopping trips. That's why there's a food court, photo processing booth, and eye center in almost every warehouse. These shops-within-a-shop also drive brand loyalty, as fans of the famous $1.50 hot dog lunch will attest.

Fill it upBut the biggest side-business story over the past five years has been booming gasoline sales. While many Costco warehouses don't have a gas station in the parking lot, the division is growing quicker than Costco as a whole. In fact, it has recently expanded to over two-thirds of the overall warehouse footprint.

Percentage of warehouses with gas stations on the premises. Source: Costco financial filings.

That's because, more than any other product, gasoline drives predictably frequent visits, which funnel members back into Costco's warehouses week after week.

"We're getting a lot of people coming to Costco to by gas and that certainly drives them into the warehouse as well," Chief Financial Officer Richard Galanti explained to investors in March.

Why it mattersThe payoff for the business shows up in two places.

First, there's supercharged sales growth. Costco posted an industry-thumping comparable-store sales gain of 5% last year. Management said that boost was powered by "an increase in shopping frequency."

Meanwhile, Costco's ability to offer rock-bottom gas prices clearly helps keep subscribers engaged. Many members even earn back their $55 annual subscriber fee with just a few fill-ups. In that way, the gas business helps push Costco's membership renewal rate further above 90%.

A good tradeThere's a significant profit trade-off with this business: Gas sales carry a significantly lower gross margin than the rest of the Costco empire. So they tend to drag down overall profitability, particularly as they expand to take up a larger chunk of revenue.

Still, trading short-term earnings for greater customer satisfaction fits squarely into Costco's business model. That's why investors can expect the company to continue to expand its presence in the gas market at an even faster pace than the overall business.

The article Side Business is Big Business at Costco Wholesale Corporation originally appeared on Fool.com.

Demitrios Kalogeropoulos owns shares of Apple and Costco Wholesale. The Motley Fool recommends Apple and Costco Wholesale. The Motley Fool owns shares of Apple and Costco Wholesale. 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.

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