Why doesn't Costco simply raise prices and nix the membership fee?

Question

I know little about the field of economics. I realize this question may be too rudimentary for this forum but I am sure someone here can explain this.

My question concerns Costco, which is a wholesale retailer that sells groceries, as well as electronics, clothes, and home goods. To even enter the store, one must have a Costco membership.

My question is simple: What purpose does the Costco membership fee serve? More specifically, why doesn't Costco get rid of the the whole "paid membership" idea, open its doors to anyone and everyone, and raise its prices to make up for the lost revenue?

Costco basically offers two different memberships, the standard membership with an annual fee of \$55 and the Executive membership costing \$110. The primary benefit of the Executive membership is that members receive 2% cash back on every Costco purchase (which is in addition to whatever cash back your credit card is earning for you). Thus, it only makes sense to purchase the Executive membership if one's yearly spending at Costco exceeds \$2,750 per year.

This is Costco's defense:

"Costco's membership fee provides a means of covering part of our operating costs and overheads thereby reducing our prices on the products we sell. This way the more members we have, the lower our prices and the more you buy, the more you save."

If Costco did not require a membership fee, Costco would generate more revenue from a significant increase in customers. Costco could raise prices slightly on every item to compensate for the loss.

If Costco is indeed making the smart decision economically by requiring a membership fee, then why don't more stores adopt this model?

Answer 1

I agree with @Alecos Papadopoulos that this is probably a marketing/product differentiation trick. You attract a specific type of consumers with a specific mindset.

Another theoretical explanation also exists:
This could be a version of second degree price discrimination. Costco may maximize its profits by selling at different prices to bulk buyers and small quantity consumers. If it would simply set two prices no one would make purchases at a higher price. By collecting a club card fee and then charging a lower price Costco can make sure that only bulk buyers will choose this option, thus achieving price discrimination.

Answer 2

Because there is not a single successful model of actually doing business. Costco's model is pretty text-book level, but not economics textbook level, but rather marketing textbook level:

• Differentiate ("In Costco we do things differently").
• Make the customer feel special (hey, here is "members only"!).
• Induce loyalty or at least "loyalty" ("now that I paid the executive fee I might as well buy from Costco to get part of it back")

Whether it will indeed be successful or not, depends on time, place, culture it operates in, as well as a few boring economic facts like, whether Costco's prices are indeed lower, etc.

Economics analyzes firm behavior at a much more abstract level, "losing sight" of all these different business strategies because Economics is ultimately interested in market outcomes (and then economy-wide outcomes), not individual-firm outcomes.