How Valuable Are Costco’s Ancillary And Other Businesses?

by Trefis Team
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Costco (NASDAQ:COST) is the largest warehouse club in the U.S., ahead of Wal-Mart‘s (NYSE:WMT) Sam’s Club and BJ’s Wholesale club. The retailer charges an annual membership fee and allows its customers to make bulk purchases at heavy discounts. Additionally, it offers a number of ancillary services such as food courts, photo centers, pharmacies, optical dispensing centers, gas stations, hearing aid centers, print shops and car washes. Although its ancillary business does not contribute much to the retailer’s overall revenues, it is quite important for Costco.
Costco’s ancillary revenue per member has grown faster than its store revenue per member, implying that existing members are using more of these services. Moreover, these services have played a crucial role in facilitating new membership signups and frequent customer visits. Therefore, apart from generating exclusive revenues, these services also assist Costco’s membership income and core merchandise business. In-store services account for about 20% of Costco’s value as per our estimates.

See our complete analysis for Costco

Use Of Ancillary Services Is Growing

Though ancillary revenues account for less than 20% of Costco’s net revenues, they have grown faster than its stores revenues. A Costco member spends about $255 on average on ancillary services every year, which has grown by about 10% annually over the past five years. On the other hand, average spending by a Costco member on general merchandise has grew by just 1% annually. This clearly implies that while the customers have kept their shopping basket size more or less the same, they haven’t been hesitant in spending more on Costco’s low-priced ancillary services such as food court, pharmacies and gasoline. As a result, ancillary services’ share in the company’s net revenues has increased from 13.5% in 2007 to 18.5% in 2012, and we expect this trend to continue in the future.

Discounted Gasoline Helps In Revenue And Membership Growth

Costco provides gasoline at lower prices compared to regular gas stations. Therefore, its members are likely to make frequent trips to the stores to take advantage of low-priced gasoline, and in the process, may end up buying other merchandise. In fiscal 2012, Costco’s same store sales increased by 7%, partially driven by frequent store visits by its customers. The company’s value proposition becomes even more prominent in event of gasoline price hikes. As gasoline prices rise, more buyers are likely to turn to Costco’s gas stations to save money on fuel. This in turn, can improve new membership signups. The retailer reported $1.6 billion in additional revenues in fiscal 2011 due to higher gasoline prices.

Pharmacy Benefit Program Can Bring New Members

Earlier this year, Costco launched a pharmacy benefit program (PBM) called Costco Health Solutions. The retailer will sign contracts with small- and medium-sized businesses to provide discounted prescription medicines to their employees through its in-store pharmacies. The idea behind the program is to make these employees familiar with the cost benefits of shopping at Costco and attract them to become its members.

Through this program, the company mainly targets its 10 million business members. Assuming that about 10%-15% of  the existing business members join this program, there will be around 1 to 1.5 million businesses taking advantage of Costco Health Solutions. Furthermore, if each contract results in even 1 or 2 employees becoming Costco members, we are looking at close to 1 to 3 million additional members. Given that Costco earns $1,500 per member annually in revenues, there is an opportunity to grow total revenues by roughly $1.5 to $4.5 billion if its PBM takes off.

Our price estimate for Costco stands at $117, which is in line with the market price.

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