How warehouse stores make money

Last week, I listened to an old episode of NPR’s Planet Money podcast. In this 15-minute installment about “anti-stores”, the hosts look at businesses like Price Club and Costco. What makes them different? How have they succeeded by re-writing the rules of retail?

“It used to be if you ran a store, you wanted to make it easy for your customers,” the hosts say during the intro. “PriceClub and Costco went in the opposite direction. They made shopping harder.” Yet, it worked. “Today, Costco alone sells more stuff every year than Amazon — by far.”

How Warehouse Stores Make Money

Here are some examples of how warehouse stores go against conventional wisdom:

• When you join a warehouse club, you pay a membership fee. It’s not much — maybe $40 or $50 per year — but it’s something, and it puts you in the hole from the start. You feel motivated to spend in order to recoup your “investment”.
• Regular retail stores have signage to help customers find what they need. Warehouse stores, on the other hand, intentionally do away with signs because it encourages people to wander the aisles. As they wander, they’re more likely to find other things to buy. (Seriously, this is a deliberate design decision!)
• Warehouse stores often sell in bulk, which gives the consumer the illusion that they’re saving money. (And they are saving money — if they use everything they purchase instead of letting it go to waste.) But bulk sales also help the store. Their goal is to have people shop infrequently. The less people come, the less the business needs to spend on overhead.
• A normal store offers a wide selection; warehouse stores offer limited selection. “When you have more selection, you have more labor,” notes Robert Price, founder of Price Club. Plus, you have to store the backstock, which costs money.

And why does Costco only accept Visa credit cards? Because they’ve struck an exclusive deal with the Visa payment network that saves them a ginormous amount of money. (Seriously, it’s huge.)

Online Shopping Gets a Piece of the Action

With the advent of online shopping, businesses like Amazon are taking the lessons from warehouse stores and building upon them.

When you buy something online, for example, much of the purchase price goes to shipping and handling — even if you don’t know it. When you pay $99/year for Amazon Prime to get “free shipping”, you’re still paying for shipping. The cost is embedded in each item’s price.

Knowing this, you can see how certain Amazon business practices make sense.

• Lots of little things are “add-on” items at Amazon. You can’t order them on their own, but instead have to buy $25 of other stuff before you can place an “add-on” item in your cart. Otherwise, there’s no way for Amazon to recoup their labor costs.
• I’m a big fan of Amazon’s “subscribe and save” program, which lets me receive one monthly shipment of items I use often (such as multivitamins, coffee, and dog food). When you subscribe to enough items, you get a big discount: 15%. That’s a win for me, but it’s also a win for Amazon because they’re able to do one big order instead of several small ones.
• Recently, Amazon has introduced delayed shipping. When you place an order, you’re given the option of delaying shipment for a few days or a few weeks. If you do, you get a credit to your account. Again, this is a win for me and it’s a win for Amazon, who can then wait to fulfill the shipment the next time I order something.

This episode of Planet Money reminded me a lot of the book Why We Buy: The Science of Shopping [my review], which describes all of the many, subtle ways stores manipulate customers into buying more.

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