The Frontal Cortex

Costco

My uncle describes Costco as the place “where you go broke saving money”. That certainly describes my experience of the warehouse store – I walk in for some toilet paper and leave with a new television, a tub of cashews and a lifetime supply of chapstick. ABC News recently had an interesting profile of the retail company:

Costco’s membership is largely made up of middle- and upper-middle class families and small business owners who pay $50 to $100 for annual memberships. So far this year, Costco has reported $386 million in revenues from membership fees alone.

Loyal customers are willing to pay those fees because of the heavy discounts they enjoy once they walk through the door — Costco never charges more than 14 percent above cost for any item.

The discounter’s impressive numbers go beyond their low price tags. Costco is the number one wholesale buying club in the country and the ninth largest retailer in the world, and last year their annual revenue was more than $70 billion, topping both Target and Home Depot.

Jeffrey Long, Costco’s senior vice president and general manager for the northeast region, attributes their growth during the recession to “the value.”

“When times are tough,” he said, “people really pay attention to what they’re getting.”

But Costco manages to turn big profits in the best and the worst of times. So how do they do it? “GMA” got a breakdown of the secrets to their sustained success.

The first secret is right there in the store’s name. Costco is able to maintain lower prices than other grocery stores by keeping their costs down.

“We keep our facilities very bare bones,” Long said. “You look around you see a concrete floor, you see a regular girder ceiling, you don’t see signs on every aisle telling everybody where the products are.”

The secret of Costco’s success – and the reason I’m willing to pay just to enter the store – is because I trust the company to give me a good deal. As a result, I don’t comparison shop on my phone when I’m browsing the Costco aisles, checking to see if I can get the same book, or sunglasses, or toothpaste for less on Amazon. My usual cheapskate anxieties have been quieted.

I think there’s been some really interesting work on what’s happening inside our head when we shop. Consider a recent study led by Brian Knutson of Stanford, Drazen Prelec of MIT and George Loewenstein at Carnegie Mellon. Not surprisingly, the fMRI experiment revealed that when subjects were shown pictures of an object they wanted – people were allowed to purchase things like a George Foreman grill, or a Napoleon Dynamite DVD – brain areas associated with anticipated rewards, such as the nucleus accumbens, exhibited a spike in activity.

But then came the price tag. When the experimental subjects were exposed to the cost of the product, their insula and prefrontal cortex were activated. The insula secretes aversive feelings, and is triggered by things like nicotine withdrawal and pictures of people in pain. In general, we try to avoid anything that makes our insula excited. Apparently, this includes spending money. The scientists speculate that the prefrontal cortex was activated because this “rational” area was computing the numbers, trying to figure out if the product was actually a good deal. The prefrontal cortex got most excited during the experiment when the cost of the item on display was significantly lower than normal. The insula, on the other hand, was most active when prices were higher than normal, suggesting that the function of this brain area when shopping is to keep us from getting ripped off. If we’re used to see the George Foreman Grill priced at $49.95, the insula generates a stab of aversive emotion when we see it listed for $59.95. That unpleasant feeling is what keeps us from placing the overpriced object in our shopping cart.

As I note in How We Decide, this data directly contradicts the rational models of microeconomics. Consumers aren’t always driven by careful considerations of price and expected utility. We don’t look at the electric grill or box of chocolates and perform an explicit cost-benefit analysis. Instead, we outsource much of this calculation to our emotional brain, and rely on relative amounts of pleasure versus pain to tell us what to purchase. (During many of the decisions, the rational prefrontal cortex was largely a spectator, standing silently by while the NAcc and insula argued with each other.) Whichever feeling we feel most intensely tends to dictate our shopping decisions. It’s like an emotional tug-of-war.

Retail stores manipulate this cortical setup. They are designed to open our wallets: the frivolous details of the shopping experience are really subtle acts of psychological manipulation. The store is tweaking our brain, trying to soothe the insula and stoke the NAcc. Just look at the interior of a Costco warehouse. It’s no accident that the most covetous items are put in the most prominent places. A row of high-definition televisions surrounds the entrance. The fancy jewelry, Rolex watches, iPods and other luxury items are conspicuously placed along the corridors with the heaviest foot traffic. (The fresh food is always located in the back of the store, so that we have to parade past the profitable aisles of temptations.) And then there are the free samples of food, liberally distributed throughout the store. The goal of Costco is to constantly prime the pleasure centers of the brain, to keep us lusting after things we don’t need. Even though we probably won’t buy the Rolex, just looking at the fancy watch makes us more likely to buy something else, since the coveted item activates the NAcc. We have been conditioned to crave a reward.

But it’s not enough to just excite the NAcc: retailers must also inhibit the insula. This is where Costco really excels. When consumers are repeatedly assured that low prices are “guaranteed,” or told that a certain item is on sale, the insula stops worrying so much about the price tag. In fact, researchers have found that even when a store puts a promotional sticker next to the price tag⎯something like “Bargain Buy!” or “Hot Deal!”⎯but doesn’t actually reduce the price, sales of the item will still dramatically increase. These retail tactics lull our brain into buying more things, since our normal response to price tags is pacified.

And this is where all those details of the Costco shopping experience make us more likely to spend money. The bare bones warehouse aesthetic, the discounted house brand, the constant reassurance that we’re paying “wholesale” prices – it’s all an effective means of convincing us to not worry so much about the price tag. As a result, we’re able to focus entirely on our anticipated pleasures, which is why I walk out of the store with all this stuff I don’t need.

Comments

  1. #1 Art
    March 31, 2010

    Nice piece.

    It cannot be so easily assumed that such buying clubs are the cheapest available price on any specific item. If you can find the same item being used as a ‘loss-leader’ in a regular store it is common to get it cheaper.

    Of course how much time, effort, and gas your wiling to spend to beat a price is going to be limited.

    One way to get the beat rice and minimize travel is to make a list of the twenty most common things you buy and carry that in your wallet. As you go to various stores check out and write down the prices. It is a pain the first few times around but once you know the stores it gets easier.

    My conclusions were that no single store gets you cheaper prices all the time. That you can’t rely in any stores low price reputation.

    A little script that encourages my insula:
    Do I need it, or just want it.
    I’ve live without it so far.
    I don’t have time to use or enjoy it.
    I can get it somewhere else cheaper.
    Over time prices on electronics are going down.
    Next years model will be better.
    Am I trying to fill a repressed need/desire by buying this? Is there some more direct way of filling that need/desire. Money is freedom. Objects are anchors.

    Say this before entering a store. Again before you decide to buy something. And again before checking out.

    Leave the credit cards at home and pay for everything in cash. A few times I have reconsidered when I looked at and felt the pile of dead presidents I would be handing over.

  2. #2 Connie
    March 31, 2010

    Some years ago Consumer Reports showed that if you were just buying fish oil capsules, the savings at Sams would pay for the membership cost. I joined and haven’t regretted it. I have a list of things I buy in bulk there and pretty much avoid the rest of the store. Works for me.

  3. #3 Kierra
    March 31, 2010

    At least part of the drive to buy more at Costco is probably linked to the desire to get the most out of the money you’ve already spent on membership dues.

  4. #4 Eric Juve
    March 31, 2010

    And where else can you go to find a 3 pack of pianos?

    (Credit to Family Guy)

  5. #5 becca
    March 31, 2010

    More importantly, where can I get a 6 pack of pianos??

  6. #6 meryl
    March 31, 2010

    Today, my 5 year old son wanted to buy a pencil case at the mall. I told him “you can’t always get what you want, but sometimes you may get what you need, and you don’t need ANOTHER pencil case.” He asked “who said so?” I said “Rolling stones.”

    Enjoy enjoy saving.

  7. #7 royniles
    March 31, 2010

    “The insula secretes aversive feelings, and is triggered by things like nicotine withdrawal and pictures of people in pain.”
    The insula does a lot more than secrete aversive feelings, assuming it”secretes” anything at all. Damasio is rolling over gravely at the thought. See this well written article on the subject: http://www.nytimes.com/2007/02/06/health/psychology/06brain.html

  8. #8 James
    March 31, 2010

    We signed up for Costco a couple of months ago and were immediately seduced by the prices. We save the receipts and will read them like pornography: “Oh my God, look how much we saved!”

    If you only buy things that you were going to buy in other places, you save a huge amount of money. If you give in to impulse buys you’ll be dead.

    They often have samples of great food and that just primes you to buy something on impulse. Part of it is feeling that you just got something for free, so you have to reciprocate.

    James

  9. #9 mrcreosote
    March 31, 2010

    My dad used to say ‘how can I save $25 if I have to spend $75 to do it?’

  10. #10 meryl
    March 31, 2010

    It’s like logical pragamatism gone wild. You walk into a shop only needing to buy an item that is $30. They told you but if you spend $100, you get $20 off. You think yeah, I can save $20 but in reality you overspent $50. Marketing pitches create non-existent needs and/or make a future need unnecessarily & urgently immediate. They convince you that it is a smart thing to do NOW, BUY NOW. And who wouldn’t want to feel smart, even for a few moments?..until your 5 year old son confronts you with “why do we need 200xrolls of toilet paper?” uhmmmmm

  11. #11 NeuroKüz
    March 31, 2010

    Nice piece… perhaps the prefrontal “rational” activity can be thought of as consciousness, whereas the NAc/insula debate is subconscious. Advertisers and salespeople can take advantage of us when we don’t engage the prefrontal cortex because we’re unaware of their tactics and motives.

  12. #12 Washed Up
    April 1, 2010

    it’s very simple. i shop, i buy. in between, i search for the other cosmic project, the undersided norm between hexagonal juxtapositions. the fearful wavegates are slightly opened–tithering, jolting my sleepish tendency to mirk the alternating superscapes and fairground monopoloies

  13. #13 bigmammafrog
    April 1, 2010

    My Granddad’s motto was ‘It’s only a bargain if you need it.’ But there are ways of convincing yourself that you need it, aren’t there?

  14. #14 Stephen
    April 1, 2010

    Fascinating piece! My wife and I have been agonizing for months over whether we should get a Costco membership. This data makes our decision even harder.

  15. #15 Texas Reader
    April 1, 2010

    I’ve found prices on cameras at Costco to be way higher than I can find online. What I really like is the produce – it’s always top notch. A friend of mine buys meat there and says it’s as good as the stuff sold at Central Market, an upscale Texas grocer.

    They have booths set up for a company that does gutters, one that does kitchen cabinets and counters, etc. I don’t know if the pricing on any of these bigger ticket items is better or not but will be pricing gutters this year and will find out.

    The clothing is pretty much cheapo stuff, butif you need tshirts for yeard work, or something like that, you can get good deals. They also have rock bottom prices on bestseller books.

  16. #16 Wary Florida
    April 1, 2010

    I have been a Costco member since 1987, long before the chain was big.

    Quality has been changing, slow but sure at the chain. A quick example, take a look at all the frozen organic vegetables, “packed for Kirkland”, Product of China. China? The most polluted country on Earth? That’s right. Costco is slowly cashing margin by diluting quality and safety. Complaining to management falls on deaf ears.

    For the first time in 23 yrs I am starting to look at BJ’s and Sams.

  17. #17 Shane
    April 1, 2010

    COSTCO IS THE GREATEST STORE IN THE HISTORY OF THE WORLD!

    The only thing that could make it better is if they would stop carrying Anderson Cooper Mom Jeans (that’s what I call Gloria Vanderbilt’s line of jeans). Just fill that whole clothing section with more free samples.

  18. #18 Zoasterboy
    April 2, 2010

    By the time I read your book I found that half of it I had already read in the blog.

    I like comment #12. I think you got Markov Chain spammed, as the website the author is linked to is an ad site, the top result being some rolling stones ad, as one commenter mentioned the rolling stones.

  19. #19 Jon D
    April 2, 2010

    Interesting stuff. Sadly we think all too little about why we do anything. Soon perhaps people will be so self-programmed to believe they are always right and that everyone who is correct agrees with their positions. I appreciate the comments above that are not about attacking/defending Costco. That’s not what your article is not about!

  20. #20 Steph Mineart
    April 2, 2010

    You should study my wife – she is immune to the Costo effect & calculates everything, even there. I swear she has a terminator-like data screen across her vision that just adds up whether something is a good deal or not and rejects stuff out of hand, because she’s so quick and so good at the money.

    It make shopping trips painful, though. I bring stuff with my lizard brain to the cart and say “I can has?” and she scans it and says “no, honey, this isn’t a good deal. Put it back.” and I schlep off to put it back and come back with some other shiny thing I found to repeat the process. Six hours later, she finally gets to check out with the 3 things she actually came in for.

  21. #21 monday1929
    April 2, 2010

    This is similar to how buy and sell decisions are made in freely traded financial markets as well- the emotional brain makes the decision and micro-seconds later the rational brain justifies it with the “fundamentals” ie. a good earnings report. See Robert Prechter for more on this.
    We really are just smart monkeys.

  22. #22 monday1929
    April 2, 2010

    This is similar to how buy and sell decisions are made in freely traded financial markets as well- the emotional brain makes the decision and micro-seconds later the rational brain justifies it with the “fundamentals” ie. a good earnings report. See Robert Prechter for more on this.
    We really are just smart monkeys.

  23. #23 Mekales
    April 2, 2010

    Some of these comments concern me in the fact that – for instance – Produce is virtually ALL imported, Fish is from farms in China (although some are boldly labled as Alaskan this or Atlantic that – check the small print!) Apparel is virtually ALL imported, on and on. If you are an American Union worker or someone who understands the importance of buying local or American made, then how can you justify “SAVING MONEY” at Costco, Sam’s, Walmart, etc. It’s a catch-22 in a downward spiral.
    I have a brother-in-law that is a Union Electrical High-Voltage worker that is OUTRAGED that his employer is laying off workers, reducing benefits and freezing raises… but yet, he and his wife make a day of it twice a month. It’s “SAM’S DAY”! They can hardly sleep the night before. A couple of times they have offered us fish – which I have shown her are farmed in China or elsewhere and we won’t eat it. But, they have no qualm in shopping there.

  24. #24 mike in tn
    April 3, 2010

    my money saving tip…don’t get a cart, when your hands are full, leave

  25. #25 Elizabeth Nolan
    April 3, 2010

    Costco’s revenue stream is in the memberships. The store sales profit / overhead cost balance themselves.

  26. #26 Anaconda
    April 3, 2010

    > My dad used to say ‘how can I save $25 if I have to spend $75 to do it?’

    Anyone truly only saving “$25.” per year would obviously be the wrong type of person to have a club store membership. But, all hackneyed parental aphorisms aside, consider the facts. Recent studies show that club store prices are, on average, about 30% less than regular retail. Google “warehouse club savings” for the data. Therefore, to save the cost of a basic $50 membership (not $75 as you imply), you’d need to purchase, on average, roughly $180 in club merchandise over the course of a full YEAR. Now honestly, who is NOT buying at least $15/mo. in basic necessities, produce, meat, food staples, soap, trash bags, etc., which if purchased at a club store, would allow the $50 annual membership fee to be recouped? Anything over that amount is pure savings back in your pocket. And if a person honestly did only “save $25.” at Costco over the course of a year (i.e. – you only spent about $7./mo), then there is nothing stopping you from walking over to the Costco membership desk, closing your membership and asking for a full refund on your prior year’s annual membership. It will be given, no questions asked. Tell me again how you would not come out ahead on this proposition? This customer-focused philosophy is what keeps Costco SO successful and its members SO loyal decade after decade.

    Posted by: Anonymous | April 3, 2010 1:36 PM

    Posted by: Anaconda | April 3, 2010 1:39 PM

  27. #27 Michele Hush
    April 3, 2010

    When I had kids at home a job that paid well, I shopped at Costco a lot and came home with barrels of stuff that wasn’t on my list. Now that I’m freelancing and there are just two of us, I don’t go unless I’m on a mission to buy something specific, like men’s t-shirts. (The Kirkland brand makes good ones.) This sentence, “researchers have found that even when a store puts a promotional sticker next to the price tag⎯something like ‘Bargain Buy!’ or ‘Hot Deal!’⎯but doesn’t actually reduce the price, sales of the item will still dramatically increase” brought Duane Reade to mind. I was there yesterday and saw a “Big Deals” sale on a display that included Zyrtec. I asked the pharmacist, “Is that really on sale?” The answer was no. It’s pernicious.

  28. #28 psychobiology
    April 3, 2010

    I’m highly dubious about the neurology in this article because you seem to be using untested brain functions as faux-authoritative fetish objects in describing a framework that is extremely familiar from marketers’ own ideas about the way they structure their stores.

    We have long known that people are less calculating than microeconomics describes. Costco’s methods of manipulating this lack of calculation long predate the research you cite. So what, exactly, do fMRI identifications of active brain regions tell us? I’d wager that they say almost nothing — while neuropsychological-internal studies may be useful for other researchers, they are useful to pop scientists only as a source of high-brow, impressive language.

  29. #29 Steve Trost
    April 4, 2010

    I’d like to note that economists don’t actually believe that people make perfectly rational cost/benefit calculations every time they buy ketchup or iPods. We just argue that, on average, people behave in a manner consistent with such a calculation. Most of us would actually consider your argument against the rational models of microeconomics as a great argument FOR our approach. When we “rely on relative amounts of pleasure versus pain to tell us what to purchase” we are unconsciously performing exactly the cost/benefit analysis that we mean. It’s not always completely rational, and not always the right thing to do, and it is definitely influenced by firm behavior and advertising. But it is also by-and-large consistent with general “consumer choice” theory.

  30. #30 Janet in Oregon
    April 5, 2010

    Just got back from Costco, where pineapples are selling for $2.99 each. Safeway is selling similarly-sized pineapples this week for $1.99. You just can’t assume that everything is cheaper there. We joined up when they first opened in our town, but have never renewed our membership. We learned early on that we can save more money by wisely shopping the supermarkets. Here in Oregon, the Costco pharmacy is open to anyone without a membership (state law) so we do use that on occasion. As for Costco gasoline, Fred Meyer is just a penny more per gallon most weeks.

  31. #31 jon
    April 6, 2010

    Things I will only buy from Costco.

    Their athletic socks…unbelievably comfortable, and long lasting.

    Kirkland Tuna. Absolutely the best solid white albacore in the world!

    Kirkland dry dog food and dog biscuits. One box of dog biscuits lasts for months, for only $1 per pound. The kibble is rated A+ for their ingredients by many websites, and is half the cost of “super premium” dog foods that in many cases have lower quality ingredients.

    Their chocolate chip cookies. Umm umm good.

    Their marinated pork loin. Usually around $2-3 per pound, and tastes so dang good when barbecued.

    I have never been disappointed with ANY of their Kirkland products.

    Customer for life…

  32. #32 edSanDiego
    April 6, 2010

    Great article.

    This goes to show why retailers like Wal-Mart are so successful. Price, price and price.

    Over the last 30-40 years store prices have gone down in real terms because of firms like these keeping a check on prices (largely by making everything in China).

    We just need a big box retailer to give us pile-it-high, sell-it-cheap housing near good schools.

  33. #33 SJA
    April 7, 2010

    I completely agree with Steve Trost’s comment. As David Friedman has said, “The central economic assumption is that individuals have objectives and tend to take the actions that achieve those objectives. That’s what an economist means by rationality.”

    It’s clear from this and other posts that Lehrer does not understand what the term “rationality” means as it used in microeconomic theory. He really seems to think that it simply means logical thinking. It would be amusing to watch Lehrer engage in his quixotic attack against microeconomics, but for the fact that people take his ideas seriously. He needs to take econ 101.

  34. #34 guy grand
    April 8, 2010

    There is a great part in the 1969 film The Magic Christian, which is almost verbatim a study in this mentality. A shop is filed to the brim with greatly discounted prices, only to watch people buy things the absolutely don’t need, but can’t pass up”.

    The film itself was about the idea that everyone, even the perceived “best of us” has our price, and Peter Sellers and RIngo as his son, proceed to find out what that price is.

    Terry Southern who wrote the book was a wickedly devilish fellow, and well ahead of his time. (He also worked on Strangelove with Kubrick).

  35. #35 leslie
    April 8, 2010

    I agree with an earlier poster. If you stick with the basics, you will probably save a lot of money. The problem comes when you’re buying TV’s and lifetime supplies of chapstick. If you don’t purchase a thing at least every two months, you’re not saving any money. But I gotta tell you, we go through a TON of soymilk, and Costco helps reduce our costs.

  36. #36 Sarah
    April 10, 2010

    It all depends what you’re shopping for. I value Costco over Sams and chain grocery stores because they sell more quality-type food items (healthier food choices) that you can only get at an organic/local food distributer store (central market or whole foods, the most common). For instance, I can get organic crackers/pasta/rice/etc. that use whole grain or spelt sugar for the same price as what I would pay at whole foods BUT I get them in larger quantities, which is great for food that doesn’t spoil fast. In the long run, it also saves on gas and time since I only have to shop for these items once every 2 weeks instead of once or twice in one week.

    If you’re searching for things like electronics, its always smarter to compare prices or bizrate.com or amazon.com (which some distributers now use to sell items)

    And for those of you who like to travel, Costco actually has some of the cheapest rates for airfare and hotel.

  37. #37 skysis
    August 29, 2010

    “Insula secrcetes aversive feelings…”
    Ahahahaa! I love it when journalists try to be know-it-all experts in science. Oh, wait, he writes for Wired. Case closed.

  38. #38 Paul
    December 31, 2010

    Just to alert Costco customers to a tactic used by Costco which makes shopping there less and less desireable:
    DATE ITEM COSTCO PRICE

    December 9/2009 KS Pecans, 1.2Kg 9.89 (no coupon)
    July 13/2010 KS Pecans 1.2Kg 11.69 (no coupon)
    December 29/2010 KS Pecans 0.98Kg 14.95 (no coupon)

    An 18% increase over the first 7 months, almost 100% increase over one year! Is the current price competitive? No, because the same quality pecans are available at most supermarkets (e.g. Loblaws) for $6.50/lb (=$13.96 for 0.98Kg).

    This is only one example of the bait and switch tactic used by Costco to entrap the loyal and unwary customer. There are numerous other examples of offering at an initially attractive price and then hiking the price beyond competitve pricing, on the assumption that customers won’t re-check prices in-store.

    I have found that, until mid-2010, only one in five food items at Costco were priced below competitors’ prices, the rest being equal to or greater than the competition. On the last visit, I found only about 10 per cent of the food items worth buying.

    Sure, we’re going to have Costco appointees respond with the “quality” arguement, but I’ve not found the quality of Costco foods to be sufficiently superior to that of the competition to warrant paying even the sme price and getting stuck with a larger package than needed.

    I won’t be returning to Costco.

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