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.