Costco is far more than a simple retailer; it’s a membership-driven powerhouse operating a highly effective subscription business model that fuels its low-cost strategy and generates immense, sticky revenue. This sophisticated hybrid approach, however, has also thrust it into complex legal waters, as a recent Ninth Circuit decision underscored its direct competition with traditional wholesalers, raising critical implications for manufacturers and investors alike.
For many, Costco Wholesale Corporation brings to mind massive warehouses filled with bulk goods and bustling weekend shoppers. While this image is accurate, it only scratches the surface of a deeply strategic business model that makes Costco a standout in the retail landscape and a compelling subject for financial analysis. Far from being just another retailer, Costco operates as a powerful subscription business, generating stable, high-margin revenue that underpins its entire market strategy and fuels its global expansion.
This unique blend of retail, wholesale, and subscription has not only cemented its position as a consumer favorite but has also created a complex operational identity with significant legal ramifications, as recently illuminated by a pivotal Ninth Circuit ruling.
Costco: The Original Subscription Empire
The concept of membership as a cornerstone of its business dates back to the company’s roots. Originally founded as Price Club in 1976, serving small businesses, the model quickly evolved to include non-business members, realizing the immense buying power a large membership base could provide. The first Costco warehouse opened in Seattle in 1983, and after merging with Price Club in 1993, the combined entity solidified its position as a global leader in warehouse clubs. This history demonstrates a long-standing commitment to a philosophy that prioritizes efficiency and passes savings directly to members.
At its heart, Costco is a membership warehouse club. This seemingly simple fact transforms it into what many analysts describe as a “subscription business in disguise.” Instead of relying solely on merchandise markups, Costco charges an annual fee for access to its warehouses and services. In fiscal year 2025, these membership fees alone generated an estimated $5.3 billion in revenue. What makes this revenue stream particularly attractive is its high margin; the costs associated with running the membership program are minimal, meaning a substantial portion flows directly to the company’s bottom line.
The strength of this subscription model is evident in its remarkable customer loyalty. Global renewal rates hover around 90%, and are even higher in the U.S. and Canada. This level of “stickiness” is typically associated with successful streaming services or tech platforms, not traditional retailers. Once customers invest in a membership, they are incentivized to utilize it, creating a powerful feedback loop that drives consistent traffic and sales.
This steady, recurring revenue from memberships creates a self-reinforcing virtuous cycle:
- Financial Cushion: Membership fees provide a predictable, high-margin income stream.
- Price Advantage: This cushion allows Costco to maintain exceptionally low prices on its merchandise.
- Customer Attraction: Low prices attract and retain a large base of members.
- Purchasing Power: High sales volume grants Costco significant leverage with suppliers, securing even better deals.
- Operating Leverage: As sales grow, the more efficient use of fixed assets leads to improved operating margins, which can be reinvested into further lowering prices or enhancing member benefits.
This cycle strengthens Costco’s competitive moat, making it incredibly difficult for traditional retailers to compete on price or value.
Navigating the Dual Role: Retailer and Wholesaler in the Eyes of the Law
Costco’s hybrid nature extends beyond its membership model to its operational structure. While many perceive it primarily as a direct-to-consumer (DTC) retailer, selling to end-user customers, the company also operates Costco Business Centers. These centers are explicitly designed to target sales to other businesses, such as “mom-and-pop convenience stores and small grocery stores.” This dual role was at the center of a significant legal challenge recently decided by the Ninth Circuit Court of Appeals.
In the case of U.S. Wholesale Outlet & Distrib. v. In No. Ventures, LLC, the Ninth Circuit addressed claims of price discrimination under the Robinson-Patman Act (RPA). The RPA prohibits sellers from charging different prices to competing buyers for the same product under certain circumstances. U.S. Wholesale, a traditional wholesaler, alleged that Living Essentials, the manufacturer of 5-hour Energy, offered more favorable pricing, discounts, and reimbursements to Costco than to U.S. Wholesale.
The key issue hinged on whether U.S. Wholesale and Costco were operating at the same “functional level of sale” and thus in competition for the same customers. The district court initially ruled that Costco was primarily a retailer and therefore not in direct competition with U.S. Wholesale. However, the Ninth Circuit reversed this decision, pointing to evidence that 90% of Costco Business Centers’ clients were businesses and that Costco exclusively purchased 5-hour Energy for resale at these centers. The court concluded that, as a matter of “economic reality,” Costco could be considered a wholesaler alongside U.S. Wholesale. This ruling has been characterized as a “plaintiff-friendly decision” for RPA claims, as highlighted by K&L Gates. For further details on the legal implications, see the analysis by K&L Gates.
This decision carries significant implications for manufacturers. It underscores the need to recognize that resellers like Costco, with their hybrid business models, may be competing at multiple levels of distribution. Manufacturers can no longer simply assign one sticker price to a distributor without considering how different arms of that distributor’s business may operate and compete. The pricing must correspond to the specific arm of the business under which the product is being resold.
Implications for “Functional Discounts”
The Ninth Circuit also affirmed a jury instruction that effectively raised the bar for manufacturers justifying “functional discounts.” Functional discounts are offered to resellers for services they perform in support of the manufacturer’s distribution system, such as marketing or promotional functions. The court emphasized that manufacturers must prove two things:
- The reseller (e.g., Costco) actually performed the claimed services.
- The amount of the discount was a reasonable reimbursement for the actual functions performed.
This means manufacturers must be prepared to rigorously “do the math and show their work” to justify any pricing differentials, attributing discounts to specific, verifiable sales and service activities that provide actual value to the manufacturer. This introduces a greater burden of proof for manufacturers seeking to defend against price discrimination claims from distributors operating at different functional levels.
What This Means for Investors: A Long-Term View
For investors, Costco’s unique model presents a robust and resilient investment opportunity. The subscription-like growth story is far from mature. With 81 million paid memberships and 145 million cardholders globally, and only 914 stores worldwide, there remains substantial room for expansion. The company consistently opens 20 to 30 new stores annually, each new location adding to its recurring fee income. International markets, such as China, have shown immense promise, with strong demand and renewal rates quickly approaching North American levels, demonstrating the model’s global effectiveness.
Digital initiatives further reinforce the membership advantage. E-commerce platforms offer lower costs and full inventory access for members, incentivizing non-members to convert and benefit from the full suite of Costco’s offerings. As an article by The Motley Fool highlights, this “stickiness” and the self-reinforcing model make Costco a highly predictable and resilient business.
The recent Ninth Circuit ruling, while creating legal complexities for manufacturers, ultimately clarifies Costco’s operational reality. It affirms that Costco’s Business Centers actively function as wholesalers, solidifying its multifaceted market presence. For long-term investors, this decision doesn’t detract from Costco’s investment appeal; instead, it provides a clearer picture of the strategic depth and operational versatility that define this retail giant. Costco’s ability to seamlessly blend retail, wholesale, and a powerful subscription model positions it for continued compounding returns, making it a business model truly worth paying attention to.
