What Costco Teaches us About The Psychology of Pricing

An Interview with Author, Behavioral Scientist, and Podcaster Melina Palmer

Over the past few decades, Costco has grown to become on the most beloved wholesale brands in America. While their approach isn’t always conventional, they’ve carved out a very fanbase and continue to be a massive force in the wholesale market. What does Costco do so well, and what can other brands learn from them?

In this interview, we speak with Melina Palmer, author of The Truth about Pricing, about why Costco is one of her favorite brands, and what has enabled their success. As Melina details, their success comes down to owning their identity as a “value brand”, to getting creative with their approach to pricing, and to using pricing tactics like scarcity in their own unique way.

Let’s dive in.

In your book, you cite Costco a few different times. What can marketers learn about pricing by looking at Costco?

Costco is fascinating from a pricing standpoint. For one, they’re a great example of how to effectively utilize loss leaders.

Costco has, for example, their $1.50 hotdog meals, and they've said they will never charge more for these, despite the incredible demand for them. They've come out very explicitly and said again and again, that they will never raise the price on them, even though they lose money on each one they sell. It’s the same way for their rotisserie chickens - they've kept the price at $4.99 and they lose somewhere between 30 and $40 million a year on their rotisserie chickens alone!

This may seem worrisome, but don’t worry - Costco makes plenty of money. They're fine. The fact that they can lose money on these items says something about member value, and how much they care about taking care of their members.

As consumers, we know that there's great value throughout Costco, and we see this in the fact that people don't do a lot of price and comparison shopping. You see an item in Costco that you want and it’s in your cart instantly, no need to interrogate the price tag, or to see how the price compares to others.

In this way, they are making money in plenty of areas around the store. And these few key items like the hot dogs and the rotisserie chicken are strategically reinforcing what the brand is about. It’s these items that make everything else easier.

It seems that these Costco items may be the “door busters” for the brand, incentivizing consumers to come in.

Absolutely - these doorbuster items also get people in the door. Costco knows that their consumers aren’t going to just go all the way to the store just to get a hot dog or grab a chicken - they’re going to pick up at least three or four more things on their way out the door to where that visit becomes profitable to Costco overall.

Costco illustrates that you don't need everything to be a big money maker. They also illustrate how brands need to look at everything they’re selling as a gestalt, not as individual items. These aren’t just specific items on their own - each plays a specific role for the entire business and your structure as a whole.

It seems that Costco, and their private labelling company, Kirkland, have become low-key cult brands. Consumers love them - so much that they’ll actually buy Kirkland-branded merchandise. Why do you think that is?

Absolutely - Costco and Kirkland have become beloved brands. Kirkland is headquartered about two hours from my house here in Washington state, but just to be clear as a quick disclaimer - Costco's not a client, and so I'm speaking only from my analysis of what I see.

But it's not surprising to me that they’ve been able to capitalize on their brands. The biggest thing about Costco is that, while they have consistent value as we’ve seen, they also have Easter eggs. There are secret things, and secret items that only the most hardcore Costco fans know.

When I did my episode about Costco several years ago for the podcast, I mentioned it to a friend and told her some of the things I was finding out. And she said, well, “What I know is you only need to buy five pies to justify your Costco membership”. And it made me think: that’s a weird thing for someone to know and to think.

It's not that Costco is going around overtly advertising this kind of information, and yet, there are people on TikTok and YouTube who make videos like this. They’re showing you the price differentials: if you were to get a pie that is this big, and if you were going to go get a pie of the same quality and buy the ingredients yourself, and try to make it, it would cost you this much. And so once you've bought five pies, you've you've spent enough, and saved enough to justify your Costco membership. And in this way, this organic content ends up encouraging people to become Costco members and to shop there and feel good about everything else they’re getting.

It seems like a real testament to the brand that they get all of this organic social media reach, and user-generated content

Costco benefits a ton from organic social media and UGC. It's fascinating that, for the most part, Costco doesn’t have to go out and do those sorts of things. They may do some paid partnerships with influencers, and help get these off the ground with tips and tidbits. If they don't, they should. They already have people going around Costco, talking about the sales and the great finds of the week.

As you talk about in your book, many great brands utilize scarcity, especially in their pricing. How does Costco utilize scarcity, and how does their approach differ?

Scarcity can be used differently by different brands. For Costco, scarcity is something that the brand uses effectively, especially because it comes to mean something specific within Costco's culture. Costco shoppers know, first are foremost, that if you see something you want, you just buy it. You know you’re probably not being overcharged for it, and you can always come back and return it if you end up not liking it.

But the other reason you do it is because the psychology of scarcity: you know other Costco shoppers are also thinking this way! And so very likely, it won’t be there for much longer. It might not be there tomorrow, and maybe it won’t even be there the next time you come back around and loop in the store.

Costco uses scarcity in a very unique way. Whereas scarcity for a brand like Supreme is about, like the quantity on the drop - it's extremely scarce in the actual number that is out there. The same concept applies to Costco, but they use it in their very “on-brand” way.

More from Melina Palmer on the psychology of pricing, the difference between being a value brand and a quality brand, and Serendipity 3’s $214 Grilled Cheese sandwich

Check out Melina’s incredible TEDx talk, There’s Nothing Magical About Monday