On a conference call last week for its second quarter ended Feb. 13, management noted that although overall gross margins in the quarter grew to 12.6 percent from 12.5 percent year-over-year, fresh foods were down 10 basis points, primarily due to commodities price inflation. On the call, Richard Galanti, the club's chief financial officer, said fresh foods' margin dip reflected the fact that Costco tends "to hold pricing as long as we can," particularly on key small business items, as well as some items in the food court, bakery and the deli.
As an example, Mr. Galanti pointed to a 15-pack of muffins costing $5.49. He said Costco sells a "heck of a lot of those to restaurants and businesses and convenience stores" for resale. To support those small business members, Costco is willing to realize lower margins for several weeks or a few months before finally bringing prices up 30 cents to 50 cents to get back to regular margin.
"That's not a competitive issue other than we want to protect the prices to the members who are buying these items," said Mr. Galanti.
The fact that the 15-pack muffin package has held that price seemingly "forever" also leads to the delayed price increase. In that same manner, despite rises in the cost of cheese and other ingredients that have impacted the profitability of pizza, Costco isn't planning on soon changing its $10-for-an-18-inch-pie deal, or $1.99 a slice, in its food court.
Mr. Galanti also noted that Costco is also able to hold prices on certain items because overall margins "have been quite good" partly due to its decision to change its electronics returns policy two years ago. Vendors are supplying some promotional support in the form of enabling additional buys at the old price for a limited period. Costco's strong private label assortments also provides some leverage in price negotiations.
Nonetheless, Mr. Galanti said with inflation continuing in the low- to mid-single digits range in fresh foods and in the low-single digit range in food and sundries, Costco has been passing along price increases on most items, particularly traditional supermarket items such as tin foil, paper goods and cereals. And with inflation appearing likely to only increase over the year, the chain will inevitably have to raise prices across the board.
"Ultimately, you've got to pass on cost increases, but we want to hold in longer and particularly on those business items like the 15 packs of muffins," said Mr. Galanti.
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- Costco Wholesale Management Discusses Q2 2011 Results - Earnings Call Transcript - Seeking Alpha
- On the Call: Costco's CFO on passing along costs - Bloomberg Businessweek
- Costco, BJ's Post Solid Results Aided By Membership - The Wall Street Journal