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Does Costco Have a Membership Renewal Problem?

Demitrios Kalogeropoulos, The Motley Fool

As membership services go, it's almost comically easy to extract yourself from a Costco (NASDAQ: COST) subscription commitment. There's no extra fee or cancellation requirement. Instead, simply tell the company that you aren't satisfied with the service and Costco will refund not just a prorated amount but the entire membership fee.

The warehouse retailer gets away with this relaxed subscription policy, because it delivers plenty of value, in terms of selection, pricing, and convenience, over and above the $60 or so that it costs to carry a membership card. Costco can point to the fact that the vast majority of members choose to pay their annual fee each year as strong support for that value proposition.

Yet the renewal rate has ticked lower in recent years in what might be an early warning sign that its competitive advantages aren't as strong as they used to be.

A full grocery cart being pushed through the aisles.

Long-term trends

In 2010, 88% of Costco members renewed their subscriptions. That number went on to improve in each of the next three fiscal years to peak at 91% in fiscal 2014 and 2015. The increases coincided with stellar growth for the retailer as comparable-store sales increased 5% or better in the U.S. market.

Chart showing renewal rates dipping to 90% over the past two years from a peak of 91% in 2015.

Costco's renewal rate then dipped to 90% in fiscal 2016 at the same time that sales growth in the U.S. fell to a 3% pace from 6% in the prior year. The company hasn't yet provided all the details on the fiscal 2017 year that it just closed, but we do know that the membership renewal rate was again at about 90%, or down by roughly a full percentage point from its peak rate.

Management isn't worried

Management says the decline is no reason to panic. "Our renewal rates are fine," Chief Financial Officer Richard Galanti told investors in an early October conference call. The drop is likely due to residual effects from its co-branded credit card switchover, executives said. After all, the retailer recently navigated a comparable situation in the Canadian market, and its renewal rates have now completely recovered in the country.

As further support for that "temporary slowdown" argument, Costco cited its rising comps and customer traffic rates. If people were really perceiving less value in their memberships, you'd expect those metrics to be headed in the other direction.

On the other hand, Costco is making aggressive moves in the e-commerce space that suggest it could be getting nervous about competition from online retailers. These include a 2-day delivery service on dry grocery goods. Given that Costco considers its warehouses, and the massive sales volumes they produce, to be a core competitive advantage, it's notable that the retailer would promote services that reduce, rather than increase, customer traffic at these locations. Yet if members are looking for ways to cut down on Costco trips, a robust delivery service might just be enough to keep them from bolting to online competitors.

Watch the rate

Investors will learn over the next few quarters whether there's a potential market share problem looming for Costco. Management's best guess calls for the membership renewal rate to begin bouncing back up to around 91% over the next few quarters. If it takes another tick lower instead, that could be the sign of a more fundamental challenge for the company.

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Demitrios Kalogeropoulos owns shares of Costco Wholesale. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.