Costco CEO sounds the alarm on looming pricing problem

Costco has built its entire business around offering the best possible prices to its members.

The chain's operating model is quite simple: It offers a limited number of products so it can get the best price possible on whatever it buys.

Costco (COST) can leverage the size of its customer base and its limited selection to place massive orders. In turn the chain can press vendors for the lowest possible wholesale prices.

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The warehouse club also can ask vendors to make changes in packaging or even how an item is produced in order to lower costs. In general, vendors will happily work with the retail giant and accept thinner profit margins because the orders Costco places are so large.

Vendors, however, do not fully control their own costs. Taxes, tariffs and other shipping charges can raise prices beyond the control of a manufacturer.

During the Covid pandemic, for example, Costco leased ships to control its shipping costs. It also absorbed some of the higher costs to avoid raising prices for customers.

Now, the warehouse club faces another pricing challenge. CEO Ron Vachris identified how it will handle the impending issues during Costco's fiscal-second-quarter earnings call.

Tariffs could cause Costco problems

Costco executives share more than most companies during their earnings calls. They may not answer a question, but they always acknowledge topics like membership- price increases even when they're not ready to talk about them.

In some cases, the company sets the stage for what could happen. Vachris' comments in the Q2 call appear to be doing that.

"As we look ahead to the remainder of this fiscal year, headwinds from foreign exchange look likely to continue," he said. "Given events over the last week, it is difficult to predict the impact of tariffs, but our team remains agile and our goal will be to minimize the impact of related cost increases to our members."

Costco imports fewer goods than you might think.

"About a third of our sales in the U.S. are imported from other countries, and less than half of those are items coming from China, Mexico and Canada," he said.

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The CEO made clear that his team would do everything possible to keep prices low for members.

"In uncertain times, our members have historically placed even greater importance on the value of high-quality items at great prices," he said. "And our teams will continue to rise to this challenge by leveraging our global buying power, strong supplier relationships and innovation."

Costco members are still buying

While many retailers have seen their sales slow, that is not the case with Costco.

Net sales for the quarter increased 9.1% to $62.53 billion from $57.33 billion a year earlier. Net sales for the first 24 weeks increased 8.3% to $123.52 billion from $114.05 billion.

"We believe that the member is probably as much focused now on quality, value and newness as they have been for quite some time," Chief Financial Officer Gary Millerchip said during the call. "[They] are still showing that willingness to spend, but they're being very choiceful where they're spending their dollars,"

He also addressed the potential impact of tariffs.

"We think that's likely to continue and maybe even become more choiceful as the impact of some return of inflation and the potential impact of tariffs could flow through as well," he said. 

"I'd say we're also seeing a continued sign of what I mentioned last quarter, where there's some indication that members are spending a little bit more on food at home versus food away from home overall."

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Costco is also planning ahead to mitigate the impact of tariffs.

"One of the things that was an increased cost during the quarter was higher supply-chain costs as we have been continuing to buy more inventory, which we think will be helpful as you think about some of the unpredictability that we've seen in supply chain timing and also with the potential risk around tariffs," Millerchip said.