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Why the Membership Model Makes Sense

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Brick-and-mortar retailing is a rough business. Even established players like RadioShack and Borders have found it impossible to stay afloat in such a cut-throat environment. Yet Costco has a happy oasis in the category, able to thrive and pay its staff well, even in the face of larger competitors.

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How? One explanation is membership fees. Patrons at Costco pay $55 a year for the privilege of shopping at the retailer and enjoying deep discounts. It's said that, since Costco shoppers save about $5 on each bottle of wine, after purchasing 11 bottles of wine, you'll have justified the yearly fee.

For Costco, it's a win-win; some 75 percent of the chain's operating profits come from those yearly fees. The warehouse chain's renewal rate is 90 percent, indicating that most customers are happy to pay them as well.

Related: How Do I Launch a Membership-Based Website?

Cost savings for consumers and financial security for retailers are just two reasons why a membership model makes sense. Here are a few others:

Develops brand loyalty

Pay an annual membership fee and suddenly you have a strong reason not to shop anywhere else.

For instance, if you pay $99 to join Amazon Prime, then that's pretty much where you're going to do your online shopping, as many of its products arrive in two days. Otherwise, you'll have to pay shipping costs.

Builds a strong customer base

If you multiply the scenario above by millions, you have an army of brand-loyal customers who keep coming back. Those satisfied customers are likely to spread the message, which is the best form of advertising. As a 2012 study by Nielsen showed,92 percent of customers say they trusted earned media including word-of-mouth recommendations from friends and family. That figure was up 15 percent over the previous five years, showing the power of word of mouth continues to grow.

Creates upsell potential

Shoppers may go to Costco to buy toilet paper in bulk, but they're exposed to some big-ticket items, including diamond rings that go for $52,000. While such items aren't impulse buys, repeated exposure during shopping trips can plant a seed for a future purchase.

Related: How to Improve the Success of a Membership Program

Provokes perceived value

Consumers know you don't get something for nothing, and the best way to save money is to pay up front. If you buy a house for cash, for instance, you'll save thousands of dollars you would have spent on mortgage payments.

By paying an annual fee, consumers feel like they're smart, savvy shoppers -- and they're right. That's why, when Marc Lore, a former Amazon executive, started Jet, an Amazon rival, he chose a membership model. "Every household in America should have a Jet membership, Lore mused. "Why not spend $50 bucks to save $200?"

Consumers have made similar calculations in other areas. Sales of digital music are down, because people would rather pay a monthly fee to stream their music. Businesses are scrapping their data centers to pay for cloud services. Some are forgoing car ownership to pay Zipcar every month to get a car when they need one.

Now, don't get me wrong. Amazon, Zipcar and Costco are thriving not only because they employ a membership model; they are also great companies.

The membership model doesn't make sense in every case, but there are some distinct advantages for those who embrace it. The key is to play upon consumers' sense of thrift and the social capital exchanged when telling a friend about a new service. This requires building a strong brand. As the old slogan said, membership has its privileges.

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