The important business of making things cheaper

The signage at a Costco food court is as retro as the prices: the price of an all-beef hot dog and 20-ounce soda (with free refills!) has never changed. The combo deal was $1.50 when it was introduced in 1985 and it’s $1.50 now.

Adjusted for inflation, that means the cost of an all-American lunch has fallen by an incredible 69.8%.

Adjusted for size and quality, it’s even more incredible, because the drinks have gotten bigger and the hot dogs have gotten bigger and better.

The soda used to be a comparatively modest 12 ounces, with zero refills. The quarter-pound hot dog is now a “quarter-pound plus” — about 10% longer and heavier than in 1985. It’s also higher quality: 100%, USDA Choice-grade beef, with no fillers.

(What’s the hedonic adjustment on free refills? Infinity?)

To what do we owe this miracle of ever-cheaper hot dogs and soda? Credit the extreme determination of co-founder and CEO Jim Sinegal to constantly lower Costco’s prices.

The hot-dog combo was an instant hit with price-sensitive customers, and Sinegal made it a point of pride to never change it. In 2018, though, Sinegal’s successor as CEO, Craig Jelinek, told him it was time: “We can’t sell this hot dog for a buck fifty, we are losing our rear ends.”

Sinegal’s response had become corporate lore: “If you raise the effing hot dog, I will kill you. Figure it out.”

That was not, however, a mandate to lose money on hot dogs and make up the loss somewhere else. Costco does not believe in either loss leaders or overcharging on one thing so they can undercharge on another.

By “figure it out,” Sinegal meant, “do whatever you have to do to sell hot dogs and a soda for $1.50 and still make a profit.” 

“That’s all I really needed,” Jelinek said. Costco went on to figure it out by building factories in Los Angeles and Chicago so they could make hot dogs for less than they could buy them.

The factories are very busy: Costco sells about 300 million hot dogs a year. And they’re profitable, too. “We keep it at $1.50 and make enough money to get a fair return,” Jelinek said in 2011.

This is an exception to the rule, of course. Almost everything Costco sells is made by someone else. Even products offered under Costco’s own Kirkland Signature brand are made by contract manufacturers.

But the hot dogs are Costco’s spirit animal, so to speak. They represent the company’s core philosophy of making money by making things more affordable. As Jim Sinegal put it, “You have to constantly think, how can we bring goods and services to market at a lower price?” 

Costco has been incredibly successful at that — which is part of the reason why inflation has been a non-issue in the United States for most of the last few decades.

Economists and the media typically frame inflation as a function of monetary policy. This morning’s hotter-than-expected CPI report, for example, prompted calls for the Fed to do more to fight inflation.

But the Fed can’t give us cheaper hot dogs. Only retailers and manufacturers can do that.

Consider Walmart.

In a 2005 paper, economist Jason Furman cited estimates that Walmart’s “everyday low prices” saved US consumers $263 billion a year.

That works out to $2,329 per household! Every year!

And, no, it’s not because Walmart sources cheap junk from China. Instead, the biggest savings are in groceries, where Walmart’s prices were found to be as much as 39% lower than competitors’ prices. Prescription drug prices were as much as 23% lower.

Perhaps equally incredible, almost everyone benefits. One study found that 72% of households do their grocery shopping at Walmart — and that 95% of Americans make at least one visit to a Walmart each year.

And even if you remain in the stubborn minority of non-Walmart shoppers, you probably benefit, too. When a new Walmart enters a market, competing retailers respond by lowering their prices an estimated 7-13%.

Imagine if the Fed could lower prices by 13%! They’d be heroes.

Some competitors have responded even more aggressively — so much so that Walmart is no longer the cheapest option. Today, Costco is an estimated 21.4% cheaper for groceries, while Aldi and Lidl (my personal favorite) are both 8% cheaper.

There’s no sign of the competition easing up, either.

This morning, the BLS reported that beef prices rose 0.9% in October from the month before, thanks to a variety of factors like tariffs and the sky-high cost of diesel. The Fed can’t do much about either of those things. 

But retailers can. By constantly innovating on things like logistics, sourcing, technology, and scale, fiercely competitive companies like Costco are always trying to make our lives more affordable. 

In at least one case, they seem likely to succeed: Kalshi estimates there’s a 68% chance that Costco will keep their hot-dog combo at $1.50 until at least 2030.

— Byron Gilliam

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