Orders are growing. So are costs: the retail margin test
By @engtmk · Research as of 5 October 2026
Friday’s jobs analysis asked whether relief on rates could arrive alongside resilient retail earnings. Today’s services report adds a complication: demand continues to expand while businesses face stronger input-price pressure.
The earnings test is whether companies can protect profit without weakening the customer demand supporting their sales. Absorbing higher costs can reduce margins. Passing them on can protect profit per transaction but risk fewer transactions or smaller baskets. Better purchasing, productivity and product mix can provide other ways to manage the pressure.
For Costco and Target, this is a framework for reading the next disclosures, not a margin forecast derived from a national survey. The two companies have different sources of revenue and different operating choices. Neither becomes an automatic winner because services activity is expanding, nor an automatic loser because the prices index rose.
This research develops the question in today’s published eToro post: healthy orders are encouraging; protecting profit is the next test.
What September’s survey adds
The September 2026 ISM Services report was released on 5 October at 10 a.m. ET.
| Survey index | September | August | Change, index points |
|---|---|---|---|
| Services PMI | 54.9 | 55.4 | −0.5 |
| New orders | 59.8 | 60.9 | −1.1 |
| Prices paid | 74.0 | 72.6 | +1.4 |
| Employment | 50.1 | 47.8 | +2.3 |
PMI and orders remained above 50 but fell: expansion continued at a slower indicated pace. Employment moved just above the threshold. ISM identifies the prices reading as the highest since July 2022.
These are diffusion indexes describing the direction and breadth of reported change, not percentage growth rates. A prices reading of 74 does not mean costs rose 74%. Prices is not one of the four equally weighted headline PMI components: those are business activity, orders, employment and supplier deliveries. Slower deliveries can lift that last component.
The implication is to separate the demand signal from the cost signal. Subtracting prices from orders would not produce a profit-margin estimate: the indexes do not measure comparable dollar flows.
Why this does not cancel Friday’s warning
Friday’s payroll report and Monday’s survey answer different questions. BLS’s payroll methodology describes an establishment survey used to estimate employment levels and changes. ISM’s employment reading is a directional business survey measure. An index barely above 50 does not specify the number of jobs added, the pay attached to them or the spending power created.
The reports can therefore coexist without either being dismissed. A more encouraging services hiring signal deserves attention, but it does not establish that household-income growth has recovered. Equally, weak payroll growth does not prove that every retailer is already losing sales.
Wednesday’s PCE and spending research examined spending strength alongside the income supporting it. This follow-up adds a second constraint: even if customers keep spending, more of the revenue may be needed to cover the cost of serving them.
Input-price pressure is also different from consumer inflation. BLS defines CPI around prices paid by urban consumers for a basket of goods and services. Business purchasing conditions do not translate mechanically into that basket. Companies can absorb costs, change suppliers, improve productivity or alter prices with a delay. Today’s survey alone cannot settle the next CPI release or the Federal Reserve’s response.
From demand to shareholder earnings
There are three practical channels to distinguish. The timing depends on contracts, inventory turnover and management decisions—not the release date of the survey.
| Channel | First financial effect | Evidence needed from the company |
|---|---|---|
| Merchandise and purchased services become more expensive | Cost of sales or operating expenses rise as costs are recognised | Supplier-cost commentary, freight, merchandise margin and expense trends |
| The business changes prices or promotions | Revenue per transaction and gross profit change; volumes may respond | Traffic, basket size, units where disclosed, discounts and product mix |
| Productivity or scale offsets the pressure | Costs per unit or expenses relative to sales improve | Operating margin, staffing efficiency and cash generation after investment |
The first effect may be visible in purchasing before it reaches reported profit. Inventory acquired at an older cost can delay the income-statement effect. Expensive replacement inventory can also use cash before it is sold. That makes inventory and cash conversion useful companions to the margin figures.
The strongest favourable case is not simply that a retailer raises prices. It is that customers keep buying, the company manages costs efficiently, and the resulting profit is sustainable. The adverse case is revenue that looks healthy in dollars while volumes weaken and markdowns become necessary.
Costco: membership income helps explain the model, not immunity
Costco’s 24 September earnings release covers the 16-week quarter ended 30 August 2026. Membership fee income was $1.850 billion, compared with $1.724 billion a year earlier. Comparable sales increased 9.4%, or 6.7% excluding gasoline-price and currency effects.
That adjusted sales figure is not a pure volume measure: it still contains other product-price changes. The release also identifies employee, energy and commodity costs among business risks. These disclosures establish the channels to examine; they do not quantify the impact of September’s survey on Costco.
Membership income gives the analysis an additional variable beyond merchandise sales. Its durability needs to be assessed through renewal, membership counts, fee pricing and the value members receive. It should not be treated as cost-free revenue or proof that merchandise profitability is irrelevant.
A retailer may choose to protect value for customers rather than maximise the margin on each item. Such a choice can support loyalty over time, but the investment case still needs enough total profit and cash generation to justify the resources employed. The test is whether any near-term sacrifice produces measurable retention or shopping benefits—not whether a strategy sounds attractive.
The earlier Costco results analysis separated the tariff-refund benefit from the underlying earnings question. The next useful evidence is sustained shopping activity and membership performance alongside expense discipline. Strong comparable sales accompanied by deteriorating operating economics would deserve a different interpretation from strong sales with resilient margins.
Target: traffic and merchandise margin need to work together
Target’s second-quarter release, covering the quarter ended 1 August 2026, reported 3.8% comparable-sales growth, with 3.6% traffic growth and 0.2% growth in average transaction amount.
Its SG&A expense rate increased to 21.6% from 21.3%. Target cited higher compensation, additional field hours, incentives and capital-project spending, partly offset by sales leverage. More sales therefore did not prevent this expense ratio from rising.
There is also an earnings-quality comparison to keep straight. The reported 9.6% operating margin included a 3.7-percentage-point tariff-refund benefit. Simply treating that headline margin as a recurring baseline would overstate what the ordinary business had to defend.
The headline-profit lesson explains that distinction; the point here is how to apply it to the next report. Compare recurring performance on a consistent basis before deciding that costs have been absorbed successfully.
The most useful combination would be resilient traffic, controlled markdowns and inventory appropriate for sales and seasonality. Revenue supported by heavier promotions would offer weaker evidence of pricing power. Conversely, a deliberate investment in staffing could be worthwhile if better service produces enough profitable demand. An expense increase is not automatically a mistake; the return on that spending matters.
The September Target research posed the same execution test around back-to-school demand. Today’s survey changes the broader backdrop, not the standard of proof.
Why small margin changes can outweigh sales growth
Consider a hypothetical retailer, not a forecast for COST or TGT. With sales of 100 and an operating margin of 5%, operating profit is 5. If sales grow 3% to 103 but margin falls to 4.5%, profit becomes 4.635—a 7.3% decline despite higher revenue.
This example assumes the stated sales and margin outcomes; it does not infer either from ISM. It also stops at operating profit, before interest, tax and share-count effects. Its purpose is to show why a small percentage-point margin movement can have a much larger percentage effect on profit.
Valuation adds another test. A business can execute well and still produce disappointing share returns if the price already assumes stronger earnings. Persistent cost pressure could affect both profit forecasts and the return investors require, but neither effect is quantified by today’s survey. This article makes no claim that either stock is cheap, expensive or mispriced without a current valuation analysis.
Three scenarios to test in the next disclosures
Demand holds and costs become manageable. Companies maintain customer activity while purchasing discipline, productivity or selective pricing protects recurring margins. Evidence would be healthy traffic and operating profit growth without unusual benefits or escalating discounts. This would weaken the case for a broad retail margin squeeze.
Demand holds but costs absorb the growth. Sales remain positive while merchandise or operating margins deteriorate. Rising inventory funding needs could also pressure cash conversion. That would reinforce the concern in today’s post: an expanding economy can still produce difficult company earnings.
Pricing protects the margin but weakens the customer response. Higher realised prices or fewer discounts initially preserve profitability, followed by softer traffic, lower volumes or a less favourable mix. This would challenge the assumption that cost pass-through can continue without consequences. Subsequent promotional activity would be an important check.
These are analytical scenarios, not probabilities or management guidance. The best counterargument to the cautious reading is that strong demand gives companies room to adapt, and operating improvements may outweigh input pressures. The best counterargument to the optimistic reading is that strong nominal sales can conceal weaker customer economics until margins or inventory reveal the strain.
The next evidence that matters
For Costco, assess shopping activity and membership trends alongside merchandise and operating costs. For Target, assess traffic, transaction value, merchandise margin, operating expenses and inventory together. For both, ask whether management distinguishes price from volume and recurring performance from exceptional items.
The most convincing guidance would explain the size, timing and location of cost changes, the actions being taken, and the customer response observed so far. A general statement that demand is healthy is less useful than evidence that profitable demand survives the pricing decision.
At the macro level, compare subsequent orders and prices readings with actual consumer spending and employment data. Persistent cost pressure alongside weakening company volumes would strengthen the adverse case. Resilient activity and recurring margins, accompanied by easing purchasing pressure, would weaken it.
Healthy orders are encouraging. The investment case still needs evidence that those orders become durable profit and cash flow. Today’s report keeps both demand and cost pressure in the analysis; it does not settle the outcome for either company.
Which would concern you more in the next earnings reports: weaker sales or shrinking margins?
Sources and freshness
Research checked on 5 October 2026 against the linked ISM report, BLS methodology pages and issuer earnings releases. The ISM page’s body explicitly identifies September 2026; its retrieved page-title metadata still says 2025. The body, dated tables and Prices section are the basis for the figures used here. Monthly report URLs can change over time.
Company results cover the earlier fiscal periods stated above and serve as operating baselines, not evidence of September outcomes. Survey interpretation, transmission channels and scenarios are analysis. The numerical margin example is hypothetical. No live price, consensus earnings estimate, current portfolio position or new trade is asserted.
My portfolio and views, not investment advice. This article is for research and education.