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Profits In Distribution

( Originally Published 1939 )

From the standpoint of the buyer what he pays for goods is their "cost" to him, although the price paid includes the profits as well as the operating expenses of the producers and distributors who supply the goods. Sometimes, of course, the distributor's operations are carried on at a loss, in which event the price paid for the goods does not fully cover the distributor's costs. Since the following chapters are based on an analysis of cost from the standpoint of the distributor-i.e., operating expenses exclusive of profits-it may be worthwhile at this point to give some consideration to distributors' profits and losses. Are the profits of middlemen and retailers, as many believe, largely responsible for the high cost of distribution?

Some distributing organizations, it is true, particularly those in the newer and more successful branches of retail distribution, have been conspicuously profitable. Thus eight of the leading national "variety" chains, according to the SEC, earned annual profits amounting to about 8 per cent of their total sales during the past few years. In this case average prices charged consumers could have been reduced by 8 cents on the dollar if profits had been eliminated entirely. But 8 per cent on sales is undoubtedly far above the usual rate of profits in distribution. For every outstandingly successful distributor there are many others that barely break even, and some that operate at a loss even in good years.

Half of Corporations Unprofitable

In 1936, for example, 76,257 of the 149,805 trade corporations in the United States, or more than half of the total number, re-ported a loss on the year's operations to the Bureau of Internal Revenue. These unprofitable distributors reported gross income (total sales plus other income) of $8,460,648,000, and expenses (deductions) of $8,673,702,000, or a net deficit of $213,054,000. Even the 69,263 distributors operating at a profit reported a net income of only $1,136,410,000 on gross income of $34,810,547, 000, or little more than 3 per cent on sales. Considered as a single group the corporations engaged in distribution reported a profit of only $923 million on a volume of $43.3 billion, or little more than 2 per cent on sales in one of the most profitable years since 1929?

These figures, it must be remembered, refer only to corporations. For every incorporated distributor there are perhaps ten organizations operated by individuals or partnerships. These are usually small and often unprofitable. Furthermore, profits for years like 1929 and 1936 must be offset against losses for depression years like 1932 and 1933. A study made by the Harvard University Bureau of Business Research of operating results of several hundred department stores over a period of eight years showed that the only years in which profits were made by the group as a whole were 1929, with 1.2 per cent on sales, and 1936, with 1.6 per cent. Losses rose as high as 6.4 per cent of sales in 1932.

Pro fit Figures by Groups

Figures collected by Dun & Bradstreet confirm the conclusion that distributors' profits do not constitute a very large proportion of the total costs of distribution. In the retail food, beverage, and restaurant group profits in 1936 ranged from 1.2 per cent of sales for fruit and vegetable markets, and 1.7 per cent for grocery stores, to 7.1 per cent for drinking places. In the general merchandise group profits amounted to 2.3 per cent of sales for country general stores and to 2.6 per cent for large city department stores, but were as high as 6.6 per cent for variety stores. Motor vehicle dealers reported a profit of 2.2 per cent of sales, and filling stations showed 2.3 per cent. Profits of jewelry stores amounted to 4.8 per cent of sales, hardware stores made 3.6 per cent, furniture stores, 6.6 per cent, radio stores, 5.9 per cent, and refrigerator stores, 7.3 per cent. Fairchild's Financial Manual reports an average profit of 4.2 per cent of sales for a group of "independent and chain department stores, specialty shops, variety chains and mail order houses" with a total sales volume of about $3.2 billion in 1938.

Published figures of retail operating results, however, are necessarily based on limited samples with inadequate representation of the vast number of very small retail stores. Since the great majority of these small enterprises earn little or nothing beyond a meagre living for their owners, the average rate of profit for retail trade as a whole is undoubtedly considerably less than published figures appear to indicate. Considering the entire retail field and offsetting good years against bad it is not unreasonable to suppose that the average profit ratio is not more than 2 per cent on sales and may be as low as one per cent.

Among the wholesale trades covered by Dun & Bradstreet surveys, wholesale grocers earned 1.3 per cent on sales in 1936, confectionery wholesalers made 2.2 per cent, dry-goods wholesalers earned 2.7 per cent, while profits of paint and varnish wholesalers ran as high as 4 per cent of sales. These ratios reflect operations of wholesale merchants, which account for only a third of all intermediary trade. Other types of intermediaries, such as brokers and agents, have much lower profit ratios, if indeed their profits can be distinguished from personal compensation. Manufacturers' sales branches and chain store warehouses, which account for a consider-able share of total intermediary trade, are conducted on a non-profit basis except as their profits are included in those of the parent organization. Taken as a whole it seems unlikely that profits in intermediary trade amount to as much as one per cent of the total volume of sales.

All these figures, it must be remembered, relate to operations in a fairly profitable year. During the depression years a considerable proportion, and probably a majority, of distributors showed a net loss on their operations.

Distributive profits of manufacturers are hard to estimate with accuracy. Published figures show total profits and do not distinguish between those resulting from distribution and those arising from strictly production activities. All manufacturing corporations in the United States, according to their 1929 reports to the Bureau of Internal Revenue, showed net income (after payment of income tax) amounting to 5.4 per cent of gross income. In 1930 the profit ratio fell to 1.4 per cent, and in the three succeeding years net deficits were incurred, rising to almost 6 per cent in 1932. For the seven-year period from 1929 to 1935 profits averaged less than one per cent of gross income; and, of course, only part of this can be charged to distribution operations.

Transportation charges are an important share of the total distribution cost but here again profits in recent years have been small or non-existent. Net income of the railways-by far the most important freight carriers-dropped precipitately from the 1929 high point of more than $800 million and since 1931 have failed in any year to recover more than a small fraction of their decline.

Three Cents of Consumer's Dollar for Profits

On the whole it seems clear that average profits taken by distributive agencies in recent years do not constitute a very large part of the price paid by consumers for finished goods. With manufacturers' distribution profits and those of intermediary trade probably averaging less than one per cent of sales and retail profits amounting to no more than 2 per cent, it seems unlikely that aggregate distribution profits amount to more than three cents out of every dollar paid for finished goods by consumers and other terminal buyers, or to more than 5 per cent of the total amount paid for the services of distributive agencies. Substantial economies in the field of distribution, it seems clear, must be sought chiefly in reduction of operating expenses, either through elimination of services or by performing distributive services more efficiently and economically, productive efficiency during the past six or seven decades have not been duplicated in the field of distribution. Furthermore fragmentary data indicate that the trend of distribution costs appears to have been markedly upward for a considerable period of years prior to 1929, even though sales volume also was generally on the increase. With declining sales after 1929, of course, operating expense ratios rose rapidly to a peak in 1932-1933. A general decline in cost ratios has since taken place. Operating expenses appear to be relatively inflexible, so that when sales decline rapidly expenses do not decrease in the same proportion.

What data we have show that in certain lines at least retail operating expenses have risen to higher levels over a period of years. For example, one study shows that American department stores with annual sales of less than $500,000 increased their expense ratios from 27 per cent of net sales in 1922 to 30 per cent in 1929, and then to 37 per cent in 1932. The rise in expenses during the period was not confined to one or two items but was general through the various accounts: payroll, real estate, advertising, supplies, service purchased, and communication. By 1936 expense ratios had been reduced, but not to the 1929 level.

Another study shows the same general tendencies in department stores with more than $1 million of annual sales volume over the period of 1921 to 1934 inclusive. In 1921 costs were 28.6 per cent of sales. In 1932 they reached a peak of 39.6 and in 1934 they were 36.2 per cent of sales.

There is at least some evidence of the same upward trend in the wholesale business. For example, a year-to-year analysis of seven-teen identical grocery wholesalers in Ohio shows a slow but steady rise in expenses from 8.9 per cent in 1924 to 9.8 per cent in 1929, then to a peak of 12.6 per cent in 1932, followed by a recession to 10 per cent in 1934.

Similarities in Europe

The upward trend of distribution costs seems to be just as true of European countries as of the United States. Available evidence indicates that costs have risen in Europe for most kinds of business as much as they have in this country. This approximate parity was especially true in 1929, but during the depression period the volume of sales in the United States decreased more than in most European countries, without a corresponding decline in expenses. Thus the expense ratios for depression years show a greater discrepancy between Europe and the United States than a normal year would reveal.

Comparisons with foreign countries are difficult because of many differences in the retail structure of the United States and Europe. A much larger proportion of European trade is in staple commodities and necessities, which have lower distribution expenses. Wide differences in the range of stocks carried, the services rendered, the use of advertising, allocation of taxes and other important factors influencing costs need also to be taken into account. The tasks per-formed by retail trade in one country may differ so widely from another that a simple comparison of gross margins does not prove that the work of providing people with goods is more economically conducted in one country than another.

In spite of many variations in the economic structure of the United States and European countries, however, total average expense margins appear to be strikingly similar. This indicates, ac-cording to Julius Hirsch, that underlying trends in distribution and cost relationships have been similar in Europe and America. In the United States, for instance, average retail costs in 1929, on a comparable basis, were only slightly higher than in Europe- per cent of retail sales as compared with 24 per cent in Germany. Wholesale foodstuffs expense ratios for roughly comparable years also show fairly close similarity-11.8 per cent for Germany, 10.6 for the United States, 10 for Norway, but only 7.6 per cent of sales for Holland. Labor and advertising costs were higher in the United States for similar business units, but the burden of taxation was somewhat lower in this country than in some European countries.

More Facts Badly Needed

That distribution costs form a large and growing share of what we pay for goods does not prove that distribution costs too much. Most of the facts needed to answer this question are not yet avail-able. In spite of the information provided by the Censuses of 1929, 1933, and 1935, whole areas remain dark. Manufacturers' selling costs, for example, have had only superficial attention, and virtually no data exist on the distribution costs of raw material producers. Still more important, there has as yet been no integrated study of distribution, commodity by commodity, from their appearance as raw materials through all the channels of distribution to the point where they are bought as finished products by consumers.

It is the purpose of the following chapters to compare the costs of some of the established forms of merchandising for which figures are available, to contrast different methods used to perform the same or similar distributive functions and to analyze some of the factors which influence these costs. In the chapter that follows, retailers' costs are reviewed from various angles. The expenses of retailing by stores handling different kinds of commodities are compared, and wide variations are shown between the different lines of trade. Comparisons are made of the relative operating costs of the different types of stores-independents, chains and super-markets, and here again the differences are great. The influence of the chief factors in retailing expense, such as wages and stock turnover, is also discussed.

In the succeeding chapter the operating costs of intermediaries and producers are reviewed and comparisons made among various types. Not only are there wide cost variations between the different lines of trade and types of operation; but, within each group, differences occur between individual concerns. In this study, however, it has not been possible to study the operations of individual firms, but only to compare the results among different types of operation and kinds of business.

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