Cost Of Primary And Intermediate Distribution
( Originally Published 1939 )
ALTHOUGH RETAILING is the most costly single phase of distribution the total of costs incurred prior to this final stage is about twice as large as retailers' expenses in selling finished goods to consumers. Not only is almost everything sold at retail sold one or more times before it reaches retailers' shelves, but these earlier stages include the sale and resale of vast amounts of raw materials and semi-finished goods between various steps of production and distribution.) Manufacturers' distribution costs are estimated at about $9 billion; transportation charges, most of which accrue be-fore the retail stage, account for $8.8 billion; and intermediary or wholesale distribution costs amount to about $7 billion. All these costs, together with national advertising and certain minor items, equal $26 billion, as compared with less than $13 billion for retail trade.
1. INTERMEDIARY OR WHOLESALE COSTS
The costs of wholesale or intermediary distribution are not only the straight-line costs of buying goods from producers, transporting them, storing them and selling and shipping them to retailers. As the Flow Chart shows, several intermediary agencies are often involved-one frequently sells to another. The sales of all intermediary dealers in 1929 exceeded $69 billion, but almost $16 billion of this amount consisted of sales from one dealer to another within the intermediary system. Thus the net outflow of goods from intermediary or wholesale trade to retailers, industry and consumers was about $53 billion. Obviously the costs of this resale or recirculation are part of the price paid for goods as they pass out of intermediary channels.
A sugar broker, for example, may sell only to wholesale grocery merchants, who in turn sell to retailers. Total costs of performing the intermediary function in sugar distribution obviously include the costs of the broker as well as those of the wholesale merchant. Similarly about a fourth of the total intermediary sales of radios and equipment and of cigars, cigarettes and tobacco are made not to retailers, but to other intermediaries. In other lines, such as automotive products, the proportion of total sales made by intermediaries to other intermediaries is 5 per cent or less. The cost of making these sales within the intermediary system must be added to the costs incurred by intermediaries in selling goods to retailers and industry.
The resultant total cost should then be compared, not with the total volume of intermediary trade, but with the net outflow from the system. This means that a rough measure of the ratio-of-cost-to-sales of the intermediary function is furnished by comparing the $7 billion cost of intermediary distribution with the net outflow of $53 billion, rather than with the total sales of $69 billion. Measured in this way the total cost involved in intermediary trade amounted to 13 per cent of sales.
Figured on the basis of net outflow the cost of the intermediary function for different commodities varies widely-from as low as 9.7 per cent of the sales of goods leaving the system, in the case of tobacco products, to 21.7 per cent for toys, games, and sporting goods. Table 26 shows the costs of the intermediary function in percentage of sales to other buyers than intermediaries for each of eleven typical consumer products as well as the dollar figures on which these expense ratios are based. The expense ratio for food and groceries was but 10.8 per cent and that of petroleum products, 14.5 per cent, while jewelry and optical goods had a ratio of 19.6 per cent. In the latter case, infrequency of sales and the difficulty and risk of estimating demand more than offset the obviously greater physical task of storing and handling bulky products like food and petroleum.
a. COMPARISONS BY TYPES OF ESTABLISHMENT
Cost ratios of various types of intermediary establishments vary widely. These differences arise from differences in the kinds of commodities handled and from great variations in the functions performed. Cost ratios (based on total sales, including sales to other intermediaries) for various types of intermediaries and the relative importance of each type as measured by the dollar volume of sales in 1935 are shown in Figure 16, while Table R of the Appendix provides similar data for 1929 and 1933 as well.
Of the various major groups of intermediaries listed by the Census, agents and brokers have the lowest costs in relation to sales-2.9 per cent in 1935. Bulk-tank petroleum stations had the highest ratio-14.5 per cent. Wholesalers proper showed a ratio of 12.6. The average for all types of intermediaries in the United States was 9.5 per cent in 1935.
Most of the major types given in the Census classification are broken down into a number of more narrowly defined types. Of these, mail-order wholesalers showed the largest expense ratio (21.4 per cent) and brokers the smallest (1.3 per cent). Whole-sale merchants had a ratio of 13.2 per cent; manufacturers' sales branches, 6.6 and 11.8 per cent, according to whether they did business without or with stock; commission merchants, 2.5 per cent, and importers, 9.2 per cent.
By 1933 sales of intermediary trade as a whole had fallen to less than half of the 1929 volume-from $69 billion to $32 billion. In spite of drastic reductions in dollar costs, the cost ratio increased from 8.9 to 11.5 per cent. With the recovery in 1935, expenses fell to 9.5 per cent of sales-a good showing with business still one-third below the 1929 volume.
Similar trends occurred in most of the principal groups of intermediaries. Wholesalers proper, accounting for about 40 per cent of the total volume, had about average experience. Manufacturers' sales branches, on the other hand, made a better showing than wholesalers proper, and closely approximated the general average of all intermediary dealers. The business of assemblers and country buyers suffered almost a 50 per cent decline while their costs rose in just about the same proportion.
Agents and brokers and chain store warehouses had excellent control of costs. In spite of a substantial loss in business, operating expenses in 1933 held close to the 1929 level. Although the 1935 recovery failed to restore 1929 sales volumes, expense ratios in both cases were below 1929. The most significant change occurred in bulk-tank stations handling petroleum products, which had an actual increase in dollar volume from 1929 to 1935, accompanied by a sharp rise in operating costs.
Even when different types of establishments are dealing in the same general commodities there is a strikingly wide variation in their expense ratios. The greatest differences are explained by the limited services and functions performed by most of the low-cost dealers such as brokers and agents, in contrast with the more elaborate setup of high-cost wholesale merchants and manufacturers' sales branches. Nevertheless some of the types which perform the same essential functions of warehousing, breaking bulk, and transportation show a diversity of expense ratios. These fairly comparable classes are wholesale merchants, manufacturers' sales branches with stocks, chain store and retailer-cooperative ware-houses. Because the first two have the expenses of selling in addition to the functions mentioned above they have distinctly higher costs.
(1) Seven Consumer Goods Lines
Analysis of Census data for the various types of intermediary dealers in important kinds of consumer goods shows interesting variations attributable to differences in the nature and cost of goods handled and to different methods employed and services rendered by various types of agencies. Data on sales volume and expense ratios for various types of intermediaries in seven important lines of consumer goods are shown.
In every one of the lines shown in the table the traditional wholesale merchant handled a larger volume of business in 1935 than any other type of intermediary. His dominance, however, was being threatened in groceries and foods, clothing and furnishings, dry-goods and electrical goods by manufacturers having sales branches. To the extent that expense ratios of wholesale merchants are representative of costs in various lines, it appears that intermediary distribution costs were lowest in groceries and foods and farm products and highest in hardware and electrical goods.
Probably reflecting the tendency of manufacturers of textile products to go direct to the retail trade rather than through the wholesale merchant, manufacturers' sales branches in the dry-goods line registered an increase in sales of nearly 58 per cent between 1933 and 1935, when they almost equaled the 1929 sales volume. Expenses were cut. from 8.5 per cent in 1933 to 6.8 per cent in 1935. Wholesale merchants, on the other hand, lost nearly 20 per cent in volume between 1933 and 1935, following an even greater loss after 1929, and were not able to effect an appreciable reduction in operating expense.
Chain Store Warehouse Costs Low
In six out of seven kinds of business shown in the table it is significant that costs of chain store warehouses were lower in 1933 than those of the two seemingly comparable outlets, wholesale merchants and manufacturers' sales branches with stocks. What is the explanation? In the first place, of course, the chain store ware-house is not a business in itself. It is the chain store organization, not merely the warehouse division, that buys the stocks to supply its stores; and the cost of selling these goods to the individual retail stores does not appear among warehouse costs. Hence these organizations are not exactly comparable with the independent wholesale merchant or the manufacturer's sales branch carrying stocks.
The wholesale merchant operates an independent business. He buys the stocks with which his warehouses are filled and he sells them to his customers in competition with other intermediaries. The total costs of buying and selling therefore fall on him.
The manufacturer's sales branch, on the other hand, is stocked by the manufacturer. It does not have to shop for the goods which in its opinion are temporarily in greatest demand at different times in different territories. In this sense it has no buying costs, but carries whatever the manufacturer wants to sell. Beyond the cost of warehousing, of transportation and of breaking bulk, therefore, it also bears the cost of selling to the trade. To the extent that it is harder to sell a particular brand to the trade than to sell the brands which seem to be in most demand its selling costs may be even higher than those of the wholesale merchant.
The chain store warehouse, on the other hand, does have to shop for its stocks, but it does not in any true sense sell them to the retail outlet. It simply supplies those outlets with the stocks which in the judgment of the management of the whole organization they are expected to carry. The costs of the chain store ware-house, therefore, are simply the costs of physical handling at the intermediary stage of distribution.
It seems fair to say that the manufacturer's sales branch is an intermediary dominated by a special producer; that the wholesale merchant is usually independent of such domination, being guided rather by his own judgment of what his customers prefer; and that the chain store warehouse is a mere machine for the performance of the routine function of storage, transportation, and breaking bulk. A chain store warehouse neither has to overcome the sales resistance of retailers nor carry the tremendous variety of stocks which the wholesale merchant thinks he has to carry if he is not to meet sales resistance on the part of his retail outlets.
In two fields of intermediary distribution, comprehensive statistics permit a more detailed examination of costs.
(2). Food Wholesaling
In the food business a rough comparison of the wholesaling costs of chains (i.e., exclusive of expenses of operating their own retail stores) with the operating costs of wholesale merchants is possible. In 1934 combined administrative, general, warehouse and transportation expenses of a group of food chains amounted to from 6 per cent to 7.5 per cent of the retail sales volume. The author of the study says:'
This is equivalent to from 7.6 per cent to 9.9 per cent of the value of goods sold, at the chains' cost prices, the chains' gross margin being taken at from 21 per cent to 24 per cent of sales. Since the ordinary wholesalers' selling prices presumably are higher than the chains' cost prices, but lower than the chains' retail prices, the cost to the chains of performing their central office functions amounts to between 6 per cent and 9.9 per cent of the wholesalers' selling prices. . . . It must be noted, however, that the chains' costs include those for several functions frequently not performed by wholesalers. These include:
1. Advertising, such as that commonly done by, and at the expense of, the retail stores which buy from wholesalers.
2. Transportation of goods from the warehouse (which corresponds to the wholesalers' establishment) to the retail store.
3. Supervision of the retail store.
4. Taxes, such as commonly are paid by independent retailers, plus any taxes levied solely, or at higher rates, on chains.
5. In some cases, costs for the wholesale function on meats and on fresh fruits and vegetables, which may run higher than corresponding costs on dry groceries.
Independents' Costs Higher than Chains'
Bearing in mind the differences in functions performed, the range of 6 to 9.9 per cent for chain costs may be compared with expenses of a group of Ohio grocery wholesalers, which averaged 9.9 per cent of sales in the same year. The 1935 Census showed a 10.8 ratio for the United States as a whole, and a sample study of eighty-eight firms shows average costs of 9.6 per cent in 1936.
Thus, there is close agreement in figures from three sources on wholesale grocery costs in these years. The average cost of wholesalers, however, is barely equal to or slightly above the maximum "overhead cost" of grocery chains, which includes not only ware-housing and equivalent wholesale expenses but also some costs ordinarily absorbed by the retailer customers of the independent wholesale merchant. The Census of 1933 segregated chain ware-house expenses as a separate item in overhead costs, amounting to 4.3 per cent of the value of goods handled.
Voluntary Groups and Retailer Cooperatives
Is it possible to perform the wholesale function for independent retailers at anything like the low costs of chain store warehouses? Apparently such costs can be achieved by retailer cooperatives, judging from data on the grocery and drug trades, in which this form of wholesaling has made substantial headway.
According to the 1935 Business Census, 157 retailer-cooperative warehouses doing over 7 per cent of the total wholesale full-line grocery business had average operating expenses of 5.2 per cent of sales in contrast with nearly 9 per cent for independent wholesale merchants in the same field. On the other hand, "voluntary group wholesalers," accounting for nearly 30 per cent of the wholesale grocery business, incurred an even higher expense-about 10 per cent of net sales.
A possible explanation of the higher expenses for voluntaries as compared with independent wholesalers, may be that the voluntaries emphasize private brands and include in their reported expenses the cost of special merchandising services extended to their customers. The costs of group advertising and other special services are sometimes treated by the sponsoring wholesalers as part of their own costs, even though funds may be collected from retail members to maintain such activities. Also, the voluntaries on the average are much larger than the independent wholesalers-with $990,000 annual sales compared with $440,000-and a Census study of grocery wholesalers by size of business shows that expenses tend to increase for the larger establishments.' This may help to explain their higher costs.
Costs in Relation to Size
Among all three kinds of grocery wholesalers-independents, voluntary groups, and retailer cooperatives-cost ratios vary with the size of the concern. For the independents the figures run from 8.3 to 11.1 per cent of sales; for the voluntaries, from 8.7 to 11 per cent; and for the retailer cooperatives from 5 to 5.4 per cent. With the exception of retailer cooperatives the lowest cost ratio for all kinds of wholesalers is in the $200,000 to $300,000 sales bracket. Above this level expenses tend to increase with size. These figures are given in detail in Table 28.
An analysis of the expenses of 493 of the grocery voluntaries studied by the Census showed that their average cost of marketing $100 worth of goods was $9.90, divided as follows: administrative expenses $2.60; selling $2.70; delivery $1.30; warehousing $1.50; occupancy $.80; and other expenses, $1.00. With some exceptions the larger houses had higher selling, delivery, and warehousing costs. Administrative expenses show little variation with size of firm, the ratio being constant at 2.7 per cent for all groups over $300,000.'
Selling expenses, which consist chiefly of salesmen's salaries and expenses and advertising costs, increase in the upper brackets. This suggests that emphasis on private brands and wide sales areas are possible reasons for the higher costs of extremely large houses. Delivery expenses also increase in the higher brackets, probably because the larger houses, located as a rule in population centers, make delivery on a larger portion of their sales and render this service at more frequent intervals.
The retailer-cooperative warehouses, with nine-tenths of their sales to their own members, have substantially lower cost ratios than either independent wholesale grocery merchants or voluntary group wholesalers. Among the latter group the degree of cooperation appears to have a definite effect on costs. The lowest expense ratio-8.3 per cent of sales-is found in establishments selling 90 per cent of their goods to members. From this point costs increase consistently as the proportion of sales to members decreases, reaching 11.5 per cent for establishments selling only 10 to 30 per cent of their merchandise to their own members.
Costs of Services and Credit
Expenses for grocery cooperatives selling entirely on credit were 6.6 per cent of sales, as compared with 4.1 per cent for those not granting credit. In spite of the economies of doing a cash business, only 31 out of 130 cooperatives analyzed made no sales on credit. Of the total number, 83 made less than 50 per cent of their sales for cash, but generally limited credit to a short period, in many cases only seven days. Apparently most grocery retailers want to buy on credit and are unwilling or unable to take advantage of the economies of buying for cash, even when purchasing through their own warehouses.
These comparisons suggest that by rendering a minimum of services, cooperative warehouses can be operated at extremely low costs. However, when numerous services such as credit and delivery are added, total expenses approximate those of service wholesalers.
Cooperatives vary materially in the services rendered. Some operate very much as full-service wholesalers while others merely warehouse a limited number of items which the retailer must call for and for which he must pay cash. Those with the least services showed only two items of expense: administrative, amounting to 2 per cent of sales, and a combined figure for warehouse and occupancy, amounting to 1.3 per cent.
One feature which distinguishes cooperatives sharply from voluntaries and helps to explain their lower costs is the smaller number of salesmen they employ. Whereas 24.6 per cent of the voluntaries' employees were salesmen, they constituted less than 10 per cent of the employees of cooperatives. On the other hand, 48 per cent of the cooperatives' working force were warehousemen, as compared with 36 per cent for voluntaries. Apparently less emphasis is placed by cooperatives upon soliciting and selling because they pay their salesmen less than do the voluntaries. Other classes of employees are paid approximately the same wages by the two types. Unlike voluntaries the cooperatives show little variation in expenses by size, but have a slight tendency toward lower costs in the higher brackets.
(3) Drug Wholesaling
In the drug business, the cooperative or mutual wholesalers also had an operating cost advantage over the conventional wholesalers, but it was less pronounced than in the grocery business. Ac-cording to a special study of the 1935 Census, thirty mutuals (de-fined as wholesalers doing more than half their business with members or under a cooperative arrangement) with sales of about $34 million had average operating expenses of 10 per cent. Eighteen houses doing over 90 per cent of their business on a cooperative basis had average expenses of 9 per cent in contrast with the 13 to 14 per cent operating expense of the usual type of full-line drug wholesaler. The two types of wholesale establishments had almost equal delivery, warehouse and occupancy expense, but the mutuals showed considerable economies in selling (1.1 per cent of sales as compared with 3.4), administration (4 per cent compared with 4.7), and other expenses (0.5 and 1.9 per cent).
While the mutuals have much lower total costs the Census report states that "the data indicate just as strongly that the selling functions performed by these two types differ materially, particularly with respect to outside selling. As a result, the information presented does not make possible valid conclusions regarding the relative efficiency of the two groups. Rather the available facts emphasize the difference in the function performed by cooperative and mutual wholesalers as contrasted to full-service wholesale merchants."
This raises the question of what the economic functions of wholesalers should be. Are they to sell, grant credit and create demand, or merely serve retailers as a source of supply? If the latter view is sound the cooperative arrangement undoubtedly provides a means of performing the wholesale function for the retailer at relatively low costs.
With selling and advertising so large a part of total expenses in intermediary trade, one cannot avoid asking whether such costs are necessary. The experience of grocery and drug retailer cooperatives suggests a more economical way of supplying retail stores with the stocks they really want. If correspondingly low costs can be achieved by the same methods in other lines of trade, wholesaling appears to offer promising opportunities for economies in distribution.