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Price Spreads In Distribution

( Originally Published 1939 )



THE CONSUMER who knows little about the processes of distribution is likely to blame the retailer or the middleman for what may seem to him an exorbitant price he has to pay. If he is told that it costs more to sell a certain article than it does to manufacture it, or that the retailer makes a profit of fifty cents on something for which he has to pay a dollar, he may easily conclude that he is the victim of profiteering and waste.

This is not meant to imply that retail prices, even in a highly competitive market, are never exorbitant. The veriest tyro in the retail field, however, soon learns that he may make no profit at all and may even lose the capital he has invested in the business, al-though he takes a seemingly huge profit on every sale he makes.

It is in the price he has to pay that the average consumer comes in contact with the system of distribution; and the spread between the cost of production and the retail price of consumer goods surely has significance. A study of the costs of distribution, therefore, can well begin right there. The figures, however, will have little real significance, if it is assumed that the price spread represents nothing but the dealer's profits or that a small spread necessarily indicates efficiency in distribution. In many lines of trade, 30 or 40 per cent of the price received by the retailer is paid out for wages, salaries, rent, and other operating expenses; and most of the remainder represents the cost of goods sold, so that the retailer retains as profit only a few cents out of what the consumer pays.

It is also important to remember that the mark-up or price spread of a particular article at any one time may be much more, or much less, than the actual cost of distributing that product. An exclusive gown shop, for instance, might be able to sell a "Paris model" to early buyers at two or three times the normal profit, and at the end of the season be compelled to accept less than actual cost for an identical product. A drugstore, on the other hand, might: find it profitable to sell a nationally advertised article as a "loss leader" at less than cost, making up the difference on increased patronage for other products.

Lack of Uniformity in Price Spreads

Entirely aside from these extreme examples, there are infinite variations in the percentage mark-up or price spread for similar articles in the same line of trade, for identical articles sold through different types of outlets, for different qualities of the same kind of product, for branded and advertised commodities as distinct from unbranded items, and for exactly the same article sold in different markets or at different times to meet varying competitive conditions. In short the main feature of mark-ups and price spreads is a lack of uniformity among different lines of trade, kinds of goods, and individual products.

This is not surprising in view of the way in which manufacture and distribution are carried on. The typical manufacturer may pro-duce and sell dozens or scores of individual products. The typical wholesale dealer or retail merchant usually carries hundreds or thousands of separate items. Each of them is interested primarily in netting a profit on the operations of his establishment as a whole, and only secondarily in profits or losses on specific items. Hence his mark-up on any particular article is the result of a variety of factors and influences of which the actual cost of distribution is only one.

Even if the cost of distributing a specific product could be accurately figured-which is usually impossible with present accounting practices-other considerations might dictate a price higher or lower than one which would just yield an average profit on the operation. Traditional pricing policies in the trade, consumer price habits, formal or informal resale price agreements, a desire to in-crease the volume of sales or to invade a new price range, obsolescence factors, market prices established by competitors, and a variety of other considerations may be fully as important as actual costs in determining the mark-up and price of a particular product.

The Facts Are Hard to Get

It is hard to get facts on price spreads because manufacturers, wholesalers, and retailers-even if they have figures-are reluctant to give them out. This secrecy is largely due to the public's habit of looking upon large mark-ups in themselves as evidence of large profits, even though the distributor may be making only a reasonable profit, or even showing a loss on his operations as a whole. One of the large manufacturers of food products some years ago gave out full information on operations and sales, showing gross profits and average mark-ups, which were in fact closely comparable with those of his competitors. The company's retail customers, however, egged on by the company's competitors, hectored the salesmen of the company about what they considered excessive profits. The company was forced to abandon this innovation. It now conceals the figures until its competitors will agree to publish their own.

In other cases, undoubtedly, secrecy clothes a guilty conscience: a realization that prices are unjustifiably high because of excessive profits or inordinate advertising expense. Sometimes, even when mark-ups are so small that they could not possibly be criticised, rigid secrecy is maintained out of fear that the figures would be distorted, misinterpreted or misused by competitors.

In spite of the limitations on the meaning of such information and of the reluctance of distributors to furnish it, a strenuous effort has been made in connection with this study to get confidential figures on actual price spreads for a representative group of products. In addition, published data have been examined carefully to supplement this confidential information.

1. UNPROCESSED FOOD PRODUCTS

A relatively simple example of the inevitable expenses incurred in transporting and distributing goods is furnished by the case of raw foodstuffs. These reach the consumer in virtually the same form as they leave the farm, yet they must be transported perhaps hundreds of miles, handled several times en route, and possibly pass through three or four changes of ownership before they reach the consumer.

A glance at shows the disparity between the prices received by the farmer and the price the consumer pays for various raw foodstuffs. This spread includes not only the retailer's costs and profits, but the entire expenses of transportation and of the various middlemen handling the products, as well as losses due to spoilage and waste. These average price spreads for a group of common farm products show that for relatively perishable products such as vegetables and fruits, distribution costs far exceed the original cost of growing them. For example, the farmer got seven-tenths of a cent per pound for cabbages in 1935, but the housewife had to pay four cents a pound at the corner grocery. Carrots cost her an average of five and a half cents a bunch, of which the farmer received only one cent, and the spread was almost as large in the case of celery and onions. In other words, it costs three or four times as much to distribute these vegetables as to grow them.

The housewife may wonder why she has to pay over five times the production cost for cabbage, when she buys eggs, for instance, for less than twice what the farmer gets for them. The answer lies in the fact that cabbage and similar vegetables are both bulky and perishable and must often be transported long distances from the section in which they are grown. Eggs, on the other hand, are not only less bulky and perishable, but they are usually produced nearer to the place where they are sold, thus saving transportation and handling expense.

Spoilage Losses

The loss and consequent cost from spoilage alone are very considerable in the case of perishable vegetables and fruits. Losses occur all along the line of transportation, and damage claims against the railroads on these products run into millions of dollars annually. All these ultimately affect the level of freight rates which in turn are reflected in the price spread. For instance, the Federal Trade Commission found that loss and damage claims paid by the railroads in 1935 on shipments of fresh fruits and vegetables amounted to 2.6 per cent of the freight receipts from such shipments and represented a much larger proportion of the carriers' net revenue. Added to this spoilage cost are the losses occurring when perishable products reach the retail stores.

To get back to cabbages again, this large spoilage loss helps to explain why the consumer has to pay four cents for cabbage which costs less than one cent to produce. Other reasons are indicated in Figure 5, which shows the costs of distributing fruits and vegetables grown in specialized producing areas and shipped for the most part to distant markets. These spreads are naturally higher than those shown in Figure 4, which were general averages covering products of both local areas and special producing districts.

The effect of distance is shown in the relatively high transportation costs for the second list of products. For example, 27.5 cents of the consumer's dollar is for transportation costs in the case of Florida cabbage, compared with 35.9 cents in the case of cabbage from Texas, to approximately the same great northeastern markets? Transportation costs were high in the case of some other products, such as Florida oranges, grapefruit, and tomatoes, because of the bulkiness of these products in relation to their value, and probably because of a larger spoilage bill.

Packing and loading costs constitute another large item in distribution costs. They range from as low as seven to eight cents for Florida tomatoes and Idaho potatoes to as high as twenty cents for Florida grapefruit and oranges.

The intermediate handlers' costs show a considerable variation, but are a relatively small item in all cases. Retail margins also vary widely-from twenty-three cents to more than forty-five cents-and are particularly high for tomatoes, onions, and cabbage, where spoilage losses are large.

Broadly speaking, the consumer's dollar spent for products from these specialty areas can be divided roughly into three fairly equal parts-one-third for the producer (except in the case of such products as cabbage, onions, and lettuce, in which the farmer's share is less), one-third for transportation and intermediary handling, and the remaining third for the retailer's margin. In connection with the latter it should be remembered that the retail margin as shown in Figure 5 does not measure the average realized margin on these products. Retailers inevitably incur large spoilage losses on fresh fruits and vegetables, and margins must be large enough to compensate for such losses and for mark-downs to avoid them. Average margins actually realized by the retailers are often as much as a third less than the retail margins shown in the chart.

2. PROCESSED FOOD PRODUCTS

Products raised by the farmer and processed before they reach the consumer go through a much more complex procedure than raw foodstuffs. In this case price spreads cover costs of processing and packaging as well as costs of distribution. Since processing is a part of production rather than distribution, its cost should be subtracted from the total spread in order to get an accurate measure of distribution costs.

An example of the entire spread in this kind of commodity between the raw material and the finished product on the kitchen shelf is soda crackers. The farmer receives 1.6 cents for the wheat, which, when processed and made into soda crackers, finally sells for 17.2 cents a pound at the grocery store-over ten times as much as the farmer received.' Bread and cereals all sell at retail prices which are from 143 to 975 per cent higher than the farm value of the wheat or rye of which they are made. Canned goods, on the whole, show even larger spreads-most of them from 500 to 700 per cent. But meats-pork, lamb, and beef for example-show spreads of only 70, 78, and 121 per cent respectively. De-tailed breakdowns of the constituents of the total spread between the farmer and consumer are available for only a few commodities, some examples of which are shown below.

a. MEATS

The relatively small price spread of meats is due to the relative simplicity of the processing and to a highly organized and efficient system for slaughtering, processing, and distributing meat products to retail dealers. In addition, the price of meat to the consumer is less than it would otherwise be because the packer covers some of his costs through the sale of inedible by-products.

On the average the consumer pays about twice as much for dressed meat at the retail counter as the farmer receives from the dealer in payment for the meat in the live animal. About half of the amount charged the consumer, therefore, goes to pay for all the processing and distribution after the farmer sells the live animal. The retailer keeps about half of this sum for his expenses and profits or 5.4 cents out of the average total retail price of 21.5 cents. Of this 5.4 cents price spread at the retail stage, 2.9 cents is paid out by the retailer for wages and salaries; store rent and other store expenses account for 1.8 cents while profits amount to 0.7 cent .4 Details are shown in Table 2.

The figure shown in the table for the selling price of the farmer is the amount returned to him for each pound of meat products sold at retail. This amount is much larger than the average amount received by the farmer for each pound of livestock since the weight of edible meat products obtained from the animal is much less than the weight of the live animal. The packer of course receives a considerable return from inedible by-products, which are not included in the distribution of retail value per pound shown in the table.

The 0.9 cent spread between the farm price and that received by the livestock dealer covers the marketing of livestock and the operations incident to getting the animal from the farm to central livestock yards in the packing centers. This includes transportation as the most important single element, and also yardage and feed charges and fees to the commission firms.

The meat packer's margin of 3.3 cents covers the entire cost of processing, beginning with the receipt of the livestock and ending with the packing, loading, and shipping of the dressed meat.

The wholesaler's function involves transporting the product from the packing plant through the wholesale agencies and selling and local delivery to the retail store. Wholesaling is sometimes done by sales branches of the packing establishments and in other cases is the function of independent wholesalers. Transportation is the largest single item of expense in the wholesaling of meat products.

b. CEREAL PRODUCTS

Bakery products, such as bread and soda crackers, have very large price spreads reflecting heavy costs for processing and pack-aging at one end, and for advertising, delivery, and other distributive operations at the other end. Macaroni and breakfast cereals, such as rolled oats and corn flakes, involve less costly processing, but relatively large expenditures for advertising and selling. For such products as flour and corn meal simple processing and inexpensive distribution result in a smaller price spread between farmer and consumer.

Take bread as an illustration. The Federal Trade Commission found that the distribution of the consumer's bread dollar in 1935 followed fairly closely the figures for 1923-1925, with the farmer receiving about the same amount as his share, the transportation agencies and the bakers getting less, and the millers, wheat middlemen, and retailers receiving more for their services than they did ten years previously. It should be pointed out that the increase in the millers' margin is more than accounted for by the processing tax on wheat which was in effect in 1935 but not in 1923-1925.

The price spread between farmer and consumer for most canned fruits and vegetables is large. Their preparation and canning is a highly seasonal industry subject to the risks of variation in the quantity and quality of crops. In addition the cost of containers and cases is high in relation to raw materials. Transportation and storage costs are also heavy because of the bulkiness and weight of these products and the necessity of holding them for long periods.

A study of the marketing of Maryland canned tomatoes shows that the farmer gets less than a fifth of the consumer's dollar for the raw tomatoes, while the canner receives for his share nearly half the consumer's dollar. Distribution charges, including broker-age, wholesaling, and retailing margins, which of course cover transportation costs, account for more than a third of the retail price. Thus the consumer pays over five times what the farmer gets for the raw product and more than twice what the canner receives for the canned tomatoes.

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