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Distribution Of Cigatettes

( Originally Published 1939 )



Cigarettes are a standardized product illustrative of lower distribution costs than many other articles of popular consumption. Tobacco distribution, like an hourglass, begins with the raw material, which originates on a vast number of small farms, passes through the hands of a much smaller number of tobacco middle-men, and after manufacture by a very small group of large-scale producers, spreads out again to wholesalers, to retailers and finally, to millions of consumers.

A breakdown of costs for popular brands of cigarettes in 1937 is shown in Table 7. The total expense chargeable to distribution is relatively low-not more than 28 per cent of the retail price. Less than four cents of the average price of fourteen cents a pack-age is distribution cost-less than one cent representing the manufacturer's entire selling, advertising, and distributing expense. Contrary to popular ideas, advertising costs are responsible for only a small part of the consumer's price-amounting to less than half a cent a package.

Both the retailer's and jobber's margins are low, and contrary to the usual relation, almost equal. Each amounts to about one and a half cents or roughly to little more than 10 per cent of the selling price. Inasmuch as general operating expenses of tobacco retailers are more than 10 per cent of sales, their cigarette profits, if any, must be obtained from rapid turnover.

The largest single item in the price of a package of cigarettes is the federal excise tax of six cents, which is paid by the manufacturer. About $500 million or nearly a tenth of the federal revenue comes from tobacco taxes, and cigarettes furnish the lion's share. In addition, twenty-five states impose taxes on cigarettes and tobacco yielding slightly more than $50 million.

Excluding this item of taxes from the manufacturer's selling price to the jobber, it would seem that the manufacturers, at the neck of the hourglass, make average profits of about 20 per cent.

In fact, their profit is probably as great as their manufacturing cost -averaging about one cent on a package.

b. RYE WHISKEY

Whiskey is an example of a commodity which costs the manufacturer little to produce compared with the price the consumer must pay. Large distribution costs are augmented by heavy state and federal taxes.

Figures submitted in confidence by an important manufacturer of rye whiskey for 1936 show that the consumer paid $2.40 for a quart of one-year-old whiskey, which cost only 30 cents to pro-duce. The distiller sold this product to the wholesaler for 61 cents, a price which covered his profit, selling, advertising, and storage costs, the important item of evaporation losses and general administrative overhead.

At this point taxes amounting to $1 a quart were added to the cost of the whiskey, making the value $1.61. The wholesaler sold to the retailer at an advance of 10 cents, or for $1.71 a quart. Selling at retail for $2.40, the retailer's mark-up was 69 cents, or more than the total amount received by the manufacturer.

Taxes are obviously the largest element in the price the consumer pays for liquor, particularly in the case of low-priced goods. The amount of the tax also plays an important part in the retailer's mark-up. Since the tax has already become a part of the price be-fore the product reaches him, he follows the usual practice of applying a normal percentage mark-up for his cost. If the $1 tax on a quart of whiskey were collected as a separate payment from the consumer at the time of purchase, it seems doubtful whether the retailer would be able to charge a mark-up of 69 cents, or nearly 100 per cent of the cost to him exclusive of tax. Certainly the retail stage in the distribution of liquor involves few of the sources of loss and heavy expense inherent in certain other types of retailing which operate with much smaller mark-ups.

C. MEDICINALS

The shifting patterns of distribution are nowhere more evident than in the evolution of the apothecary's shop of a generation ago into the drugstore of today, which has become more and more a miniature department store selling thousands of articles of general merchandise. Even the drug business has changed radically in character. Packaged medicinals have lost some of their disrepute and many standard remedies are now manufactured by reputable pharmaceutical houses and often sold on doctors' prescriptions.

The drugstore today carries from 2,500 to 3,000 distinct products, or as many as 8,000 or 10,000 items, most of them small low-priced articles. Like other kinds of retail business invaded by chains, the typical drugstore operates a cash-and-carry business with rapid stock turnover. An average gross profit of 40 per cent of the retail price, or a mark-up of 67 per cent over cost, is regarded as enough to pay normal operating expenses and yield a good profit. Thus the retailer may sell for ten cents a tube of tooth-paste costing him about six cents. Actual mark-ups on specific products vary widely and sometimes surprisingly, however. This is particularly true of nationally advertised cosmetics and pharmaceuticals as compared with similar unadvertised products.

For example a standard headache remedy of simple chemical composition, which the promotional effort of the manufacturer has made a household word throughout the United States, is normally sold in retail drugstores at a price of 59 cents for a bottle of a hundred tablets. For this the wholesaler's net price to the retailer is just under 37 cents, so that the retail mark-up is about 60 per cent. With a mark-up of 16 per cent, the wholesaler pays the manufacturer 32 cents for the same product. Since the manufacturer's expenses consist largely of advertising and promotion, actual factory production costs are probably considerably less than half the price he charges the wholesaler. In this case, therefore, a very large share-perhaps three-fourths or more of the amount paid by the retail customer-goes for costs and profits in the various stages of distribution.

Unadvertised Goods Cost Less

The retailer can buy another product, not nationally advertised, but identical in appearance and composition and just as effective a remedy, from an obscure producer for a price of 11 cents for a bottle of a hundred tablets. This article may be sold at retail for 39 cents or sometimes for as little as 23 cents. At either price there is a substantial saving to the consumer over what he would have to pay for the advertised brand in spite of the fact that the retailer's mark-up is much larger than for the advertised product.

Another example is an alkaline remedy, which is nationally advertised and intensively promoted among the medical profession and is frequently prescribed by physicians to their patients. The consumer pays 79 cents for a four-ounce bottle, which costs the retail druggist about 50 cents if he buys it direct from the manufacturer, and 60 cents from a wholesaler. The total price spread is 29 cents or 58 per cent of the manufacturer's price. Since the manufacturer probably spends much more for advertising and promotion than for production, distribution undoubtedly absorbs two-thirds or more of the consumer's dollar.

A chemically identical, but unadvertised, competing product made by an old and reputable pharmaceutical manufacturer is sold direct to the retail druggist at a price of 38 cents for an eight-ounce bottle. This the latter ordinarily sells to the consumer for 89 cents, representing a price spread of 51 cents or a mark-up over the manufacturer's price of 134 per cent. Here again, in spite of the fact that the percentage of price spread and gross profit to the retailer is much greater than for the advertised product, the consumer makes a large saving in buying the unadvertised one. For eight ounces of the advertised product the consumer would have to pay $1.58, of which the retailer would retain about 58 cents, whereas he pays only 89 cents for the unadvertised product on which the retailer's gross profit is 51 cents.

d. ELECTRIC REFRIGERATORS

Unlike other products discussed in this chapter, electric refrigerators, like oil burners, radios, and automobiles, have a high unit value. The purchase of such products is a considerable investment for the average consumer and their sale usually involves protracted negotiations and demonstrations, installation and service charges, and frequently instalment financing.

Most of the mechanical refrigerators in the retail market are manufactured by a few large and well known companies and are distributed through wholesale channels to department stores, electrical specialty shops, mail-order houses, stores operated by public utilities and to a few other types of retail outlets. They are usually extensively advertised and sold under the manufacturer's trade mark.

Although detailed figures for a specific refrigerator were not available, confidential information on percentages of average mar-gins and mark-ups were obtained. Applying these percentages to the average retail price in 1935 gives a fairly typical picture.

The average price paid by the retail customer for domestic electric refrigerators in 1935, according to an analysis of data from confidential sources, was $156. The manufacturer's cost was estimated at about $58, so that the total spread between production cost and the retail price was $98. About $12 was retained by the manufacturer, $16 was the wholesaler's margin, and $70 represented the costs and profits of the retail dealer. In other words the consumer paid as much to the retailer for selling the refrigerator as to the manufacturer for making it.

e. AUTOMOBILE TIRES

Automobile tires are an appreciable item in the family budget of most of the nearly twenty million American families owning automobiles. Tires on new cars, it is true, do not constitute a very important part of the cost of the automobile, but in normal years three or four times as many tires are sold for replacement purposes to automobile users through retail dealers.

The tire industry has long been concentrated in the hands of relatively few large corporations which sell tires for new cars directly to the automobile producers. Distribution of tires to the re-placement market has changed rapidly in recent years, and today tires are sold to consumers through a large variety of retail channels. Ten years ago independent dealers-specialty tire shops, garages, hardware stores, and general merchants-handled nine out of every ten tires sold at retail. Today the independents have lost a large share of their business to large-scale retail organizations such as mail-order houses, chain stores, oil company filling stations, and tire manufacturers' retail stores. The latter organizations now account for half the retail business.

Invasion of the retail field by these mass-selling organizations resulted from the vast expansion of the market occurring in the twenties, and also because the price and distribution policies of several of the largest manufacturers favored the large retail buyers. Today the independent wholesaler has been almost eliminated, and 90 per cent" of the output is sold by manufacturers directly to retailers or through manufacturer-owned outlets directly to the public.

More Tire for Less Money

As a result of these shifts in distribution, and because of intense competition between large producers and powerful retail buying organizations, as well as lower raw material costs and improved manufacturing methods, the retail customer today gets a much better tire for much less money than he did a decade or more ago. A recent study compares costs for a best quality tire for light cars in 1926 and 1938. The smaller 1926 tire cost the consumer $23.95, with an average mileage of 14,200 or $.00169 per mile, while the heavier 1938 tire cost $19.35, with an average mileage of 26,500, or $.00073 per mile. On the basis of 1926 values, the 1938 tire represented $44.78 worth of mileage, or $25.43 more than it cost. Also, no consideration was given to the value of increased comfort and safety which were built into the 1938 tire.

Table 8 shows the cost and price changes occurring between 1921 and 1933. Marketing costs declined substantially, but not as much as the retail price, and far less than factory costs, which in 1933 were at a little more than a fifth of the 1921 level. In spite of the great decline in prices and costs, therefore, slightly over 50 per cent of the consumer's dollar went for marketing costs in 1933 as compared with only 40 per cent twelve years before. This difference in trends is no indication that marketing is less efficient than it was in earlier years. In fact the contrary is probably true,

The extent of price spreads for tires varies also according to the channel of distribution. Goodyear Allweather tires sold through the usual wholesale distributors to retailers at $8.40 in 1930 bore a total distribution cost of $3.44, or 41 per cent of the retail price. The intermediary distribution functions accounted for 16 per cent, and retail operating expenses were 25 per cent of the retail price. Sears, Roebuck's Allstate tire, a comparable product and sold through Sears, Roebuck's retail stores for $6.47, entailed a total distribution cost of $2.07, or 30.2 per cent of the retail price. The difference in distribution costs accounted for most of the differential of $1.93, or 23 per cent, in the prices of the two tires. Similar tires were sold by Sears, Roebuck's mail-order division at $6.17, with a distribution cost of $1.16, or 18 per cent of the retail price.

f. GASOLINE

In spite of the fact that gasoline is a well-standardized, imperishable commodity, easily transported with relatively small loss and usually handled in large quantities by simple mechanical methods, there is a relatively large spread in price between the value at the refinery and the amount paid by the consumer. Although some variation in prices to retail customers exists because of different transportation costs to various markets, the situation in the New York market is typical of the several elements (other than transportation costs) which make up the final price.

After subtracting the amount of the taxes the twelve and a half cent net price is still more than twice the refinery price, reflecting transportation and distribution costs of seven cents. Of this sum, the retailer's margin of four cents and the jobber's of two cents, nearly equaled the total cost of producing the gasoline, shipping it by water from the Gulf port to New York harbor, and delivering it in tank cars to the New York jobber. Furthermore even the one cent margin between the Gulf port price and the jobber's cost included a small charge for additional processing in New York.

Obviously the six-cent margin of the jobber and retailer, amounting to nearly half the retail price, exclusive of taxes, offers the largest area within which appreciable savings might reasonably be expected. But individual companies feel powerless to cope with the problem, although many leaders in the industry recognize the possibility of reducing costs of wholesale and retail distribution.

Too Many Filling Stations

One source of high costs seems to be the excessive number of retail filling stations and consequent low average volume of sales. With the existing number of retail outlets the volume of business per station is so small that a margin of four cents per gallon, or nearly 50 per cent of the price to the retailer, is necessary to give the filling station operator an adequate compensation. If the number of filling stations could be cut in half the retail customer would still be adequately served, but the average volume per station would be doubled and the unit cost of selling could be greatly reduced. In this respect, of course, gasoline distribution is no different from many other lines of retail trade.

A reduction in the number of retail outlets would also lower the operating expenses of the bulk-tank station or wholesaler, whose margin is two cents a gallon. As the situation now stands many of the small retailers are poor credit risks and are serviced on a cash-on-delivery basis. Often they are unable to buy as much as a hundred gallons, the minimum quantity which can be handled economically from a tank-truck. Instead of emptying a full one hundred gallon compartment by hose into the retailer's tank, bulk distributors have to supply these outlets by "bucketing," five gallons at a time. This operation is of course wasteful and time-consuming and increases the wholesaler's cost.

A "Volume-Minded" Industry

In spite of these wasteful practices, the industry is so volume-minded, and competition among refiners and wholesalers is so keen, that no single company can attempt to correct the situation.

If one company reduced the number of its stations without agreement on the part of others, competing concerns would buy up or supply the abandoned locations with the result that no change would be effected.

Entirely aside from this problem, there are other opportunities for economies in wholesale operations. A number of oil companies located their bulk-tank stations in the days of kerosene and horse-drawn tank wagons so as to serve a territory within a radius of five to ten miles. Now that large automobile tank-trucks are available to serve a radius of twenty-five to fifty miles, depending upon the density of outlets, it would be possible to effect substantial savings by discontinuing many of the existing stations. This has often been considered but has not been carried out because of the probable resentment at such action on the part of the local population. These bulk distributing stations, particularly in the South, are frequently an important source of employment and income in the small communities, and abandonment of a station by one company might easily lead to a local boycott against that company's products.

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