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 Business News | April 2007 
High Prices Do Not Necessarily Mean High Profits
 Carson Varner - Presswire
Timers older than I talk of the corn husker era, when a farmer might pick, shuck but not shell 60 bushels or an acre of corn in a day. Today, on that same 170-bushel-acre, inside a $300,000 combine, the work is done in minutes.
An automobile is produced with 40 percent less human labor than decades ago. Cornhuskers - and many auto jobs - are gone.
But don't be sentimental about a past that is only romantic in hindsight. Especially for the less wealthy, higher living standards are a fine tradeoff.
Farm and factory efficiency are well known. But what about that long road through numerous middlemen to us, the end user? We call that distribution. Typically, this road adds 60 percent to the cost of goods in the United States. Food distribution is generally a little less and the margins for luxury items like jewelry are far more. In poorer countries everything is jewelry. Two hundred or 300 percent markups are common. Think of the benefits to an average Mexican family with a $4,000 yearly salary if those costs could be whacked down.
Science and engineering develop better seeds and machines. Improved distribution is often driven by mere ideas. Among my distribution heroes are Henry Ford, Sears Roebuck, A&P and Sam Walton. They worked toward increasing profits by lowering prices. This is counter-intuitive, revolutionary and crazy.
In a famous lawsuit, Ford appeared at the time to be more interested in working out his obsession of putting America on wheels than actually making a profit. His business partners, the Dodge boys, thought low prices meant lower profits.
Ford bought them out and then, as Will Rogers said during the Depression, we became the first people in history to drive to the poor house in our own cars. Ford slipped when he ignored consumer demand for colors other than black. In spite of his legacy, much of the world still believes high prices mean high profit.
A&P, the Atlantic & Pacific Tea Co., developed the supermarket concept as it spread from sea to shining sea. Tactics were often unethical and now illegal. Lose money in new stores until the competition goes bust was the rule.
Still logistics, efficiency and good management upped the American living standard several notches.
In stereotype, Germany was a land of "tinkers and poets" (i.e. impractical) and France a "nation of shopkeepers." So romantic to many American tourists were the open air markets and the quaint small corner food stores.
I recall the high prices. I remember the old lady in the non-self-service food store reading from her list while the grocer behind the counter fetched the goods. A working family in 1950s France spent 60 percent on food. We spend 10 percent.
The crunch in France came in the early 1970s as big box stores moved in. Would France, through legislation, save its nation of shopkeepers? They voted for the future and, while service is less personal, prices are lower and the living standard higher.
A professor of mine remembered bombs greeting the opening of new Sears stores in 1950s Venezuela. Leftist terrorists driving out the Yankee imperialists?
No, it was competing businesses fearing the philosophy of low prices and superior logistics. In too many poorer countries, a very few "competitors" run the show. A few means an oligopoly (monopoly is one). Typically, prices are fixed, markets are divided, margins are astronomical and efficient foreign competitors are kept out under the banner of preserving culture. I would add preserving the culture of inefficiency and attendant poverty.
When retailers get a deal on a batch of goods, the custom is to enjoy the expanded margin. Sam Walton thought it might be good business to pass that savings on to the customer. Wal-Mart claims, with brilliant logistics and intelligent pricing, their average shopper saves more than $2,000 annually. They also admit, with secret pride, of having put more of the inefficient out of business than anyone else in the history of American business.
Critics assert much of the obvious consumer benefit is because employee wages and benefits are so low. One wonders how lavish wages and benefits were in those small stores in small towns that are no longer in business.
Wal-Mart prices are no doubt welcome relief for lower income Americans, but now let's go south of the border, down Mexico way and look at Wal-Mex. Inefficient Mexican retailing had long been in the iron hands of the few. Their battle cry was "Mexico for the Mexicans." The Mexicans they meant were the small group of store owners and distributors at the top. That class led a comfortable life with little competition, while the poor were ignored.
As it did out of Arkansas, Wal-Mex went into smaller towns and off the main road Mexican cities. The efficient distribution and low price philosophy is raising many Mexican families to the status of formerly poor. For many, I guess, living standards are up by about 20 percent.
Let's end today's lesson with an ethics twist. Charities are created to do good, to make the world a better place. Frankly, I invested in Wal-Mart to make money. Wal-Mart established Wal-Mex for the same purpose.
Yet, while motivated by money one business after another seems to do amazing things to improve the world. The idea is not new. It goes back to Adam Smith, the great guru of free markets.
In about 1770 he wrote that businesses set up for profit so often are driven "as if by an invisible hand" to make the world a better place. I memorized that line in school many years ago. Now I see what it means.
Carson Varner is a professor of finance, insurance and law at Illinois State University. |
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