What Determines Value and Cost (Part 2)

What Determines Cost?

Last week we saw how the cost of raw materials may vary over time. We also discussed the influence changing currency markets have on product costs. There are many other factors, although we only have space to discuss a few.

1. Transportation. When petroleum exceeded $140 a barrel, prices of all commodities jumped. Almost all products are energy dependent. Even farm stands, where the produce is sold where it is produced, reflect increased transport prices as merchants pay for packaging, items they cannot produce themselves, and shipping.

Interestingly, as transportation prices fell, the retail costs did not drop as rapidly. This was due to a need to make up previous losses and the fear that the reduction in oil costs was just temporary. With commerce interlaced, it takes only one area of elevated merchandise expenses to affect all others.

2. Insurances. How do I insure thee? Let me count the ways…. Businesses maintain liability, fire, production, and property insurances. They may pay for or contribute to employee health, dental, and other insurance plans. Although per product the expense may be minimal, these costs have to be passed on to the consumer.

3. Salaries and Payroll Expenses. Salaries are among the greatest expenses a company has, especially in the United States, Japan, and Europe. A major factor in moving to a third-world company for production is the relatively low cost of labor, a lack of employee benefits, and few government regulations.

In addition to salaries, many countries require additional expenses such as Social Security (half is paid by the employer), unemployment insurance, and business taxes. Add in business contribution to medical insurance, pensions, sick time, vacations, and office perks, and the actual cost of labor may be double the salary rate.

4. Taxes. When will people stop falling for the politician’s lower tax ads? If Federal or State taxes are reduced, local property and school taxes rise. You always land up owing more no matter what they do. There are income taxes, land taxes, usage taxes (such as toll roads and bridges), and taxes on purchased items.

You are aware of sales tax. Almost every state and many localities add a percentage of the product purchased as a tax. I happen to live in New York, which has state, county, city, and other add-on fees. But even before the sales tax, many products get import taxes known as tariffs. They serve a dual purpose: raise funds for the government and increase the cost of foreign goods that can sell for less than similar domestically produced items (usually due to low foreign labor costs).

There are also excise taxes added to products and services. These can be added at the front end (taxes the production company pays) or directly on the consumer. Examples of such fees included those added to gasoline and other fuels, alcoholic beverages, tobacco products, and on telephone and cable bills. New York has been considering a tax on sugary beverages such as certain fruit drinks and soda.

5. Building Costs. It costs lots of money to build a factory, and considerably more to maintain it, upgrade it, and fix problems. Many companies (in part due to local ordinances) spend millions anually on landscaping, safety or security fencing, parking lots, and the maintenance of all such things. As you might expect, all these costs are added to the price of the product.

6. Profit. No one is in business to break even or to lose money, although that does frequently happen. All along the line, every company, person, and associated group takes a share of the pie. Each slice adds to the total cost. Let’s consider who may take profit from the cost of an apple:

a) Farmer
b) Sorter
c) Trucking company
d) Crate builder
e) Cold storage facility
f) Another trucking company
g) Wholesale produce market
h) Commodities traders and product brokers
i) Retail store chain
j) Local store

While the apple does not cost the tree anything to produce, when you consider the maintenance of the farm and equipment, the taxes, insurance and fees owed each step of the way, salaries and benefits, spoilage, and profits for all people involved, even if all involved takes a fraction of a cent per fruit, that one poor apple may become worth 20 or 25 cents before it reaches the consumer.

The Unknown Factors. While it may be possible to calculate a simple product produced or grown locally, it is nearly impossible to even guess at how much a more complex product costs. When a store cries that it’s selling for below cost or is losing money, or when an advertisement announces a major sale, just how accurate is the information in the ad?

During the next few weeks we will investigate how advertisement and store statements mislead the customer into believing they are getting a great deal. Don’t cry for the store owners.