Minimum pricing for alcohol appears at least 2 years away and when implemented looks most likely to be a ban on below cost selling. However cost isn’t as easy to determine as you might think.
I’ve been thinking about this and to explain my thoughts I’m going to start by simplifying things. If you have any manufacturing process you have 2 types of cost, fixed and variable. Fixed is stuff like plant and machinery, variable would be raw materials, labour and the like.
It might sound quite simple to say for any given commodity, “it costs 10p to make, it sells for 15p, that’s 5p profit” A ban on below cost selling would be to say outlaw the selling of said commodity for below 10p. It all sounds simple enough.
The fact is that there are bans on below cost selling already in the world. In global trade it is possible for one country to subsidise a sector, agricultural or manufacturing and effectively dump that commodity or product on world markets below cost. This is generally considered aggressive and frowned upon and one of the purposes of the World Trade Organisation is to attempt to discourage this sort of thing. Though it has been said it doesn’t do that good a job when you consider the agricultural subsidies given to European and American farmers by their respective governments and the artificially low price of Chinese currency.
I’ve got distracted from a beer related rant, so back to the point. From my earlier point regarding fixed and variable cost within manufacturing, there are 2 forms of accountancy usually done. Financial and Management. Again this is an over simplification. The financial accounts are a legal requirement and involve such delights as Profit and Loss statements and Balance Sheets. The purpose of which is to reveal whether the company made a profit and what the book value of the company is. Book value isn’t actual value, that’s market capitalisation, but that’s irrelevant.
The management accounts are often called cost accounts because at a basic level they are an attempt to determine the costs within a business. There are numerous methodologies, one of which I know something about. Activity based costing, but as that time of my life was a painful experience I have locked away I don’t much wish to go into detail. I shiver even thinking about it.
These accounts are company confidential, and confidential for good reason. You really don’t want a competitor to know the details of your cost structure because that is a significant part of competitive advantage. Companies make attempts to benchmark themselves against competitors in order to measure competitive advantage. You might not wish a price war, as your goal isn’t to destroy the competition but to provide a return to investors, but you might wish to know whether your operation is as efficient as the competitors and whether you could win one if they picked a fight.
Now the reason for all this different cost accountancy arithmetic and different ways of measuring cost is simply that each economic process is slightly different and you want to pick a model that reflects what you are doing. For a manufacturing plant, like a brewery, your per pint cost is different if you make a million litres from if you make 2 million litres. If your plant has a capacity of 2 million litres you are likely to be operating at cost efficiency if you are knocking out the full 2 million. Your fixed cost is apportioned over 2 million pints rather than 1 million. However you might only have a market for a million pints. You could also have a market that is split into sectors. Regions of the world, or indeed on or off trade. You will also have a breakeven point. The first half million litres you are selling at a loss because you haven’t covered your fixed costs, and the rest at a profit because from there it is all variable cost. It makes perfect sense, once fixed costs are met to find a market and sell additional product with a price calculation based only on variable cost to reach capacity. That is, we need to sell a million pints at X price to meet our fixed costs, but heh, from there our only cost is commodity grains, so long as we offload it above variable cost, we are quid’s in.
But this assumes cost is only manufacturing cost. What about distribution through the supply chain as it makes its way to the supermarket shelf? It costs more to supply the shop farthest from your distribution depot than it does the one nearest. What about the cost base of the farmer producing the agricultural commodities? He is growing stuff based on last year’s commodity prices and will sell it at this years, at a loss if he has to, because if he doesn’t it gets ploughed into the ground and he gets no money back. He isn’t in business to make a loss but in a bad year minimising losses is better than losing everything.
You have to take the costs of every organisation into account, to ensure none are supplying below whatever arithmetic you’ve used to calculate cost.
So how the hell do you actually calculate cost and enforce that when cost is company confidential?
The answer is not to bother because for booze the model is likely to be duty + VAT. I.e. ignore the actual cost and implement a measure that doesn’t force an organisation to make public what is private, and provide an administrative burden.
Hardnott Dave posted an interesting post here, where he calculated some interesting things about duty and VAT, and from his numbers I’ve worked out some of my own.
As per his numbers, Carling are paying 41p a pint duty, and soon 8p VAT (at 20% next month), making a duty + VAT pint of 49p a pint. The cheapest I can find this beer for is 40p a can (£10 for 24 440ml), or 56p a pint. The cheapest offer for cheap lager is currently sold at 7p above cost.
Therefore I’d like to say to everyone that moans about irresponsible below cost selling and loss leading by supermarkets. The price of cheap lout will not be affected. Thhhppppptttt. That is the sound of me blowing a raspberry.
Thhhppppptttt. Thhhppppptttt. Thhhppppptttt. Thhhppppptttt. Thhhppppptttt. Thhhppppptttt.