COGS: The Ratios and The Squeeze

An article has been making the rounds noting that the public believes that businesses clear a 36% profit after taxes, or in other words, net of everything.

That is, of course, an order of magnitude more than businesses actually make.  This comes from people thinking, "Gee, well, I heard they double the price before they put it on the shelf, and I'm sure there's some costs in there so they don't get to pocket the whole 50%, so, I guess... 30%?  Or 40%?  Or..."  And you average out those rectally-sourced guesses and 36% is where you land.

The problem is that "I'm sure there's some costs in there" grossly underestimates the reality.  Back-of-the-napkin math, the real average take-home profit across all of retail is something resembling 5%.  Five percent.  I get a shiny nickel when you buy that dollar can of Coke.  Or, more to the point, I split a nickel with my business partners.  As Zoe Washburne said, "At last we can retire and give up this life of crime."

Different retail scale levels produce that profit differently, however, and are vulnerable to different pressures.  Due to the alignment of ratios, big retail is about equally vulnerable to changes in occupancy costs, labor costs, and the cost of goods sold (COGS).  Small retail is vulnerable to everything, but mostly to COGS, and extremely so.  These days COGS for small retail are increasing at a frightening pace, against an MSRP that's printed right on the product a lot of the time and thus cannot be changed.  Small retailers, especially in our industry, are being squeezed by manufacturers/publishers.  And eventually some of us are going to pop.  (As it happens, Funko POP! products are one of the contributors to this problem.)

Big retail has four primary buckets, each shorthanded to 25% of gross sales but in reality with some variance.  Essentially:

• 25% of gross sales - Occupancy.  A combination of rent/mortgage, utilities, licensing, maintenance, and so on.
• 25% of gross sales - Labor.  Total payroll, not counting capital gains for shareholders.
• 25% of gross sales - Cost of goods sold (COGS).  This means 75% of the price tag is markup at big retail, by the way.
• 25% of gross sales - "Bottom line."  Includes debt service, capitalization, advertising and branding, litigation, taxes, and somewhere in there, around 3% to 8% final profit.

The 25% is good for visualization but in reality occupancy is slightly less, COGS is usually slightly more, and there exists all manner of room for creative accounting in "bottom line."  Labor tends to land right at 25%, though.  I apologize that I'm not citing a source on this, it's something I've learned so repeatedly and since so long ago I couldn't answer for it, and my Google-fu is failing me on locating a primary source.

The restaurant industry, by the way, is so much simpler:

• 33% of gross sales - Food.
• 33% of gross sales - Labor.
• 33% of gross sales - Everything else.

Right away looking at the big retail cost buckets, you know small retail should be sunk because small retail pays so much more for COGS.  We do make up some ground in the other areas, particularly when we rent downmarket or utilize other non-prime commercial space.  Here is how that stuff breaks out for DSG and stores like it:

• 15%-17% of gross sales - Occupancy.  Which is why there is no game store at the Scottsdale Quarter.  Breakpoint (mall) rent is 8%, so your middle-of-the-bell-curve game store is probably paying about that, with the rest of occupancy coming from the other line items.  Renting downmarket (a dump, in other words) definitely lowers the pressure, but introduces other problems.
• 22%-25% of gross sales - Labor.  Try what you want, it's tough to escape this figure without being a one-worker shop.  We sometimes shave a dollar here or there by virtue of attracting people who would rather make $9/hr with us than $10/hr at Wal-Mart.
• 50% of gross sales - COGS.  More on this in a moment.
• 8%-13% of gross sales - "Bottom line."  Which is why if you get into any significant debt as a hobby game or comic store, it's tough to see how you're going to make any money until you overcome that burden.  Between cap, advertising and branding, and taxes, and God help you if you have to sue someone or defend a suit... yeah, you maybe put 3%-4% of gross into your pocket.  You typically need a windfall to grow, expand inventory, or survive adverse finances.

So, COGS is the real ballgame, isn't it?  And this is why it's so difficult when a customer expects us to give a big discount -- after all, we bought it for around half the price, right?  What's so bad about ten percent?  Well, that's all our profit and then some.  That's a loss, actually.  Do that enough times and we won't have to worry about discounting anymore, or showing up to open the door.

The above, of course, puts forth an assumption that the retailer is keystoning, or marking up the item to double what they paid.  In an industry like hobby games and comics, where there is often an MSRP printed right on the box or book cover, the store owner cannot always do that.  When prices in distribution go up, all of a sudden profit goes down, because usually the store can't just mark the item up however much is needed.  Your local coffee shop can do this, Jim's Comics can't.

But what about buying Magic cards on the cheap?  Yes, that does happen.  So, let's explore COGS a bit further with that in mind.  With the real COGS having gone up to ~54%-56% for SKU merchandise, the store has to make that up somewhere.  For TCG singles and used comic books, there exists a curve: COGS may be as much as 75%-80% for fast-turn, red-hot Standard staples, as little as under 1% for long-tail slow-turn commons.  The mean is around 44%-46%, offsetting the SKU markup in the aggregate.  In other words, the store only paid $3 for your $10 Commander single because: (a) It will sell slowly; (b) Its value might drop; (c) It offsets higher costs elsewhere; and (d) They probably already had several in stock, so your one card has a lower probability of enabling an otherwise missed sale.

It would take another post entirely to get into the price manipulation in the cesspool that is "MTG Finance," but suffice it to say there is a great deal of abuse going on and it's enough for me to recommend stores that don't have expertise on the payroll stay out of singles entirely for now.

There is a certain equilibrium in these ratios: given a normal healthy velocity of movement of goods, you don't build up too much deadwood, you don't lose too much to the clock or calendar in overhead, and at the end of a $60,000 month, the owner gets to pocket about three grand, give or take.  Probably the owner leaves at least half of that in operating capital and gets an extra thou in savings and/or that year's Christmas fund.  But all it takes is a price hike on a major product line, with no corresponding increase in MSRP, to wipe out those gains.

[Edit: Removed obsolete information about publisher wholesale ratios.]

Thirty-six percent.  Human beings walking around on this earth, and voting no less, think businesses pack in profit on the level of 36% take-home.  It's such ignorance I am amazed they can successfully put on their pants every morning, and yet here we are.  And that is why the jackwagon playing X-Wing keeps telling people they can get the StarViper on Amazon for six bucks less if they want to.