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parity and prestidigitation

On some level, we all know that we’re sort of getting screwed by retailers. Generally speaking, the larger the retailer, the greater the damage that they can inflict (and no, I’m not going to mention any names). We’ve all made comments to the effect that a retailer or manufacturer makes an item for $2 that ends up retailing for $50. This is, of course, engaging in a little bit of spurious logic that somehow the remaining $48 is finding its way directly into someone’s pocket, which is far from the case. In fact, there are a lot of very good reasons why a $2 product can end up costing $50 in a store, a lot of reasons that we all (without knowing it) want that item to cost $50 in a store- the number of jobs that are supported by its eventual sale, the amount of money driven directly into government coffers by tax on the item that we depend on to pay for our services, etc. I’m not arguing that there isn’t some greed and gouging involved, but there are reasons why we all depend on the economic system generating profits at various stages. The tacit agreement is that retailers and manufacturers should keep their greed below our radar (not difficult, given the sad level of awareness that most of us have of the costs and logistics of retail). If they fulfill that one small requirement, then we will pretty much give them free reign to charge whatever they want and make whatever they want, as long as the charges are broadly consistent across product types.

Yet sometimes, and for Canadians it is one of those times, retailers (and, behind the scenes, manufacturers) manage to trip up even on this simple requirement. Like charging Canadians significantly more than Americans for an item when our currency has virtually the same value. This is one of those things that can drive otherwise friendly, polite, unassuming Canadians to distraction. The last time our dollar hit parity, it was brushed off as a temporary blip and retailers waited months to adjust prices (and even then, did so under considerable pressure). Note that when the dollar went into freefall in 2008, they didn’t wait so long to adjust the prices back up.

To their credit, the venerable American institution Brooks Brothers, who have a small number of retail outlets north of the border, did not wait to be asked and dropped their prices 15% in Canada earlier this week. They could teach a few things to other retailers, who are hemming and hawing about how Canadians can’t use the dollar as their only measurement, while being fairly vague about what other measurements we should be using. This is where working for manufacturers for a number of years comes in handy. So here’s an analysis of some of the excuses being coughed up as reasons why currency parity cannot equal pricing parity. I am not an expert, these are just my observations based on my own experience in the milieu.

1. Market Size- Canada is a small market and therefore does not benefit from the buying power that the United States has. After all, we’re only one tenth their size, so there is no way we could ever get the same volume discount. I’ve always admired how simple, straightforward and sensible this argument sounds, particularly since it’s such an utter load of crap. Sure, if you’re talking about different items being sold in Canada and the United States, that’s true. But how do you calculate parity on items that are different to begin with? You can get close, but it’s never going to be equal.

The same rules apply to different retailers. Different retailers have different prices and that’s the end of it. Canadian Tire can be expected to sell a sleeping bag for a different price than Target in the U.S.

But for items sold by the same retailer (including over the internet) to both countries, this excuse is hogwash. If I am ordering 500,000 of an item to sell to the U.S. and 50,000 to sell to Canada, I don’t place my orders separately. I place one order for 550,000 and work out the differences when it comes time to ship them out. In fact, I get a better deal by combining the buying power of both countries than I would for either on their own. If I’m really smart, I’ll even use NAFTA-compliant trilingual packaging and labeling, so that I get a mass deal on that as well. Most successful manufacturers know how to leverage their full buying power to get the best pricing. That’s why they’re successful.

And, as a side note, keep in mind that market size does not automatically equal buying power. Many retailers with outlets in Canada find that these stores have a MUCH higher return per location than their American counterparts. So, while we may only be a tenth of their size, we buy way more than a tenth of the product that they do.

2. Shipping costs- It costs more to ship to Canada than it does to the United States. This one is completely opaque to most people, so they just take it on faith. And there’s nothing wrong with that, because it’s true. Since there are far more vessels going to the United States from everywhere (but especially from the manufacturers’ hub of south China), it is substantially cheaper to ship to the United States. The last time I saw reliable figures, the difference was between 30 and 40%.

How much of an issue that actually is, however, depends a lot on what item you’re talking about. Shipping containers come in a few standard sizes, but by far the most common is a 40’ one. The cost of shipping any individual item is determined by how many of them you can shove into a 40’ container. If you’re a big retailer, that’s all there is to it. You buy products by the container load. If you’re a smaller retailer, you may have to contract an agency to buy a number of items and mix them up to fill one container, which has added costs. However, this scenario is only relevant if you’re shipping mixed containers to Canada and full containers to the U.S. I’m sure it happens. I’ve never seen it. Honestly. If a retailer is ordering container-loads of goods for the United States, they can always find a way to squeeze out one full container for Canada.

So we'll assume that we’re dealing with a container going to the U.S. and a container going to Canada. Let’s say they’re really different in cost. The one to the U.S. is going to cost $3,000 and the one going to Canada is going to cost $5,000. Say we have 1,000 units of an item in a container (note: this would make it a fairly substantial item, something like a large piece of luggage). The freight on that item to the U.S. is going to be $3. The same item will have a freight cost of $5 coming to Canada. This definitely accounts for some of the difference. Our theoretical $2 item now costs $5 in the U.S. and $7 in Canada. But that’s a fairly large item. If you were using something the size of a wallet rather than a piece of luggage and you could fit 10,000 of them in a container, then the difference falls to only $0.20 between the countries. How much of a big deal is that?

3. Taxes & Tariffs- The universal wisdom is that these are higher in Canada than in the United States. I’ve never seen a comprehensive analysis, but I’m willing to bet that it’s true on a very grand scale. However, that only means that when a Canadian and an American importing a variety of goods from overseas look at their bills at the end of the year, the Canadian is likely to be holding a somewhat higher bill. There are all sorts of rules that apply to the importation of goods and how much duty is levied on them and these have mostly to do with which industries a country is trying to protect. Imagine you are importing two items from China. They are alike in every way, except that one is made out of cotton and and one is made out of synthetic fibre. If you're shipping them to Canada, there is no difference in terms of the duty you'll pay. Going into the U.S., with its massive, struggling textile industry, you’re likely going to pay six times the duty on the cotton piece. So where you end up paying more duty is a lot more detailed and specific than working out a general rule.

Then, of course, you need to keep in mind how much this actually affects the price of the final item. Remember, duty is charged on the value assigned by the importer, which means its value when it leaves the point of origin. For our example of a $2 product that costs $50 in store, whoever imports it pays duty on $2 only. In order for this to make a substantial difference between Canadian and American retails, the variance in landing costs would have to be huge.

4. Shipping costs, Part 2- This is where calculating shipping gets complicated. There are very smart people who spend their entire careers doing this sort of thing, so you don’t need to be able to sort out exactly how much shipping is involved in getting something in the door of a United States retailer as opposed to a Canadian one, but you should be skeptical about grand claims that it’s just always more expensive in Canada.

Once a product arrives in its destination country, it actually has to make its way to the store where it will be sold to you and me. There can be a few steps to this process, but lets stick with our model of a large retailer and look at what is most common for them. From the port where it lands, the item goes to a number of distribution centres (generally referred to just as “DCs”), who then divide the shipment into smaller bundles and send it to individual stores.

In the United States, the population is spread out over the country’s entire land mass. A large retailer needs to have several DCs in various regions to service this and to coordinate stores receiving merchandise at roughly the same time. This is an expensive network to maintain and requires a fleet of trucks on the road at all times. There is a lot of ground to cover. And if there’s a lot of ground to cover in the U.S., imagine how much there must be in Canada, which is so much larger. The answer is a hell of a lot less.

Many retailers service Canada out of a single DC in Ontario. Others have three or four, but it’s never all that many. And, unlike the United States, Canada’s population, or at least the lion’s share of it, lines up in a neat, straight line along the border. So, once a product is in Canada, there’s a less complicated procedure to getting it to its final destination and fewer places where goods need to be directed. In anything, less complications mean less cost.

5. Difficulty of execution- Now here’s something to consider. How much work and, more to the point, how much cost is involved in making all the changes necessary to come up with new pricing? There’s needing to reprogram cash registers, scanning systems, adjusting inventory value, changing web site information, changing printed information that may have been set months in advance… There’s a lot of difficulty in changing a price, let alone changing all the prices for all the items. The easiest time to do it is obviously at the end of a season, when new products are coming in and old products are leaving. So maybe that’s what they’re waiting for.

Ha. This is where we can look at the Brooks Bros. system. They haven’t changed their prices anywhere. They’ve simply implemented a 15% discount, the same type that retailers everywhere do all the time when they have sales. This is something that can be implemented very quickly. What takes time is deciding who’s going to pay for it.

Retailers and manufacturers spar constantly over responsibility for the costs of special giveaways, sale pricing, anything that involves cutting into their profits. So even when groups can agree that near-parity in retail pricing should be a goal, it becomes a complicated process to determine who’s going to barf on their bottom line to make it happen. (Which is why it shouldn’t surprise anyone that a company like Brooks Brothers, which serves both as a retailer and as a manufacturer of its own goods, should be the first to step up.)

6. Timing- "It takes a while to see the benefits of currency differences." This one always sounds suspicious. It’s the argument gas companies make when their prices stay the same even as the price of oil tumbles. In fact, it’s probably the best argument you can get for delaying any move towards price adjustment (and we’d take it a lot more seriously from gas companies if they didn’t jack up their prices at the pumps the second there’s a rumour of an increase in the price of oil).

Retailers and manufacturers don’t just buy what they need on a daily or weekly basis the way an individual does. The quantities in which they need to secure materials force them to order months in advance and to lock in a price at that time. That means they’re stuck paying that price, potentially for months after the rules have changed, because they had to commit in January to a program that will finish shipping in June. Of course, the counter argument is that they’ll be making more money, because the sales that they’re making in Canada will suddenly be worth more than what they projected. The key is finding the tipping point: At what time does the extra revenue generated by the higher dollar meet or exceed the higher price paid for the materials? it takes work to figure this out and work takes time. Even when you've had advance notice to prepare, you're going to have some lag- potentially months- in adjusting prices.

What’s truly weird about this argument is the following: I’ve not once heard anyone use it to explain why they need a delay in changing prices. It’s a fairly sensible argument, that would allow retailers time to negotiate with suppliers and divide costs. I guess that gas companies have ruined that line of logic for everyone.

The problem with all these arguments is that they take a long time to explain. I’ll bet you’re exhausted just reading this blog post and I’m just a neophyte without any kind of economic training. If you watch the news, you’re lucky if you get a 5 second sound-bite of someone explaining the difficulties of price parity and all they’re likely to do is say a couple of the words I’ve used as “subtitles”.

Forcing someone to explain their logic is a long process and it all comes down to the fact that the same rules just don’t apply to every type of product. Parity can come, but it’s individual retailers who have to do the analysis and figure out when they can adjust prices and how close to parity they can come. Given that this debate keeps resurfacing, perhaps it’s time to enact legislation forcing retailers to make product specifications available- item size, carton size, container quantities, percentage duty charged, etc. None of these reveal how much the retailer is paying or earning. It just allows the enterprising consumer to see how great the difference between Canadian and US costs actually is. And keep in mind, this isn’t asking the retailer to supply anything they don’t already have- they need this information to import and stock the product anyway.

Until that happens (stop laughing), I’ll leave you with my sound-bite, an oversimplification designed to go head to head with those of the retailers who are saying that achieving price parity is a difficult and complicated procedure:

There is no excuse for not achieving near-parity in the vast majority of cases. The slow but steady rise of the dollar has provided retailers and manufacturers with time to plan for the inevitable arrival of currency parity. Within a few months at most, the differences between retail pricing in Canada and the United States should be negligible and we should take our business solely to those companies where it is.


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