Company accounting at The Observer

The perfume itself is often the cheapest part of the package, accounting for as little as 3% of the overall cost for the cheaper fragrances, according to one industry estimate. Packaging and marketing make up a far larger proportion of the cost to the manufacturer, but the potential to make money should not be underestimated: the profit margin on a celebrity perfume can be as high as 95%.

Oh dear. We seem to have some confusion among the lefites as to what a profit margin is.

Profit is what you\’ve got left after all of the costs are paid. No, the profit margins on perfumes are not 95%……they might be 95% on the costs of manufacturing, this is true. Scented alcohol and a cheap bottle, well, maybe. But that isn\’t all of the costs, is it? As they say, marketing makes up a rather larger part of the costs….bringing that profit margin right down again.

The real problem here is that they\’ve got confused between gross margins and net profits.

Say that the perfume sells for £40 (roughly what they\’re talking about here, for a Katie Price brand).

3% of that is £1.20. That\’s the cost of the scented alcohol… their figures recall. They\’re charged 34p for the bottle and packaging. £1.50 as the cost of goods.

So, what they\’re trying to say is that the rest of the £38.50 is profit….sales price minus cost of goods equals profit, right?

Ah, no, for as they also say marketing makes up a far larger proportion of the cost to the manufacturer. We don\’t really know what that number is but let\’s say that \”far larger\” is 10%….three times or so the number that it\’s \”far larger\” than. Maybe it\’s double, maybe it\’s four times, who knows, but we do have to make some assumptions.

10% of sales price is £4. So we\’ve now a total cost of £5.50 for something that sells at £40. Not a 95% profit any more, is it?

But even this is wildly misleading. From our £40 we first have to deduct VAT (and I\’m not even going to begin to talk about excise duties on perfume). I can\’t be bothered to work this out properly but call that £7 (0.175x £40). We also need to have a retail margin. Shops, do not, after all, sell things for the good of their own souls. Retail margins appear to be around 20% on designer perfumes. Add another 10% for the wholesaler, shall we?

So, now let\’s add up our costs. £7 VAT, £12 retail margins, £1.50 cost of goods, £4 cost of marketing…..sure, there\’s an awful lot of guessing in this but we\’re somewhere near reality at least.

£24.50 from a sales price of £40. Now we can get to our gross profit (umm, maybe not the right word, but profit before contributions to overheads shall we say): ….something like 40%. This is very different indeed from our 95% as claimed by the newspaper, isn\’t it?

And we can go even further than this:

Over 200 new launches each year, of which only 5% are still on the market after two years and only 3% after three years.

If perfume were in fact so hugely profitable there wouldn\’t be that horrendous (97%!) fall out rate would there? That\’s more the behaviour of a fiercely competitive market….one where profit margins have been so severely squeezed that for the majority of the participants at least it\’s only a marginally profitable business to be in. Or unprofitable even, given that so many participants (participants in the meaning of brands at least) leave the market each year.

And we can even work out why this is happening. Given that you can now go to India and order up the whole package, neatly wrapped, all you have to do to launch a new perfume is find some \”celebrity\” that appeals to some segment of the market (Jade Goody, Katie Price, Beyonce, Ken Dodd perhaps, for some meaning of the word \”celebrity\”) and phone around a few retailers and fashion mags. Plus, umm, pay the launch costs of course.

Low barriers to entry (200 new entrants a year!), fierce competition, rapid exit from the industry of the marginal players (97% fall out rate!). These are not signs of high profit margins you know, not at all. They\’re signs of (and indeed causes of) low profit margins.

As above, the confusion in The Observer is because they\’ve fallen for the old nonsense of believing that the retail price minus the cost of goods is the profit margin.

And it ain\’t, it really just ain\’t.

Now maybe those workers in India are poorly paid: but at least part of the cause of that is that the British Government takes between four and five times the cost of goods to pay for outreach diversity advisors rather than allowing the money people are willing to pay for the perfume to flow to those poorly paid workers in India.

\”Last night anti-poverty campaigners said it was unacceptable for western companies to cut costs by using subcontractors who pay low wages to workers in the developing world.Dominic Eagleton, policy officer for ActionAid, said\”

Or, indeed, the British Government charges four to five times the cost of goods so that it can make donations to Action Aid which help to pay the salaries of people like Dominic Eagleton. (Page 18 here).

4 thoughts on “Company accounting at The Observer”

  1. But even this is wildly misleading. From our £40 we first have to deduct VAT… I can’t be bothered to work this out properly but call that £7 (0.175x £40).

    VAT is 17.5% on top of the net price, not 17.5% of the gross retail price, if you see what I mean. The simple way to work out VAT from the gross price is;

    Net Price = 40/47 Gross Price
    VAT = 7/47 Gross Price

    Thus in your example, the Net Price is £34.04 and the VAT is £5.96.

    However not all of the £5.96 will be payable as all input VAT (VAT on raw materials, marketing etc) can be claimed back.

    Tim adds: That’s exactly the bit I couldn’t be bothered to work out. But it will still be total VAT of £6 on retail price.

  2. Pingback: Company accounting at The Observer « Tips On Accounting

  3. Yes, the actual price is £34.04 NOT £40.00. All calculations regarding margins should be calculated net of VAT, both input and output. Otherwise you can end up owing the Revenue lots of money, because you owe them the difference between the two amounts.

  4. I believe profits on individual perfumes are very high. But revenues are rather binary: they tend to sell well or not at all.

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