I’ve often wondered why craft beer costs more than our normal mass-produced and popular brands. Is it because it tastes better – like the Bru brand to the left, it’s really nice. Or because it cost more to produce? Or the smaller breweries have less economies of scale? Or does tax have something to do with it. It may be a combination of all of these, or some other factors I have not mentioned. However, a quick search of the internet revealed the answer to me – it is about cost of production, but not the raw materials. It is also about volume, but not volume sales.
An article I found on the Huffington Post is a good example of the cost issue faced by craft brewers. If you look at the article, you will see that largest cost item is packaging – the bottle and label you may think. A bit of further digging around the internet revealed that the greatest part of the packaging cost is shipping. But not shipping to end customers, shipping to be bottled. It seems a bottling machine is quite expensive, and at small volumes is not easy for a craft brewery to purchase. Instead, they often send the beer away in vats to be returned in bottles. The Huffington Post article suggests that 50% of the cost to the customer is margin. I am not sure if this is the case in Europe, but certainly small craft breweries are unlikely to be able to invest in a large bottling plant at the outset. As volume increase, they may be able to do so. Let them stay small I say, the variety of beers is better then.
I read an article in a leading Irish newspaper recently which has a typical cost volume profit theme underlying it.
The article related to the “Western Rail Corridor”, a route from Sligo to Limerick which had been closed down many years ago. In recent years with the help of local campaigns and some political backing, some of the line re-opened. According to the article:
“A report by consultants drawn up before the service began concluded that, even with healthy passenger numbers, it would not be able to wash its face and would need hefty subventions. And the passenger projections in that report were substantially higher than those that actually travelled in the first few years”
It seems the passenger volumes have been quite low in recent years too. But then Irish Rail did something – they lowered fares and made tickets available online. With online fares as low as €6, the passenger number have increase from 23,000 to 41,000 in the year to November 2014. I do not know what the operating costs are, or whether these passenger numbers are sufficient in the long term, but it is a classic example of the relationship between price, cost and volumes. Assume the costs are the same at 23,000 or 41,000 passenger levels, the rail company is likely to be better off – maybe not making a profit on the route, but at least covering more of its costs.
A few weeks ago I posted a piece on costs and profits when there is too much volume in the market. This post takes a look at the TGV (high-speed) service of SNCF. It’s in a spot of bother in terms of profit and management are considering various options.
I have been on the TGV several times. It is a fabulous service, but in today’s low-cost flight era it’s a bit expensive. And that’s exactly what a recent post from the Economist noted. According to the post, many TGV routes are no profitable. The reason for non- or low profitability is two-fold 1) increased competition from low-cost airlines who entice passengers with lower fares and 2) increasing costs paid to the rail track operator. SNCF management have apparently suggested three possible solutions, as follows:
1) decrease volume – i.e. reduce routes to those which are more profitable and attract adequate passenger numbers
2) increase volume, by lowering price. This could attract passengers back from low-cost airlines. It is a risky option though, as failure to attract enough passengers could worsen things
3) overhaul operations to be more like a low-cost airline i.e. become more cost conscious and efficient.
Which ever of the above three options are chosen, it is a classic case of the application of Cost-Volume-Profit (CVP) analysis. The costs and revenues will determine how profitable the TGV routes are, but so will the volume available. For example, using option 1 may improve profitability, but may not address costs or revenues. It may also be a bad option politically. Option 3 might keep service volume, but increase profitability and maintain pricing. And, as mentioned, option 2 might increase profitability if passenger volumes increased. It is not to hard to imagine a management accountant at SNCF using CVP techniques to show managers possible outcomes of each option.
Last summer I again took the car to Europe, using the Dover-Calais crossing. Not too long before I went I read an article about a UK Competition Authority ruling against one of the ferry operators – read here.
One of the operators is (now) owned by euro tunnel, hence the competition ruling. But let’s bring this to basic costs, volumes and profits. The ship I travelled on was almost empty, and as there is so much capacity on the route some operators are being pushed into a loss scenario. Why? Well, think about it for a moment – costs of running a large ferry are probably quite fixed. Prices may be low due to competition, but volume is relatively static. So, lowering price to attract passengers may be a loss maker. Similarly, too many operators may mean smaller passenger numbers for all, driving some into a loss situation.
So, as basic economics may dictate, ultimately one operator will fail as the market will force them out. And remember CVP analysis is based on a subset of the cost curves used in economics.
In October of this year, Michelin star chef Derry Clarke had a go at Dublin restaurants selling “cheap meals” – see here. I guess Clarke was thinking from his own view when he said “the number of restaurants offering meal deals at economically non-viable prices just isn’t sustainable, it’s the same cost in McDonalds, but we have all of the overheads”.
He may have a point about the number of restaurants being sustainable, but Derry, stick to the cooking. Any management accountant could figure out that even if meals are sold cheap (and I doubt they are below cost as Clarke suggests), they still make a contribution towards overhead costs. It would be better to have 50 guests in a restaurant earning a contribution of €5 a head (€250 in total) than having an empty restaurant. In the latter case, costs such as labour, heating, rent and so on are still incurred.
I have been reading a book recently on the history of the London Underground. It’s called Underground to Anywhere by Stephen Halliday and I actually bought it in the London Transport museum, on Covent Garden. Of course the tube is 150 years old this year, and you will find more about that here.
Reading the book I was quite surprised by how much accounting was in there. Two things stand out from the early days of the tube which related to accounting. First, the financing seemed to be quite precarious. As each line was built by private companies, private finance was raised. And when results proved less than expected, it seems quite a bit of creative re-financing went on. The author actually notes that without the somewhat suspect and complex financing, London’s Underground may not have grown to what it is today.
The second thing was the fares structure in the early days. Before lines were connected, the fares seemed to have been standard at say 2 pence. However, the author notes that the various companies started to raise and lower fares and certain times, or lower fares overall to increase passengers numbers and revenue- a classic cost, volume profit (CVP) scenario.
In January 2011, a long-planned €350 million plan to build a 600,000 tonne incinerator near Dublin port finally seen work commence on the build. As you might imagine there have been many protests against the project, which would be privately operated. At the same time, the four Dublin local authorities were also planning a land-fill site north of the city. However, in January 2012, the Irish Times reported that the land-fill site plan has been scrapped. It seems that the volume of waste now being generated in Dublin does not merit a new land-fill site. And, indeed the need for the incinerator too is being questioned. It seems that due to a combination of increased recycling and lower economic activity that the volume of waste has decreased dramatically. As a management accountant, I think of this from two angles. First, from a capital investment view, someone had to decided the ultimate size of an incinerator. This would be based on a combination of commercial viability and waste volume I assume. Second, from a cost-volume-profit (CVP) view, I wonder has anyone considered the effects of volume on the “profit” (i.e. viability) of the incinerator. According the to the Irish Times article, the volume of the incinerator should be halved – which I think should mean a full re-examination of the costs and investment involved. Of course, the counter argument is it is better to have spare capacity for cover for future increases in waste generated (e.g. improved economic activity, increasing population)