Retailers’ shelves are full of merchandise, purchased at different times, at different prices, and from countless wholesalers who, themselves, have varying markups. Items that move slowly are marked down for easier sale, quantity purchasers obtain discounts, damaged items are sold at a loss, etc, etc. Employees get their commissions, suppliers of replacement merchandise get their markups, and the cycle continues. Just like running an Equity Portfolio, right? The more commissions the retailer pays out, the more profit he brings to the bottom line. Just like running an Equity Portfolio, right?
Now, what really happens when retailers: (1) reduce their buying and selling expenses to zero, but (2) add an additional 1.5% to overhead, while (3) keeping a profit target of 10%?
This is precisely how the normal Flat Fee Arrangement plays out. But, even without the increase in overhead or fixed costs, the profit is a bigger number. Sometimes. the old fashioned way is better.
| |
Regular Commissions at 2% |
Flat Fee Arrangement at 1.5% |
| Total Cost of our Inventory |
$102,000 |
$100,000 |
| Sale price to produce 10% net/net profit (has to be enough to cover commissions both ways) |
$114,240 |
$110.000 |
| Less commissions to employees @ 2% and at 0% Cost Basis |
-$2,040 |
-$0 |
| Net Receipts on sales of merchandise |
$112,200 |
$110.000 |
| Less Increase in Overhead Expense |
-$0 |
-$1,575 |
| Total Profit on sales |
$10,200 |
$8,425 |
| Total profit as a % of original price |
10.00% |
8.43% |
So by cutting both our acquisition costs and our selling costs (and abusing our employees in the process), we've effectively reduced our gross sales by $2,200 and our actual dollar profit by $1,775 while locking in a 15.7% smaller profit margin. This Math is flawed in one respect. The lower level of service and/or commitment you get from suppliers and salespeople will absolutely cause other costs to rise, as they will provide their best service to better customers. You won't sell as much stuff, and you won't sell it as quickly.
Applying this illustration to the stock market and equity trading, one would find similar results. With a full service broker, you may wind up with a sales target for a particular stock that is somewhere between 25 and 75 cents per share higher (the larger the position, the smaller the differential). But you'll get a phone call when a selling target is reached, or an old favorite has come back into range. And, with independent brokerages all over the place, you need not pay for service with body parts.
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Commissions - Part 4 <--
