Obscene profits?
This morning, while sipping my morning coffee, I heard that enquiry into the alleged price gouging by oil companies has revealed that what best explains the whole mess is supply and demand (see this New York Times report). I know—I just know it—that there are those who are sceptical that supply and demand can have such a gross effect on the price we pay at the pump.
It’s easy to be sceptical; I’ll admit that. But I learned a lesson in supply and demand—and its effect on price—just a bit over twenty years ago. It’s a lesson that ultimately resulted in my becoming the rather die hard capitalist that I am today.
I was in Germany on a military exercise. During the course of this exercise, my tank platoon were just outside a small German village. As frequently happened, some of the local boys (in the 12-14 year range) came out to check out my tank. While we were all standing on our tank talking, I pulled a soda out and started drinking. One of the boys offered me some money for one of my sodas (actually, the crew’s sodas; this is an important fact). Wanting to live up to the reputation of Americans as generous people, I let the kid have the soda for free. Suddenly, the demand for soda went from one-fifth of the German population present on that tank to one hundred percent of that population. What was I to do? Give one away for free and then start charging money? So I gave away five of our remaining sodas, leaving us with three.
(Bullcrap. My tank commander made me double-time it into the village to replace—at my cost, of course—the sodas I gave away.)
Note the effect of price on both the supply of, and demand for, the sodas. When there was actually a price for the soda the non-crew demand for soda amounted to a demand on the part of only one German child. This changed—drastically—when there was no price for the soda. This then led to a sharp drop in the supply of soda. If I were to have charged that single German child more than he was willing to pay, there would have been a change in the demand for soda, but no change in the supply. If I had simply accepted his price, the supply of soda would have gone down only be one soda; plus, we’d have a contribution to the next soda purchase. (It staggers the imagination: that German child knew more about free enterprise than I did.)
“But look,” you’ll want to say, “you’re ignoring at least two things, the fact that you didn’t really want to sell soda, while oil companies do want to sell gas and the fact that soda isn’t a necessity, but gas is.” (Some bleeding-heart type will no doubt want to say that my heart was in the right place, which as we all know matters more than anything.)
Okay. You’re right. I wasn’t interested in selling soda; I was interested in international relations. And oil companies do want to sell gas, which is precisely my point. As I said above: Had I wanted to maintain my supply of soda, then the strategy would be to charge more for it than the German boy was willing to pay. There is nothing in it for an oil company to charge more than we are willing to pay. Not only that, but the oil companies are also subject to the law of supply and demand: they must purchase crude oil at market prices, unless they are drawing their own crude from the ground. In most cases, however, the oil companies act as middle men. They have to purchase crude, refine it and then sell the refined product. Refining isn’t inexpensive. All costs involved in bringing fuel to market must—they absolutely must—be passed on to the consumer. And in order to remain in business, and to remain competitive, they must make more in the sale than they have spent in production, marketing and transporting of product. This is called profit. And they must price the product so that (a) they can actually sell the product, otherwise they have a non-moving supply, in which case they will end up losing money or going out of business, rather than making money (i.e., the price cannot be too high); (b) they do not run out of product, or simply do not make enough in revenue to cover cost of doing business, much less make a profit (i.e., the price cannot be too low); (c) they can pay all the costs involved in doing business; (d) they can remain competitive (if their prices cannot be lower than the competition, then they had better not be much higher; and the quality had better be high).
“Yes,” you say, “but they make in the billions of profit, and their executives draw huge salaries and bonuses, while we are scrimping and saving and hocking jewelry at pawn shops just to put enough gas in our tanks to get to work.”
It is true that oil companies make in the billions of profits. But they also spend in the billions just to do business. The element to look at isn’t the raw dollar figure of the profit; it is the percentage that the raw dollar figure represents that we have to look at. The anger at ExxonMobile stems from the fact that it made $36.130 billion in profit. Goodness, that’s obscene! But that $36.130 billion in profit was a mere 9.7 percent of ExxonMobile’s total revenue, which was $370.680 billion. In other words, it cost ExxonMobile $334.55 billion just to do business last year. If a figure which represents a mere 9.7 percent is too much profit how much is acceptable? Would we be okay if ExxonMobile’s profits were just $17.5 billion? That would be a profit of just under 5 percent. I don’t think I have ever worked for anyone who thought that was an acceptable profit margin.
Let me ask you something. Would you be satisfied with an income that was, after all of your bills and taxes were paid, only 5 percent more than all your expenses? Let’s take someone who makes just somewhere in the neighborhood of $30,000 per year. If he makes 5 percent more than he needs just to pay his bills and his taxes then he makes only $1500 per year, or $125 per month. Maybe he can put that in the bank, or take part of it to take his family out to dinner once or twice per year. But now let’s say that, on that same $30,000 per year you were actually making 9.7 percent more than you need to live on, in other words, $2910 per year, $242.5 per month. I doubt that you will shriek in horror, lamenting, “Oh, my goodness! I’m just as evil as ExxonMobile!!!” More than likely you will complain of having only the $242.5 at the end of the month. Neither would you reject a raise which would leave you with 9.7 percent more than you needed live on.
A 9.7 percent profit margin. Price gouging? As price gougers, these guys are failures if they could produce no more than a 9.7 percent profit margin. Price gougers should be made of sterner stuff. (Besides, making a profit is not a function only of the price one charges for product. More about this below.)
What is obscene here is not ExxonMobile’s 9.7 percent profit. What is obscene is the innumeracy (to wit: ignoring the relatively more important matter of the profit margin, focusing on the net income instead) and paucity of economics education among United Statesians (to wit: not even knowing, much less understanding, the relation between supply and demand and price). (I should be more charitable. My parents are business people. I got most of my business and economics education just by keeping my ears open at the dinner table. Benefits of a privileged childhood, no doubt.)
“Fine,” you say, “they made only a 9.7 percent profit. But Phil, surely part of the reason for that is the grossly high prices they are charging for their product.” Perhaps. But ExxonMobile is only one oil company. In general, gas prices are relatively high at just about every station at which I could possibly fuel up. Are we to assert collusion on the part of all the oil companies. There is nothing in it for them. And the only thing that any one of them would have to do is break with the others and sell at a lower price that the others. As I said above, there is nothing in it for an oil company to charge more than we are willing to pay.
“But they are charging more than we are willing to pay,” you say, “and they can get away with it because we need gas, so we have to pay what they say.” Even if that were true, which I deny, one of the many things that companies need to have to remain in business is the good will of the consumer. When I listen to how people ( grossly uninformed people, I might add) feel about what they are paying at the pump, it seems to me that the good will of the average consumer is lost. That is not good for business. One of the oil companies could suddenly became the greatest American hero just by lowering its prices. Not one of them is doing so. The reason for this is quite clear to me: the “crude oil price excuse” is the primary reason.
Besides, all of this assumes that price is the only thing that makes companies profitable. It isn’t. Profitability is also a matter of good management of resources. I have no knowledge of how to run an oil company (though I wouldn’t mind learning). But I do know how to run a couple of other businesses. One way a company can maximize profit is by looking for ways to increase efficiency and cut waste. Let’s say you are running a business and as you are conducting your walk-through you note four hourly-wage employees standing at the water cooler, talking about the previous night’s episode of Survivor. You note that they spend 10 minutes talking. How much time has been wasted? (Time for which you are paying, mind you.) If you said 10 minutes, you are wrong. The answer is 40 minutes, because you were paying four people to talk for 10 minutes; you paid for forty minutes worth of a BS session. What if that happened every day all year long? 40 minutes per day, 5 days a week, 260 days per year (ignoring holidays). That’s 174 hours per year that you spend paying four people to talk at the water cooler. Let’s say that taken all together the average hourly wage paid to those four amounts to $25.00 per hour. That’s $4350.00 per year, paying people to stand around and talk. ExxonMobile employs thousands. Do you suppose that from time to time some of those thousands stand aroung talking?
We have considered only the effect of labor upon profitability. There are hundreds of other factors involved. In the restaurant business, one of the most important is food, especially condiments. You know those ketchup packets you take too many of at your favorite hamburger place? That cuts into the profit of that establishment. You may not use all that ketchup, but the restaurateur pays for it. The same goes for all those extra napkins, too. Then there are all those people employed by the company that have nothing to do with producing the product that the company actually sells, most of whom are employed to assure compliance with federal—and other— laws: clerks, secretaries, accountants (expecially tax accountants), lawyers (all those lawsuits). Then there are janitors and maintenance personnel. All of these are actually a bit of a drain on profitability. Sometimes it’s a wonder that any business can make a profit! (Of course, in post-New Deal America that no doubt is one of the many goals of federal legislation.)
“Well,” you say, “that has little to do with the fact that it can’t all be explained by the increase in the price per barrel set by the world oil market. When I fueled up on Monday, the price at the pump was $1.97 per gallon. On Tuesday, it went to $2.79! The gas that was already in their tanks didn’t go up in price; they had already paid for it!”
Sure. But look, the value of any commodity isn’t just a matter of how much it cost the seller. Price has to take into consideration the future. It’s a fair question, which I’ll have to discuss; but I cannot do so at present.
The last thing to say about all this is that there is a problem in any discussion of profit. That problem is the definition given to the term. Capitalists define profit as a positive return (as opposed to a negative return, or loss) made on an investment by an individual or by a business. Marxists define it as a mechanism of class exploitation, where surplus value is extracted by capitalists from their workers and suppliers beyond the point where costs are covered. Given how marxists define profit (i.e., exploitation) and that most of the loudest voices (i.e., Democrats and the Alien Media Nation) are marxist, the real problem here is that any profit has been made, not that too much profit has been made. For any profit is objectionable because it is evidence of exploitation. But marxists know better than to go after anyone and everyone who makes a profit, so they take advantage of our functional innermeracy (an innumeracy which they have helped bring about by means of their unchecked control of the public education system) and pick on someone who has made a mere 9.7 percent in profit; and they can get away with it because that 9.7 percent is 9.7 pecent of billions, making it seem obscene.
9.7 percent profit margin remains only 9.7 percent. It is hardly profiteering.
It’s easy to be sceptical; I’ll admit that. But I learned a lesson in supply and demand—and its effect on price—just a bit over twenty years ago. It’s a lesson that ultimately resulted in my becoming the rather die hard capitalist that I am today.
I was in Germany on a military exercise. During the course of this exercise, my tank platoon were just outside a small German village. As frequently happened, some of the local boys (in the 12-14 year range) came out to check out my tank. While we were all standing on our tank talking, I pulled a soda out and started drinking. One of the boys offered me some money for one of my sodas (actually, the crew’s sodas; this is an important fact). Wanting to live up to the reputation of Americans as generous people, I let the kid have the soda for free. Suddenly, the demand for soda went from one-fifth of the German population present on that tank to one hundred percent of that population. What was I to do? Give one away for free and then start charging money? So I gave away five of our remaining sodas, leaving us with three.
(Bullcrap. My tank commander made me double-time it into the village to replace—at my cost, of course—the sodas I gave away.)
Note the effect of price on both the supply of, and demand for, the sodas. When there was actually a price for the soda the non-crew demand for soda amounted to a demand on the part of only one German child. This changed—drastically—when there was no price for the soda. This then led to a sharp drop in the supply of soda. If I were to have charged that single German child more than he was willing to pay, there would have been a change in the demand for soda, but no change in the supply. If I had simply accepted his price, the supply of soda would have gone down only be one soda; plus, we’d have a contribution to the next soda purchase. (It staggers the imagination: that German child knew more about free enterprise than I did.)
“But look,” you’ll want to say, “you’re ignoring at least two things, the fact that you didn’t really want to sell soda, while oil companies do want to sell gas and the fact that soda isn’t a necessity, but gas is.” (Some bleeding-heart type will no doubt want to say that my heart was in the right place, which as we all know matters more than anything.)
Okay. You’re right. I wasn’t interested in selling soda; I was interested in international relations. And oil companies do want to sell gas, which is precisely my point. As I said above: Had I wanted to maintain my supply of soda, then the strategy would be to charge more for it than the German boy was willing to pay. There is nothing in it for an oil company to charge more than we are willing to pay. Not only that, but the oil companies are also subject to the law of supply and demand: they must purchase crude oil at market prices, unless they are drawing their own crude from the ground. In most cases, however, the oil companies act as middle men. They have to purchase crude, refine it and then sell the refined product. Refining isn’t inexpensive. All costs involved in bringing fuel to market must—they absolutely must—be passed on to the consumer. And in order to remain in business, and to remain competitive, they must make more in the sale than they have spent in production, marketing and transporting of product. This is called profit. And they must price the product so that (a) they can actually sell the product, otherwise they have a non-moving supply, in which case they will end up losing money or going out of business, rather than making money (i.e., the price cannot be too high); (b) they do not run out of product, or simply do not make enough in revenue to cover cost of doing business, much less make a profit (i.e., the price cannot be too low); (c) they can pay all the costs involved in doing business; (d) they can remain competitive (if their prices cannot be lower than the competition, then they had better not be much higher; and the quality had better be high).
“Yes,” you say, “but they make in the billions of profit, and their executives draw huge salaries and bonuses, while we are scrimping and saving and hocking jewelry at pawn shops just to put enough gas in our tanks to get to work.”
It is true that oil companies make in the billions of profits. But they also spend in the billions just to do business. The element to look at isn’t the raw dollar figure of the profit; it is the percentage that the raw dollar figure represents that we have to look at. The anger at ExxonMobile stems from the fact that it made $36.130 billion in profit. Goodness, that’s obscene! But that $36.130 billion in profit was a mere 9.7 percent of ExxonMobile’s total revenue, which was $370.680 billion. In other words, it cost ExxonMobile $334.55 billion just to do business last year. If a figure which represents a mere 9.7 percent is too much profit how much is acceptable? Would we be okay if ExxonMobile’s profits were just $17.5 billion? That would be a profit of just under 5 percent. I don’t think I have ever worked for anyone who thought that was an acceptable profit margin.
Let me ask you something. Would you be satisfied with an income that was, after all of your bills and taxes were paid, only 5 percent more than all your expenses? Let’s take someone who makes just somewhere in the neighborhood of $30,000 per year. If he makes 5 percent more than he needs just to pay his bills and his taxes then he makes only $1500 per year, or $125 per month. Maybe he can put that in the bank, or take part of it to take his family out to dinner once or twice per year. But now let’s say that, on that same $30,000 per year you were actually making 9.7 percent more than you need to live on, in other words, $2910 per year, $242.5 per month. I doubt that you will shriek in horror, lamenting, “Oh, my goodness! I’m just as evil as ExxonMobile!!!” More than likely you will complain of having only the $242.5 at the end of the month. Neither would you reject a raise which would leave you with 9.7 percent more than you needed live on.
A 9.7 percent profit margin. Price gouging? As price gougers, these guys are failures if they could produce no more than a 9.7 percent profit margin. Price gougers should be made of sterner stuff. (Besides, making a profit is not a function only of the price one charges for product. More about this below.)
What is obscene here is not ExxonMobile’s 9.7 percent profit. What is obscene is the innumeracy (to wit: ignoring the relatively more important matter of the profit margin, focusing on the net income instead) and paucity of economics education among United Statesians (to wit: not even knowing, much less understanding, the relation between supply and demand and price). (I should be more charitable. My parents are business people. I got most of my business and economics education just by keeping my ears open at the dinner table. Benefits of a privileged childhood, no doubt.)
“Fine,” you say, “they made only a 9.7 percent profit. But Phil, surely part of the reason for that is the grossly high prices they are charging for their product.” Perhaps. But ExxonMobile is only one oil company. In general, gas prices are relatively high at just about every station at which I could possibly fuel up. Are we to assert collusion on the part of all the oil companies. There is nothing in it for them. And the only thing that any one of them would have to do is break with the others and sell at a lower price that the others. As I said above, there is nothing in it for an oil company to charge more than we are willing to pay.
“But they are charging more than we are willing to pay,” you say, “and they can get away with it because we need gas, so we have to pay what they say.” Even if that were true, which I deny, one of the many things that companies need to have to remain in business is the good will of the consumer. When I listen to how people ( grossly uninformed people, I might add) feel about what they are paying at the pump, it seems to me that the good will of the average consumer is lost. That is not good for business. One of the oil companies could suddenly became the greatest American hero just by lowering its prices. Not one of them is doing so. The reason for this is quite clear to me: the “crude oil price excuse” is the primary reason.
Besides, all of this assumes that price is the only thing that makes companies profitable. It isn’t. Profitability is also a matter of good management of resources. I have no knowledge of how to run an oil company (though I wouldn’t mind learning). But I do know how to run a couple of other businesses. One way a company can maximize profit is by looking for ways to increase efficiency and cut waste. Let’s say you are running a business and as you are conducting your walk-through you note four hourly-wage employees standing at the water cooler, talking about the previous night’s episode of Survivor. You note that they spend 10 minutes talking. How much time has been wasted? (Time for which you are paying, mind you.) If you said 10 minutes, you are wrong. The answer is 40 minutes, because you were paying four people to talk for 10 minutes; you paid for forty minutes worth of a BS session. What if that happened every day all year long? 40 minutes per day, 5 days a week, 260 days per year (ignoring holidays). That’s 174 hours per year that you spend paying four people to talk at the water cooler. Let’s say that taken all together the average hourly wage paid to those four amounts to $25.00 per hour. That’s $4350.00 per year, paying people to stand around and talk. ExxonMobile employs thousands. Do you suppose that from time to time some of those thousands stand aroung talking?
We have considered only the effect of labor upon profitability. There are hundreds of other factors involved. In the restaurant business, one of the most important is food, especially condiments. You know those ketchup packets you take too many of at your favorite hamburger place? That cuts into the profit of that establishment. You may not use all that ketchup, but the restaurateur pays for it. The same goes for all those extra napkins, too. Then there are all those people employed by the company that have nothing to do with producing the product that the company actually sells, most of whom are employed to assure compliance with federal—and other— laws: clerks, secretaries, accountants (expecially tax accountants), lawyers (all those lawsuits). Then there are janitors and maintenance personnel. All of these are actually a bit of a drain on profitability. Sometimes it’s a wonder that any business can make a profit! (Of course, in post-New Deal America that no doubt is one of the many goals of federal legislation.)
“Well,” you say, “that has little to do with the fact that it can’t all be explained by the increase in the price per barrel set by the world oil market. When I fueled up on Monday, the price at the pump was $1.97 per gallon. On Tuesday, it went to $2.79! The gas that was already in their tanks didn’t go up in price; they had already paid for it!”
Sure. But look, the value of any commodity isn’t just a matter of how much it cost the seller. Price has to take into consideration the future. It’s a fair question, which I’ll have to discuss; but I cannot do so at present.
The last thing to say about all this is that there is a problem in any discussion of profit. That problem is the definition given to the term. Capitalists define profit as a positive return (as opposed to a negative return, or loss) made on an investment by an individual or by a business. Marxists define it as a mechanism of class exploitation, where surplus value is extracted by capitalists from their workers and suppliers beyond the point where costs are covered. Given how marxists define profit (i.e., exploitation) and that most of the loudest voices (i.e., Democrats and the Alien Media Nation) are marxist, the real problem here is that any profit has been made, not that too much profit has been made. For any profit is objectionable because it is evidence of exploitation. But marxists know better than to go after anyone and everyone who makes a profit, so they take advantage of our functional innermeracy (an innumeracy which they have helped bring about by means of their unchecked control of the public education system) and pick on someone who has made a mere 9.7 percent in profit; and they can get away with it because that 9.7 percent is 9.7 pecent of billions, making it seem obscene.
9.7 percent profit margin remains only 9.7 percent. It is hardly profiteering.
posted by James Frank Solís
at 18:34
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