A Little about Cost Markups: What do Balloons, Movie Theater Popcorn, Snow Cones and Starbucks Coffee have in common? They, along with Cotton Candy and Fountain Drinks are on the list of

But what is a “Markup?” and “What does this mean to us?” Markup, or Margin, is a marketing term for the price that a business puts on a product above what it costs to produce and deliver the good, usually determined as a percentage. In other words: the part that is straight profit.

Certainly there are more expensive items than coffee, cotton candy and popcorn –like porsches, condominiums and golf resorts– so what makes these items special? What kind of a markup would cause such a big deal?

How about this: No matter what a company sells, their price is a combination of two numbers: the cost of making and transporting the good they are selling (COGS) and the margin of profit (Markup).

COGS + Markup = Price

COGS is a set cost determined by the various expenses, fixed—such as overhead and insurance, and variable—such as raw materials and employee wages, that go into producing the product. Companies can do very little to affect this aspect of price, or at least that’s how I see it from the marketing side of the fence. The second part of price, however, the markup, can be shifted easily—this has no basis other than the price your customer is willing to bear.

For most consumer products, the average markup (“Retail”) is about 30%. For commodities –sugar, soap, pillowcases– markup is closer to 10%. But for “Premium” products –retail items aimed at the very rich, or the very demading (this is where we talked about Porsches, but also includes watches, Italian shoes, and vodka)– markups often approach 200% of Cost. And then “Ultra Premium” –products called by names like Mikimoto, Piaget, and Alfa Romeo– enjoy 400 and 500% markups. People gladly paying $750,000 for a car that costs around $20,000 to produce. For more on this, here is a great link.

But these don’t touch the 99.9% profit margins of the products mentioned above– the less than 1/50 of a cent that it costs to produce the .5 grams of a latex balloon that is filled with a burst of helium valued at 1/80 of a penny and sold for $3.00 at fairs and circuses across the US. This equates to a 1000% markup above COGS. Similar equations can be run for cotton candy, snow cones, your super-value bucket at the movie theater and your double iced caramel machiatto.

Imagine paying a 1000% markup on your car or your next burrito. That would be a $20,000,000 Altima or an $850 dollar Carne Asada bowl.

I am going to share with you today’s observation of China. Close your eyes and envision a map of the United States. Okay, now open your eyes and keep reading… You’re going to point on that map to these locations as I list them: New York, Los Angeles, Chicago, Houston, Philadelphia, Phoenix, San Antonio, San Diego, Dallas, San Jose. These are the Top 10 U.S. Cities by Population and Rank. You may have noticed your finger stopped in about every major region of the country and crossed the continent at least 3 times. Further down that list you’d touch Detroit, Memphis, Jacksonville and Seattle at 23.

Now, the Top 10 Cities in China are Shanghai, Beijing, Shenzhen, Guanzhou, Tianjin, Nanjing, Dalian, Hangzhou, Shenyang and Harbin. If you were to do the same mental map-pointing with this country, you’d find your finger never strayed from the east coast. In fact, you’d find that most of these cities, 8 out of 10, cluster like shotgun fire to within 2 hours of each other.

China is a huge country, roughly the same area as the United States, but with more than four times the population. Across such a broad expanse of people and geography, one expects the country to have developed several distinct and unique cities and cultures. In the US, for example, we have Northerners and Southerners, we have City People and Country People, but we also have Suburbanites, Rednecks, New Englanders, Westerners, Mid-Westerners, Snow Birds, Beach Bums, Grunge Rockers, Cowboys, and Californians. There are lots of different lifestyles with different cultures and values, but these groups are dispersed across the length and breadth of the country. From what I can tell, China does not work this way.

In China, the businesses, industries, infrastructure, government, and foreign political influence—not to mention the wealth and leading founts of culture—are all located on a stretch of the country’s east coast spanning from Beijing down to Shanghai, the rough equivalent of the state of California. Meanwhile, the western portion of the country, perhaps 90% of the land area, is occupied by about 60% of the population and responsible for less than 25% of the GDP.

So, why does this strong disparity between East and West exist in China? Similar to that of the industrial North and agrarian South in the antebellum US, the cause is the drastically different cost of doing business in the regions. “The government is doing things to move China west,” said Randy Creel, a logistics expert at a major MNC in China. “The hesitation is the lack of infrastructure and its effect on logistics costs.” Effects on logistics costs that work out to about 200% more investment per mile for companies to run their businesses in Western China. China is on a self-perpetuating cycle of eastern growth and western lag that will require more than government incentives to Western businesses and FDI spenders. It may require an all-out reallocation of infrastructure build-up that the country has never before undertaken. At least not until the 2008 Beijing Olympics. –Shawn Butler

In the years of Thomas Edison, the business model of the motion pictures industry was vertically integrated and tightly controlled among a very few. The original inventors of the technology joined together and created a single trust called the Motion Picture Patents Company (MPPC) in 1908. From this time up until the Paramount Decision of 1948 when government regulatory forces broke up the tight vertical integration between content production and distribution, the industry was dominated by a few giant corporations exercising oligopolistic powers.

The Value Chain for this industry was a closely controlled, proprietary vertically-integrated monopoly. All the components: production, distribution, and exhibition were under the control of the studios themselves. This allowed them to engage in several practices including block and blind booking before these were deemed illegal in regulatory decisions by the federal government.

The introduction of Television had a powerful effect on the Business Model of the Movie Industry. Initially, television broadcasting was seen as a threat to the Movie Industry and its programming was a new competitor for the already declining attention of the film audience. However, by the early 1950s, the film studios recognized that the new technology was benefitting them. Past opinions aside, they did not hesitate to take advantage of a secondary market for their products, selling their extensive libraries for Television exhibition.

The arrival of the Videocassette Recorder (VCR) created another lash of retaliation from the Movie Industry. The technology, both Betamax and Video Home System (VHS), was met by a vehement lawsuit which, although taken all the way to the Supreme Court, proved ineffective. The Betamax Case of 1984 essentially paved the road for the introduction of new distribution technologies that were to come. As with television, the existing industries quickly realized that rather than fighting the technology change, they could have been profitting from it. Again they had found themselves in a legal battle against an alternative, and lucrative, new distribution channel. Direct sales of films to VCR owners quickly gave way to video sales to Rental Stores, creating the two-tiered pricing system that is still utilized with the introduction of DVD technology. With a 40 to 60 percent split of the rental revenues, the Home Entertainment category is now the most profitable segment for the Motion Picture industry.

The internet was met with similar trepidation. As though struck with the same inexplicable amnesia that repeatedly appears in their plotlines, the Film Industry completely ignores their history and continues to view technological advancement as a threat. The big 6: Disney, Sony Pictures, Paramount Viacom, Fox News Corp, NBC Universal and Time Warner, joined together to form the Motion Picture Association of America (MPAA). In an organization that bears the very same traits that led to government antitrust intervention a century ago, the major Hollywood studios have again united to create closed standards that hinder competition. Together with a similar organization in the music industry, the Recording Industry Association of America (RIAA), the MPAA exerts a concerted effort to find and prosecute internet-based piracy and file sharing. In place of embracing these technological advancements and evolving complementary technologies to generate greater profits, like the billion dollar online film business being operated by early-adapter Blockbuster.com, the motion picture industry is again seeking legal insulation against the natural progress of their industry.

I see two possible scenarios for the Motion Picture Industry in the next 5 years. One, it will succeed as it has never before in controlling the distribution and exhibition of its products. This will undoubtedly follow a multi-year court hearing and perhaps several appeals that will be costly not to the media corporations, but to the consumers who are subpoenaed for testimony for or against the practices condemned. Afterwards, movie industry products like HD DVD and Blu-ray will have multiple layers of encryption to prevent copyright infringement. Movie theaters will be equipped with state-of-the-art biometric security to prevent movie-goers from “movie hopping” within the theater. Blockbuster will require a password, DNA sample, and a large cash deposit prior to releasing any media for rental. The internet will be laced with information-eating viruses that seek out unlicensed copyrighted materials on civilian computers, erasing it and signaling the Ministry of Truth to prevent any further crimethink. Meanwhile, independent filmmakers will capitalize on the benefits of unsolicited word-of-mouth product marketing facilitated by a peer-driven audience base of information sharers to create the future blockbuster films with zero dollar marketing budgets.

Or the second scenario, where the lessons of cooperation and compatibility push the Motion Picture Industry to adapt to a digitally enabled consumer society. They evolve their product offerings into a format that takes advantage of the rapid file sharing capabilities of the continually broadening internet. The MPAA will pioneer the technology of degradable digital, where all digital files have a shelf life before evaporating into zeroes and ones. This becomes the new standard format for movie viewing, people watching degradable digital on their cell phones, ipods, laptops, and home theaters. Independent filmmakers and Hollywood studios both make giant amounts of money from the now much larger consumer pie as we watch the multiplex theater go the way of the opera house, becoming a quaint experience where parents take children for a night of nostalgia and pay premium prices. A new market of Film Viewing Houses emerge after the pattern of IMAX theaters, targeting the Audio/Videophiles who are seeking the “Ultimate” in film-viewing experience. Formal Standard Setting becomes secondary to a spirit of innovation so that the “Best” technological advancements can come to the forefront, with the understanding that the whole industry will benefit from an increased interest facilitated by an improved customer experience. Movie-making will follow in the direction that television and internet are now going. The consumer, not the seller, determine the content and usage practices.

These ideas may be a little far-fetched, but they stem from lessons that history has taught in the areas of electric current, telecommunications, and long-distance trav
el. Businesses that will continue to succeed are businesses that focus on the benefits they are providing to customers and which are capable of adapting their own business model to follow the advancement of technology as it realigns itself with that overarching goal. Media and delivery channels will continue to change, but creating a relationship of trust with your customer base will assure financial success and maximize long-term shareholder value. –Shawn Butler

New York City gets a bad reputation. As the most filmed city in the world, it is no wonder that I had many preconceived notions about NYC. Many of them were true. It is bigger, taller, and even more fast-paced than I had anticipated. I had blisters on my feet by the end of day 2. But I also had been lead to believe that this city was full of rude, selfish, busy and impatient people.

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Although hailed as a new tier of clever competitor-specific comparative advertising, the “iconic” [sic] Mac vs. PC Ads are nothing new to consumers. For decades, we have watched the world’s Super Brands go head-to-head in the beverage industry. We’ve enjoyed ring-side seats between The Choice of a New Generation and Always Coca-Cola (NYSE: KO), as well as Budweiser (NYSE:BUD), undisputed King of Beers battling the “President of Beers,” Miller Brewing Co., now SABMiller (NYSE: MO).

In these instances, it is nothing more than Madison Avenue’s take on a tactic we’ve all used since grade school– make fun of anyone doing better than us! Microsoft (NASDAQ: MSFT) controls a 90% marketshare in the computer/software ind. Mac (NASDAQ: AAPL) is by far the underdog, and in retaliation, they are not going after the usual mix: price, prod. quality, availability, instead they post ads saying, “90% marketshare and undisputed dominance in business? Well, atleast I’m cool!” For all the lauds of “cleverness” and subtle “jabbing” TBWA\ is receiving for the Mac vs. PC ads, let’s take an honest look at what Steve Jobs is really saying:

[youtube=http://www.youtube.com/watch?v=qHO8l-Bd1O4]Personally, I prefer Alltel’s Chad campaign. It’s the exact same concept– Alltel, (NYSE: AT) the smallest of the 5 major wireless carriers, poses their spokesman, Chad, as the suave, popular, cool guy who is competing against the huge established companies, characterized as geeks and nerds. Basically, aren’t these all just new iterations of the playground joke “Sure you get better grades, but atleast I’m not a dork!” –Shawn Butler
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