Why Does This Stuff Cost so Much”

One of the constant topics for audiophile
conversation is “Why does this stuff cost so much?” The whole subject recently
came to a head on one of the audiophile forums when an old interview was posted
in which even speaker manufacturer Ashley James attacks audio manufacturers for
excessive margins. Is this true? Are we getting ripped-off? Let’s take a look:

The standard argument for High End pricing
usually has something to do with small sales volumes resulting in higher costs
because of the unavailability of economies of scale, or with “hand-crafted
luxury” (which often means little more than inefficient production) or with
R&D, of which huge amounts are claimed, sometimes even accurately, for
often simple-seeming products. Let’s set all of these things aside as
unknowable in any particular case and examine, instead, the manufacturing
business in general:

The “typical” operating model for most
manufacturing businesses of any kind, in any industry, calls for retail pricing
of 5X the cost of production for most goods and 8X the cost of production for
anything made of plastic. This high cost for plastic goods may have something
to do with the VERY great expense 
(and capital investment) involved in
producing the necessary production molds, and the considerable expense of
operating, maintaining, and when necessary, replacing them and their related
production mechanisms.

Let’s
talk here, though, only about the other model – where the Manufacturer’s
Suggested Retail Price (MSRP) is just, typically, 5X the manufacturer’s cost of
production. The first thing to understand is that, whatever that price may be
(let’s call it US$100), at least 50% of it is likely to be given as a discount
to the dealer for stocking the product, promoting it, demonstrating it (as
necessary), paying someone to sell it, covering the dealer’s overhead, and,
finally, for providing the dealer with whatever profit he may earn.

That would, if it were the
case, leave US$50 for the manufacturer. That 50% dealer margin may not always
be sufficient, however, to get dealers to actually buy and stock a
manufacturer’s products. On the forum, Ashley James gave an example where one
dealer demanded a discount of more than 82% from MSRP in order to make a
purchase. Where that happens, obviously the manufacturer will either see less
in payment for his goods or must lose the sale entirely.

Another
reduction to the amount seen by the manufacturer may be the cost of delivering
the goods to the dealer: Most manufacturers pay the freight on all but the
smallest dealer orders, and this may mean (depending on the goods) another
reduction of 5% or more (of the dealer cost) to the manufacturer’s revenues.

In the audio industry, most
manufacturers can’t afford to maintain an in-house sales force to call on
existing dealers or to bring in new ones, so they hire a “Manufacturer’s Rep”
organization to sell for them. This typically costs them another 7 to 10% of
the dealer cost of their sales, and can leave them with AT BEST (US$100 – US$50
dealer discount ― US$2.50 freight [@5%] – US$3.50 [@7%] Rep commissions
=) just US$44 to cover the entire cost of their operation and give them
whatever profit they may hope to keep for themselves. At US$20, just for the
cost of goods, plus (using 15% of the cost of goods as a reasonable average)
US$3 for packaging, that leaves them only (US$44 – US$23 =) US$21 left, STILL
IN THE VERY BEST CASE, as gross profits to cover all of their facilities costs,
promotional expense, wage and employee benefit costs, taxes, and net profits.

All of the numbers just
quoted were for US domestic sales, only. For international sales, it’s
reasonable to assume that most audio manufacturers will need to engage a
foreign distributor to sell into each particular country. The normal
distributor discount, OVER AND ABOVE, the US dealer discount is 30%, so on
foreign sales, the MAXIMUM amount a US manufacturer is likely to see as its
total gross revenue on a US$100 MSRP sale 
is (US$100 MSRP – 50% dealer discount = US$50 – 30% foreign distributor
discount =)US$35.

If we reasonably assume
that the manufacturer’s sales will be (something like) 50% domestic and
(something like) 50% foreign, that means that the manufacturer’s gross profits
on all of its sales will average just US$16.50 on all goods sold. (US$21 on
domestic sales + US$12 (=US$35 foreign gross profit – US$23 for goods and
packaging) on foreign sales = US$33. US$33 divided by 2 = US$16.50)

It is out of that US$16.50
average gross profit on every US$100 of goods at MSRP that the manufacturer
really has to cover all of his facilities, promotional, wages and other costs
and earn whatever real net operating profit will remain to him.

Do you really want to know
why this stuff costs so much, though? To the last reason, add this one: Some
years ago one of the very top High End electronics manufacturers came out with
some wonderful and utterly gorgeous amplifiers, featuring extremely thick
machined aluminum faceplates with even heavier machined aluminum front lifting
handles (each amp weighed well over 100 pounds). When I commented to him that
the amps were beautiful, he said “Well, they ought to be: Those faceplates and
handles cost me US$200 a set, and, at a 5X markup from cost, they add US$1,000
to the price of each amp.” I thought about that for a moment and then asked
“But the amps only retail at US$5,500 apiece; wouldn’t you sell more by cutting
the price to US$4,500 and using just a plain sheet metal face plate and
handles?” His response was that “Quality goods have to look like quality goods;
if I used cheap appearance parts, even if the amplifiers were the same in all other
ways, I might not sell any at all!”

And
you know, I think he was exactly right: If I’m going to pay thousands of
dollars for a new toy, I want it to LOOK LIKE thousands of dollars; not
anything ordinary. Don’t you agree?