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Letter to the editor

October 11, 2010
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Dear Editor,

While Mr. Lee covers a plethora of factors covering the article topic (“If oil prices are going down, why don’t gas prices,” April 2010), in my not so humble opinion he omits the most important factor (retail profit margin forces) impacting the retail price of gasoline which is what most people take note of.

Having been in the wholesale and retail gasoline business for more than 20 years, I will explain that factor by way of an example using simplified but realistic figures.

The retailer sells a gallon of gas for $3. There is a total product cost of $290 per gallon including all direct taxes and fees (not including any overhead or credit card fees). This results in 10 cents per gallon net profit margin. For convenience lets call this the Survival Level, the level at which the retailer can have enough net profit margin to pay overhead and remain in business. (Note that if a credit card is used there may be a 1.5 percent fee as well as an allocation of one cent of a larger transaction fee which would shrink the margin by 4.5 cents a gallon.)

Now, the retailer gets notice (by fax, e-mail or other method) that as of a certain time on that date his cost has risen by two cents a gallon. Typically this notice is timed so that it is impossible to order and take delivery of product at the lower price. It should also be noted that a direct wholesale cost increase of any amount results in an even higher cost when all taxes based upon price are factored in.

Although the retailer might like to increase the retail price immediately upon receipt of notice that there has been an increase, competitive pressure (i.e. the retailer down the street is maintaining a low price) this is not always feasible unless the retailer wants to lose market share. Some retailers may feel they can sell off inventory on hand purchased at a lower cost before raising their price.

Eventually the margin squeeze must be readjusted to a Survival Level resulting in a price increase.

Now, perhaps the wholesale cost (price of oil) decreases. If the retailer ha not yet adjusted the retail price upward to the Survival Level, the retailer will maintain the price in order to once again attain survivability.

If the cost has now fallen below the point where the profit margin has now reached the Survival Level, the same competitive forces may allow the retail price to remain frozen (or drop less than the decrease in cost) so that margins in excess of the Survival Level can now offset those that fell below the Survival Level for a given period. Further, this is a period where retailer may seek to do more than just survive until market forces once again dictate that they shrink the profit margin.

In a nutshell, the retail customer often thinks the retailer makes more profit when they see the price go up, when the typical scenario is for the retailer to make more money as the retailer may see prices holding steady or dropping slightly.

Earl Weiss, sec.
Chicago’s #1 Car Washes, Chicago, IL