Pricing formulas needed for viability

26 Jul, 2019 - 00:07 0 Views

eBusiness Weekly

Business Weekly Last Word

The two fuel price increases in the last fortnight are an example of rigid adherence to a pricing formula that uses the interbank rate at the time of import as fixing the final cost of the fuels, so as interbank rates rise then fuel costs rise.

Regrettably others in business do not follow this sort of formula with many of the price rises in June driven by the guessed-rise in the black-market rate over the next month but no reductions since the collapse of the black-market late that month and so no reason to hedge against swinging exchange control losses.

The fuel formula starts with the landed cost in US dollars of the fuels. This is the cost, per litre, when the fuel arrives at the Feruka terminal of the trans-Mozambique pipeline and covers the costs of the crude, the refining, the shipping, the Beira port charges and the pumping charges. The first three are set in a very sensitive global market and the two Mozambican charges are required, by treaty, to be reasonable. Mozambique cannot profiteer but obviously can make a fair profit.

This landed price is converted at the rate prevailing two or three weeks before it finally reaches a service station. This aspect the formula makes sense as Zimbabwean service stations will not be selling tomorrow petrol landing at Beira today. The recent pair of price rises reflect that fairly steep climb in the exchange rate at the end of June and the beginning of July and as subsidies are now not given that steep climb between two periods of more stable rates is now being brought into the price.

The rest of the formula that the regulator must use to set the maximum retail price are all in RTGS cents a litre. These are the costs of pumping fuel from Feruka to Msasa, the Msasa costs, the mark-up by the oil company, the cost allocated to the tanker owner and operator, the mark-up by the service station retailer and, dwarfing all of them, the basket of taxes and duties on fuel. The previous period of steep climbs in the interbank exchange rate were partly ameliorated by a drop in excise duties, but the steep rises of a few weeks ago were not, so were more noticeable.

A lot of nonsense is said and written about the predicted effects of a modest rise in fuel prices on the prices of other goods and services, as if a 10 percent or 15 percent rise in the price of fuel will double prices. In fact, for almost all business operations, fuel costs are less than 5 percent of total costs and even in the transport sector rarely exceed 30 percent of total costs, a fact that kombi drivers and owners try and supress.

It is easy, b y a simple example, to show the effect of this week’s rise in the cost of petrol from $6,10 a litre to $7,47 a litre. A farmer in Goromonzi is bringing in 500kg of her crop of avocados in her petrol pick-up. She needs around 10 litres for the return journey, so will have to find an extra $13,70. That, divided by her load, means that she needs a little under 3c a kilogramme more to make the same nominal profit. On present retail prices that would be around 1 percent, so perhaps the farmer needs 1,5 percent more on the wholesale price. That will be one factor setting prices in the free market in avocados, but is likely to be dwarfed by the more usual swings in supply and demand, being so small.

This sort of example is, by the way, fairly typical. Rising fuel prices will have a small, although noticeable, effect on inflation but nothing like the sort of predictions floating around and made by people who could not pass the mathematics examination at Grade 7.

But what is more interesting in many ways about the fuel price increases is the fact that there is a formula that is based on actual costs and fixed mark-ups, rather than on guesswork or political caprice, along with a strict separation of the foreign currency component and the basket of local contingency components. Since fuel is 100 percent imported, the prevailing exchange rate at the time of import will obviously drive the major component of the price, especially now that the fixed duty per litre has dropped as a percentage of the final price.

Yet the price of petrol and diesel is sufficiently low that some economists have been accusing the Government of still providing a hidden subsidy; they have missed the fact that the exchange rate used is a historical one, not yesterday’s.

That concept, of using a pricing formula built around actual costs, is one that could with benefits to many be adopted by most other providers of goods and services in Zimbabwe. Such a formula could include provision for possible exchange rate losses without detracting from the concept, and at least that possibility would be carefully quantified and would need to be rational if the supplier was not going to be undercut by competitors. Such a formula would not only produce the lowest viable and profitable price, thus ensuring the business remained viable but could retain or increase market share, but would allow managers to see at a glance where productivity was low and where costs seemed out of kilter.

At present many are still doing their calculations in US dollars and then converting at the exchange rate they suspect might prevail in a month’s time, assuming the worst. This is not universal, even among those obviously still doing sums in US dollars. For example, some in the fast food business were among the major pushers for redollarisation, advertising their US dollar price as the primary price. With the advent of SI142 that become illegal. Most, while still thinking US dollars we suspect, are using the latest interbank rate to find the RTGS price. While not as good as doing the calculation in RTGS dollars from scratch this is an improvement on what was being done. One factor in that business, of course, is the very high degree of competition. The large chain and the medium-sized chain are faced by a plethora of independent operators, some owned and staffed by families, some with very modest overheads, who have adopted a very wide range of strategies to maximise volumes and seize market share. Sometimes capitalism does work rather well.

The pharmaceutical business is regrettably at another extreme. While dropping the demand for US dollars, and only US dollars, for life-saving drugs it is still obvious that a very high exchange rate is being used, one far higher than the interbank rate, the black market rate or even an assumed interbank rate of a month ahead.

This sector could well be overtraded at the retail level. There are quite modest suburban shopping centres for example with four or more pharmacies. It would seem impossible for cartels to form at the retail end of this business, the Harare International Conference Centre being needed to host the required meeting.

But at the wholesale and import level there is little or no completion along with, so it is reported, very strong actions taken to preserve sole agencies and the like. Retail pharmacies give the pressure they are under on their own purchases as to why they were forced to charge US dollars and now use an outrageous exchange rate. This would seem to be a case where intervention would break monopolies, sole agencies and cartels so a free market would actually be free.

In other areas where there are a small number of suppliers of essential goods, but still competition, it is obvious that even modest competition can have very large effects with prices for some products seeing gaps of up to 50 percent between the lowest and highest suppliers. The competition in the retail sector is also seeing further gaps develop, meaning that consumers who abandon brand loyalty, as most have now done, and shop around, as many do, can cut their cost of living significantly.

We suspect that there have been serious upheavals in market shares in recent months, depending on how producers and retailers price their stock, and that with contracting volumes the first prize is going to those who figure out how to calculate the cheapest viable price. With volumes declining they are the ones most likely to retain volumes by drastically increasing market share.

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