Last week’s post concluded that hearing aid markup is “roughly keystone: 2x, not the ‘exorbitant’ 5x or even higher markup claimed on the Internet.” The conclusion was based on supporting, albeit sparse, data, which is more than can be said for the 5x claim reproduced in Figure 1. Besides, talking about markup as a multiple is misleading and sloppy when speaking of complex goods and services.
What Is Wrong With This Picture?
Almost everything. It is distorted from the ground up and misleading or just plain wrong. What do those boxes really mean?
1. That Green Box. A $399 wholesale instrument is not a “high quality hearing aid” by our industry’s standards. That price is below wholesale pricing for a mid-level product and about $1000 below the wholesale cost of premium instruments.
2. Those Black Boxes. The boxes are not wrong but they are also not right. That’s because they don’t have any numbers in them. Yes, costs like rent and payroll accrue with running a business and keeping it afloat, but they’re not usually included in the markup formula. Yes, the owner hopes to realize some profit after paying for all costs. I won’t argue with the boxes, but the visual makes profit look proportionally large, while I will argue that actual per instrument profit is quite small, box-wise.
The only truly correct part of Figure 2 is the sign-off:
It’s important to understand why hearing aids cost so much today.
Right, and yesterday too. But we can’t understand cost without numbers and the numbers have to be credible, too. Transparency being what it is (not), I understand why the creators of Figure 1 skipped the numbers and resorted to tall black boxes so you could use your imagination, especially if you imagined “exorbitant” retailer profits. But that doesn’t mean the boxes are right or meaningful when it comes to describing markup.
What Does Markup Mean, Exactly?
The concept of markup needs elucidation and disabuse. The term itself is thrown around with abandon but with little thought as to what it really means, what goes into it, what’s not part of it, and how it’s calculated in any event. Markup is an equation, which means it has a precise definition that does not change. We wrote about markup back in 1995{{1}}[[1]]Hosford-Dunn H, Harford E & Dunn D. (1995) Audiology Business and Practice Management. San Diego: Singular Publ’g. p. 103.[[1]] and nothing but the numbers in the equation has changed.{{2}}[[2]]If you know your costs and selling price, you can use simpler formulas such as the one given to building contractors at Shubee Business Tips.[[2]]
Typically, markup means the percent of selling price that is added to the cost. The formula for calculating price for a given markup in percent is:
Selling Price = (Cost of Goods & Services)/(100-markup) * 100
It is very important to include all overhead expenses in the cost calculation. A hearing aid with a wholesale cost of $500 and a sale price of $1500 has a markup of 66.6% over its invoice cost, but this does not reflect dispensing costs. If those service costs amount to $700, the total cost to the audiology practice is $1200, so the markup is only 20%. If the sale price includes maintenance and follow-up services that amount to $200 (total cost to dispenser of $1400), the true markup associated with dispensing and maintaining the hearing is only 6.6%.
Markups do not always translate into profits. Incomplete analysis of the cost of service delivery can result in inadequate markups that convert into losses rather than profits.
That’s one view, but not a view shared by the folks who brought us Figure 1. Their view–which relies on ballpark numbers, black boxes and economic-speak for face validity–is expressed in sweeping, damning conclusions that seemingly leave no room for argument:
The manufacturing cost of a typical high-end hearing aid is less than $100, and the wholesale cost is around $500. Any system that charges customers $5,000 for hearing aids is a broken system.
Lots of Room for Argument
The $100 hearing aid fable was deep-sixed in no uncertain terms by Harvey Abrams’ masterful post last year. No need to beat that dead horse.
The $500 wholesale cost puts the lie to their own claim in Figure 1 that the “cost to design and manufacture a high quality hearing aid” is $399. No need to embarrass them further here.
The “markup” in Figure 1 is everything over the wholesale cost of the aid, without taking overhead and other selling costs into account. That’s not right but we can’t tell yet how wrong it is.
The $5000 retail price of two instruments begs the question of what’s included in markup and what’s left on the table as profit. Those questions require further investigation to reconcile these diverging views.
Economically, the idea that there are expensive and inexpensive hearing aids is just what a Demand Curve requires of a Supply Curve. The Internet Suppliers of basic products will sell more Quantity at lower Price. Professional Suppliers of high end products plus service and expertise will sell lower Quantity at higher Price. More price choices means higher Utilization and market growth. What’s broken about that? Nothing if you’re an Economist.
Hearing Economics Does Its Own Internet Infomercial
Inquiring economic minds want to look in those black boxes!
Tune in next week when Hearing Economics offers a new, improved version of Figure 1, in which you will again get to feast your eyes on green and black boxes!!
AND, all viewers of this column will be amazed to see that the boxes are filled with numbers!!!
But wait, there’s more. Walk with me. The big news is that you will see different number-filled green and black boxes for different years!!!!
(editor’s note: this is Part 11 in the multi-year Hearing Aid Pricing series. Click here for Part 10 or Part 12).
Here in the UK I always used the concept of gross margin and net margin. Particularly useful as I could explain to employees (as well as customers!) that a discount often meant (indeed usually meant) selling at a loss to the business. Profit was something monitored very closely during the year (projected) but actually only valid at tax year end. There was gross profit and net profit after taxes. How profit is distributed depends on the Company structure and effect on taxation.
I take my hat off to all in the private sector who struggle with their business in difficult times without government props and aids that keep other sectors bumbling along. But, then again, I am a Thatcherite Economist!