Everyday Economics For People, Chapter 8: Why Businesses Sometimes Sell At A Loss

In order to take maximum advantage of the businesses from whom you purchase goods and services and to whom you rent your skills and labor, you will need to understand their decision-making processes. Once you are informed about how they think, you will be able to time your exchanges with them always at their most vulnerable moments, reaping the greatest possible benefit for yourself. Don’t feel bad; businesses spend all day thinking about how to target you when you are at your most vulnerable, and turnabout is fair play.

There are some additional factors that were not previously mentioned which can have major impacts on macroeconomic supply and demand. The biggest one is probably tax policy, which currently allows for corporations to deduct the cost of investments in inventory from their income, and to carry 80% of their losses forward indefinitely until they can use them as tax deductions against future profits. In simple English, that means they can use losses this year to say to the IRS that they made no money 40 years from now or whenever they actually do make money. Sounds crazy, but until the law changed in 2017, they used to be able to be able to use present-day losses to get refunds on taxes from up to two years ago, or carry the full 100% of losses forward as deductions for up to 20 years!

So, in practice, what does that mean for businesses? In the past, it meant that they could spend huge amounts on inventory at the end of a 3-year profit cycle — exactly enough to lower their present income to a low enough negative that they qualify for a full refund on their previous two years of taxes. And, if they did this right before a recession, or in the first year of a recession, they could accumulate massive inventory and reduce their past and future tax bills, perhaps all the way to zero, for up to 20 years forward depending how much they “lose.”

Post-2018, they are not able to back-date costs to offset previous years’ taxes, so one of the most major tax loopholes available has been eliminated. However, they are still able to carry costs forward, now indefinitely instead of only up to 20 years, although that is unlikely to matter in any but the most extreme cases. They will still be able to carry current losses forward to discount future taxes by up to 80% of the current loss, which means that they can discount investments by 80% of the tax rate, which is 21%, meaning that they “effectively” discount the cost of durable investments by 16.8%.

Prior to 2018, it was important for corporations to do their investing no later than the year following their two highest profit years, such that they could recoup from the government taxes they had already paid as well as carry forward their losses. That had useful ramifications for deal hunters, but the law has changed, and we can now expect slightly different behavior from corporations as a result.The rules of deal hunting were changed in 2018.

The way the tax law is now structured, with a flat rate and no back-dating of costs, it does not matter, for future tax purposes, when a company makes durable investments. So, whereas previously they had a strong tax incentive to make their durable investments immediately after an economic peak, now they have no such incentive. Rather, companies have an incentive to either to make their investments during profitable years to avoid taxes, effectively adding fuel to the fire of an overheating economy and pushing peaks higher, or to spread their investments over the cheapest possible moments, which will mean that many will want to slow down production until near the bottom of the recession, at which point they will want to start ramping up when costs are at their lowest — allowing troughs to be lower.

The net effect of this is that whereas before, large amounts of capital were likely to be invested immediately as economic conditions worsen — pushing against the collapse — now the investments will ramp up during boom years, and then drop off a cliff when profits begin to wane, and then wait until economic conditions have already worsened considerably, and investors can receive more production for each dollar they invest. In effect, this is likely to create even crazier peaks and even deeper recessions, with even more volatility at the extreme ends. There will also be very, very modest increases in tax revenue from the 20% of losses that can no longer be deducted against future and past profits. This is bad news for the general population, but it is great news for asset traders and the minority of people who time their spending and labor with optimal conditions for maximal benefit. Now you are about to be a part of that small minority that is able to take advantage of the even greater damage economic recessions cause! (If you feel survivor’s guilt about this, the solution is not to go back to being exploited, but to buy more copies of this book for all those others who don’t know the rules of the game we all have to play! Okay, or any other way you could get them the information. Remember, never pay for anything you don’t have to. Also remember that paying for intellectual property supports its creator to create more, and somebody has to pay them or they won’t share their creations.)

Before we get to the part about taking advantage of conditions, however, we will consider another few factors that impact business decisions throughout the economic cycles. An important consideration of market supply in the United States today is that it has become increasingly composed of massive corporations rather than medium and small sized firms. This means effectively that they have vast enough resources to be able to operate at a loss during recessions, and for it to be profitable in the long run to take those losses, because it allows them to maintain market share and avoid duplicate startup costs during the next recovery and boom. Thus, many large firms are willing to accept modest upkeep costs to hold their positions geographically and psychologically where they are. Again, since 2018, this will be diminished; running at a loss in the first two years of a recession no longer garners a tax refund.

Now let’s consider the way that costs work for these firms. If they deal in durable goods, then as we previously discussed, they will generally accumulate large inventories during economic recessions in order to sell them throughout the economic cycle, sometimes with mouth-wateringly high profit margins. But, if they manufactured something during a recession, it may still be slightly profitable to sell even during a recession. Hold that thought.

Per-unit manufacturing costs are fairly easy to calculate, but after that the costs get a little bit more complex. Consider shipping costs: these are determined by many factors, including fuel prices, current scarcity of shipping capacity, and average distance units must be shipped from their point of manufacture. Additionally, it is very expensive to ship a unit by itself, but shipping 2,000 units together costs almost the same as shipping just one. So, in order to keep costs low, firms want to have many manufacturers spread across the regions they serve, they want to move everything in bulk, and they want to move things when there is not a lot of competition for truckers’ time.

As you may have already noticed, firms face some trade-offs here. Moving things in bulk is difficult when you have low turnover in your stores, because you won’t have any space to add inventory if you haven’t sold the old stuff already. But, the time you’ll get the best deals per mile from truckers is during the recession, when there is low turnover across every store and there’s not a lot of reason to move products. Additionally, new orders for manufacturing are cheaper per item the more you purchase, and they are cheaper per item if you order during a recession. But, again, where can you put all of this new inventory if you aren’t selling your current stock?

The solution is simple. The firms must increase turnover of existing inventory. The benefits they will achieve from operating at large scale will often be enough to make it profitable overall to sell some items in some cases for less than it cost to manufacture them, if that’s what it takes to move the product. Sounds absurd, and it is only possible because most consumers behave in absurd ways with things like “brand loyalty.” And yet, it is not only possible, but a mundane occurrence during a recession. Those sales during a recession are effectively an investment in future revenue when those same customers or their friends have more income in the booming years and think things like, “I remember that great deal at Super Duper Store; I bet they have great deals again now!”

By operating at a loss during a recession, the firm is paying for a variety of benefits: avoidance of start-up costs when consumer demand returns; retention of favorite employees; retention of storefront tenancy and market share; continual presence in consumers’ minds; bulk deals on manufacturing and shipping; national advertising; future tax deductions from present losses.

However, in order to stay open, a store must also pay rent, utilities, wages, taxes, licensing fees, and insurance. With the exception of wages, these costs are mostly fixed per year regardless of the amount of revenue the store generates. Wages have a minimum under which they cannot fall, if the store is running on a skeleton crew throughout the entire year. Because a store has all of these fixed costs, selling items at a moderate loss just to keep the wheels of the machine spinning is hardly even relevant in comparison to what they already sink into maintaining a store when business is slow.

Then there is the concept of the “loss leader.” This refers to a commonly valued item that the business can sell at a loss in order to draw customers in on the expectation that they will choose to shop for more than just the “loss leader,” resulting in an overall profit. During an economic boom, these items may be sold at a profit, but with thinner margins than other items. During a recession, these items may be sold at a significant loss to the company, which is a great opportunity for a buyer.

There is one final consideration: inventory requires space and depreciates gradually over time. Space has a cost. Whether that cost is rent one pays or rent one must forego to use the space oneself, it is more expensive to house a large inventory than not to house a large inventory. Therefore, firms have an incentive to reduce inventory levels as low as possible without running out of stock. Because firms have an incentive to invest heavily in inventory during the top few boom years and during the bottoms of recessions, and because inventory is difficult to turnover during recessions, they are likely to have large amounts of inventory during recessions which cost them marginally to keep in storage. In contrast, during boom years, firms are likely to have very low surplus inventory with high demand and high manufacturing costs (and high rents). The net result is even better bargains during recessions and terrible price spikes during booms.

All of this is to say, big firms have a lot of reasons to sell at a loss during a recession. A recession is the time when businesses are at their most vulnerable, and they are over a barrel because they need to keep revenues up even if they are bleeding money by doing so; they’d bleed even more if they didn’t. If you have managed to save up your money until the stores are in this weakened position, you will be perfectly poised to take advantage of every desperate attempt they make to bring in customers, and pick up all of your long-term desires at the lowest their prices are ever going to be.

Section I: Building Wealth Through Financial Habits

Chapter 1: Credit and Interest Chapter 2: Rent and Ownership Chapter 3: Budgeting & Reducing Expenses Chapter 4: Bargain Shopping Chapter 5: Optimizing How You Allocate Your Productive Time Section I Conclusion

Section II: Taking Advantage of Factors Bigger Than Oneself

Chapter 6: Crash Course In Microeconomics Chapter 7: Crash Couse in Macroeconomics Chapter 8: Why Businesses Sometimes Sell At A Loss Chapter 9: You, The Savvy Consumer Chapter 10: You, The Savvy Producer