Why do Things Cost An Arm and A Leg?

How many times have you scrolled through social media and seen posts like these asking “Why is everything so expensive?!”

• “I want a three-tier, multicolored, beautiful cake for my son’s birthday by this weekend – I know it is a holiday weekend, but I need it. It needs to look EXACTLY like this picture and taste amazing. Who makes amazing cakes? Preferably someone who doesn’t charge an arm and a leg!”
• “Who can recommend an excellent hairstylist who does this intricate coloring on my difficult hair but doesn’t cost me an arm and a leg?”
• “I’m getting married in two months and want to find the BEST and most EXPERIENCED photographer who won’t cost us an arm and a leg!”

For small business owners, the prevalence of these posts is often disheartening and discouraging. Running a business is expensive, let alone the cost of cake ingredients, hair products, and photography equipment. Yet, the hours spent on honing one’s craft and creating high-quality final products are valuable too. And, of course, we all have bills to pay, mouths to feed, and a living to make. Yes, the actual cost of an arm and leg is tough to measure. But if we go by worker’s compensation figures, the price of an arm and leg totals over $162,000.

OK, So Why Do Things Cost So Much? So, maybe people aren’t charging a literal arm and leg for their services. But, if you still feel like it is too expensive, the question remains: Why IS everything so expensive?

Why are things so expensive?

Materials and Expenses

Small business owners pay out of pocket for the materials to create the final product. Therefore, when pricing their services, they need to include the money spent on every material or ingredient, no matter how small.

• Let’s take a closer look at that beautiful three-tier cake described above. When you buy a cake, you’re also buying milk, flour, eggs, butter, buttercream, fondant, sugar, and any additional decorations. So if you need three layers, you’re paying for triple the ingredients. Of course, these are the cost of goods sold, but they are not the only costs your favorite baker has!
• They also have costs of doing business. For example, the person making your cake will also have to factor in additional materials they purchase, such as dowels or cake boxes. Then there are indirect costs, including business expenses such as rent, utilities (gas, electricity, phone, internet), licenses, software needed, maintaining a website, marketing, advertising costs, accounting costs, legal costs down to buying a new stove or the latest baking pans or gadgets.

But if our favorite baker only charged you for ingredients and expenses, what profit would they earn? $0. For their time, effort, and careful attention to every beautiful detail, they would make no money at all. That brings us to our next consideration. Time

Time is Money and You Have to Charge for It

Time is money, and people aren’t going to give you hours of their time for free. So, you think, “I can bake a cake in no time,” think again. CakeBoss explains that time spent on a cake includes customer consultations, design planning, shopping, baking, decorating, and cleaning. Blogger “Rose Bakes” calculates that she typically invests 3-8 hours in every custom cake. So, how much is 3-8 hours worth?

• Most small business owners will set their hourly wages and calculate accordingly. As an example, let’s start with minimum wage. The federal minimum wage is $7.25—and unless you’re living under a rock, you know that’s a controversial number. You can’t make rent in ANY state on a minimum wage income. But if your baker charged minimum wage for six hours of their time, it would cost you $43.50. That’s the absolute minimum, and that would be in addition to the materials and ingredients we already discussed. If you were your own boss, would you pay yourself minimum wage? Probably not.

Profit Margins

After the cost of materials and time, small business owners still need to make a profit. This is separate—the cost of labor is not the profit. Sticking with our cake example, the minimum wage baker would make only $43.50 if they didn’t include an upcharge for profit. If you spent six hours creating the perfect cake, would $43 make it worth your time? Would starting a few of these a week be not only a sustainable business, but would it help you pay your bills, feed your family, and continue running a successful business?

• No! That’s why small business owners must charge you more than just the cost of materials, their expenses, and labor. Profit margins vary by industry. But in general, the average profit margin across industries is 7.71%. 5% is typically considered low, while 10% is deemed to be healthy. So, a business-savvy baker who wants to make a solid living would likely charge you the cost of ingredients and materials, a portion of the costs it takes to run a business, plus the cost of labor, plus a 7-10% upcharge.

Cutting corners on any of these costs would mean undervaluing their time, energy, and talent. But, of course, none of us want to do that or ask anyone else to do it either.

Small businesses have high costs. Small business owners need to charge for their expenses and time and earn a profit that reflects more than minimum wage. But, of course, if you feel like that means they are charging “an arm and a leg,” you’re entitled to buy a cheaper cake. A common argument our hard-working, hypothetical baker hears is, “But I can get a cake from Wal-Mart for $15.” Large businesses like Wal-Mart have economies of scale, from bulk purchasing ingredients to producing a large volume of cakes. They can also operate some portions of their business as ‘loss leaders’ to get buyers in the door (so their customers spend more money at the store than just the cake).

Small businesses sure don’t have this luxury. Running a small business is hard enough without constant haggling or justifying their costs. They can’t compete with Amazon or a chain store, don’t expect them to. They can’t. They simply have higher costs.

Final thoughts on why things are so expensive…

The next time you see a price tag from a small business that you think is charging an arm and a leg, I just ask that you remember what it truly takes to run a small business.

Small businesses make up your small town, your community, and your main street. They are your neighbors. Their prices are simply covering their business costs and trying to put food on their table. One thing is for certain; our beloved baker certainly isn’t making an arm and a leg from selling you that $150 three-tier, multicolored, beautiful cake for your son’s birthday.