RVMS Blog: Welcome to Bike 2.0

Note: in the following weeks months I’ll be covering the Top Ten Lies We Tell Ourselves In The (USA) Bike business. For your reference:

#10: Bad News Is No News

Here’s #9:

The Lie
The bike business makes its money selling bikes.

The Reasoning
Bike brands sell a lot of bikes. Bike shops sell a lot of bikes. Consumers buy a lot of bikes. A bike costs a lot more than, say, a pair of tires. Therefore, bikes are the lifeblood of the bike industry. Duh.

The Reality
The bike business is a lot like the movie business. Despite the sticker shock at the cost of your tickets, your local theater famously ends up with very little of that money, functionally turning the downtown multiplex into a very expensive popcorn stand with an interesting marketing gimmick. Which, given the quality and pricing of multiplex food, is a very fortunate thing for them.

Nor do the studios do much better. For every box-office hit, there’s a dozen lesser-grossing movies that fail to make back their production costs. (And when you see those box-office-vs-production-costs numbers on the local entertainment channel/website, keep in mind that those costs don’t include all kinds of other bottom-line-sapping fees, percentages, and overall cost-of-doing-business expenses.) In fact, when you get right down to it, big studios make the majority of their profit on license fees, DVD sales & rentals, video games and other spinoffs, and of course, the endless reruns available 24/7 on your local cable channel.

So when you come right down to it,  the bike business is a whole lot like showbiz. Only, you know, without all the fame, limos, starlets, money, and cocaine.

But we still have more fun.

Case(s) In Point
Retailers. According to the National Bicycle Dealers’ Association (that’s NBDA to us insiders) and their annual Cost Of Doing Business studies, the typical bike shop hasn’t turned an appreciable  profit on bikes in the last decade or more. Bike profits hover within a point either side of the break-even mark, and attempts to get bike brands to raise published SRPs to allow retailers a little breathing room are inevitably pulled down by competitors offering comparably specced product for less. While most distributors now publish (and enforce) perfectly legal anti-discounting policies to control the perceived value of their brands, it certainly hasn’t shown up on their retailers’ bottom line. Not is it likely to anytime soon. At least not under the current business model (that’s called foreshadowing).

Bike Brands are in a similar pickle. The industry is so competitive price-wise, and competing models so comparable in spec, that raising the price of a $500 retail bike by an extra ten bucks at wholesale will almost certainly render the bike unsellable at retail. The best product managers can do is try to hide lower-priced components (often found in front derailleurs, pedals, stems, headsets, and tires) among more prestigious ones, thereby lowering their cost. Product managers are amazingly good at this, which may explain why the best ones are so very well paid. But retailers and, increasingly, consumers have learned to spot these tactics, with the latter abetted by online buyers’ guides and the ubiquity of incredibly detailed information on the internet. (Retailers still have to do it the old-fashioned way, and the ability of a top bike shop buyer to memorize, recall, and compare spec is a thing of wonder.)

Another tactic is to negotiate discounts with suppliers. Shimano is famous for maintaining pricing even to its very largest customers, so this is typically done by putting non-Shimano brakes, cranks, or whatever on the bike. The component’s manufacturer offers up  top-of-the-line parts at a deeply discounted price (thereby raising the credibility/perceived value of both the part itself and the bike it’s going on)  while the OE manufacturer scrambles to make up the discount via economies of scale (production volume) and/or increased sales in its aftermarket channel.

But the real profit-killer for bike brands lies in preseason programs and the cost delivering them. A huge part of the Bike 1.0 business model involves tying up (larger) retailers’ open-to-buy dollars (floor space) with preseason orders, and that in turn necessitates discounts and dating (financing) programs. By my admittedly rough estimates from published BPSA figures, bike brands financed US $300-400 million in inventory in calendar year 2008 for lengths of time between 60 and 120 days. And all those associated costs are subtracted right from the brand’s bottom line.

One of the reasons bike brands invest so heavily in high-end race machines is because those are the only bikes they can turn a reasonable profit on. But the arms race is at work there, too, with profits being funneled into R&D and marketing, which includes the literally millions of euro spent every year by bike companies on pro racing teams.

In fact there’s a much deeper level of irony at work here: the only way most bike brands can afford the backbreaking costs of Pro Tour racing is by spreading them across the entire product line…which means that the $10,000 bikes the pros ride are quite literally subsidized by all the $500 bikes regular folks ride. You know, the same bikes and cyclists that the guys who those $10,000 bikes are so contemptuous of.

But Wait, There’s More
So the bottom line of all this is that very few people in the bike business are making very much money off the sale of bikes. Even the Asian factories that actually manufacture the frames & components are sweating bullets and scraping by on EBITDAs that would be laughable in other industries.

Under the Bike 1.0 business model, pretty much the only guys with double-digit net margins are the kingpins like Trek and Specialized and their affiliated factories (primarily Giant and Merida, respectively), plus a few— a precious few—component suppliers, notably Shimano.

The real money is in the aftermarket side of the business, which may explain why so many bike brands use the economic leverage of their bike sales dollars to force equipment of various assorted quality and value onto retailers sales floors.

Of course retailers are glad to have the good stuff. It’s the not-so-good stuff they’d rather not give floor space to, and that’s where the leverage comes in (it’s the same with the weaker bike models too, but let’s stay focused on the equipment side of the business for a minute for another paragraph or so).

Because equipment margins—both for suppliers and retailers—are typically half-again (or more!) what they are for bikes. And because bikes take up many times the square retail footage per profit dollar times inventory turn (yes, even when stacked vertically), there’s a huge struggle on both sides to focus on the relatively small number of square feet in the typical bike shop with the most dollars available to be squeezed from them. And who could blame them? After all, they got into the bike business at least in part to of make a living. Or thought they did, anyway.

But let’s step back a minute. All this is going on under the old business model which, remember, only directly involves about 40% of the bike sales dollars in the industry. But it’s impacting much of the remaining 60%, too, because those 60% companies are playing by the same crazy rules as the more successful 40% ones. Which is either dumb or completely nuts or both. You don’t run a successful corner coffee shop by trying to be as much like Starbucks as possible. If fact, if you’re smart, you try to the opposite, and try to be as un-Starbucks-like as possible.

The whole Bike 1.0 system runs on level-loading factory production to get the best price (and avoiding the big month-long production gap around Chinese New Year). Which means big bike brands have to take a lot of production at times when consumers don’t particularly want to buy it, like October through January. So they turn the situation to their advantage by getting retailers to inventory that unwanted production for them, and they do it by extending free credit and/or discounts until consumers are ready to buy. And of course that means they have to have the best-possible factory pricing to help pay for the whole Rube Goldberg cost structure in the first place.

The Bike 2.0 Solution
But what if some smart Bike 2.0 bike brand paid a little more for their production, shipped it after Chinese New Year, and sold it on a more timely basis to smart Bike 2.0 retailers, who took delivery when the product was actually sellable? The business model would offset slightly higher production costs with savings on discounts and credit, effectively taking those dollars out of the banks’ pockets and putting it back into the channel that actually makes and sells the bikes. And then what if those smart brands split the savings with their smart retailers?

Retailers would make more profit, either by making higher margins or by selling more product or both. Bike brands would make more profit, allowing them to offer more models or more R&D or lower prices overall. Consumers would end up paying less for fresher (that is, with up to 6 months’ worth of product & cosmetics updates incorporated) bikes. And Bike 2.0 brands and retailers would be able to compete effectively with the larger names who remained shackled to an industrial revolution-era production system that cuts off a big slice of their hard-earned profit and gives to a bunch of bankers who probably never rode a bike in their lives.