Oct
06
2008

Bike Industry Economics

A look at this week’s issue of the Economist, as it might relate to the bike business.  Or vice versa.

As the US economy, and the world, stare down the long barrel of a certainly-powerful economic danger, I thought I’d try to make sense of it using what I know best: bicycles.  So as the Economist points out in this article in this week’s issue, we are certainly facing a global economic crisis.  At the risk of oversimplifying an admittedly complex problem, it all comes down to the fact that banks won’t lend money to each other, and they sure as hell won’t lend to plebeians like you and me.  And then when banks do loan money, it’s at rates that are reminiscent of vegas bookies who back up their loans with kneecaps and teeth – basically, they’re demanding a risk premium to lend to each other, when historically there has been none.  As we’ve all seen, lots of banks seem to be disappearing these days.  Would you lend to one?

So, back to bikes, as I’m trying to keep this from getting too ungodly boring – the bike industry model is pretty simple.  While supplemented with in-season refill orders, bike companies sell a substantial amount of the year’s business in bikes and bike stuff to shops in a big early “booking” order that helps companies with forecasting and market trends, usually around the late summer or early autumn, and then the bike companies get paid for this big order over a generously long time (warning: that’s like CREDIT.  Danger suspected!  Blinky lights!)

To a great extent, this has already happened for the 2009 model year: most of the bikes you’ll see on showroom floors now and through the spring have already been ordered.  So, depending on how a bike company books revenue, things might seem pretty peachy right now.  But if bike shops, a classically cyclical business that tends to do poorly in the winter, have to borrow money to get through the winter – say, because christmas sales are down due to a crap economy – then we could be facing a situation very similar to what the banks face.  Shops have inventory (just like banks have inventories of bad debts, which now apparently the government might buy), but like the bad debt inventory, they may be challenged to sell it (and there’s no chance the government will offer a bail out package to buy bike shop’s bad inventory of unsellable bikes).  For sure, you can’t pay rent with a new road bike.  So bike shops may start doing what banks are doing now: hoarding the cash they do have, and reducing the amounts they pay to creditors (the bike companies).  This spring could be a very, very difficult time for bike retail.

America only?  Not likely.  Just as the USA banking problems are now spreading to Europe, so too is Europe exposed to similar bike industry risks.  As the Euro tanks (As of writing, it’s down to 1.3488), the forecasting orders placed in recent months from any USA-based bike companies are getting more and more expensive to repay.  Not to mention that the same banking industry problems, and lack of affordable credit, are now ripping through the European economies.  Just ask Germany about their $51-Billion government loan to save Hypo Real Estate, Germany’s second-largest property lender.  Sound familiar?

So this begs the question: imagine there was no credit for bike shops.  This is the most doomsday scenario, but I rather enjoy taking ideas too far when they’re still considered hypothetical.

If bike shops could only display what they could afford to purchase, and had only their sales to support the inventory of their sales floors, we’d see a few things happen pretty quickly, I suspect: shops would seem empty, sales would fall precipitously, and many would move or close due to overheads they can’t afford.  On the supply side, manufacturers would be crippled by a lack of forecasting capability, and would be forced into just-in-time style delivery.  But that presumes they’d have the inventory in stock, which they wouldn’t, because manufacturers depend on the credit from suppliers for drivetrains, components, wheels, tires, and in some cases even the frames they adorn with their brand name.  The COD model can sometimes help a single shop through a tough time while they get back on their feet, but it doesn’t seem to work well in aggregate.

Basically, the bike industry business model is krazy glued to the availability of global credit markets, and just to be sure they’re together, they’re then welded shut together in a steel box.  They’re inseparable, as the model exists today.  If the worst happens, and I hope it doesn’t, a total meltdown of global credit will vaporize the way the bike industry works within a year, and the only companies that might stand a chance of survival are those with a lot of cash in the bank, and those with a deeply vertically-integrated supply chain.  Which is probably nobody, as far as I can tell.

And I bet the bike business isn’t alone in this.

Written by chris in: General Musings |

13 Comments »

  • A deeply vertical supply chain can mean many things.

    One example would be selling direct to consumer. This would be one way to increase margins and get paid instantly…of course the dealer base that grew your brand would not like it – but if they disappear anyway, you will need to sink or swim yourself.

    Even without a credit crunch – the distribution model for bicycles is years behind many of todays successful business models.

    Comment | October 7, 2008
  • Agreed, I meant backwards-vertical, into the supply chain for raw materials and parts (the part that needs credit). But you’re right, vertical can go the other way to the consumer, and once I worked for now-defunct Supergo, a company that exploited that very fact. That said, I’m not convinced that the bike industry distribution model is “behind”, though I admit it’s different and doesn’t follow the newer rush towards services, or the digital distribution options that exist. The model exists because of the fragmented base of dealers that consumers rely on for sales and service. Experiments are being made with company owned stores from Specialized, Trek, Giant, and even smaller companies like Stork, but the purchase experience really depends on there being a place to go to try the bike. What if the model were simply as evolved as it could be, given “typical bike buyer behavior”?

    Comment | October 7, 2008
  • So maybe General Motors can use that government bailout cash to come to Specialized’s rescue after all?

    I just noticed you redesigned your website.

    Comment | October 7, 2008
  • The bike industry has helped put itself in the bind by getting sucked into “model years” in the first place. This grossly inappropriate concept came in during the destructively competitive mountain bike boom from the very late 1980s through the end of the 1990s, when the technological spiral succeeded in chasing almost all the consumers away.

    Our current customer base made up of numerous niches has spawned more than enough models to supply them, but the industry is still stuck on the model year concept. Constant change, labeled as innovation, but really just annoying manipulation, still destabilizes customer satisfaction and devalues inventory already in stock. Meanwhile, no one has developed a more powerful and advanced engine. Poor saps still have to pedal it.

    Electric and electric-assist bikes try to get around the limitations of the motor, but at the cost of more technological gimmickry and massively greater weight.

    Take away the need to pedal and you take away the urge entirely. But that’s another subject for another post.

    Comment | October 7, 2008
  • All true, Chris. But how much of what you write here applies mostly to the enthusiast-only side of the biz?

    Selling to newbie consumers is good because (a) they aren’t yet locked into the model year malaise (b) they’re cost conscious but not RRP conscious and (c) they’re new. Enthusiasts are a dying breed, we’re not making enough of them to survive only on their business.

    Getting new folks into cycling has always – but always – been the big dream. Gas price worries and the health fixation (of self and planet) is now bringing more newbies into cycling. Not all are buying new bikes just yet (there’s still not a lot on the sales floor they’d be attracted to for utilitarian purposes) but bike shops in US and UK are reporting servicing is way up.

    And bike shops can make good money from fixing stuff, often better money than flogging brand new bikes. Consumers can compare online prices and know how to squeeze a bargain: it’s tougher to haggle over a fork bleed or a winter overhaul.

    It’s the servicing side to the bike business that will expand massively in the years to come. Bike sales will continue to leak via a multitude of channels. The very top IBD-only brands will be able to tough it out in bike shops but there’s only a handful of these brands.

    Comment | October 7, 2008
  • If we consider ‘enthusiasts’ to be those who are enthusiastic about cycling, then I’d say that segment is not dying at all, thanks in great part to the gas prices and health issues you mention. But I agree with you that the higher end is tougher to get excited year after year, and growing the world cycling population is a far better goal and focus. I just think relying on servicing (that is, fixing broken stuff) is a stretch, as bikes are getting more and more reliable all the time (especially the newbie bikes!).

    Shops can make money in service, but at the shop I was at, it was the lifetime value of our core customer base that kept us running and growing, and at times surviving. That adage that 20% of your customers are 80% of your revenues might be a stretch for the bike biz, but it’s definitely not even revenue across all customers. And repair alone does not pay the rent, the math at $50/hr just doesn’t work. Maybe at $100/hr, but that seems an unlikely price to reliably charge repeat clients.

    For an example of a shop that I think is doing an utterly fantastic job of staying healthy and developing a tribe of customers to help weather a storm, take a look at http://www.passiontrailbikes.com, a shop near me (and yes, a Specialized dealer, but that’s not the reason). Be sure to sign up for their email newsletter.

    Comment | October 7, 2008
  • alan

    Financing in the US retail bike industry has an interesting similarity to the way subprime home ownership was financed prior to the banking collapse. Most bike retailers are undercapitalized enthusiasts who are strong on product knowledge but weak on business skills. They operate with sketchy and unreliable budget planning that frequently results in delinquent debt payment to the bike manufacturers and distributors that supply them. However, they enjoy some of most generous and lenient vendor inventory financing schemes of any retail industry. Payable dating of 3,4, and 6 month duration is common even in the dangerous conditions of Fall 2008. How can that be possible? Here’s the similarity to the financing of subprime housing. Like the OPEC nations that constantly recycle their petro-dollars back to the oil consuming nations, the large bike factories in Taiwan and China and their banks have amassed large fortunes that need to be utilized. The OPEC banks, investors, and sovereign wealth funds ultimately “invested” their money in bonds of the CDO (Collateralized Debt Obligations) type. These contained RMBS (Residential Mortgage Backed Securities) of various qualities, but containing enough toxic sub-prime ones to make the whole security worthless. Some bike retailers of dubious credit-worthiness are the retailer version of subprime mortgagees. I predict that today’s banking crisis will cause the current vintage of bike manufacturer’s finance programs to be the last of its kind and that in the future, bike retailers will face financing needs similar to the real world of manufacturer-retailer economics.

    Comment | October 8, 2008
  • I’d like it to be not dying, but I look at the average age of bike shop customers and the average age of racers (of almost all cycling disciplines) and can’t but help come to conclusion that we need a fresh influx of enthusiasts.

    I’ve been editing trade mags for cycling since the early days of mountain biking. The bike demographic is now more skewed to relatively affluent, middle-aged men than ever before. For sure we need to remain committed to this demographic because of the 80/20 rule but there needs to be an awful lot more outreach from the bike trade to create fresh enthusiasts. It sounds like Passion Trail Bikes is doing this, and keeping their current customers enthused, too. A bike shop with an email newsletter? Simple, cheap, effective, yet sadly, rare.

    Repair doesn’t pay the rent if your shop is enthusiast-heavy because enthusiasts like maintaining their own bikes but newbie customers need bike workshops. My main point would be that sales of new bikes will continue to decrease as a percentage of an IBD’s business and the days of having hundreds of bikes on the sales floor are long gone. Servicing – and, of course, selling accessories at full margin – is where bike shops make money.

    Comment | October 8, 2008
  • Ron

    Chris & Carlton Reid,

    I came and read this post of yours at a perfect time, courtesy Cyclicio.us blog. I have written a post on my blog with a very similar vibe. Click here to read it

    I would love to know what your thoughts/comments are to the questions I posed. See you there!

    Comment | October 9, 2008
  • Great post, it gives good insight into how the current economic crisis can impact some local businesses. Bike shops are in this postion because the market (and manufacturers) are focused on high priced road bikes instead of making affordable road bikes. The lower end of the market is ignored. A focus on this end of the market would bring in new customers and reduce the credit needs of bike shops.

    Comment | October 30, 2008
  • Jack

    I must admit that looking at the bike dealer business from the outside is really scary. Mostly because I see a lot of wringing of hands over the loss of high dollar customers in the likes of “enthusiasts” rather than much of a real attempt to provide a fun, upbeat and inviting atmosphere to the rest of the human race. If you consider how poorly run many dealer shops are (odd hours, dirty stores, outdated displays, faded merchandising, etc. not to mention a level of arrogance not found in many other retail stores) it is not a mystery why so many are seeing their business wane. Now, add the economic problems and you have a perfect storm. The up side? Maybe those of you who actually “get” retailing will survive and be even stronger.

    Comment | December 2, 2008
  • I am getting 404 pages genuinely regularly, I’m not too certain why having said that if I refresh the webpage it returns alright.

    Comment | June 18, 2011
  • Great blog. I just wanted to say thank you for your efforts!

    Comment | August 5, 2011

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