A Case Study In Perfect Competition: The U.S. Bicycle Industry And How Independent Retailers Can Thrive! By Jay Townley
I had an epiphany, as in a sudden insight into reality, in May at a meeting where a long time friend in the industry offered the opinion that the U.S. bicycle industry is in a classic state of perfect competition. My immediate response response was “…that sounds like a good thing!” My friend, who went back to graduate school school after working in a bike shop, for a major component manufacturer and prominent bicycle brand quickly responded with “…no, you don’t understand.” He went on to explain that when he studied economics in graduate school he became aware of perfect competition which is a term of art in economics for the most competitive market imaginable – one where the companies and businesses realize the bare minimum profit necessary to keep them in business. At the time we were in a meeting together with six other people from the bicycle industry – and the room went silent for a time. As the group started to to discuss the notion of perfect competition it became apparent that no one strongly disagreed, and in fact there seemed to be more agreement than not that our industry was indeed in perfect competition . We ended our meeting, and went our separate ways, but the concept of perfect perfect competition stayed with me, kind of like the dull pain of a toothache. When I got back to my office I did a search on the web and found quite a lot about this subject. Here is a summary of what I learned. Perfect competition , according to economists, is the most competitive market
imaginable. In the real world, it is rare, and there are even some economists that feel it may not even exist in its purest (I take this as worst) worst) form. The example of a market in perfect competition that is referenced by those economists that believe it does exist - is agriculture. Competition is … competition, so what makes perfect competition different from all other forms or kinds of competition? According to economists – because it is so competitive that any individual buyer or seller has a negligible impact on the market price. Products are homogeneous, or composed of parts that are all of the the same kind. Product and pricing information information is also perfect in that everyone, including the ultimate purchaser knows everything about the products, including the best prices available in the market.
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In a market in perfect competition everybody is a price taker, producing and selling essentially identical products and each seller has little or no effect on market price, and is unable to sell any output at a price greater than the market price. Firms earn only normal profit, or the bare minimum profit necessary to keep them in business. If firms do earn more than normal profit, which is called excess profit, the absence of barriers to entry mean that other firms will enter the market and drive the price level down until there are only normal profits to be made. Manufacturing output will be maximized and price minimized. This sounds very familiar to me – and I am sure you can also relate to real world examples of the U.S. bicycle industry as you read through this explanation of perfect competition.
Component manufacturers scramble to get the latest designs and functionality to market in a timely fashion. Bicycle suppliers struggle mightily to craft and specify bicycle products that have more value than the competition and sweat over the timing and dealer programs to introduce them. Bicycle retailers loose sleep over how much to commit for and what to bring to market – and whether to become a concept store or remain independent, and which suppliers to do business with. And with all this activity, no buyer or seller has a negligible impact on the market price, and everybody in the channel of trade is a price taker, earning the bare minimum profit necessary to stay in business. Last year and this season are good examples. In 2005 we had our best year ever for the sale of high-end road 700c bicycles selling above $1,000. And in 2005 the typical bike shop lost 5 margin points on the sale of new bicycles, continuing an unfortunate trend of loosing money on the sale of new bicycles that has plagued our channel of trade for over a decade. High-profit bike shops, while they performed much better than the typical shop, also came in just below their cost of doing business on the sale of new bicycles in 2005, the first actual loss for high-profit shop on the sale of new bicycles in a decade. Despite the continuing, and apparently growing losses on the sale of new bicycle, the U.S. bicycle industry posted one of its best years for apparent market consumption in 2005 – second only to the record set in 2000. 2006 started off well enough, but now as we enter the 3rd quarter of the year, some bicycle brands are reporting overstocks from last season, and retailers are reporting some 2006 models already are out of stock as the brands introduce and start to deliver 2007 models.
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History does matter, and in economics, path dependence refers to the way in which apparently insignificant events and choices can have huge consequences for the development of a market or an economy. In the case of the specialty bicycle retail channel of trade, the collective choice not to adopt Uniform Product Codes, or UPC’s has come back to blind the industry again, and again over the last twenty five to thirty years. The seemingly insignificant, competitive based choice o f not adopting UPC’s has made bar coding technology, and the full power of its inventory and sales tracking efficiency unavailable uniformly across all levels of our channel of trade, making real channel efficiency impossible. Simply stated – brands and manufactures don’t know what is selling at retail and retailers have little or no input or influence on what is reordered and manufactured to refill the supply pipeline. As most economists will tell you…where we have been in the past determines where we are now, and where we can go in the future. This, in turn, leads to the importance of information. Economic and channel efficiency is likely to be greatest when information is comprehensive, accurate, and readily and cheaply available. As evidenced by the specialty bicycle retail channels recurring pattern of having too much or not enough, many of the problems facing economies and markets arise from making decisions without all the information that is needed. Currently our channel of trade operates on the premise that if a brand or company can acquire or gather more information than its competitors it is a good thing. However, economists will tell you that asymmetric information, when one channel player knows more than the other channel players, can be a serious source of inefficiency and market failure. Uncertainty can also impose large economic costs. The power of the Internet has greatly increased the availability of certain information. However, even with all its information power, there are specialty bicycle retail channel inefficiencies, like not knowing what is actually selling at retail, that the Internet will not be able to solve. Accordingly, uncertainty – literally not knowing, will remain a huge source of specialty bicycle retail channel inefficiency. And this inefficiency makes our blindness complete. Potentially the most useful information, about what will happen in the future…or the ability to more accurately forecast future demand, replenishment, inventory and sales will simply never be available under our channels current state of perfect competition and The best example of perfect competition that I have heard recently is in my own backyard…Madison Wisconsin, one of the best specialty b icycle retail markets in the country. As most of the industry knows there are two Trek company stores in Madison, and one of them, located on the East side has been identified as the companies flagship store. Erik’s Bike Shop is a successful multi-store retailer headquartered in the Minneapolis-St. Paul Minnesota market. Erik’s established a store in Madison several seasons ago, and carries Specialized, as what I understand is its marquee brand.
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Several weeks ago, according to the buzz among bicycle dealers, Specialized announced to its dealers in Madison that Erik’s will open a second store, reportedly directly across the street from the Trek flagship store on the cities East side. By the way, both the Trek flagship and the new Erik’s that will carry Specialized are both in direct competition with an established bicycle dealer that has carried both the Trek and Specialized brands for many years – and is just one-mile away! To make this market situation even more “perfect,” the Trek flagship and new Erik’s store are located almost within sight of a large new Dick’s Sporting Goods that opened last year. This is, I suggest to you, much more than just two brand competitors going head-to-head in one of the best specialty bicycle markets in the country. It is also a clear example of perfect competition at its best, or should I say worst. The most competitive market imaginable…where output will be maximized and price minimized. Consumers, particularly adult enthusiast cyclists have been and will continue to be the clear beneficiaries of this most competitive of markets. The retailers, including the two backed by deep pocket bicycle brands, will beat on each other and will become more efficient to survive, and as a result prices in the market will be kept surprised. Keep in mind that in a state of perfect competition a firm that earns excess profits will experience other firms entering the market and driving the price level down until there are only normal profits to be made – the bare minimum profit necessary to keep them in business. All of the retailers in this scenario, when it comes to full fruition, including those backed by the big brands, will still only have a negligible impact on the market, including the market pricing. This all raises the question – at least in my mind, of the big guy that was there first, Trek Bicycle, erecting or creating some type of barrier to entry. I am sure they will think about such a thing – and they may actually try several potential barriers to another new store, which might very well also be a brand “concept,” entering their geography, and market space. At the end of the day…there is no real barrier to entry that can be put in place, or actually exists for that matter, because the largest brand seller in our channel of trade still doesn’t have enough mass or leverage to dominate through a monopoly, and I am not talking about the board game. Most markets exhibit some form of imperfect or monopolistic competition. There are fewer firms in this imperfect competition than in a perfectly competitive market and each can to some degree create barriers to entry. Such barriers would allow the existing firms to earn some degree of excess profits without a new entrant being able to compete to bring prices down. So far, the consolidation in the U.S. specialty bicycle retail channel of trade hasn’t reached a point where there are a small enough number of brands and /or manufacturers with enough product differentiation to allow the creating of barriers to market entry. The
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number of bike shops has kept falling over the last seven years, but here again, no retail organization has grown to the point that it can create barriers to market entry. And what about the current independent bicycle retailer that has been in the market the longest? He is clearly at a dangerous place, but is the only one of the players who can breakaway from the state of perfect competition that has a strangle hold on the rest of the industry and the specialty bicycle retail channel of trade. By the way, this retailer was made aware in advance, first that the Trek flagship store was going in a mile from him, and next that Erik’s Bike Shop was going to locate a new store within about the same distance from him. He has reacted by remodeling the interior of his current location. I have not spoken with this particular retailer since the news about the location for the new Erik’s store, but I have E-mailed, and when I do talk to him, here is what I am going to suggest. 1. Hyper-differentiate your store. This is a term coined by Mike Basch, former CEO of YaYa! Bike, and it means differentiate your store totally from any other bike shop or bicycle retailer in your market so that you stand out as the brand in your market. It will be important to keep the adult enthusiast cyclists that are now customers – but the key will be crafting and marketing features and benefits to retain them as clients for life. 2. Market to and really welcome casual cyclists, women, minorities, baby boomers seniors – everyone that is now underserved by all-the-other bike shops and concept stores. This is a key strategy for growth. It involves a product selection that will give all the non-enthusiast adults a truly en joyable bicycle riding experience while not forgetting about the kids. 3. Focus totally on the consumer. Our channel of trade is now very product focused, and we think everyone that walks in the door is also product focused. This is a false premise. Shoppers, all shoppers are looking for an enjoyable experience, and that experience includes focusing on their wants and needs, while making them comfortable in the store. 4. Educate your whole organization to focus totally on shoppers and customers. Because of the current product focus of our channel of trade, we don’t educate our employees about the vital importance of focusing totally on the shopper, and not making any snap judgments about who a cyclist or customer is, or isn’t. Hiring and educating customer service naturals is way more important than in-depth product knowledge. 5. Make it all about them and an extraordinary shopping experience. There is no retail selling today – everything a retailer does, everything retail employees do is marketing. The whole store, and the whole attitude has to make it all about them from the parking lot to the windows to the front door to the greeting – through making the bicycle buying process easy and fun, and the whole visit to the store extraordinary. Making it all about them and providing an extraordinary shopping
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experience is the path to increased transaction values and increased close rates. 6. Make your store the brand. Work with, stock and sell brand products that will provide the features and value your customers want and need, and the margins you need to grow your business. Present a uniform brand image in everything you do and that your staff does and says – one brand face. And develop and promote formal word-of-mouth customer referral programs to leverage your store brand in the market. 7. Create individual client solutions. You and your staff – your whole store, your brand and the shopping experience you provide are for one purpose. To create individual solutions for your customers wants and needs. In doing so you will create clients for life. 8. Become an efficient database manager. Educate your staff to the importance to your business of utilizing all the features built into to your computerized point of sale system and any other retail shopping systems you incorporate into your retail process and shopping experience. The uniform entry of shopper, customer and client information is as important to your business as a un iform and consistent new bicycle assembly process and check list. 9. Become an efficient direct-response marketer. Staying connected to prospects, shoppers, customers and clients utilizing a regular direct-response marketing plan is essential to growing the number of transactions generated by the business, and it is reliant upon a clean and current database. 10. Follow the Phillips Rule of never ever selling anything in your retail store below your cost of doing business. This will lead to consistently earning excess profits. All ten of these suggestions together create the foundation for a new level of specialty bicycle retailing that changes the paradigm and take the retailers that follow it out from under the state of perfect competition that the rest of the channel of trade is trapped in.
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