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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 was “…that sounds like a good
thing!” My friend, who went back to graduate 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 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
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) 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
same kind. Product and pricing 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 of 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 bicycle 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 enjoyable 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 uniform 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.