The End of the Beginning; Observations from Glitter Gulch

/0 Comments/in , , /by

“Now, this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

Overall, Vegas showed signs of being the end of the beginning of the snowboard industry’s consolidation process. 
 
Which is convenient, since I’ve always wanted to use that quote. The first person who identifies the person being quoted by calling or e-mailing me, the approximate date of the quote, and the event being referred to will be acknowledged along with their business in the next Market Watch.
 
In Vegas, the industry shows some signs of stabilizing, but it has a long ways to go. There were few or no new exhibiting snowboard companies, but not less by my count. Prices were up, down or unchanged depending on who you talked with. But not too much either way. Careful cash management has become more important than taking market share. With a couple of exceptions, senior managers seemed to feel that they had or could get enough cash to do what they needed to do, but not what they would like to do. Significant product innovations were rare. I saw only one new step-in system. Making a profit is still tough. Retailers seemed more deliberate perhaps because there were fewer choices to consider.
 
The Good News
 
The good news starts with SIA’s retail audit, where a big increase in hard goods sales by units and dollars was reported through the end of December in both chain and specialty shops. Especially in boards, the dollar increases were generally more than the unit increases. This translates into an increase in the price per unit at retail. It’s about time. Over the same period, snowboard apparel sales plunged, but that’s more a reflection of last season’s unsustainable growth rate and poor weather than of a problem with apparel.
 
The chaotic over supply that resulted from companies producing with the goal of achieving hopelessly optimistic projections, to keep factories running, or to take market share from competitors is gone, bludgeoned by the sacred sledgehammer of financial reality. That’s not to say that over capacity isn’t still an issue (see “The Bad News” below), only that the conditions that lead to forty dollar wholesale board prices are pretty much gone. At least they are gone until confidence in Chinese production quality increases, but that’s a discussion for another time.
 
The next thing I noticed was that all the booths looked more or less the same as they each looked last year. Oh, they’d been renovated or dressed up and rearranged, but they were basically the same. Let me explain why this is really good news.
 
When an industry consolidates, managers have to start running their businesses differently if they are going to be counted among the survivors. The cornerstone of these changes in management perception and focus are financial. There’s a seminal moment when the realization hits home that all these cool marketing things would be great, but if we do them, we won’t be around to enjoy the benefits. At that moment, the competitive environment begins to get a little more rational and the tendency for new companies to enter starts to decline. We’re there.
 
I’ve always looked forward at Vegas to walking around to see who had thought up “the next snowboard.” Usually, it was some strange contraption that might have made technical sense but had no chance from a marketing perspective. It wasn’t there this year. But there was one new board with an unusual technical innovation- a double flex.
 
Nobody I talked to had ridden it, but the consensus was that it made conceptual sense and might work. It’s important that it wasn’t just a board being introduced by somebody who wanted to be involved in snowboarding. It appeared to be the result of cautious development and careful market analysis and timing. Based on the background of the owner, I expect there’s enough capital behind it and the risk has been carefully thought out. I’ll bet they wouldn’t have introduced it two years ago even if it was ready given the market conditions that existed then. In other words, it’s a rational product introduction based on a competitive advantage which the owner believe can be validated in the market. He doesn’t care if he’s cool. 
 
That’s another positive indication of a market that is starting to behave rationally.
 
I say this every year, but the show was more businesslike than the previous year. As long as there continues to be free beer in the booths after the show closes, I can stand it. I say that every year too.
 
At least partly due to SIA’s good work on the subject and its decision to cancel the Snow Show, the buy sell cycle is progressing more smoothly. There was plenty of business done in Vegas, but it wasn’t, and didn’t have to be, done in a frantic way. In the first place, it’s a lot easier to choose between fifty brands than three hundred. In addition, brands and retailers are doing more work before Vegas. More retailers, planning to carry most of the brands they carried last year, are coming to Vegas to confirm decisions they have largely made- not to begin and conclude the information gathering process in five frantic days like they use to.
 
The final piece of good news is that there are 60 million people in the United States between the ages of 5 and 20, over half of who have not yet moved into adolescence. There’s plenty of room for snowboarding to grow. We’ve also got the attention of every big company in the country with a brand name, because they know that if they can’t get the loyalty of some piece of this group, their future success is doubtful. I guess that’s good news…..maybe.
 
The Bad News
 
When a consolidation happens, profits drop. That drop can be temporary or permanent. I am not going to conclude that it’s permanent in the snowboarding industry- the demographics alone suggest there’s some money to be made- but the same handicap that has kept skiing among the financially disabled has the potential to do the same to snowboarding.
 
That handicap is too much production capacity. There are always more than enough soft goods factories. If every ski and snowboard factory in North America closed, there would still be enough manufacturing capability in Europe to supply all the skis and snowboards the world wants. Hell, there might be enough if all the plants outside of Austria closed. I don’t expect our excess capacity problem to go away.
 
The capacity problem is reflected in the actions of the (mostly) ski companies from Europe trying to establish their snowboard businesses in the United States. Unfortunately, I observed in Vegas some tendency on the part of European owners to interfere with the marketing direction the U.S. managers are trying to set, and I suspect that will be to the detriment of the brands’ success here.   Oh well, I’ve seen lots of U. S. companies have the same problems when they tried to move into Europe. People who live in glass houses….
 
The point, however, is that these companies, with tens of millions of dollars invested in snowboard and ski production equipment, really, really, really want to make product to keep those factories running. They look at the whole market from a production, rather than a market, perspective. I have some personal experience telling companies with factories that the market required less product. Their first priority is simply not brand positioning- it’s maintaining and increasing production.
 
Then there’s the fact that we’ve still got fifty plus brands competing in North America. It’s too many. I still believe snowboarding can support more brands than skiing, but not fifty. I expected to get to Vegas and see fewer.
 
The big brands, and the brands owned by big companies, making money or not, are likely to survive. They either have a balance sheet or an access to capital that insures it. The small brands that have pursued a consistent strategy and niche also have a reasonable chance to be successful. They all report anticipated sales increases consistent with their historical growth. It’s potentially a breakthrough year for them because if a retailer wants any product from a smaller brand, there aren’t many choices. Of course, sometimes the managers at these brands can be a little disingenuous when they talk to me, but I asked the same question in enough different ways that I think they mean it. I hope so.
 
As usual, being big or having a market niche seems to be the way to succeed. It’s tougher when you’re in the middle either by size or brand positioning.
 
In Las Vegas, I saw light at the end of the consolidation tunnel, but land mines on the cave floor. The demographics suggest a huge opportunity, but everybody wants a piece of it. Knowing who your customer is has gotten tougher as what use to be distinct specialty markets overlap and many new customers are as interested in fashion as they are in the sport. I am reminded of what happened to skateboarding the last time it got respectable. The kids dumped it because it wasn’t cool.

 

 

Tackling The Snowboard Industry Buy/Sell Cycle Are We Trying to Fix the Wrong Problem?

/0 Comments/in , , /by

The buy/sell cycle seems to be on everybody’s mind these days. The brands are concerned because the decline of in season orders means they have to take more inventory risk. Retailers, on the other hand, are thrilled to be able to get quality product in season at discounts, though are perhaps concerned that it’s tougher to hold their margins due to oversupply.

Everyone should be concerned; because if we follow this pattern we’ll turn into our old friend the ski industry with everybody struggling to differentiate their commodity products and nobody making much money. You should know at the outset that I’m not optimistic we can avoid falling into that same trap. There’s no reason snowboarding should be different from any other industry as it works its way through its business cycle. If we can it will be because we’re growing as an industry, are willing to ask tough, specific questions and can find some common ground between our individual competitive positions and the good of the industry.
 
The first thing we might do is to define what we mean by the buy/sell cycle. The term is thrown around pretty loosely. I’ve defined it as the process and timing of product purchases by retailers as it relates to the brands’ order and manufacturing schedule. If you don’t like my definition, please come up with one of your own. The point is that we should agree on what we’re trying to discuss and so far I don’t think we have.
 
Next, we have to make sure we’re attacking the right problem. As I’ll explain below, I believe the “problem” we have with the buy/sell cycle is really just a symptom of existing industry conditions and until those conditions change, the symptoms we call the buy/sell cycle won’t change dramatically.
 
I’ve talked about those industry conditions before and have said they are typical of any maturing industry. They include:
 
·         Overcapacity
·         Slower growth
·         Dealer margins fall, but their power increases
·         Product is viewed as a commodity
·         Competition emphasizes cost and service
·         Industry profits fall. Cash flow declines when it is needed most and capital becomes difficult to raise.
 
My guesstimate of industry board manufacturing capacity this year is three million boards. That’s not a theoretical, seven days a week, three shifts a day capacity. That’s two shifts a day, maybe five days a week. I’m not saying three million boards will be made, but that they could be. The fact that this capacity has been invested in creates a lot of pressure to put it to use. And to sell those boards to somebody. Cheap.
 
What’s being sold to retailers in the 1996-97 season? I don’t know, but I’ll put the number 1.2 million on the table. Could be higher, could be lower but whatever the number is, it’s a lot less than three million.
 
I remember waking up from my nap in an economics class when the professor said “Production increases and prices fall until marginal revenue equals marginal cost.” At the time I was pissed at him for waking me, but it seems he had a point. Each manufacturer is trying to beat out the others for market share and of course each is convinced that they are the one who will be successful. The more they invest to bring their costs down, the better price they can offer. But so can the other factory who is doing the same thing with equally blind faith that they will be the successful one.
 
Pretty soon there’s all this production capacity.   As they brought their manufacturing cost down, the price at which they could sell the board comes right down with it. Pretty soon they’ve competed their way to the point where they have to sell a lot more boards to make the same profit. And they keep cutting prices until, theoretically at least, they can sell a board for just one dollar more than it costs them to make it; just above the point where marginal revenue (what they earn from selling one more board) equals marginal cost (what it cost to make it).       
 
Each competitor has done what they perceive to be in their own best interest, and look at the fine mess they’ve gotten themselves into.
 
Basically, Pogo was right.
 
We Have Met the Enemy, and He Is Us.
 
So before we spend too much time and energy trying to fix the buy/sell cycle, let’s realize that we’re seeing in that cycle the symptoms of some more fundamental industry conditions. The buy/sell cycle problem will exist as long as over capacity exists.
 
I’ve heard basically four proposed solution to the buy/sell cycle problem. Some have been put forward seriously, and some tongue in cheek. Reviewing them offers us good perspective on how futile it can be to attack symptoms instead of the problem.
 
·         Establish a fund to purchase and close bankrupt plants.
 
The scary thing is that this may be the best solution of the four. Unfortunately, bankruptcy laws all over the world seem to start with the premise that jobs have to be saved. So factories have been like nerf balls. You can squeeze them down to nothing, but when you let them go they spring right back up.
 
·         Cooperation among brands to improve the order flow and restrict supply after the preseason.
 
Aside from being blatantly illegal, at least in this country, what I call the “You First” principal of business, where no company will do something first unless its competitor is willing to do it, makes it unlikely this can be done.
 
·         Convince the retailers to cooperate in the long term interest of the industry.
 
These get more and more unlikely as you go down the list.
 
·         Tell SIA to fix the problem.
 
They are trying with the on snow show in Salt Lake. If, as I believe, they are focusing on symptoms and not the fundamental problem, it’s not enough.
 
So far, most of this article has explained how we’re attacking the wrong problem. It has ridiculed the proposed solutions and expressed pessimism that we can do anything but suffer the fate of the ski industry. If, as a result, you’ve been persuaded to see the problem a little differently, maybe you are ready to consider a different approach.
 
First, I want to suggest that you support the show in Salt Lake. It’s not “the solution,” but it’s a start and right now it’s all we’ve got.
 
Second, nobody can measure in any meaningful way how big the problem is and how it has changed over the years. I asked maybe half a dozen snowboard companies “What percentage of your projected annual sales are booked in the preseason and how does that compare to three years ago?” Most didn’t have a specific answer or wouldn’t tell me. Some think it’s less, some more. At a middle of October in Washington State, Dave Ingemie, President of SIA, gave a presentation on sales for this season. He presented clearly the preseason bookings for skiing. When he got to snowboarding, he basically said “Sorry, we don’t have the data yet.”
 
Lacking good information and the ability to quantify the extent of the problem, it’s hard to see how we can try to manage it, or even say what it is. We’ve got to trust the company that collects data for SIA, or we’ve got to trust somebody else. It’s somewhere between sad and funny that some people are looking to SIA to take the lead but won’t help them collect the industry information they need to develop plausible options.
 
Third, companies have to look more formally at their volume versus margin assumptions. It may not be in their interest as brands to grab ever last unit of sales they can get in an endless battle for market share. If they can take that approach, then their interests and those of the industry can begin to approach each other a little.
 
It’s an up hill battle. I’m suggesting we try and do what no industry I know of has succeeded in doing. I don’t know the solution, but I am convinced that without good information we can’t hope to find one.
 
For example, saying “Let’s fix the buy/cycle” doesn’t lead us anywhere useful. But if knew what the average gross profit margins was by product for each of the last three years, at the wholesale and retail levels, and we knew what total sales by units were, then perhaps we’d begin to be able to have an intelligent conversation about how volume impacts profitability, again motivating a convergence of industry and company interests.  
 
Making broad generalizations about solutions to the wrong problem won’t get us anywhere. Carefully analysis of higher quality data may lead us to manageable opportunities to make incremental improvements that won’t seem quite so overwhelming.
 
There’s a lot at stake. I think it’s worth the effort.

 

 

Money: That’s What I Want. Sources of Capital for a Growing Business

/0 Comments/in , /by

If your only business is snowboarding, you need money for three reasons. First, your business should grow at least as fast as the industry, and that growth translates into more cash tied up in the business. Second, extreme seasonality and the extended dating customers are demanding requires more working capital. Finally, tough competitive conditions are probably reducing margins, leaving less cash flow for each unit of product.

Adequate working capital is never enough to make a company succeed. Survive and continue, yes- but not succeed. On the other hand, not having enough capital has destroyed many businesses that were otherwise viable. Another time we’ll talk about determining how much working capital you need. For the moment, let’s assume that’s done. The subject for today is where to find it.
 
Two general comments about raising money. First, the only thing we know for sure about your estimate of capital requirements is that it’s wrong. We don’t know it you’ll do better or worse than projected, but either way, your capital need is usually greater than anticipated. Most investors, when looking at a new business, assume that twice the capital projected will be needed. Allocating an additional 15 percent for surprises may make sense if you’re budgeting a project for an ongoing, established business, but it’s wildly optimistic for a startup or fast growth.
 
The second thing to recognize about raising money is that it takes longer than you expect and requires your continuous attention, especially if you’re raising equity. Plan to be distracted from running your business.
 
The smaller and less established your company is, the tougher it is to find capital unless it comes out of your pocket. Profitable, established companies have an easier time of it, but the options are essentially the same.
There are only seven places I know of where you can find capital.
 
·         Your pocket
·         Your friends’ and relatives’ pockets
·         The bank (including bank like entities like the Small Business Administration)
·         Asset Based Lenders
·         Third party private investors
·         Your customers and suppliers
·         The public markets
 
Let’s look briefly at each one.
 
Your Pocket
 
Nobody is going to invest in your business unless you do. As a result, most small businesses get started with the owner’s personal capital. It can be a home equity loan, savings account or an advance from your credit card, but it’s going to be your money.
 
Your Friends’ and Relatives’ Pocket
 
“Joe’s starting a business!” I’m putting up $5,000 and we’re all going to get rich!” People you know well are the easiest to approach, and the most likely to be supportive. Nobody likes rejection, and you get a lot when you’re raising money.
 
People who love and trust you may not ask the hard questions a banker or third party investor would ask. As a result, your expectations and theirs may not converge. Especially when taking money from friends and relatives, make sure the relationship is defined as rigorously as it would be with somebody you didn’t know.
 
Is the money a loan or equity? Do they expect dividends? A job? Are they really prepared for the possibility of losing all or part of the money? Can they truly afford it? How do they propose to get their money out of the business? By when? It’s hard not to accept cash when you are enthusiastic about your business and it is offered with so few strings attached. But spelling out the relationship now will save you money, time, headaches and friends latter.
 
A client of mine has an exciting new product. His partner is contributing his time, professional expertise and reputation, and some cash for a stake in the business. The agreement they’ve got calls for him to receive 25% of the “net profit” after allocation of direct expenses and “appropriate overhead.” It isn’t clear if he continues to receive such compensation after he leaves the company. We’re rewriting the agreement to eliminate the ambiguities. Imagine all the fun the lawyers could have arguing over what “net profit” and “appropriate overhead” means.
 
The Bank
 
Banks are in business to earn some interest and a little fee income. They aren’t interested in sharing the risk of your business with you. The wise person who said “Banks will only lend you money when you don’t need it” was basically right.
 
What a bank will do is look at your company’s performance for stability and consistency. But even a small business that’s consistently profitable and been around for a while isn’t typically going to get an unsecured line of credit. The bank will require a security interest in inventory and receivables. They will probably also insist on a personal guarantee. From their perspective, a small business owner and his business are the same entity because the owner controls and flow of money between the company and himself.
 
A startup or company that isn’t stable and established won’t get a bank loan, though that doesn’t mean they can’t get money from a bank based on the owner’s personal assets.
 
Asset Based Lenders
 
An asset based lender functions much like a bank, but is willing to take more risk. They compensate for this by charging higher fees and interest, controlling access to the money according to a carefully defined formula, and tracking the assets they control as collateral very carefully. A bank looks at your cash flow as a primary source of repayment. That is, they analyze your company as a continuing entity. An asset-based lender is less concerned about profitability than about their ability to liquidate the company’s assets for at least as much as they have lent to you. Your business may collapse, but the asset based lender still feels they will get every cent they have coming to them.
 
Third Party Investors
 
The good news about a professional investor is that they will put you through a more rigorous legal, business, financial and market evaluation before making an investment. At their best, they will provide you with skills and experience that will help you build your business in addition to access to capital. The possible downside is that they will take control out of your hands, may have active involvement in the company, and will be looking for a big return. They will be in your business to make money.
 
It seems that everybody who knows the term venture capitalist thinks they are the place to go to finance a new business. But venture capitalists invest in, say, ten businesses expecting eight of them to fail to live up to expectations. That means they are only interested in you if you can demonstrate the potential for rapid growth with a clear competitive advantage or unique product. It also means they generally aren’t interested in investing $50,000. At a couple of million you may get their attention.
 
The reason is simple. The time and effort they put into making an investment is expensive. It represents too big a percentage of a small investment. Nor can they expect the returns they want to aim for on smaller deals.
 
Your Customers and Suppliers
 
A larger company who wants to work with you may be willing to provide some up front payments to get your product. Suppliers often offer terms to companies they hope to expand their business with if required by the competitive situation. At its best, you get terms from your suppliers such that you collect from your customers before you have to pay the supplier.
 
These business cycle dynamics can be an often overlooked source of working capital.
 
A client of mine that is producing interactive conference calls (almost like talk radio over the telephone) has found its large corporate customers so anxious to use the service that they are being paid in advance. Essentially, they can grow without raising any outside capital by utilizing the business cycle they have created.
 
The Public Market
The advantages of going public are that you get a higher valuation of your company, access to future funding, and liquidity for your personal equity in the business. The disadvantages are the reporting requirements of a public company, the fact that your company is something of an open book, the loss of flexibility, and the expense. I understand somebody else is doing an entire article on going public in this issue, so that’s enough said by me on the subject. 
 
Those are your choices. Which one is right for you depends on how much capital you want to raise, what you want it for, the history of your business, and its prospects.

 

 

Getting In Deep Trouble; Why Companies Get There, and What it Takes To Recover

/0 Comments/in , , , /by

It doesn’t matter if you’re a retailer, distributor or manufacturer. It doesn’t even matter if you’re in the snowboard business. In every industry, companies get in trouble for the same basic reasons, and require the same things to recover

All businesses in trouble share two characteristics: denial and perseverance in the face of inescapable change. It’s easy to believe in what worked in the past, and hard to step outside our comfort zone and do things differently.
Businesses suffer from information overload, just as individuals do. Big surprise since businesses are made up of people. When companies get into trouble, day-to-day management of immediate crises (like finding enough cash for payroll) consume managers. Their ability to identify opportunities and problem solutions decline because they can’t see past the next phone call from an irate creditor or reluctant supplier. Pretty soon, they’re paralyzed by action. Managers and staff alike are frantic, but nobody addresses the fundamental changes that get companies in trouble in the first place.
A business owner once looked me straight in the eye as he told me that he had to sell his product for under what it cost to produce it. Why? Because that’s what his competition was doing, he said. Denial and perseverance. The fact that he was liquidating his net worth a little at a time and working for less than he could have made at McDonalds wasn’t really something he’d focused on.
The owner of a business can’t afford to shut out critical information just because there doesn’t seem to be time to consider its significance. Ignorance can kill.
Like the frog that won’t hop out of water if the temperature is raised slowly to boiling, many companies seem all too willing to cook rather than change with the business environment.
There are a lot of reasons businesses boil rather than hop out. The five most common ones that I’ve seen in my work with troubled companies include:
Failure to answer the question “What’s the Goal?”
Seems like a simple question, right? What are your goals for your business? Can you measure them? By when do you want to achieve them?
Think about it. How do you know if you’re succeeding if you don’t have tools to measure success and keep you focused on where you want to go? Most businesses that get into trouble have never answered this question and companies jumping into the snowboard business today are often prime example.
Business goals are measurable and realistic. They can always be quantified; an increase in sales, gross profit percentage or dollar sales per employee. Don’t be constrained by traditional measures. If it meets the criteria, works for your business, and keeps you focused, it can be a goal.
Failure to respond to a change in the market
Does anybody doubt that IBM could have dominated the PC market if they had decided to do it early enough? Bill Gates offered them a chance to buy the rights to MS-DOS and they turned him down. Oops.
It’s easy to keep doing what has worked for you in the past. Everybody likes to stay in their comfort zone. A dramatic change in the way your business operates involves perceived risk and is inevitably disruptive and messy. Building an organization that is receptive to change, so that change is ongoing and incremental instead of chaotic, is a critical ingredient of business success.
A character flaw in the owner/chief executive
No, we’re not talking a crook or a psychopath. Like all of us, business executives have strengths and weaknesses. The strengths that allowed Steve Jobs to establish and build Apple Computer became, in the judgment of some, liabilities when it was time to manage the larger, corporate organization that Apple became.
Perhaps individuals who establish and build companies come to believe in and depend on themselves too much. They are often right to think that they can do anything in the organization better than anybody else. Trouble is, they can only do one thing at a time, and this hands-on-everything approach creates a bottleneck at their door and discourages other employees from taking the initiative to solve problems.
Inadequate control systems
“Inadequate Accounting System Scuttles Company” isn’t the kind of headline that boosts circulation, but it should be obvious that you can’t run a business without current, accurate information.
A company I was hired to turn around was operating two businesses on one accounting system. “Nothing wrong with that!” you say. True enough, unless you use one data base for both companies. You credit one business and debit the other. At the end of the month, the books balance, but the numbers are meaningless.
As a result, monumental adjustments were required to create good, meaningful data and they were months behind in doing it. The owner, by the way, was a CPA. Before I ever got there, he’d invested close to $1 million in the venture and ended up losing most of it. Go figure.
Growing too fast
Remember the business cycle; especially in a highly seasonal business like snowboarding. You have to invest money (for salaries, advertising, inventory, whatever) before you can sell anything. The more you sell, the more money you have to invest to keep the business running. It’s called working capital. Profit is an accounting concept. Nobody ever pays their bills with profit. Companies run on cash. If you grow faster than your financial capabilities allow, you can be profitable, but still broke.
If your business is growing (even if it’s not, but especially if it is), do a simple cash projection. It can be as easy as beginning cash balance, plus sources of cash during the month, less itemized expenses for the month, equal cash balance at the end of the month. That number becomes the starting place for the next month. Make it as simple or as complex as you like; whatever works for you.
You know two things for sure about a cash projection. First, that it’s never right. Hey, it’s a projection! Second, that the more you use it, the more valuable it becomes. It’s your money. You must understand the financial dynamics of your business no matter how much you’d like to leave it to your accountant.
Find some quiet time to evaluate your business with regards to these five issues. Better still, have an objective third party whose business acumen you trust evaluate them with you. However hard it is to correct any deficiencies you discover, it’s easier to do now than after the business is in decline.
 
Company Already In Trouble?
What Does it Take To Climb Out?
 
·         A viable business
Evaluate your competitive position. Why are customers going to buy your product instead of somebody else’s? If you don’t have a good answer, ask yourself if the risk you’re taking is worth the potential return.
·         Bridge capital
There’s always a shortage of capital, though it’s typically a symptom rather than a cause of the company’s problems. There has to be cash from some source to keep the business going while the problems are fixed.
·         Management
Managing a turnaround requires a different set of skills than managing a healthy company. Often the individuals who were at the helm as the business declined are the wrong ones to rebuilt it, if only because their credibility and confidence is poor.
·         A little time
If creditors have judgments and are attaching bank accounts, the bank has called the loan, and the IRS is padlocking the place for failure to pay withholding taxes, an organized liquidation or bankruptcy filing may be your only choice. Positive changes take time to have an impact. Options decline with circumstances.
·         A plan
You have to convince yourself, your employees, customers, suppliers banker and other stakeholders that you can recover.

 

 

Dr. Jekyll or Mr. Hyde; The Dilemma of the Skateboard Factory Owner

/0 Comments/in , , /by

“Blanks are killing the industry.” “Yeah, but they give the skater a good deal.” “But pros are what builds the industry, and we can’t support pros on blank margins.” “The problem is that we have too many pros to support.” Etc., etc., etc.

In this highly emotional debate, there’s some truth to everybody’s position. A lot of people seem to feel very strongly both ways from time to time, and it’s an unfortunate source of friction in the industry at a time when it would be nice if there could be a little more cooperation.
It’s a Numbers Thing
Once you get past the strong feelings and the concern for the industry that, hopefully, drives them the dilemma for people with skateboard factories comes down to the numbers. There are two basic business models skateboard factories (or any factory, for that matter) can follow that theoretically make sense. One is higher margin, lower volume. The other is lower margin, higher volume. For companies with factories and brand names, there’s also the internal tug of war between wanting to keep the factory running and maintaining the brand’s position in the market.
Let’s look at two factories- one owned by Dr. Jekyll and the other by Mr. Hyde- and see how the operating perspectives and financial circumstances of these theoretical businesses differ.
Dr. Jekyll
Dr. Jekyll doesn’t own a brand. Just a big old money eating factory that needs to be fed. Whether he makes a single deck or not, wages, insurance, utilities, telephone, interest, and a hoard of other expenses all have to be paid. He’ll make decks for anybody who can pay him his normal price.
Let’s say his overhead (the money he has to pay every month whether or not he makes a single deck) is $50,000. Notice that he doesn’t have to support a team or pay for any ads. He’s making twenty thousand decks a month and the materials and direct labor for each one is about nine dollars.   He sells each of those decks to whoever is going to resell them for, say, fourteen dollars. Here’s how his monthly income statement looks
Revenue                       $280,000           (20,000 decks times 14 dollars each)
Cost of Goods Sold      $180,000           (20,000 decks times 9 dollars materials and direct labor)
Gross Profit                  $100,000
Overhead Expense        $ 50,000
Pretax Income               $ 50,000
Great business. If I believed these numbers were real I’d dump consulting and writing and open my own skateboard factory, which is just what the industry needs.
Mr. Hyde
Mr. Hyde has not only a factory, but also a successful skateboarding brand. It’s not that he wouldn’t accept some shop or blank or export orders, but just for the moment let’s assume he doesn’t need to.
His overhead is the same $50,000 a month as Dr. Jekyll. It costs him the same nine bucks to make a deck. But his deepest darkest secret, contrary to his advertising, is that his decks are fundamentally no different from those of his competitors. So he’s justifiably concerned with protecting his brand name, because the perception of that brand name is really the only competitive advantage he has.
He doesn’t want to flood the market with decks, because that would weaken his brand name. Let’s say he makes 10,000 decks a month.[1] Because the brand name demands a higher price, he can sell them to retailers for $30. Here’s his monthly income statement so far.
Revenue                       $300,000           (10,000 decks times $30 a deck)
Cost of Goods Sold      $ 90,000
Gross Profit                  $ 210,000
Overhead Expense        $  50,000
So far, this is an even better business than Dr. Jekyll’s is. If the expenses stopped right here, Mr. Hyde would have a pretax profit of $160,000 compared to $50,000. I want to be in the business even worse than the first one.
But the expenses don’t stop here, so let’s keep going. There are going to be operating expenses other than overhead. He’s got more customers to deal with and more selling expenses. In additional to what I’ll call administrative selling expenses, there are the advertising and promotional expenses to support the brand; team, trade shows, stickers, advertisements, giveaway product, sponsorships, printed selling materials, the web site…. Quite a list.
Just for fun, let’s say that those costs total another $60,000 a month, bringing the pretax profit of Mr. Hyde’s business to $100,000. Without claiming that these models really represent existing reality in the skateboard manufacturing business, let’s see what we can learn from them.
By the Book
 
The textbooks say both of these business models- higher volume, lower margin and lower volume, higher margin- should be viable in the same industry at the same time.
The first, utilizing a price leadership strategy, makes money by spreading costs over a larger volume and eliminating most traditional selling expenses. If Dr. Jekyll can sell 10,000 decks a month, and assuming his overhead remains constant at $50,000, he breaks even that month. Every additional deck he sells in excess of 10,000 generates $5.00 (The selling price of $14 minus the direct costs of $9) that falls right to the bottom line. In our simplified model, he should be theoretically willing to accept any order (after 10,000 decks) that pays him more than $9 a deck.   The factory is sitting there anyway with fixed overhead of $50,000 a month and if he sells a deck for $9.01 that’s an extra penny in his pocket.
Mr. Hyde’s breakeven point is 5,238 decks a month even though his expenses below the gross profit line are much higher than Dr. Jekyll’s. Shows you the power of a higher gross margin, and value of maintaining the market position of your brand doesn’t it?
Mr. Hyde has a factory to feed too and even with a successful brand, he isn’t immune to the thought that every deck he makes for more than $9.00 puts some money in his pocket once he’s past his breakeven point. He realizes of course, that he’s essentially competing against himself by making OEM decks and maybe hurting the market position of his own brand, but there’s that factory to feed
It seems at the end of the day that there’s a little Dr. Jekyll in Mr. Hyde.
The Real World
Putting the textbooks on microeconomics back on the shelf (maybe in the section marked “fantasy”), we rejoin Dr. Jekyll and Mr. Hyde in the real world.
You see, lots of other people saw those numbers in the textbook and thought they could have a business like that too. They started factories and brands. When potential customers come to see Dr. Jekyll, and he quotes them $12.00 a deck, they mention that down the street it’s only $11.50 a deck, or maybe that there’s some quantity discounts, or possibly some terms, or an extra deck thrown in for every ten you buy, or something. Well $11.50 isn’t that much different from $12.00 Dr. Jekyll reasons. He still gets a good gross margin. Of course, his break even just went up some decks, but that’s okay. He can accept a couple of shop orders he’d been turning away.
Could be that more than one customer asks for lower prices. Maybe he has to go even lower than $11.50. That breakeven volume of decks keeps going up, and the margin declines further. The lower margin means he has to invest more cash in the business. Getting more volume, from anybody who wants a deck, becomes his purpose in life.
A funny thing happens on the way to higher volume. At some point, he’s got to buy more equipment. Maybe he has to pay overtime wages to support the production volume. His beautiful business model has gotten ugly. Margin is down and overhead expense is up. What’s he supposed to do?
Maybe he can start a brand.
Back at Mr. Hyde’s place, he notices there are lots of new brands, and that it’s getting really cheap to get decks made in small quantities with or without graphics. Determined to defend his brand name and market position, he hires some more team riders, runs some more ads, or whatever. In spite of these efforts, his volume drops a little because there’s an awfully lot of product out there and it’s awfully alike. So his total gross profit is down because he’s now spreading his constant overhead over fewer decks. His expenses have increased because of the new advertising and promotional expenses.
He suddenly remembers the guys he threw out of the place because they wanted him to make OEM decks and scurries to try and find their business cards.
Dr. Jekyll and Mr. Hyde are both to be congratulated on the logical business decisions they have both made. How come things just keep getting worse? What can they do to fix this? Could it be that their existing business models don’t work under emerging competitive conditions and that focusing only on competing in the hard goods market for core (whatever that means) skaters isn’t the answer?
Tune in next issue for the continuing adventures of Dr. Jekyll and Mr. Hyde.

[1] In practice, of course, a brand with a factory doesn’t just sell decks, and its costs aren’t just those associated with the decks. Margins also vary depending on whether or not sales are to distributors or direct to retailers.   But I’m trying to make a point here, so give me a little leeway and let me keep it simple.

 

 

Don’t Worry, Be Happy, Part II; Skateboarding will Survive a Slowdown

/0 Comments/in , , /by

It was three or four months ago that I stopped getting the nearly weekly calls and emails from somebody who wanted to open a new skate shop. As weeks dragged on without the sound of enthusiastic voices eager to make their mark in skateboard retailing I wondered if that wasn’t a sign of a market top.

 
Now, as you all mostly know, sales are a bit soft. As usual, there’s not a heck of a lot of hard data, but it feels like the luckiest ones are just seeing slow growth (single digit) while the less fortunate are down from last year. Various youth oriented retailers (Hot Topic, Gadzooks, Children’s Place Retail) have reported some weaker than expected results. Vans reported that their comparable retail store sales for the quarter ended May 31 declined 7.4% from the same quarter the previous year.
 
Recent government economic statistics have confirmed what we who have to deal with reality already knew- the recession last year was a little worse than advertised. There’s some talk now that we could have a double dip recession. After the decade of prosperity it wouldn’t surprise me if we had a bit more of a counter trend.
 
Screw all that. Anybody in the skate industry who truly thought skateboarding was going to grow like a well-fertilized weed forever was not in touch with reality, to use the polite term. But our demographics are still favorable, the major brands haven’t screwed up their distribution, skate parks are popping up like mushrooms, and skating seems to be gone mainstream without, so far, losing its coolness. The people selling skate apparel to the lifestyle crowd should be sending royalty checks to the skate hard goods companies.
 
So maybe we aren’t quite gushing cash like we were. Maybe we don’t need to make skateboards 24/7 right now. That doesn’t mean you can’t have a good business, enjoy the industry and make some bucks.
 
A Lesson From the Ski Business
 
Yesterday I talked to a ski industry veteran who told me about brand name shaped skis on sale for $49 and $59 a pair. Shaped skis are the skis that pretty much took over the market a few years ago. Being easier to learn on and turn, I’m told, they relegated most straight skis to the dump. If they’re so hot, how come they’re selling for less than cost at retail? For less than a complete skateboard, come to think of it.
 
Oh, for the usual reasons. Desperation to stay alive. Willingness to exploit a formerly hot brand. Lack of product differentiation. Fighting for market share rather than focus on brand positioning. 
 
As an industry, skateboarding isn’t and won’t be immune to these kinds of shenanigans. The best thing we have going for us is that the major hard goods companies know they have to control their distribution or they’re screwed. Unlike skiing, or snowboarding for that matter, the skate companies seem to know it and are actually acting on it. In its heart of hearts, each core skate company seems to know that if one of its competitors tries to blow open its distribution, it will clobber that brand, not leave the others in the dust. The snow/ski companies knew the dangers of pushing distribution too hard, but couldn’t resist the urge to fight for market share by expanding that distribution. That’s why there are $49 shaped skis and the Vision snowboards are right next to the Burtons in Garts.
 
How can we avoid this fate?
 
Being a Successful Retailer
 
Well, apparently you read Skate Biz. Every issue, Skate Biz highlights one or more skate shops that have been successful. Get all your back issues (you do keep them in a safe and secure place don’t you?) and open them to the pages talking about these shops. Read the articles on the shops from each issue. Now make a short list of what pretty much all these shops do. In no particular order, your list will look something like this.
 
  1. They’ve all been around a while
  2. The owner is actively involved in management and is in touch with the customers.
  3. They have some kind of budget and cash flow awareness. They watch inventory and expenses.
  4. They can tell you, in a general sense, who their customers are. There is customer loyalty.
  5. They are involved with the community and the sport.
 
You’ll note that these five points don’t just apply to skate retailers, which is fine as most shops sell something besides skate.   
 
There’s one more thing I think more and more of them should be doing. Rather than running ads and doing various other kinds of non-focused advertising, they should be using email and the internet to not just reach their customers, but to have a relationship with them. I didn’t say sell on line. But most skate shop customers are email and internet users I suspect, and that’s a huge opportunity to reach exactly the right people with information they actually want at a low cost.
 
“Good” Competitors
 
I was afraid this article was going to end up as another boring discussion of things to do when business is a little soft. You know- control expenses and inventory, protect your brand, stay focused on your core customer, and stuff like that. Each business needs to do those tactical things.    But instead, let’s talk a little more strategically about something I’ve touched on from time to time- industry structure and what makes good competitors.
 
We all know that the core skate companies do and have done a lot to grow and promote skateboarding. It’s almost an article of faith that that’s a good thing, and it is. What does it really mean though?
 
It means, up to this point at least, we’ve had a group of largely “good” competitors. Though they were for sure competing with each other, they largely did it in a way that’s been good for the industry.
 
They have stayed committed to the technology that goes into making skateboards, trucks, wheels and bearings. By legitimizing this technology, entry barriers have been created by defining what a skateboard is and is not. They have made it difficult for new brands and products, even from much larger companies, to come into the market and succeed.
       
They have shared the cost of developing the market. There is no single dominant company in this industry that could have done it alone. Their common focus and direction is, in a word, remarkable. As a result, they’ve increased industry demand to the benefit of all.
 
Generally, they’ve been pretty risk averse. They haven’t gone out looking for growth and market share at all cost. They have been very conservative in adopting any new technologies. Mostly, they haven’t tried to expand outside of skateboarding and they’ve been cautious about their distribution. In fact, it’s tough for new entrants to gain access to distribution channels. Being risk adverse means they haven’t had to react to each other in ways that are detrimental to industry structure.
 
Because the companies have been risk averse, the consumer’s risk when buying a skate product has been reduced. Basically, the products are pretty much the same and work pretty well. Maybe more importantly, no skater ever has to risk being laughed at by his friends because he bought “the wrong” product. He can always find something that functions well that meets the social requirements of his circle of friends.
 
To put it simply, the strategy of the leading brands helps to perpetuate industry structure. How did it happen that everybody has been so cooperative? I don’t exactly know. I guess I could speculate that it has to do with the fact that most of the company principals grew up in skating, know each other well and share a common perspective on the industry. It’s also because they’ve got a good thing going and because the industry is pretty small. Maybe this is one of those times when “why?” doesn’t matter. It exists and it’s great.
 
But, while we’re still a small industry we’re not quite so small anymore. Or at least we’re not quite so unnoticed. The customer base has expanded and maybe isn’t composed of mostly “core” skaters in quite the way it use to be. People with less interest in keeping things the same are becoming involved in skating. Skate brands and companies will, I believe, find their way into the hands of organizations with less perceived interest in being “good” competitors. 
 
As I’ve discussed in my last article, there may be some pressures emerging that will make it tough for the skateboarding industry to continue along as it has. At the same time, I’ve never known an industry where the interests of all the leading companies were so aligned and consistently pursued for the ultimate benefit of the industry. Maybe they’ll surprise me and keep doing it.