A Sustainable Competitive Advantage: The Zumiez 100K

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I have written before about the value of Zumiez’s hiring, training, and promotion process. They take kids with a passion for the activities and brands their stores sell, train them, support them, make them compete with their peers, and promote the ones who succeed. The average age of store managers is something like 23 and pretty much all their district and regional managers started out as sales people in a store. 

This approach to culture and staffing is so important to them that it’s been allowed to impede their growth plans when they couldn’t identify enough good people to staff new stores. In hindsight, I imagine they are thrilled that happened given the way the environment for brick and mortar is evolving.
 
Anyway, it’s easy to read SEC filings and intellectualize about this, but when you walk into the annual 100K party at Keystone, where the company’s best sales people are celebrated, you look up and see a sustainable competitive advantage staring you right in the face. That’s never happened to me.  The fact that I was afraid I was the oldest person in a room of 1,300 only dampened my enthusiasm a bit.
 
A competitive advantage is only sustainable if none of your competitors can duplicate it. I suppose somebody else could do what Zumiez does, but they’d better get started. They’re 30 plus years behind.
 
I’m guessing most of the Zumiez sales people don’t read my column. If they wrote one I’d sure as hell read it to find out what brands were succeeding. If they did read it, I’d tell them how lucky they are to have jobs involved with something they love (hell, maybe just to have jobs), solid support and training, the opportunity to advance based on performance and, if they want it, a career.
 
And finally, I’d tell them what a great thing it is to be part of something that can support and validate them. Without getting too deep into generational history (read this book if you are curious what I’m talking about), let’s just say that this is a group of young people who are going to have to pull together to solve some big problems not of their making. I’m seeing it with my own kids (they don’t work at Zumiez) as they form groups and relationships outside of the immediate family that involve strong personal bonds. I see it where I went to college, where the number of students who return for reunions are much larger than they ever were in my generation.
 
So the environment Zumiez has created not only works for these young people, but for Zumiez as well and is consistent with the way generations turn over and repeat themselves in our society over decades. And it has significant implications for how any brand markets itself today.
 
But, as usual, I digress. Back at the 100K, the introduction of brand founders was particularly interesting. In groups (there’s a lot of them), they march founders out on stage and give each one a chance to say a few words. Somebody told me they’d meant to bring a decibel meter to measure the applause each brand got (or didn’t get). That would have been brilliant. I would love to publish that list with the noise levels listed.
 
Among the brands that got the loudest cheers were brands that are urban, or youth culture, or whatever word you want to use. But they were definitely not action sports brands. Not to say that some action sports brands weren’t well received, but I thought the reception of the various brands was a good indication of how the industry is evolving.

It is true that a deeply imbedded, successful culture can be destructive to a company if the culture resists evolving with the competitive and economic environment. I can’t say for certain that Zumiez (or any other company) won’t someday have that problem.  But Zumiez can minimize that potential by just letting the young sales force that is part of its target demographic drive brand selection and be the arbiter of what’s “cool.”  If they do that I think this competitive advantage can continue to be sustainable.  That’s a hell of thing and unusual in our industry.

 

 

Why Crocs Might Go Private

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I’ve been holding on to this article on Crocs for a while mostly because I just didn’t have time to do anything with it.  What it says is that Crocs is looking to go private because it’s just not as cool as it was.  Currently, it’s traded under the symbol CROX on the NASDAQ and is at $12.88 as I write this.  Here’s a five year stock chart on the stock’s movement.


You’ll note that the stock is trending down at a time when the market has been trending up. 

In the 9 months ended last September 30th, Crocs earned $77.4 million on revenue of $964 million.  That doesn’t sound so bad.  Okay, but in the same 9 months in 2012, it earned $135 million on revenue of $898 million. Selling more and making less.  If that isn’t a sign of being less cool, I don’t know what is. 

So what have we got here?  The gross margin for the nine months fell from 55.8% to 53.9% and selling, general and administrative expenses rose 18.3% from $350 to $414 million.  Operating income fell from $151 to $106 million.  I’m going to resist the urge to do a complete financial analysis (I hear those sighs of relief).   

My point is simple.  It seems a lot of people still want to buy Crocs, and the company can make money.  What they can’t do is satisfy Wall Street’s endless demands for the growth that makes stock prices rise.  And I’ll bet anything that if they try to do that, their gross margin will continue down and the brand will lose credibility as it tries to push its distribution harder, faster, further.  Remember it would be trying to do that in a poor economy with a lot of competition. 

Is this starting to sound at all like any other companies we follow? 

Some smart person probably said, “Hey, if we weren’t public, we could pull back our distribution, improve our brand positioning and gross margin, cut some expenses (from not being a public company and because our improved distribution would let us reduce some marketing expenses) and maybe make more money with less working capital invested!”  Perhaps they’d consider closing some of their 600 or so stores as well. 

Maybe that would work or maybe, for this brand, it wouldn’t.  But continuing to try and satisfy the requirements of the public market looks like a bad plan.  I haven’t heard that there’s a deal done yet.  I’ll let you know if I hear and you do the same for me.

K-Swiss Acquisition of OTZ Shoes: There’s More Here than Meets the Eye

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When I first read about this deal, I thought “Good for the team at OTZ. I hope K-Swiss does well by them” and kind of let it go. Then at a reader’s urging, and through a few clicks on the internet, I decided there might be something to write about here. I don’t have any information that isn’t public. 

First, I went and looked at K-Swiss. It felt like a confused brand. It’s certainly not action sports. It’s part casual footwear and part athletic footwear. It’s not youth culture as I think about it. It kind of seems like casual sneakers in search of a market position (Well, there’s another company I’ll never consult for).
 
Apparently, I’m not completely out of line to suggest that it had some issues. Its stock reached an all-time high in the middle of November 2006 at a bit above $37.00 a share. In January 2013, right before its acquisition by E.Land was announced (I’ll get to that) K-Swiss stock was trading at $3.13 a share.
 
Its last 10K filing for the year ended December 31, 2012 showed sales that had dropped over the year by 17% from $268 million to $223 million. It lost $35 million dollars and had lost money in the three prior years as well. It last turned a profit in 2008, when it earned $21 million on sales of $327 million. Guess it’s at least partly a victim of the economy.
 
OTZ Shoes, according to its web site, was conceptualized in 2005 and came into being in 2009. The idea was based on “… the oldest shoes ever found. These belonged to Oetzi, the iceman, and dated back to 3300B.C. The shoes were quite remarkable considering the time period – made of deer skin stitched to a bear skin sole with an internal woven net filled with dried grass and moss for warmth and comfort.”
 
OTZ CEO Bob Rief should expect a call from me, because I really, really want to know if they ever tried to duplicate those shoes out of the original materials just to see how functional they actually were. Don’t suppose you could sell them, but it would have some PR value.
 
If forced to characterize the OTZ brand, I’d call it outdoor with a cool factor. It’s not action sports in the traditional sense, but that’s fine. The connection to Oetzi and the oldest shoe in the world lends the brand a distinctiveness. I hope they cherish and manage that well because it might be a long term point of differentiation. I’d suggest more pictures and info on Oetzi and his shoes on the web site. I’m surprised there aren’t any. Maybe copyright or trademark issues?
 
What initially troubled me was that this deal felt a bit like Kering (formerly PPR) buying Volcom and Deckers buying Sanuk. In both those cases, a larger company that was kind of circling the youth culture/action sports space wanted credibility and an entrée to those consumers. In both cases, so far, the deals haven’t worked out the way the acquirers envisioned, especially given the prices they paid.
 
Under the acquisition agreement, “…OTZ Shoes will continue to operate as an independent subsidiary of K-Swiss Inc., with key executives remaining in place.” Let’s hope that deals holds up. I’d be very curious as to what the actual language in the contract says.
 
Then I thought to myself, “K-Swiss’ problems look like they go way beyond anything OTZ can resolve no matter how successful it is,” followed by “Why has OTZ allowed itself to be bought by a company that’s going south at a disturbing rate?”
 
Turns out, there was a simple answer. On April 30, 2013 E-Land, a Korean conglomerate, concluded the acquisition of K-Swiss that was announced in January. Here’s the press release. It says, in part, “Established in 1980 in Korea, E.Land has grown to become one of the largest South Korean conglomerates, primarily specializing in fashion and retail/distribution. E.Land is Korea’s first and largest integrated fashion and retail company, with operations spanning nine different countries across three continents, including Korea, China, India, the United States and Italy. Comprised of over 60 affiliated entities, the Company offers close to 200 brands and operates more than 10,000 stores worldwide, recording approximately US$7.1 billion of revenues in 2011. E.Land’s newer businesses also include restaurants, construction and leisure.”
 
That’s a lot of brands and a lot of stores. Clearly OTZ and K-Swiss will have the resources they need. I have to imagine that E.Land management hopes the team at OTZ can be of assistance to K-Swiss, though for all I know K-Swiss can grow by leaps and bounds just by being in E.Land’s distribution channels. Then again, I just wrote about Decker and expressed some concern that they might not understand what they’d bought in Sanuk and that they might try to distribute it in ways that wouldn’t help the brand. 
 
Obviously E.Land will offer OTZ some opportunities to expand distribution. I hope the independence that OTZ has been promised extends to having control over when, where, what kinds of stores the brand goes into. I’m also wondering if we can expect more acquisition from E.Land in our space.

VF’s Strategy; Why it is Consistent with the Competitive Environment

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VF filed its 10K annual report with the SEC three days ago, so I’ve been able to get a more complete picture of their performance for the year and quarter. You can see that report here. As you probably know, VF is a large consumer conglomerate that owns 30 brands including Vans, The North Face, Reef and Timberland which are part of its Outdoor and Action Sports segment. Its other segments include Jeanswear, Imagewear, Sportswear and Contemporary Brands. We’ll talk about the general strategy and focus on Outdoor and Action Sports. 

Pieces of the Strategy
 
Revenue for the year rose 15% as reported from $9.46 to $10.88 billion. Not following my usual process, I want to jump right to the balance sheet and report that inventory fell 6.8% over the year from $1.45 to $1.35 billion. Partly what’s going on here is that they are getting their Timberland acquisition (purchased in September of 2011) under control. But typically, you’d expect inventory to rise some with sales and when it’s doesn’t, it’s a good thing.
 
Now let’s jump to page 1 of the 10K to see what their broad strategy is:
 
“VF’s strategy is to continue transforming our mix of business to include more lifestyle brands. Lifestyle brands connect closely with consumers because they are aspirational and inspirational; they reflect consumers’ specific activities and interests. Lifestyle brands generally extend across multiple product categories and have higher than average gross margins.”
 
Connection with consumer and higher margins. No wonder they like outdoor and action sports.
 
Meanwhile, over in the conference call, VF Chairman, Chief Executive Officer, President, Member of the Finance Committee and for all I know Czar of all the Russians Eric Wiseman talks about their other focuses.
 
“…an obsessive focus on continuously improving our operational capabilities to drive growth and strong consistent returns to our shareholders; and finally, a highly efficient supply chain that includes owned and sourced manufacturing, which gives us unparalleled structural advantages, including product innovation, speed to market, low cost and outstanding quality. Individually, any one of these strengths would be an enviable asset for any company to have. Yet together, in concert, they’re at the center VF’s DNA and what allows us to be so successful.”
 
Keeping the supply chain efficient is no simple task. From the 10K:
 
“On an annual basis, VF sources or produces approximately 450 million units spread across 36 brands. VF operates 29 manufacturing facilities and utilizes approximately 1,900 contractor manufacturing facilities in 60 countries. We operate 29 distribution centers and 1,129 retail stores. Managing this complexity is made possible by the use of a network of information systems for product development, forecasting, order management and warehouse management, attached to our core enterprise resource management platforms.”
 
I don’t want to put VF on a pedestal here. There’s a never a section in the press release, conference call or SEC filings called “Places where we really, really screwed up.” It does not always go smoothly. 
 
Nor is it ever finished. I wouldn’t be surprised if a big piece of CEO Wiseman’s job was to make sure the whole organization is thinking about incremental ways to make things better. Everybody should be empowered to ask, “If we combine production for these two brands, can we save $0.03 a garment?” “If we make it at a factory we own, will the faster turnaround time mean lower total inventory that offsets the higher cost per piece?”
 
Sales increases are swell, but it’s nice to have ways to improve your profitability by increasing gross margin dollars or controlling expenses if they aren’t easy to come by. And it’s good to have a balance sheet that lets you invests in efficiencies- especially if your competition can’t.
 
VF is trying to do what I’ve been arguing in favor of for years. No wonder I like them.
 
The Outdoor and Action Sports Segment
 
This segment generated $5.87 billion, or 54%, of VF’s revenues for the year. It had an operating profit of $1.02 billion, representing 58% of total operating profit for VF, and an operating margin of 17.4% (higher than other segments with Jeanswear being second at 16.7%). That margin is down from 19.9% in 2010 and18.2% in 2011. The decline is largely due to Timberland.
 
Segment revenues grew 28.6% from $4.56 billion the previous year. Jeanswear is second at $2.79 billion representing 26% of total revenue. It was up only 2.1%. Growth of 6.3% by Sportswear was the second fastest segment growth.
 
But there’s a caveat. Of that 29% growth, 19% was the result of the Timberland acquisition and only 10% was organic (from the existing brands). But 10% organic growth is way better than any of the other segments did, except for “other” which grew 12.5% but was only $125.5 million in revenue for the year. 
 
The North Face is the largest brand in the segment, with Timberland second and Vans third by revenue. There are 100 VF operated North Face stores worldwide. Timberland has 200 stores and Vans 350.
 
Domestically, the whole segment was up 21% but 12% of that came from Timberland. International revenue was up 37% with Timberland representing 26%.
 
The North Face and Vans grew globally 9% and 23% respectively in 2012. Their direct to consumer business, including new store openings, comparable store sales and online, increased 13% and 18% respectively. In 2013, Van’s revenues are expected to be up 20% and The North Face up in the “high single-digit” range. Timberland’s revenues are projected to be up in the “mid-single-digits.”
 
Outside of the Americas, Vans revenue growth was in excess of 30% in constant dollars. It was up 60% in constant dollars in Europe and 20% in Asia. Direct to consumer was “a big part” of this growth.
 
We also learn that Reef’s revenues were up 17%, though we aren’t told anything about what its total revenues are. This is significant only because they haven’t said anything about Reef in the past probably because there was no good news to report. 
 
VF’s total capital expenditures in 2012 were $252 million. Of that total, $156 million or 62% were in Outdoor and Action Sports.
 
Some Overall Numbers
 
VF’s $10.9 billion of 2012 revenue generated $1.09 billion in net income. They spent $585 million on advertising. International revenue was 23% of total. 5% was organic and 18% due to Timberland. Direct to consumer revenue rose 25%, but 15% of that was Timberland. It accounted for 21% of total revenues. They opened 141 retail stores in 2012 and expect to open 160 in 2013. Gross margin improved from 45.8% to 46.5% “…primarily due to the continued shift in the revenue mix towards higher margin businesses, including Outdoor & Action Sports, international and direct-to-consumer.” Hmmm. Sort of seems to leave out North American wholesale business. 
 
For the last quarter of the year, VF’s revenues were $3.03 billion and it earned a net profit of $334 million. No details provided.
 
Okay, don’t stop reading here just because I’m going to talk about pension accounting. This is important. VF made a $100 million voluntary contribution to its pension plan during the year. What’s going on in the world of pensions? Not just at VF. 
 
How much you need to contribute to a pension plan obviously depends on a whole bunch of assumptions involving how many people will get pensions for how long and how much you’ll earn on the money invested in the plan. In 2012, VF assumption was that the rate of return on its pension assets would be 7.5%. They’ve reduced that to 7% in 2013. At the same time, they’ve “…altered the investment mix to improve investment performance.” I won’t go into the details, but from their description, I’d conclude they’ve increased the level of risk in their portfolio to try and earn that lower targeted return.
 
There’s a lot of this going on. Company and government pension plans have found themselves underfunded at least partly because they’ve been stubbornly unrealistic for years about what they could expect to earn on their pension assets. I think they’re still unrealistic. If they reduce the expected rate of return, the required contributions to the plans go up.
 
This is going to be messy. Not for VF necessarily, because they earn a lot of money and can afford to contribute to their pension plan, though obviously it will have some impact on the earnings per share. You’ve already seen some governments have problems in this area. Just be aware is all I’m saying.
 
The Evolution of VF
The Outdoor & Action Sports segment is presently the driver of VF’s success. They’ve acknowledged that in the description of their strategy quoted above that describes the kinds of brands they want to own. If they can improve Timberland’s performance, this will be even truer. As a company, they’ve changed their focus through buying and selling of brands. I don’t expect that to change. They say it won’t. They sold one brand last year. If Outdoor & Action Sports continues to offer the growth and returns it’s getting now, and brands in other segments can’t offer similar ones, I would expect to see further buying and selling of brands by VF.
 

 

Aunt Jenny’s Egg Beater, Hoodies, and Water Heaters; The Evolution of Manufacturing, the Future of Fast Fashion and the Impact of the Internet

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My Aunt Jenny died maybe 12 years ago at the age of like 97. I helped clean out her house and one of the things I saved was her egg beater. It was made by the Dazey Manufacturing Company in St. Louis. I don’t know if it’s 60 or 90 years old. The company is out of business. 

I didn’t keep it for sentimental reasons (I mean, it’s an egg beater). I kept it because it’s the best damned egg beater I’ve ever seen and I wouldn’t know what to replace it with. It’s made of heavy duty stainless steel. Except for some paint chips on the handle, it looks and works like the day it was made. It spins so effortlessly and smoothly that it keeps going for north of half a dozen turns after you release the handle and is well balanced and almost vibration free.   No planned obsolescence here.
 
I really miss products like this. I believe that paying more for a product that lasts a long time (if you can find them) is a better financial decision than paying less and having to replace it often.
 
So I was intrigued to find this article on a hoodie made by American Giant. I’ve ordered the full front zip one for $79.00 (shipping included). It’s made in the U.S., only available online, and is supposed to last a long, long time. The product is backordered due, I assume, to all the favorable publicity they’ve had.
 
They started by redesigning the hoodie from scratch, as you’ll read in the article. CEO Bayard Winthrop “…argues that by making clothes in America, he can keep a much closer eye on the quality of his garments, and he can make changes to his line with much more flexibility. An Asian manufacturer wouldn’t have been able to do all of the custom, intricate work that American Giant’s clothes required.”
 
Okay, hold that thought. Let’s move on to the water heater.
 
The December issue of The Atlantic has an article called “The Insourcing Boom” by Charles Fishman which you can read here. Anyway, General Electric owns something called Appliance Park in Louisville, Kentucky. It includes six factories, each as big a suburban shopping center, and it’s where GE use to make all its appliances. It employed 23,000 at its 1973 peak, but only 1,863 by 2011. They tried to sell it in 2008 but there were no takers.
 
But in February, 2012, they started a new line to make their high end GeoSpring water heaters there. On March 20, they started making high end French door refrigerators there. By now, they’ve probably started making a stainless steel dishwasher and they are working on an assembly line to make front loading washers and dryers, the article says.
 
Bringing certain products back to the U.S. to make has to do with higher Chinese labor costs and, for better or worse, lower U.S. ones.   But that’s not the whole story. When they took a close look at the GeoSpring water heater, they found it was a manufacturing nightmare that could only be justified when labor was $0.25 an hour. In their redesign, they cut out 20% of parts and reduced the cost of materials by 25%. They cut required labor hours from 10 in China to 2 in Kentucky. Quality and energy efficiency improved.
 
Okay are you ready for this? The Chinese made product retailed for $1,599. They were able to cut the retail price of the U.S. made one by 19% to $1,299. I assume they are holding their margins or they wouldn’t have done it.
 
Here’s what I said in a recent article talking about U.S. manufacturing.
 
“Once the labor cost differential isn’t so dramatic, then other costs become more important. Travel, freight, time to market (which impacts the amount of inventory you have to hold), communications issues, surprise delays, custom duties, control of intellectual property and quality control are among the costs that may be higher with foreign production. But most general ledgers aren’t set up to isolate those costs.”  I missed, by the way, energy costs which are also making the U. S. more attractive.
 
“It’s an accounting hassle, and no fun. But if you take the time to figure out those costs, you may find there’s a certain logic to making some formerly foreign produced products in the U.S.”
 
I’m guessing the CEOs of both General Electric and American Giant would agree with me.
 
The American Giant business model works because the product is only sold through their web site. They have no brick and mortar retailers. I may be willing to pay for quality, but if you had to add a retailer’s margin in there, it would be out of my price range.
 
Pretty clearly, the internet can facilitate the sale of higher quality products by avoiding a level of distribution and cost. I’m not quite sure if that’s completely good or bad, but it’s a fact. I’ve written before that I thought we were early in the process of figuring out the model for internet and retail coexisting. Here’s an impact I hadn’t thought of until now; it might facilitate U.S. production and higher quality. The benefits of having design, production, marketing and fulfillment in one place are, I suspect, significant. 
 
Let’s distinguish between fast fashion and supply chain and inventory management. Fast fashion (which I define as rapid turnover of artificially supply constrained product) is a marketing idea. Good supply chain and inventory management is necessary to fast fashion, but it would be a good idea even if nobody ever came up with the fast fashion moniker. It can never be bad to be able to react quicker to the market and hold less product in inventory.
 
Every company I write about these days is talking about managing their supply chain better, reducing their time to market and “micromanaging” their inventory. They don’t all use the term fast fashion, but to some extent that’s what they are reacting to or trying to emulate. It’s so universal it seems like a bubble.
 
I’m wondering if fast fashion isn’t a trend that will run its course. I understand the excitement it can generate, but once the novelty wears off, I am uncertain shopping more often for product that isn’t really that well made just because it’s “new” will support a long term business model. 
 
In the days of our ongoing economic malaise, it can be hard to find a lot to be positive about. But as I use Aunt Jenny’s eggbeater to make an omelet, wait with anticipation for a hoodie I expect will last a long, long time and wonder if I should be replacing my water heater, I’m feeling kind of hopeful about what might be an important long term trend back towards higher quality products and domestic manufacturing.

 

 

PPR Earnings Release and Volcom- Exit Strategies for Core Brands

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This article was occasioned by PPR’s release of its quarterly results, but that’s not really what it’s about. When PPR, or Decker’s or VF or Jarden releases earnings we’re interested in what happened mostly because we’d like to know what’s going on with Volcom, or Sanuk, or Reef, or K2/Ride. We never find out very much. 

Volcom is in PPR’s Sports & Lifestyle Division which includes Puma and Volcom (including Electric). Puma did 821 million Euro in the March 31 quarter and “other” brands in that division, which means Volcom, did 65.6 million Euro. That’s about $87 million at the March 31 exchange rate.
 
Maybe ten days ago, I wrote about Nike’s quarter, indicating it was kind of a waste of time for me to analyze Nike’s financials. Instead, I tried to focus on some comments Nike’s CEO made about sources of product innovation. The goal was to try and provide a little perspective that maybe helped smaller companies in action sports (or maybe it should be called active lifestyles?) think about how to compete and succeed in the eight hundred pound gorilla era. I think that approach is valid not just for NIKE, but for all the large companies that have bought up companies in our industry.
 
PPR management made clear in the conference call that they were disappointed in Puma’s results, and that they were working hard to improve them. At the time of PPR’s acquisition, there was speculation that Volcom might help Puma become “cool” and that we could see a Volcom shoe line created with Puma’s help.
 
At the time of the acquisition by PPR, Volcom was a company that was very strong in its market niche but, in my analysis, didn’t have anywhere to go. It was so closely identified with its niche it didn’t have the strength to break out of it. PPR, with about 4 billion Euros of revenue in the recently completed quarter, and the owner of such luxury brands as Gucci, Bottega Veneta and Yves Saint Laurent, didn’t buy Volcom for its 65 million Euros of revenue (1.6% of PPR’s total) and its growth potential in the “core” market. They didn’t buy it just to help Puma or to do Volcom shoes.
 
What do they have in mind? What do any of these behemoths have in mind?
 
At the most obvious level, PPR saw what VF has done with Vans and The North Face in its action sports segment and the associated growth rates and said, “We want a piece of that too.” If nothing else, you might expect that PPR will be interested in additional acquisitions in the space, perhaps in competition with VF.
 
Neither Nike, nor PPR, nor VF is interested in a brand that has no potential beyond the “core” market. It would just be too small to temp them. When the PPR/Volcom deal went down, I suggested, only partly in jest, that maybe PPR would expand Volcom into upper end boutiques. I (probably) don’t see any product collaboration between Volcom and Gucci. But I’ve watched brands like Nixon get some traction in that upper end market with some of their higher priced product, and I just wonder what’s possible. With PPR’s help, could Volcom open some stores that carried some new classes of Volcom product? Go and see what WESC is doing. 
 
A brand, like Volcom, that’s secure in its niche and roots has the potential to grow out of that niche without confusing its customers and destroying its market. It’s not a sure thing, and it’s not easy. It’s management’s challenge every day.
 
For better or worse, we created that opportunity when we chose to pursue growth across markets and expand distribution. We created a much larger market, but one we couldn’t take advantage of on our own.
 
Large, successful companies in action sports are small, inexperienced players in the broader fashion business. As Volcom discovered, even going public and shoring up your balance sheet doesn’t solve that problem.
 
I’m sitting here trying to think of companies who have smashed through that barrier without help. I’m not doing very well. Everybody who is thought to have the potential to go from core to fashion seems to be acquired.
 
That, I guess, is the strategic point I started to think about as I read PPR’s quarterly report and looked for information on Volcom. A successful exit strategy for an action sports brand owner, in general, will require a revenue size that is proof of concept and is big enough to be interesting to a possible buyer. There also has to be an indication that you can hope, with the right support, to move past the core market and into the much larger fashion space. You can see that’s an issue for hard goods brands.
 
In the future, then, when I review the reports of Nike, VF, Decker, Jarden, VF and any other big companies involved in our industry,  I’ll try and pull our trends and ideas that are more interesting than the change in the current ratio. More fun for me to write. Hopefully, more valuable for you to read.         

 

 

There Is No Action Sports Industry. Or Maybe It’s the Same as its Always Been

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Sometimes I just can’t help myself. Many years ago, I wrote an article called “Are There Any Core Shops Left?” My good friend and editor at the time Sean O’Brien thought enough of it to put it on the Transworld web site for discussion. Without telling me. In hindsight, his instincts were good, but I was the slightest bit confused when I started seeing posts and getting emails that either told me how smart I was or hung me in effigy.
 
I think I might be about to do it again. What I want to tell you is that many of you who think you’re in the action sports business are wrong. And if you don’t act accordingly, things could become difficult. More difficult. I want our old economy back!
 
This has been in my head for a while in unformed ways. The launch of Nike’s Chosen campaign, their investment conference yesterday, an email I got from somebody who’s had a lot of success in our industry, and my evaluation of some of the recent industry deals including Volcom and Sanuk has caused neurons to fire and thoughts to coalesce. So let’s look at just what this industry is and has become, what I think are the major, long term, strategic trends, and the implications for how this industry, whatever it is, will change.
 
What Is the Action Sports Industry?
 
I’ve expressed an opinion about this before, but want to do it a bit more forcefully. The action sports industry is a small industry composed of businesses that sells products to participants in a number of individual sports and to the first level of non-participants that closely associate with the lifestyle and athletes. If that isn’t who most of your customers are, then you’re in the youth culture or fashion or some term I haven’t thought of business.
 
That doesn’t mean that your roots can’t be in action sports, and I’m not trying to imply any kind of criticism of a company that’s graduated out of action sports (we are way, way past any concerns about “selling out”. That almost sounds laughable now). But if you think you’re selling to action sports customers, as I’ve defined them and you’re not, you’ve got a challenge because you’re probably trying to punch outside of your weight class.
 
Why did we ever believe action sports was a bigger industry than it is? That’s easy; it’s due to 20 or 25 years of THE BEST ECONOMY EVER. With rising incomes and asset values, easy credit, and low inflation you can, as the saying goes, sell snow to the Eskimo. So any shop that sold hard goods could be known as a core store. But it wasn’t.
 
As I suggested in the title, then, the real action sports industry is a lot like it’s always been. We just thought it was different. What made it change?
 
Trends We Should Pay Attention To
 
How do you know when a successful brand has graduated out of the action sports market? That’s easy- they get acquired. Somewhere around $40 million in revenues, to pick a number, they start to get big enough to be attractive to a strategic buyer that makes it worthwhile to sell.  Hopefully, they also get smart enough to know that they don’t really have the resources, expertise, or competitive advantage to step outside the action sports market they came from without help. Expect more CONSOLIDATION as the trends I’m discussing here play out. 
 
Volcom pretty much said in their filings that industry conditions and difficulty growing meant it was time to sell while they could get a good price. Look at the deal Sanuk got. Notice that PPR’s CEO specifically said in an interview they didn’t pursue Quiksilver because they didn’t see the growth potential. Buyers want growth potential. Successful sellers know they have it, but that they can’t do it themselves.
 
And that means, if you try and grow out of the real action sports space, you’re going to face some big honking competitors. Bigger all the time. Nike’s almost its own trend. I’ll get to them. Think about Burton in the snowboard space a few years ago. Why did Burton own the hard goods market?
 
First, great product.  I’ve never heard anybody say different. Second, financial strength. That strength meant the best athletes and the biggest advertising and promotion program. So consumers wanted the product and it checked at retail at good margins as long as the distribution was well managed.
 
In its snowboard niche, Burton was like Nike in the athletic footwear market; unless they screwed up everybody was fighting over second place. But Burton has a problem Nike doesn’t have. Nike’s concern, they say, is about picking the best of their growth opportunities. Burton, as best as I can figure it out, hasn’t been able to grow much outside of its core snowboarding franchise. Even if it were for sale, Burton would not be attractive to a strategic buyer lacking that growth opportunity.
 
The lesson? Either plan to stay in the core action sports market, or be prepared to sell when you threaten to break out of it. 
 
Let’s talk about NIKE, THE ONE COMPANY TREND. At the start of this article were a couple of links to Nike that may interest you. Here’s another one to a press release on a conference they held last year. It’s worth a read. I actually have the transcript of that conference, though I can’t find it on line any more. It’s 75 pages long but worth reading. If you’re really interested, let me know and I’ll send you a copy.
 
Nike is $20 billion in revenue. As you’ve no doubt read, they are now taking the Nike brand directly into surf, skate and snow. They think they’ve now got the credibility to do that, having been somewhat cautious in their approach for a couple of years.
 
I have to say their timing surprised me a bit. For years, Nike flopped around the action sports space screwing up their attempts to get in it. Then they got a little realistic and decided to exercise some patience. They hired a few of the right people and used their unmatched product capabilities and financial strength to edge their way in cautiously. I thought they were doing fine. But it feels like they might have run out of patience sooner than they should have.
 
It will be interesting to see if the Chosen campaign is seen as authentic or arrogant.     
 
In its investment conference, Nike talked about its ability to market and merchandise a product or brand down to the city level. They pointed to their focus on customizing product for individual consumers (try it on line!). They discussed the process where an innovation from one product makes its way to other products and brands. They were very thoughtful about the integration of brick and mortar and digital and expect growth there. The analysis they’ve done about what kind of stores to put where is intriguing. And they had a good discussion of their integrated systems for managing costs and inventory, which I love.
 
Of course, it’s their investment conference, so you’d hardly expect them to highlight where things hadn’t worked out so well. Still, it was impressive. There was a clear analytic framework that I think gives them unusual flexibility for a company their size.
 
And that brings me to the email I received from the gentlemen with a lot of success in our industry who said, in part, “Based on how they [Nike] have single handedly destroyed the competitive brand environment in sports like Football, Tennis and Golf does this mean that Action Sports brands have to work on the basis that they will be relegated to being a fringe player in a culture and sport they created?”
 
Well, maybe. But let’s not over dramatize this. There’s nothing we can do about how Nike (or any of the other large companies) runs their business except, in this case, maybe learn some lessons from them based on the things they do well. I might have said this a time or two, but don’t worry too much about what the competition is doing- just run your own business well. If you adopt just a bit of Nike’s thoughtful, analytical approach to your market, you’ll be doing a good thing.
 
One thing you might think about is whether Nike is trying to ‘take over” the action sports market or just use legitimacy in that market to be credible with customers outside of what I’ve defined as action sports customers. See, this is why explaining what action sports is and being aware of how it’s changed is so important.
 
One way you need to do that is to FOCUS ON THE ECONOMY. I know it’s hard when you have to run your business on a day to day basis, but look beyond, the day, week, month, quarter and even the year. Recognize that, historically, the “good old days” were an aberration we’re not returning to in the foreseeable future. Want to know why? Go read this book so I don’t have to make a long speech. It’s a pretty easy read. The bottom line is that this is a financially caused, global recession and they last a long, long time. Always have. You must build your business around that assumption. Most of you, I hope, already have.
 
One of the economic things you’ve got to think about is inflation. You are going to see some product cost increases, and it’s not clear how much you will be able to pass through to your customers. Factor that into your financial model.
 
Next, we can’t forget VERTICAL RETAILING, which I expect will continue to grow and even accelerate. Vertical retailing is a financial and merchandising strategy that is viable partly due to changes in consumer perceptions and habits and because we’re selling a lot of product to a different consumer. You don’t have to be “core” anymore to be cool and most of our customers aren’t action sports consumers as I’ve defined them.
 
Where does this leave the “core” retailer? Well, kind of where they’ve always been if they are really core retailers; servicing the group of customers I’ve described above for whom community and expertise are the most important factors. That was never a huge market.
 
Specialty shops and small chains that really weren’t core retailers have mostly gone away. Even some really good retailers who have been around for many years are struggling. Partly that’s because we’re no longer in the best economy ever. But it’s also because they are dependent on customers outside the traditional action sports niche as I described it and don’t have an adequate advantage with those customers over the vertical retailers and large chains for the reasons we’re discussing here.
 
Some years ago, I created a list of things I thought core retailers had to do well to succeed. The list included good systems and financial data, close connection with the community, a reasonable internet presence, quality, trained employees to whom you could offer a career path, revenues in excess of $1 million and a willingness to take some risks in the product you carried as a point of differentiation.
 
It’s not a bad list, but when I wrote it I thought a specialty retailer who did all that would just kill it. Now it’s kind of a minimum bar to succeed. And doing all that isn’t enough if you’re trying to compete with the big, vertical brands for the non-action sports customer.
 
Price has become more of an issue than it ever was and (forgive this gross generalization) there is no financial model that makes sense for a specialty retailer that carries the same brands as the chains and vertical retailers and serves the same customers. This is going to be especially true as product costs rise.
 
Related to vertical retailing is distribution, or rather NOT DISTRIBUTING. Here’s a link to an article I wrote after SIA posted its sales report in March. Basically, SIA members reported higher margins and better sell through with lower sales. They sold less but earned more and created perceived value through scarcity. I’ve been beating the drum for focusing on gross margin dollars rather than sales or gross margin percent for years. It took the worst recession since the Great Depression to scare them into controlling inventories. I really hope they don’t screw it up next year.
 
Around 2000 when I took my first close look at THE INTERNET and its impact on the industry, I thought it was just another distribution channel. Maybe that was an adequate answer then, but it’s way more now.
 
It’s your most important point for customer contact and information. It’s a tool for managing and controlling inventory. There is no successful brick and mortar retail without a closely integrated internet presence. I could create a much longer list, but just imagine running your business without the internet and we’ll leave it at that. It’s no longer a choice and I guess it really hasn’t been for a long time.
 
So What?
 
Determining whether you are “action sports” or “not action sports” is obviously not as clear cut as I’ve made it sound. Most retailers and brands fit somewhere along a continuum. Yet determining who your customers are is critical (duh) and maybe the distinction I’ve made is a good way to start thinking about it. For most of you, it’s not the same customer you used to have.
 
For better or worse, big companies have learned to buy brands in our industry and support them without killing what made them special. Consumers won’t know that Volcom is owned by PPR. More importantly, if they did, they probably wouldn’t care anymore. 
 
The buyers of industry brands can’t justify their purchase prices unless those brands grow at a pace that means they take market share. So you, as an independent brand or retailer, are competing with businesses that were successful in their own right but are now backed by various 900 pound gorillas committed to growing them. Sophisticated, well managed gorillas at that.
 
Don’t despair. Just recognize the market you’re in and who you’re competing against. Then plan accordingly. Like the old saying goes, “Call on God, but row away from the rocks.”           

 

 

The Relationship Between Marketing and Business Risk; Do One and Reduce the Other

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Have you ever noticed how often the group of people who create ads, run promotions, and manage sponsorships are called the marketing department? That’s always struck me as kind of odd. I think marketing is the process of figuring out who your customer is, or can be, and why they buy your product. Advertising and promotion are the tactics you use to reach and attract those customers after you’ve reached some decisions about your customer based on your marketing.

I suppose it’s so obvious it shouldn’t have to be said, but if your advertising and promotion isn’t based on solid marketing you can spend a lot of money and damage the only real asset you have in this business- your image. We’ve all seen retailers and brands do it.
 
The thesis of this article is that good marketing reduces business risk and the perception of business risk, perhaps helping you to think in a way that facilitates recognizing new customers and markets.  It’s critical if you’re shop or brand is going to stand out in a crowded and highly competitive market.
 
The Status Quo and Its Downside  
 
 Right now, in this industry, everybody pretty much does the same advertising and promotion stuff. You all know what’s on the list of the ways we compete and I won’t bother repeating it here. I recognize that sometimes somebody’s ad is cooler than somebody else’s, or a particular team rider breaks out from the crowd for some period of time. But at the end of the day if we’re all doing the same stuff, and our products are more or less all the same, how do you, as a shop or a brand, break out from the crowd?
 
Answer- you don’t. If you’re doing the same as everybody else, and your product is no better, the best you can do is to be as good as they are. The exception, of course, is that you can do more of what all the others are doing. It may not be better or different, but it has an impact. But to do more, you have to have more- dollars that is. Then it’s only the big guys who win.
 
It probably hasn’t escaped your attention that the big are getting bigger and controlling more and more of the market. I’m suggesting that’s inevitable- in any industry- if, lacking solid marketing, the only basis for doing better over the long term is to spend more on advertising and promotion and cut prices. That tendency is exacerbated by the fact that it’s the larger businesses that are most likely to really do good marketing.
 
The Perception of Risk
 
I suppose this article had its genesis over a year ago when I talked to Santa Monica based ZJ Boarding House co-owner Todd Roberts at ASR. In the course of talking about a whole bunch of stuff, we got around to the ongoing travails of smaller retailers and what they needed to do. Todd said, “Jeff, you can’t be afraid to take some risks.”
 
I thought he was right. Still do. But at the time, I didn’t know where to go with it. It didn’t seem useful to say, “Take more risks!” unless I could explain why the risk was worth the potential payback and how it could be controlled.
 
Still, it seemed an important point, so I put it in whatever the part of my brain it is that holds ideas to be thought about and addressed later. It recently popped out more fully formed.
 
In helping businesses in this industry manage transitions, I’ve known for a long time that we all, including me, like to do what we’re comfortable with and have done successfully in the past. It’s human nature. So we go with the flow in running our businesses, following the annual schedule for developing ads, sponsoring events, attending trade shows and all the other stuff. It feels low risk, doesn’t it? That’s because it’s what we’ve always done.
 
Conversely, from time to time, really new ideas for advertising and promotion come across our desks. But they don’t fit our frame of reference. There isn’t a place for them in the annual advertising and promotion schedule. Other companies aren’t doing them. Doing the new things seems risky. Doing the same old stuff doesn’t.
 
Granted, it’s also a matter of available funds. It’s much less risky to do something new when you don’t have to cut out something old to try it. Another advantage to bigger companies with strong balance sheets.
 
We tend to perceive low risk in doing what we’ve always done. We perceive higher risk in doing new things. I think it’s the other way around. Industry conditions and the difficult competitive environment require that you do some of these new things if you are going to succeed. If you don’t, you have no opportunity to be better than anybody else.
 
And that gets us to marketing as a competitive tool, a money saver, and a way to fix your perceptual problems.
 
Doing Marketing
 
Sometimes I just have good karma. I’d been working on a talk I had agreed to give on how we compete as an industry and how we can do it better. Before I finished preparing, I flew off to ASR. I walked into the room late, but managed to hear most of Mikke Pierson’s (the other co-owner of ZJ Boarding House) talk on how to utilize your data base effectively. I know this article is turning into a damned ZJ Boarding House promotional piece, but sometimes you just have to go with the flow.
 
So here I am, thinking about how the industry competes, why brands and shops need to take some risks, and why they often seem reluctant to do it. Having managed to put off my article deadline until after ASR, I was getting desperate for a good way to tie this all together in the real world.
 
And Mikke saved my ass.
 
To make a longer story short, he said, “We spent $4,000 with Customers First to clean up our mailing list and plot our customers on a map so we knew where they were coming from. We did our usual promotional mailing at a cost of $16,000 and it generated $135,000 worth of business. The cost of doing the mailing was a whole lot lower because we knew who we were mailing to and why. We didn’t have to pay the post office for returns, and we didn’t waste money on duplicates, people who weren’t interested, or who were too far away to come to the store.”
 
The $4,000 spent with Customers First is real marketing. And I want you to notice the following things.
 
  • It wasn’t some esoteric, company wide, long term, epic undertaking that produced a ream of data that nobody knew what to do with. It was practical, cheap, quick, and the return was immediate and measurable.
 
  • It reduced risk. They knew much better who they were doing a mailing to and why. Maybe just as importantly, it also reduced the perception of risk.
 
  • It generated additional sales- quickly.
 
  • It didn’t cost them money- it saved them money.
 
  • It wasn’t some change of direction, risk the company strategy. It was a fairly minimal, common sense sort of thing. If it hadn’t worked out they would have been out $4,000 and a little time and would have learned something.
 
  • It focused on their customers- not on their competitors and not on the industry.
 
What I said I was trying to do at the start of this article was demonstrate the relationship between marketing and business risk. The relationship is both perceptual and practical. Good marketing reduces your business risk. It also reduces the perceived risk because your actions and decisions are based on good data. That means you are more willing to try some new things.
 
And I don’t think you have much choice. Focus on your end customer and why they buy from you. Think of a dozen questions you’d like to have answers for and how those answers would make it easier to reach those customers. Answer just one and see what you can do with the information. The risk of not trying is just too big. Like Walt Disney said, “You don’t build it for yourself. You know what the people want and you build it for them.”

Action Sports; Are We Still in That Business?

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Seems a silly question I suppose. Action sports are what we do. It’s what we’ve always done. It’s what we love. Our trade shows are more fun than anybody else’s. We get to take vacations and call them business expenses or, even better, product testing. Uh, not that I’ve ever done that, Mr. Tax Man, sir. But I’ve heard about it.

I’m not quite sure that’s the business we’re in any more. Or, to put it more precisely, I’m thinking that action sports is only part of our business. A smaller part for many of us. Maybe I’m just playing with words. “What’s in a name?” somebody once asked. Maybe a lot if that name determines how you think about who your competitors and customers are, how you need to do business, and the market where you position your product. Put like that, it’s a survival issue.
If you’re going to make money in this industry, you need to recognize how it has evolved and run your business accordingly. By reviewing that evolution, and talking about how you might redefine the business you’re in, I’m hoping some things you should be thinking about doing differently will become obvious. Or, at the very least, you can start to move in the direction of identifying those issues and opportunities.
Can It Be This Simple?
I thought this would be a nice easy article to write. Just sort of review some industry evolution. You know- how we use to sell mostly to participants and tended to be focused on a single sport, but now we’re selling across the sports, increasingly to non participants who just want to look good and maybe feel some connection to the lifestyle and account for the majority to most of our sales and even more of our profits. Then pronounce we’re in the fashion industry and be done.
Wouldn’t it have been great? “Wham! Bam! Thank you ma’am!” [good luck translators] and Boardsport Source would send me a check, and I could move onto my next project. But then I realized two things. First, that Boardsport Source pays by the word.  This was looking like a damn short article, and that wouldn’t do.
Second, and arguably more importantly, pronouncing that we are in the fashion business wasn’t much help to anybody. It was kind of like saying the goal of a business was making money. True, you need to do it, but it doesn’t say a thing about how to go about it.
So it appears I’m stuck at my computer a bit longer.
Still, my blazingly short description of our evolution as an industry- from participant to non participant as main customers and towards the fashion business- is generally accurate, though not adequate as I explain below.
Fashion Business- What’s That?
Are you thinking, “We all know what the fashion business is, so there’s no need to discuss it?” Well, you’re smarter than I am because I’ve decided I don’t quite know what it means, at least not in a useful way. Have you ever noticed that when the consensus is that “everybody knows,” you’ve probably got something worth digging into?
Here’s what I think characterizes the fashion business:
  • All product differentiation is created by advertising and promotion (branding) and design.
  • No functional product difference remains exclusive for long.
  • The fashion business is huge. The action sports business is tiny.
  • The fashion industry encourages product replacement. If we all wore our shoes and apparel as long as we reasonably could, the fashion industry would be a hell of a lot smaller than it is.
  • In a product we are encouraged to replace from season to season, function can become less important than form.
  • The customer base is no longer easily identified or segmented. Marketing (the process of figuring out who your customer is and why they buy from you) is critical. And challenging.
  • Your relationship with core participants is different. You want to sell to them, but they may be more important to you for the legitimacy and brand power they can give you with all the non participants who represent your biggest opportunity for growth.
If you think about these points, you may come to some of the same conclusions I came too. The one that sticks out like a day glow, skin tight orange/lime green ski suit on the slopes (Those aren’t fashionable again yet are they?) is that it is absolutely futile to say, “We’re in the fashion business,” because that business is too vast and varied and massive to tell you anything useful.
Which bring us to marketing.
Marketing- No Way to Avoid It.
 
Remember that we all use to be our customers. Market segmentation? If they boarded, they were a potential customer. If they didn’t they weren’t. Marketing done. It was easy, accurate and damn near perfect. It was seductive because it didn’t require any effort and didn’t generate any uncertainty.
Like an archeologist digging down through the layers of a civilization, we can find the remains of those days in some companies, where the people who manage the still critical advertising and promotions function continue to be called The Marketing Department. I have no idea why. If you accept my definition of marketing above, they don’t do any marketing. But somehow the name hangs on.
“What’s in a name?” I asked at the beginning of this article. Maybe a lot if you think you’re doing marketing, but what you’re really doing is running ads, supporting riders, and sponsoring contests. Lacking effective marketing, you have no way to judge if you’re running the right ads, supporting the right riders, and sponsoring the right contests.
If you agree with me that you’re now in the fashion business to some extent, your first job is to find out just what part you are in. You have to do some real marketing. You have to find out who your customers and potential customers are and why they buy from you.
Competitor Identification
As soon as you recognize you aren’t just in the action sports industry, but in some (clearly identified) segment of the fashion business as well, then the lists of companies you are competing against changes. Those non board sport participating customers that you are selling to are comparing your product to those of brands that have nothing to do with action sports.   Why might they buy your product? Why will a particular non skating customer buy Brand X of skate shoe rather than a Nike if they are just looking for a comfortable, casual shoe?
Obviously, if this wasn’t an issue skate shoe companies wouldn’t be making casual shoes less closely tied to actual skating.
So, you may have some different competitors. I wonder if those advertisements and promotions being churned out by your non marketing department are as relevant as they once were? You might wonder too. Are you spending all that money in the right place?
Then There’s the Customer
Just who is your customer? For most brands and retailers it’s not just core skaters, or surfers, or snowboarders anymore. It hasn’t been for quite a while. I think we’d all agree on that. If you want to grow your business to a serious size, there just aren’t enough of them around.
Look at your distribution and how it’s changed. There are a lot of clues about your customers there. Go ask your fifty largest customers to describe the person who buys your product. Don’t accept a vague answer. Work to collect some of that data if you don’t already have it.
Consider what you might learn. When you sell to a core participant, your customer tends to be  knowledgeable, function oriented, possibly less price sensitive, and knows about the competitor’s product. When you are selling to somebody who’s a lifestyle customers they are, well, not necessarily like that. They perceive themselves to have choice of brands beyond what the core customer may consider.
This has huge implications for how you advertise and promote your brand. Just as one example, the core customer may recognize and identify with specific sponsored riders and how they perform. The broader market “fashion” customer is less likely to recognize the rider or the trick, but may be attracted to their perception of that rider’s lifestyle and the places they go.
If that’s true should your ads be less technical? Does it change your choice of sponsored riders and how you compensate and present them? Etc.
For most brands and retailers, it’s no longer accurate to say only that, “We’re in the action sports business.” There’s an important and growing (maybe dominating) fashion component to your business, but describing your company as being, “In the fashion business” is too broad a statement to be useful, even though it’s true.
Chuck out the old habits. Recognize that your market is changing, and you have to do some work to figure out how and what that means. It’s no longer handed to you on a silver platter. And if you’re calling your Advertising and Promotions Department “Marketing,” will you please change that? You’re driving me crazy.

 

 

The Impact of Consolidation; Wasn’t That Over Years Ago?

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Yes. And no. The snowboard industry consolidation that started around 1995 or 96 could probably have better been called extermination. Literally hundreds of brands went away either because their founders got tired of losing money or because the Japanese stopped paying cash in advance for snowboards. Though there were exceptions, these brands didn’t get subsumed under the multi-brand umbrella of a large corporation. They just ceased to exist.

A Business Week article in September talked about the fact that prices on recent acquisitions of apparel makers have been at cash flow multiples 20% higher than what companies were purchased for just a few years ago. Some of the recent, richest deals have closed at multiples of cash flow that are twice what public apparel makers trade for. A graph in the article shows the value of mergers and acquisitions in the apparel sector were around US$ 6.5 billion in 2000 and are projected to be nearly US$ 40 billion in 2005.
 
Quiksilver has announced that it’s earning for the year ending October 31, 2006 are expected to be US$ 0.87 to US$ 0.88 cents a share. Analysts had been expecting US$ 0.98 per share. Earnings are expected to be US$ 0.86 to US$ 0.87 for the year ended October 31, 2005.    They said the integration of Rossignol, acquired in March, the strengthening of the dollar and higher interest expense were responsible for their projection of essentially no earnings per share growth in the coming year.
 
These two things got me thinking. Sometimes that leads to an article.
 
The 90s snowboard consolidation was largely confined to the small world of the snowboard industry itself. And as I said above, consolidation maybe wasn’t the right word for it. This consolidation is different. It’s not confined to snowboarding, or even to what we have called action sports. It’s taking place in the context of the much, much larger lifestyle/fashion/apparel (pick your favorite term) market. It’s big companies buying companies that we in action sports use to think of as big, but that are turning out to be small compared to the companies buying them and the markets the acquirers are in. Hurley bought by Nike, Quik bought DC and Rossignol, VF Corporation bought Vans, Addidas bought Salomon (and has now sold it to The Amer Group). I’ve forgotten all the brands K2 has bought. I don’t mean to suggest this is new, but I expect it to continue. It has ramification for brands and retailers.
 
Let’s see what they might be.
 
Stuck in the Middle
 
The conventional wisdom is that you either need to be a niche brand, or a big company with a low cost structure. If you’re stuck in the middle, you’re screwed. We could talk, I think, about how that may have changed or be changing due to the role of brands, how marketing has evolved, and the internet and the leveling of the information playing field, but that’s a topic for another day. For the moment, let’s go with the conventional wisdom.
 
We continue, thank god, to see the regular emergence of new action sports brands. Some of them get some traction in the market. We all know why. Committed snowboarders, for example, who think of snowboarding not just as a sport but a lifestyle are interested in buying brands different from the ones anybody could buy pretty much everywhere. I’d argue that this group of committed snowboarders, as a percentage of total snowboarders has shrunk, but it’s still a basis for a new brand to get a toehold.
 
I look at these companies as niche brands who, due to their small size, flexibility, limited availability, coolness factor, and cost structure control, have a way to compete. Remember when one of these brands ran the ad telling kids how to fake lift tickets or something like that? Boy were the resorts pissed off and you couldn’t hardly blame them. But it generated a lot of talk. Can you imagine a large snowboard brand with close ties to resorts using that kind of marketing?
 
At the other extreme are the big players. But if I try and list the big snowboard only companies (or the big surf only companies, or the big skate only companies) I end up with a damn short list. Not even Burton, even with the leading position in the snowboard market, is a snowboarding only company any more. Quik’s’ certainly not just surf with acquisition of Rossignol.
 
The big players are increasingly multisport, year around businesses with a significant and growing presence in the apparel/lifestyle market. K2 Corporation, Amer Sports, VF, Nike, Quiksilver come to mind. There are others you might name. I think the companies stuck in the middle are those with revenue of, oh, let’s say under $1 billion who don’t have defendable and competitive lifestyle/fashion/apparel brands.
 
Got your attention with that number did I? Good. That was the idea. Want to say $800 million? Okay with me. But whatever the number it’s at least one order of magnitude bigger than what we usually think about when we say “big” action sports companies.
 
The idea I want you to come away with is that many of the companies with the potential to be “stuck in the middle” are now much larger and the revenue range of such companies much wider. In this much larger market, you can be stuck in the middle at $25 million. Or at $400 million.
 
Remember action sports- especially in hard goods- is an industry where you have to do everything right just to be in the game. And, in contrast to how it use to be, doing everything right doesn’t give you a long term competitive advantage (I’m not sure there are any of those anymore unless they are related to brand)- it just gives you a chance to compete and make it to another season.
 
A further factor in catching companies in the middle is the squeeze on hard goods prices and margins that has resulted from wide distribution, lack of product differentiation, and the availability of cheaper, quality, manufacturing. Downward pressure on prices can mean less margin dollars even if the margin percentage remains the same. Nobody is immune to this.
 
So What?
 
Because of the encroachment on action sports of the lifestyle/fashion industry, and the fact that there seems to be more money to be made in soft rather than hard goods, companies in the middle face a tough competitive challenge. Much (most?) of their growth potential is in selling soft goods to the lifestyle market. But their competitors in that much larger market have resources and advantages that the pure action sports companies can’t even come close to matching. What can they do?
 
Well, they can sell. For many, that will be by far the best financial decision they can make. So we will see this continuing wave of consolidation. As usual, there will be those companies who will have been mismanaged and need to find a deal. But even solid companies, looking at their market position and circumstances, will rationally decide it’s time to sell.
 
They’ve grown steadily, are profitable, and respected in the core market. They are a trend leader with a serious cool factor. The next step in growth requires them to begin to expand their distribution into the broader market. Potentially, they may begin to erode their image. They will begin to run right into the much larger competitors who have them out resourced by ten to one. Even if they are successful, they may not have the working capital they need to follow through.
 
Typically it’s right at this point where the company’s value will never be higher. The Business Week article suggests that might be right now. It’s not easy to recognize, and there are damn few successful entrepreneurs who don’t think next year will be better than this year. But making a deal right then, with your market aura in tact and your financial statements pristine and before you start to run head long into the 500 pound gorillas who will be your competitors is where the deal needs to be made. And that’s why I think we’re going to see more deals.
 
But who to buy? If, as I’ve suggested, the core market of actual participants who define themselves and their lifestyle by their participation is shrinking then the niche brands, while they may be successful, don’t have the room to grow they use to. So why would they be attractive to a larger company if they can’t contribute substantially to growth and profitability? They probably aren’t. So the number of attractive acquisition candidates shrinks, and the price, as seen above, gets bid up.
 
And the Retailers?
 
Four things. First, we seem to have been through, and maybe we are still going through, the extermination phase with retailers. I have no numbers, but I think we all share the perception that a lot of individual retailers have gone away and comparatively few have opened.
 
Second, I expect the “stuck in the middle” analysis above for brands to apply to retailers as well. We’re already seeing some consolidation and I’d expect more. As I’ve written, the only financially attractive exit strategy for a core shop run by the founder/owner seems to be to open enough additional stores to create a size, management structure, and ”proof of concept” that makes the mini-chain attractive to buyers. This is consistent with the discussion above of why a brand would sell.
 
Third, I can imagine that purchasing inventory is going to get interesting for shops as the companies they buy from have more and more things to sell them. Remember that the days of the single sport/activity shop are long gone. I wonder if K2 will want you to buy both your snowboards and your football equipment from them. Okay, granted I don’t know of a snowboard shop that sells football equipment in the summer, (and I don’t know if K2 sells it) but there must be one. What kind of incentives might they offer you to consolidate your buying for various activities with them? Hmm. Maybe I should ask them.
 
Fourth, are you sure you’re still an action sports retailer? I mean, a lot of you are selling an awful lot of soft goods that aren’t really sports functional to people who don’t participate. Maybe, for some retailers at least, it’s time for you to reconsider how to redefine yourself to take better advantage of the whole lifestyle/fashion/nonparticipant thing. Could be there are some opportunities you’ve been scared to look at that make sense?