I first learned about the concept of perfect competition in the bike business from my friend Chris Allen. He’s a longtime industry guy, currently retired, with credentials that include Suntour, West Coast Cycles, Raleigh, Haro, GT, Shimano, Crank Brothers, Intense and others
“It was in ’01 after the Schwinn/GT debacle, and I decided to get a masters in business,” he recalls, “mostly to try and understand what was going on in the bike industry. So I enrolled in San Diego State University’s intensive MBA program. Among the courses I took was Managerial Economics from Dr. Maurice Rahimi.”
One of the things covered in the syllabus was the notion of perfect competition: a type of market in which there are many companies that sell identical or near-identical products or services and where none of them has enough market power to set higher prices on their products or services without losing business. Sound familiar?
Dr. Rahimi used hi-fi components and computers as examples of perfect competition. “But I was really struck at how much of this applied to the bicycle business,” Allen recalls. “There are seven or eight criteria that describe perfect competition, and every one of them applies to the bicycle industry.”
“The first thing that struck me is that the products were identical; everyone was shopping from the same factories in Asia,” Allen says. “One factory would serve as the source for three or four major brands and the differences were minimal until you got into the high end where engineering became the differential.”
The market was also transparent — pricing was known, and both dealers and consumers knew what they could to pay for a given product. “Sellers had to turn themselves inside out to justify a dealer paying an extra dollar for their bike versus a competitor’s, so there was a hard ceiling on what any given supplier—wholesaler or retailer—could charge,” Allen says.
“Brands lived in fear of being undercut by competitors. Market share wasn’t a factor because it didn’t affect what you could charge for your product.” Large companies could leverage their market share to lock in dealers (thereby shutting out competitors), but they couldn’t achieve a (significant) price premium, Allen says.
Allen’s observations turned out to be prescient, because nowadays the bicycle business is taught literally as a textbook example of perfect competition at a number of colleges and universities, according to industry maven Jay Townley.
What’s so perfect about it, anyway?
Let’s take a look at the definitions of perfect competition and how the bike industry fits the bill.
At the Taipei bike show we place our orders for the year, and there’s a guy standing behind us at the booth who plunks down a Gold Card and says, ‘I’ll have what he’s having.’ —Skip Hess
1: A large number of buyers and sellers. Of course, “large” is a relative term. But according to Georger Data Services, there are more than a hundred bike brands currently selling in the US market, and that doesn’t include those that sell consumer-direct only. That’s a lot of brands for a relatively small market. Now compare with the number of airlines, mobile phone or auto manufacturers. Much bigger markets, but far fewer brands.
In terms of buyers, bicycle imports to the US have remained remarkably constant since 2000, current Covid-based supply shortages notwithstanding. And, thanks to ten years of season-long product discounts, every one of those bikes has found a buyer.
2: Low entry and exit barriers. It’s relatively easy for a company to enter or exit the bicycle business. To get in, all it takes is a pulse and checkbook ... and if you meet the latter requirement, any number of factories or suppliers are prepared to look the other way on the former. And, aside from offloading inventory, the cost of getting out is even lower.
As industry legend Skip Hess told me back when he was president of Electra bikes, low barriers to entry means that “My product managers and I bust our asses all year long designing the very best bikes we can, and at the Taipei bike show we place our orders for the year, and there’s a guy standing behind us at the booth who plunks down a Gold Card and says, ‘I’ll have what he’s having.’”
As Chris Allen pointed out earlier, this is somewhat less true with high-end carbon frames and bikes, but it’s absolutely true for the bulk of the bicycle business. If you and I want to start a bike company, we can be up and running in less than a year. And it takes even less than that if we want to start a bike shop. I talked about this in the context of Walmart’s Viathon brand a couple of years ago.
3: Perfect factor mobility. In the long run, factors of production — labor, capital or available factories — allow free long-term adjustments to changing market conditions. In other words, it’s relatively easy to move production from Japan to Taiwan to China to Vietnam. And because of low barriers to entry, it means just about anyone can play.
4: Zero transaction costs (also called perfect mobility). A subset of factor mobility. Buyers and sellers incur no or minimal costs in switching factories, suppliers, or retailers.
5: Perfect information. Prices and quality of products are known to consumers, retailers, suppliers and factories. Thanks to the internet, this is now true of virtually all industries, but it’s especially true in the bike business, where a few dollars' difference is all it takes to drive consumers from one brand to another. According to dealers I’ve talked to, even industry-leading brands like Trek or Specialized command les than a 10% price premium at the cash register versus comparably specced bikes from competitors.
There is as much actual differentiation between, say, Coke and Pepsi as there is among any number of competing bike brands.
6: Profit maximization. In a perfectly competitive market, firms sell at prices where marginal costs meet marginal revenue. In other words, competition keeps profits low, and there’s a hard ceiling on maximum profits. I talked about this in more depth in last month’s column, Why salaries (and profits) are so darned low.
7: Homogeneous products. The characteristics of market goods or services do not vary across suppliers. That’s one reason bike companies are so focused on the minutia of materials, tube sections and racing teams in their marketing: Brand A’s thousand-dollar mountain/road/gravel bike is pretty much the same as Brand B’s. There is as much actual differentiation between, say, Coke and Pepsi as there is among any number of competing bike brands.
8: Constant returns to scale. That’s a fancy way of saying that profits don’t go up much as companies get larger. In other words, economies of scale are only minimally effective. Other than order size, there are not a lot of additional profitability options. And with increased order size comes increased operating and capital costs. That’s one reason leading bike brands are moving to purchase bike shops. Simply being larger doesn’t make them significantly more profitable, and vertical integration is one of the few ways left to enhance profits.
As noted in the previous section, perfect competition is a type of market in which there are many companies selling identical or near-identical products and where no one has enough market power to be able to set higher prices on their products or services without losing sales.
And, whether we like it or not, that’s exactly the type of market we have in the bike business. Stay tuned for more about perfect competition and Bike 3.0 next month.
