The dilemma of the skateboard-factory owner.

“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.”

Et cetera, et cetera, et cetera.

In this highly emotional debate, there’s some truth to everybody’s position. A lot of people seem to feel very strongly either way at any given 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 concern for the industry that – hopefully – drives them, the dilemma for skateboard factory owners 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 host 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 dollars. Notice that he doesn’t have to support a team or pay for any ads. He’s making 20,000 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 skateboard 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 dollars 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. Because the brand name demands a higher price, he can sell them to retailers for 30 dollars. Here’s his monthly income statement so far:

Revenue$300,000 (10,000 decks times 30 dollars 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. If the expenses stopped right here, Mr. Hyde would have a pretax profit of 160,000 dollars compared to 50,000 dollars. I want to be in this business even more 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 de 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, tours, 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 dollars a month, bringing the pretax profit of Mr. Hyde’s business to 100,000 dollars. 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 that 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 dollars, he breaks even that month. Every additional deck he sells in excess of 10,000 generates five dollars (The selling price of fourteen dollars minus the direct costs of nine dollars) that falls right into his pocket. In our simplified model, he should be theoretically willing to accept any order (after 10,000 decks) that pays him more than nine dollars a deck. The factory is sitting there anyway with a fixed overhead of 50,000 dollars a month, and if he sells a deck for $9.01 that’s an extra penny in his pocket.

Mr. Hyde’s break-even 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 nine dollars puts some money in his pocket once he’s past his break-even 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 microeconomics textbooks 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.

It could be that more than one customer asks for lower prices. Maybe he has to go even lower than $11.50. That break-even 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 has 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 awful 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’ve 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 hardgoods 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.hics. 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 awful 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’ve 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 hardgoods 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.