The business plan: bike brand cost analysis

The bike brand purchases the frame set from the factory for $500 per frameset. This is the bike brand’s variable cost. The bike brand’s fixed costs include marketing expenses, research and development expenses, staff and overhead. Marketing expenses are the largest expenses for the bike brand: it includes advertisements in magazines, bikes for bike teams and all the other promotional initiatives that are used to differentiate the brand from the competition. Staff is a large expense because bike brands are traditionally located in Western markets where labor costs are higher; there are fewer people, but they cost more to retain. The bike brand also must borrow to finance the three to four months it takes for the frameset to be ordered, produced and delivered. With large orders (thousands of frames), the bike brand must pay a deposit; this is cash that is paid long before any of the bicycles are sold. Presumably, the bike brands retain in house engineers who design new frames on computers, and then use these design to have molds made. Molds are large, long term capital outlays, and these kinds of payments are traditionally financed with debt. Frame and Wheel thus estimates that the bike brands have material interest expenses to pay.
Traditional / per frame
Factory
Bike Brand
Revenue
500
1500
Cogs
100
500
Gross profit
400
1000
Operating expenses
Staff
75
150
Overhead
125
100
Marketing, R&D, admin
25
300
Total
225
550
Operating income
175
450
Interest expense
50
100
Income before tax
125
350
Tax
25
123
Net profit
100
228
Gross income margin
80.0%
66.7%
Operating income margin
35.0%
30.0%
Income before tax margin
25.0%
23.3%
Net income margin
20.0%
15.2%
OPEX  as % revenue
45.0%
36.7%

Frame and Wheel reads with great interest about how the largest advertising company in the world, WPP, has been buying up companies that specialize in advertising using technologies such as Facebook. Although traditional forms of advertising are likely to have a place in the promotion of bicycle brands, the rapid emergence and acceptance of social network technologies (Facebook and Twitter) as advertising mediums suggests that marketing and promotional expenses might fall for the bike brands in the future. This means that the marketing bills will be lower, and presumably means that the bike brands will have higher margins, unless of course they decide to cut the prices of their framesets in order to expand market share. This cost is an item that in Frame and Wheel’s view can be cut, rearranged and replaced with a stream of revenue for a constituent, either an IBS, a customer or a shareholder. Frame and Wheel also notes that factories in China are capable of designing frames, which suggests that the bike brand may no longer need to retain so many engineers. Although some engineers are probably required from a practical and marketing standpoint, the idea that all of the innovation occurs in the West is no longer a hard and fast assumption. If this is the case, the bike brands may find that they no longer have to borrow so much to build and own molds. This would lower interest expenses. Finally, bike brands do pay tax, because they are located in countries where tax systems are more developed. Corporate tax can be as high as 40%; Frame and Wheel assumes 35%. These costs help explain why the bike brand sells the frameset to the IBS for $1,500 per frame.
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