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June 23, 2008 - The Economy of The Treadmill

Between the year 2000 and 2004 the price of a barrel of West Texas Intermediate Crude Oil was fairly stable between $30.00 USD and $40.00 USD per barrel.  Between 2004 and today that same barrel of crude oil has risen, on average, by over $100.00 USD per barrel.  In the year 2000 copper sold for $1,734.00 USD per ton.  By 2006 it had risen to $6,939.00 USD per ton and today’s spot prices go for $7,793.00 USD.  We can go on and on about the increase in prices for steel, plastics, and energy inputs that go into manufacturing fitness equipment, but all you can really say is that it has gotten a whole lot more expensive to make a treadmill or elliptical.  (Note: Historical prices provided by the USGS website and NIMEX)

What does this really mean to consumers, manufacturers and retailers of fitness equipment?  How does the increase of component inputs affect the competitive landscape between the various participants?  We have failed to post many articles to the blog this year due to the growth in our business, but a solid look into this subject is just what the doctor ordered!  This is the first article in a three part series that will look at the affect of input prices that affect the competitive landscape of the fitness industry.  This article will look at manufacturers.

Starting in April of 2008, the Treadmill Doctor team has been visiting factories and manufacturers of various stripes discussing their plans for the upcoming year.  Obviously we won’t get into specifics and names, but needless to say we have been hearing a common refrain this year: It is getter more expensive to do business!  But what does that really mean.  Just because the cost of steel goes up, doesn’t mean that the cost of the piece of fitness equipment has to go up correspondingly.  The fact is that steel is a relatively minor part of the cost of a treadmill or elliptical trainer.  What we are really seeing is a multi-factor inflationary model affecting fitness equipment manufacturing costs. 

The first factor is a general price inflation of manufacturing inputs.  Component cost such as steel, plastic, belting, electronics, motors and other smaller items are increasing for all manufacturers.  These items are seeing single and double digit increases in their cost to manufacturers.  This has some negative affects on manufacturers, but in some ways it does not permanently affect the competitiveness of manufacturing companies.  If the cost of inputs increases due to commodity pricing, then the costs for all manufacturers go up equally or nearly identically.  The problem for manufacturers is simply finding the best way to pass on the cost to the consumer.  Does the company pass on the whole cost or reduce their profits?  Do they limit the features and quality in the machine or increase the price?

Most companies find compromises based on reducing features and quality if they are trying to hit certain price points, they decrease their own profit margins, or they increase prices to retailers in the hopes that the retailers will squeeze their own margins to absorb the component inflation.  The bottom line is that the market will sort the appropriate pricing model based on the success or failures of company choices.  While sometimes painful, these decisions are relatively quick for companies to make and correct if mistakes are made.  Bad decisions due to general inflation of inputs, while painful, are rarely fatal for manufacturers and do not significantly alter the competitive landscape between manufacturing companies.

The second factor that is affecting manufacturing costs is the rapidly increasing cost of product distribution and transportation.  Reading the Wall Street Journal the other day, I was struck by a graph on the page that hit especially close of home.  As a treadmill and fitness equipment parts distributor we import parts from Europe and Asia.  I recently received a bill for ocean freight and was going to call and scream at our freight forwarder because I thought that they were trying to slip one by me until I saw the Wall Street Journal graph.  In 2007 the average cost of transporting a 40’ cargo container from China to the U.S. was $4,000.00 USD.  In 2008, with oil in the $140.00 USD range, the cost of transporting a 40’ cargo container from China to the U.S. is, on average, $7,000.00 USD.

The cost increase on a typical 40’ container that carries 72 treadmill units is $41.67 USD to the manufacturer.  Assuming a 25% markup in a competitive marketplace the cost increase to the retailer is $52.09 for ocean freight.  The added cost to the consumer at 35 points retail markup is $80.40.  That is just for ocean freight at current crude oil prices.  If oil goes up as anticipated next year to $200.00 USD per barrel and a 40’ container cost goes to $16,000.00 USD, the costs change to the following: $166.67 to the manufacturer, $208.34 USD to the retailer, and $320.52 USD to the consumer … PER UNIT … JUST FOR OCEAN FREIGHT!

Most people in our industry don’t realize that the vast majority of a treadmill cargo container, nominally carrying 72 units, is mainly shipping air or Styrofoam.  It is incredibly inefficient way to transport fitness equipment.  It would be much more cost efficient to transport the components, separately and more tightly packed to assemble in the U.S. 

The problem for most manufacturers has been that the labor cost savings has been so great for manufacturing in China that the imported product has been more cost competitive even with the transportation inefficiencies.  This cost advantage no longer exists.  An examination of the simple ocean freight costs proves this out.  Add the fact that most Asian manufacturers are much less efficient than most US manufacturers that we have visited, and the Asian products are becoming non competitive in the US marketplace.  US manufacturers, even with more expensive labor, have an absolute cost advantage in real terms with their Asian competitors for similar quality equipment.  The cost of transport has fundamentally changed the competitive landscape for manufacturers.  Companies that produce and manufacture products in the US, even with some foreign components are able to offer greater quality equipment for less money then their competitors producing overseas.

We at Treadmill Doctor believe that US manufacturers already have an absolute cost advantage at current ocean freight prices.  An increase in the price of oil will only magnify this advantage.  If you add an increase in the price of oil to the third of our factors then you can potentially see all foreign produced fitness equipment disappear from the US marketplace.

The third cost factor that we see as a potential risk for manufacturers is the currency exchange risk that has been introduced into the marketplace.  For a variety of factors including a $400 billion USD Federal Government deficit, a persistent trade deficit, paying $600 billion USD per year for foreign oil imports, and other factors, the American Peso … err … I mean the U.S. Dollar has steadily lost value against the other major world currencies.  Since 2005 the USD’s value has decreased by 30%.  This means that it takes 30% more dollars to buy the same products now as it did in 2004.

That has an amplified affect on retail prices for fitness equipment in the U.S. market place.  For example, take a treadmill that a manufacturer can import for $500.00 USD from their Chinese supplier in 2004.  For the purposes of our example, let’s assume that ocean freight remained constant.  I know that’s a laughable assumption but I am an economist and we like to assume can openers when possible.  The manufacturer’s selling price assuming a 25% margin will be $625.00 USD to the retailer.  The cost that the retailer will charge the consumer assuming a 35-point retail margin will be $964.55 USD.  Let’s now move to 2008 with a 30% drop in the value of the American Peso.  The unit that used to cost the manufacturer $500.00 USD in 2004 will not cost him $650.00 USD.  The retailer will now pay $812.50 USD and the consumer will pay $1250.00 USD.  This also assumes that the cost of all components also remains constant.  Please do not laugh at this statement!  We have to assume this to compare apples to apples.

To wrap it up this means that currency devaluation has increased the price of Chinese imported fitness equipment by $285.45 USD in our example for the same piece of equipment while a similar quality piece of equipment made in the US has not increased at all.  Now add in ocean freight to today’s levels and this piece of equipment will cost $365.85 more than a comparable quality piece of fitness equipment made in the U.S.  Add in the increase in raw materials and the expected increase of the cost of shipping for next year and the advantage becomes so great that foreign manufacturers are non-competitive.

Treadmill Doctor has been accused in the last year of having a bias against Asian and European manufacturers.  This couldn’t be further from the truth.  What we have observed is what has been clearly stated in this article.  Foreign manufacturers have had to either, increase prices to uncompetitive levels or decrease the quality to uncompetitive levels.  Just as foreign manufacturers did in the late 1990’s and the early part of this decade, US manufacturers have a golden opportunity to strike a blow to foreign competitors.  With such a great cost advantage the US, manufacturers have a great story to tell to US customers, not with meaningless platitudes about buying American.  When you study actual consumer spending patterns, few people care about that at the end of the day no matter how they answer a poll.  Now US manufacturers can tell a truthful story about giving the consumer more quality for less money… and they have the numbers to back it up!