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Price Pressures Mean Higher Costs Next Year

Published February 1, 2008

SHENZHEN, China—Rising raw material and energy prices have contributed to steady cost increases over the last few years, but those cost hikes will likely pale next to the price hike for the 2009 model year, especially for bikes made in China.

Raw material and oil prices continue to rise, forcing increases in ocean and domestic shipping costs.

Chinese factories are now required to provide healthcare, benefits and a higher minimum wage for their workers, contributing to a substantial rise in foreign labor costs.

In addition, the dollar is expected to lose up to another 9 percent of its value against the Chinese yuan, adding more currency pressures.

Meanwhile, the Chinese government is refunding less of its value-added tax (VAT) for goods and services that are exported.

Add up these myriad factors, and the result is tremendous cost pressures on suppliers. In response, manufacturers will be forced to accept shrinking margins or pass some of the cost down to consumers.

“It will be an incredible year. On every visit, virtually every maker has talked about labor, material costs, exchange rate, VAT and a host of other specifics. I expect significant increases for 2009 models. Fortunately, it’s global, so it will impact everyone equally,” said Bob Margevicius, Specialized’s executive vice president of the bike group.

Oil Woes. Fueled by rising oil costs, overseas shipping costs are creating a major pressure point for companies that import bikes from overseas.

“Early estimates are that costs could increase 15 to 20 percent,” said Joe Hawk, chief operating officer for Haro Bicycles.

For goods coming into the United States, this double-digit percentage translates into a per unit cost estimate of between $1 [full container, juvenile only] to $1.75 [full container, adult only] per unit, according to Hawk.

Others have budgeted more moderately for shipping increases. Randy Danioth, Seattle Bike Supply’s vice president of purchasing, anticipates a 5 to 10 percent increase above current levels.

Danioth accepts fuel surcharges as an uncontrollable cost, but said he was uplifted by a conversation he recently had with a large container ship builder.

“I asked if they were taking similar steps as the airline industry has done to build more fuel-efficient ships in the future,” Danioth said. “I was very pleased to hear them state that this is a top priority for them.”

The price of oil fluctuates and cost could recede with demand. But as crude oil still hovers near $100 a barrel, many manufacturers are keeping a close eye on prices and negotiating with carriers when possible.

“The recent volatility and variability in the price of oil has been front page news and recently a number of carriers have announced emergency fuel surcharges,” said Reed Pike, director of marketing for Raleigh America.

“We try to anticipate and plan for these types of changes and will be evaluating those surcharges in relation to our plan and the potential impact on our shipping rates.”

But even with careful planning, manufacturers may not be able to absorb freight increases. As a result, Haro’s Hawk said manufacturers will have to adjust prices accordingly.

“The short answer is yes, prices will have to be adjusted,” said Hawk. “However, ocean freight is just one component of pricing pressures today. While Haro will maintain its value position in the market, we expect continued pricing pressures upward with the spring launch.”

Sourcing Strains. Manufacturers who source their products in China—which accounts for nearly all bicycles sold in the United States—are facing additional pricing pressures.

They include:

• The continued appreciation of the Chinese yuan against the U.S dollar, which makes everything imported from China more expensive;

• Continued increases in Chinese worker salaries, including new mandates for employer-paid health insurance and social security benefits;

• The Chinese government’s decision to slash its subsidies, given in the form of tax rebates, on hundreds of exported products including bicycles and tires;

• A new labor law, effective Jan. 1, that mandates written employee contracts and adds other protections for workers. Among other impacts, the law cracks down on short-term contracts and will make it more difficult for employers to fire their workers. While the law may improve employees’ standard of living, it will come at a cost.

Ying-Ming Yang, chairman of the Taiwan Bicycle Exporters Association, said rising labor costs are less of a problem than the currency appreciation.

“The labor costs in total still do not represent a very big percentage [of manufacturing costs] for the whole bicycles. I think the exchange rate is a bigger problem,” Yang said.

Yang is also chairman of Kenda, a tire manufacturer with factories in China. He said labor accounts for only about 10 percent of total manufacturing costs in Kenda’s Chinese factories, he said.

If China’s new labor law boosts wages by 15 percent, which Yang said is a rough estimate, the net effect on total costs would be only 1.5 percent.

A greater impact is China’s decision to allow the yuan to appreciate against the dollar.

Under pressure by U.S. politicians, China has let its currency slowly strengthen since July 2005, when it ended its longstanding policy of fixing the exchange rate at 8.27 yuan to the dollar.

By mid-January, the yuan was at 7.23 to the dollar—an increase of 12.5 percent—and most analysts expect it to strengthen by another 9 percent in the next 12 months.

While the stronger yuan may reduce the U.S. trade deficit, it makes everything imported from China that much more expensive—including bicycles.

Manufacturers also are dealing with the Chinese government’s decision to slash or eliminate a rebate it paid to exporters on some 2,500 products, including bicycles and tires.

The government’s goal was to discourage manufacturing of “low-value” products and encourage factories to move upmarket.

The impact has been significant, Yang said. For bike makers, the rebate went from 13 percent to 9 percent. For tire exporters like Kenda, the rebate fell to 5 percent, effectively raising prices by 8 percent.

Yang said the rising costs in China may help Taiwan recapture some of the production it has lost to the mainland.

It may also encourage bike-makers to seek out new locations for low-cost production such as Vietnam, which could become an attractive location if the European Union eases its anti-dumping duties on Vietnamese-made bicycles.

Components Creep Up. Those same pressures affecting companies manufacturing bikes in China also will impact the price of components made in Chinese factories.

Model year ’09 components from SRAM Taiwan are going up 3 percent, whereas SRAM China parts are jumping 9 percent. Shimano’s components made in Japan are going up 2 percent, and its parts made in China and other Asian countries are increasing 5 percent.

“The increase in China reflects the five percent increase in tax and rising utilities, materials and labor there,” said John Nedeau, SRAM’s vice president of sales. “We increased pricing for ’08 suspension about 4 percent and drive train and brake parts 2 percent, so ’09 pricing reflects recovering all our increasing costs, especially in China.”

Component price hikes do not translate directly into increased bicycle pricing. Product managers mix and match more expensive components with lesser parts to check price increases.

In addition to getting creative with spec, suppliers will also push the technology of their bikes to create a more compelling story for the consumer faced with higher retail prices. And technological improvements have a bigger impact on pricing than bare components.

“As far as new products in general, when we do innovate, our effort is to improve the experience as opposed to lowering the product cost, so the component content or material cost is generally not a key driver in our design and development,” Specialized’s Margevicius said.

“I can tell you that our frame cost for the the new Stumpjumper FSR carbon is higher than the previous version. The new composite suspension parts, as well as the integration of some special high-modulus carbon, and a new IS-11 construction process all contributed,” he added.

—Jason Norman, Doug McClellan and Matt Wiebe contributed to this story.

Topics associated with this article: Earnings/Financial Reports

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