MARKETING

A Bicycle Built for You

After succeeding with unorthodox marketing, this entrepreneur is going to try it again.
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For his second entrepreneurial act, Vermont Teddy Bear founder John Sortino is counting on an unorthodox marketing strategy to sell his high-end cruiser bikes to the over-40 crowd


In the fall of 1992, a disgruntled John Sortino wheeled his new bicycle back to the shop. He'd ridden the 21-speed mountain-style hybrid only twice, and already the derailleur needed adjustment. So did the brakes. His $900 machine, the shop mechanic informed him, would require frequent maintenance and mechanical adjustment.

Sortino was annoyed -- but also inspired. "I love to manufacture things," he says. "And I figured I could build a bike that didn't need all that maintenance." He could even picture it: a high-end cruiser with a comfortable seat, upright handlebars, and fenders; rugged, yet smooth-riding; no derailleur but perhaps a hassle-free, internally geared hub; and not a retro look exactly, but something timeless. Above all, he wanted a dependable bike, fun to ride and low on upkeep. "I studied the industry and was amazed that nobody made anything quite like that," Sortino says. "I thought there would be a big market for people over 40 who don't like mountain bikes and can't find anything else."

Convinced he had spotted a promising niche, Sortino moved quickly. He hired a technician to design the bike and then sank $1 million of his own cash into development. By mid-1994 he had put together a small manufacturing crew -- machinists, welders, painters, and assemblers -- to begin crafting the prototypes.

Although Sortino lives in Burlington, Vt., a college town on Lake Champlain, he chose downtown Chicago for his production operation, leasing 20,000 square feet in a former printing plant. He liked Chicago's bicycle heritage. Decades ago, before they decamped for the Pacific Rim, more than 60 manufacturers operated along Lake Street, then nicknamed Bicycle Alley. "Chicago used to be the bicycle-making capital of North America," Sortino says, "and we want to rebuild that industry."

With Sortino most often in Burlington, home to the company's design center and marketing department, the factory is under the direction of George Gregoire, recruited last year as chief operating officer and treasurer. At 58, Gregoire has been a certified public accountant, a controller for a major unit of Continental Can, and a software developer. He was also chief financial officer of Cannondale Europe BV, a $40-million division of Cannondale Corp., itself a $150-million Connecticut company best known for its mountain bikes.

Gregoire's experience in the huge and lucrative European bike market prompted Sortino to broaden the company's reach with an assembly center in the Netherlands. Using frames supplied by the Chicago plant, the European operation builds bikes for distribution mainly in Holland and Germany, where high-end American bikes have great sex appeal. If the European venture meets sales projections, it will contribute roughly half the company's total earnings.

Sortino himself is an amiable guy with a taste for microbrewed beer and the live bands in Burlington's night spots. With his shaggy hair, he looks more like a Woodstock veteran than an entrepreneur. But his credentials are solid. Until last year he ran the Vermont Teddy Bear Co., which he started from a pushcart in Burlington and built into an Inc. 500 company. By 1994 Vermont Teddy Bear was the world's largest stuffed-animal mail-order house, with more than 300 people making bears, generating $20 million in sales. Sortino took the company public in 1993, retired from active management in 1995, and is using his equity stake, worth about $4 million, to fuel the bicycle venture.

Sortino's strong suit is marketing, and at Vermont Teddy Bear, he sidestepped normal retail channels. He promoted the bears heavily on radio, spending more than $15 million over the years for ads on the shows of such big-name personalities as Don Imus, Howard Stern, and Rush Limbaugh. Customers ordered the product directly through an 800 number, eliminating the normal middleman. Direct selling was key to the teddy-bear company's success.

* * *

It's one thing to sell a $50 teddy bear direct and quite another to sell a $900 bike that way. Even so, Sortino thinks he can. Circumventing the retail-dealer channel is a renegade and risky approach that sets his new venture, the Chicago Bicycle Co., sharply apart from industry norms. But there is a method to Sortino's madness. If it works, he could realize the fattest margins in the bicycle business.

Thanks to Gregoire's input, Sortino's business plan sports an insider's feel for competitive advantage -- as in, for example, electing not to buy key components from Japanese giant Shimano, as most bike makers do. Shimano dominates the market for derailleurs, crankshafts, brake sets, and other key components, and from that catbird seat it demands strict terms about, for instance, how and when it gets paid.

Most bike sales -- 60% of them -- occur in the spring, which can create huge cash-flow issues for manufacturers. "When you deal with Shimano," Gregoire explains, "you not only must pay cash up front; you have to order the parts 30 days before they are run. After 30 to 50 days in transit, the parts spend another month in your production system. You build the bikes and ship them to dealers, but most dealers can't afford to buy the inventory outright. The manufacturer ends up financing the receivables, often for four months or more. "

So it might be 200 days from the time a typical manufacturer pays for its parts until it sees any cash from sales. "And," Gregoire adds, "when you have to make the bikes that far ahead, you can only guess which colors and styles will be hot. By August leftovers are deeply discounted because you're getting into your next season." Obsolescence and finance costs together can take 10% to 15% off the top line, the industry veteran says. The dealer takes another 30% to 35% for its margin.

By building bikes strictly to order and running Chicago Bicycle on a cash basis, Sortino thinks he can capture the 50% of the top line that other bike makers give up and can move most of it to Chicago Bicycle's bottom line. Although his company imports some components, nothing comes from Shimano. His vendors allow 30-day terms; the parts spend an average of 15 days in inventory at the Chicago plant, which requires less than two weeks to make and deliver a bike that's been ordered. "We collect our money, based on credit cards, when the bike is shipped," says Gregoire. "We actually get the cash from the customer before we pay our suppliers, which makes for healthy cash flow."

The U.S. bike market, worth about $3.5 billion, saw 12.5 million units sold in 1994 -- most of them children's bikes retailed through mass merchants. Higher-end lines -- from such companies as Trek, Specialized, and Cannondale -- are handled by the more than 6,000 bicycle dealerships.

Mountain bikes accounted for 64% of the units sold through dealers in 1994; cruisers, fewer than 1%. In the results of his test marketing, however, Sortino sees a huge, untapped pool of people who want a bike just like his -- not for racing in the mountains but for transportation, recreation, or fitness. Most of those potential customers, he believes, are age 40 and up, the massive baby-boom cohort and its elders, who have been turned off by the industry's focus on fancy technology and like the idea of a comfortable ride and minimal maintenance.

The European market -- more than 20 million bikes were sold there in 1994 -- is especially inviting for U.S. manufacturers. Some even consider it a cash cow. "Any high-end American-made product is like gold in Europe," Gregoire says. "I saw that with Cannondale. If the bike is made in the USA, it's worth an extra $300 to $500 over there."

Sortino is factoring that premium into projections for his first full sales year, 1996. He forecasts U.S. revenues of $2.3 million on sales of 2,700 bikes, at an average retail price of $850. But in Europe, where he hopes to sell 2,150 bikes, sales of $2.8 million are projected -- $500,000 more on 550 fewer bikes.

Capacity at the Chicago plant is about 7,500 bikes a year, which should suffice through 1997, when Sortino hopes to be exporting to China, Australia, and possibly Africa and South America. "Our goal is not to dominate the world tomorrow -- our sales objectives aren't that huge," he says. "But I do want this to be a worldwide company."

* * *

The Chicago Bicycle Co.'s first production models rolled off the line last fall, with names like Shoreline Cruiser, Silver Shadow, and Wonder Bike. Consistent with Sortino's early vision, each of the six basic styles features balloon tires, sprung saddles, fenders, and chain guards. Averaging 33 pounds apiece, they are a good 5 to 8 pounds heavier than an aluminum-frame mountain bike.

Aluminum is lighter than the chromoly used in Chicago Bicycle's handmade frames, but chromoly -- steel alloyed with molybdenum -- is sturdier and gives Sortino's bikes a springy strength that produces a cushioned ride. Customers can specify one of 12 paint-color schemes from a chart that comes with the promotional materials, the hard-copy aspect of the direct-marketing campaign.

An internal gear hub in three-, five-, and seven-speed versions -- "the brains of the bike," Sortino says -- costs Chicago Bicycle about $125. It's manufactured by Sachs, a German company that makes BMW motorcycle transmissions. The gears, encased in the hub and impervious to weather, rarely need adjusting. (Working toward 100% domestic content for his bikes, Sortino plans to manufacture his own hubs, starting this year, possibly in an old gun foundry in Vermont.) Beyond paint color and gear count, customers can select from four types of handlebars, five kinds of saddles, four styles of fenders, and three kinds of tires, including whitewalls. "We're using the best components available," Sortino claims.

Naturally, expensive materials make for expensive bikes, and the direct-manufacturing cost of the start-up's bike currently averages about $432, versus an industry norm of about $300 for a comparable cruiser. Sortino's costs should drop to the same level as volume purchases grow, but even as his costs fall, the former teddy-bear maker plans to hold his bike prices firm -- $725 for a three-speed up to $950 for a seven-speed bike.

That's high for bikes that are technically unsophisticated, but Gregoire argues that sticker shock won't be a stopper, especially for the upscale consumers the company is targeting. High-end cruisers, he says, typically sell in the $800-to-$900 range domestically and for $1,000 to $1,200 in Europe. Besides, Gregoire contends, expensive mountain bikes have removed much of the price sensitivity from the bicycle market.

Bicycle dealers are less sure."We're curious to see how they do," says Andrew Kelly, general manager of Metro Bicycles, a seven-store chain in New York City. He likes the bikes; he's just not sure people will spend nearly $1,000 to own one. "Almost every company out there is making similar bikes," Kelly says, "from basic beach cruisers at $230 to models over $800. Obviously, some people will question spending almost $1,000 for a bike, so I think price will be an issue."

* * *

Sortino has so far invested about $1.3 million in the start-up, using proceeds from sales of his Vermont Teddy Bear stock. "If we have to, we can get through most of this year with my own money, plus my guarantees on credit lines and machinery leases. Then earnings should help out," he says. He actually expects to see positive earnings, some $406,000, in the second quarter of calendar 1996. But as production ramps up from 80 bikes a month last fall to 500 a month this spring, and as spending on direct marketing kicks into high gear, Sortino is hoping he doesn't have to rely solely on his own capital. The company is actively soliciting investors.

If sales projections hold, Chicago Bicycle will spend close to $3 million this year to deliver its pitch through a variety of radio formats -- news-talk, top 40, classic rock, oldies. "With radio, you can target the audience," he says. "Then we'll analyze how those stations perform for us. I buy on results."

Direct mail supports the advertising. A prospect induced by a radio spot to dial the toll-free number (800-CITYBIKE) speaks with a sales rep, who mails out a brochure and a color chart.

Sortino's initial geographic target is metropolitan New York, including parts of Connecticut, New Jersey, and Long Island. Then come San Francisco, Los Angeles, Boston, Philadelphia, and parts of Florida, along with Chicago and Burlington, where the company has showrooms. The initial results have been encouraging, much to Gregoire's surprise. "John's objective was to sell high-end cruisers for nearly $1,000 to people who don't see the bike first," he says. "Most people would think he was crazy, including me. But now that I've fielded the phone calls and seen the impact of the marketing, I see it happening. We're shipping bikes to people who haven't seen anything but the brochure."

For customers who do need to eyeball the bike or prefer to purchase through a local dealer, Sortino aims to have display models in bike shops in each of his advertising markets. The Metro Bicycles chain, for example, is his dealer in New York. "When a customer buys through us, we will special-order the bicycle and either assemble it here and deliver it, or drop-ship it to their home. It's their option," says Andrew Kelly. "The assembly is really pretty simple."

Dealers get demo models only, so they don't carry an inventory of Chicago bicycles, saving on warehouse costs and floor space and reducing the risk of unsold stock. Furthermore, Sortino's radio ads will direct listeners to stores where his bikes can be found. Consequently, the founder expects dealers to settle for below-average margins -- 20% instead of 30% to 40%. Obviously, Sortino prefers to sell factory-direct -- the company's profits are that much greater -- but for customers who demand to heft the bike first, the dealer link is pivotal.

Either way, Gregoire, for one, is confident the bikes will sell. "We have people who come in here, knowledgeable buyers, who ask how we can retail this bike for less than $1,000, given the quality of the components," he says. "We explain that it's three things: we're not carrying finance costs like everyone else, we have much lower obsolescence losses, and dealer markups are lower. The customer makes out, and we make out. We do have advertising costs," he adds, "but if we can hold them to 10% of sales, we'll be net winners on margin. That won't happen this year, however. We'll be spending heavily to establish our name."

Building brand identity in a cluttered retail world is no small feat, though, and competition is intensifying. Since Sortino started Chicago Bicycle, two major U.S. companies -- Trek and Specialized -- have introduced cruisers at substantially lower prices -- $250 for a Trek single-speed Cruiser Classic and $350 for a Specialized four-speed Shark Cruiser. Schwinn, virtually bankrupt two years ago, now peddles seven kinds of cruisers, costing from $219 to $449.

Gregoire questions the other companies' retail strategy, which depends on bike-shop sales exclusively. "I think they have them in the wrong place," he says, "in there with all the mountain bikes. Some big guys could follow us into direct marketing, but will they? They may never be interested in this approach until they realize, five years from now, that the high-end cruiser market has grown from 20,000 bikes to 500,000, and Chicago Bicycle has 90% of it."

Sortino, sitting astride one of his Silver Shadows, surveys the competition and professes no worry. "They're all good bikes," he allows, "but they're not this bike."


EXECUTIVE SUMMARY

Company: The Chicago Bicycle Co., with headquarters in Burlington, Vt., home of founder and CEO John Sortino; and a manufacturing plant in Chicago, traditional home of the U.S. bicycle industry. Sortino is also the founder of the publicly traded Vermont Teddy Bear Co., which he left in 1995.

Concept: Build top-of-the-line cruiser bicycles in the United States for the recreational 40-and-older rider; handle European distribution from an assembly center in the Netherlands

Projections: Revenues of $5.1 million in the 1995-96 sales year, rising to $51.5 million in 1997-98

Competitive advantage: Sell direct and make to order to eliminate dealer markups and accounts receivable and reduce plant inventory

Hurdles: Persuading mature adults to spend close to $1,000 on a bike they must finish assembling themselves, in competition with established brands sold by retailers who also offer service


THE FOUNDER
John N. Sortino,
age 44

Family: Married, with three children

Education: B.S., mathematics, State University of New York at Plattsburgh personal funds invested: $1.3 million and counting

Equity held: 73%

Salary: $0

Previous job: Founder and CEO of the now publicly traded Vermont Teddy Bear Co., in Burlington, Vt.

Lineage: "My grandfather, after he came from Italy, owned a fire-engine company. My father owned a gasket-milling company in Buffalo. I belonged to five unions and worked in a lot of factories."

Philosophy: "When I die, I want it to read on my gravestone: 'He was a manufacturer.' "

On being an entrepreneur: "I do this to have fun, create jobs, make money, and service the customers -- all equally balanced. And I want to sell to the Chinese and the Japanese to reduce the trade imbalance, so it's a political thing, too."

Hobbies: Baseball, movies, bicycles, teddy bears

Recommended reading: The Entrepreneur's Manual, by Richard M. White.


HOW CHICAGO BICYCLE PROPOSES TO PROFIT ON A HYPOTHETICAL $1,000 BIKE

Industry Norm Chicago Bicycle

Retail price $1,000 $1,000

Less: Direct bike cost -300 -300

Dealer markup [1] -300 --

Credit costs [2] -100 --

Bad debts [2] -25 --

Bike obsolescence [2] -25 --

Parts obsolescence -10 -10

Freight -20 -40

Assembly cost [3] -- -50

Radio ads [4] -- -100

Net proceeds of sale $220 $500

Less: Operating cost -125 -125

Net income per $1,000 bike $95 $375

1. By selling direct to consumers, Chicago Bicycle pockets the usual dealer markup.

2. Because it builds to order and has no inventory to finance, Chicago Bicycle saves on credit costs and dealers' bad debt and accumulates no obsolete, last season's models.

3. Chicago Bicycle will pay local college students to receive, assemble, and service customers' bikes, thereby incurring a small additional expense on each bike sold.

4. Direct-selling costs loom larger for Chicago Bicycle.

Building to order in the United states lets chicago bicycle operate on a cash basis with little inventory.


The Financials (in thousands)
1995 1996* 1997* 1998*

Gross sales $300 $5,104 $30,856 $51,501 [#]

After-tax income Loss $216 $3,114 $5,149

* projected

# To achieve this number, Chicago Bicycle must grow more than twice as fast as Cannondale Corp., which began to produce one of the country's premier lines of bikes in 1982.

Figures supplied by Chicago Bicycle Co.


WHAT THE EXPERTS SAY

Competitor

Scott Montgomery
Vice-president of marketing and Japanese operations for Cannondale Corp., in Georgetown, Conn.

I don't like to second-guess entrepreneurs, because I recall how people doubted my father when he started Cannondale, which now does about $150 million a year. But John Sortino faces some tough obstacles here.

His two biggest weaknesses are that the product appears overpriced and that he'll have a hard time getting distribution through bike dealers. He can always sell a few bikes direct, but without dealer support he will limit his growth.

Furthermore, companies like Cannondale, Trek, and Specialized are going to come out with their guns blazing for these cruisers. When that happens, Sortino is going to be up against strong brand names. For next summer, we will definitely make a cruiser with an internal hub, and we'll make it from aluminum, so it will be lighter than his bike and priced comparably.

In our view, 32% of the market is in the United States and 68% is international. Sortino hopes to export, and that's the right idea, but he should do so only after establishing his U.S. side. The brand needs to acquire a little cachet before it will catch on in Europe.

Bicycle dealer

Richard Cohen
Owner, Richlyn Bike & Fitness, in Allendale, N.J.

I think Sortino is selling himself and his customers short by not distributing through dealers. It sounds like an excellent product, but he hasn't made sure his customer has a place to get the bike serviced. Most people are not mechanical. They don't have the time, desire, or ability to assemble a bike themselves. When they hit a bump while riding and need their wheel straightened, where will they go? Selling direct might be good for him, but it's bad for his customers.

Sortino wants dealers to stock showroom bikes so customers can see them, but he's going to allow dealers markups of just 20%. He'll have trouble finding many willing to do that. It costs a dealer 36.5% of sales just to survive; that's the average cost of doing business for a dealer in the United States. Why should we take his product, do all the work, and not make any money? I'd rather put something out on the floor that will give me an acceptable return on my investment.

Industry observer

Marc Sani
Editor of Bicycle Retailer & Industry News, a trade journal based in Santa Fe, N. Mex.

It will be crucial for Sortino to establish a dealer network. Going direct, he is unlikely to sell many high-end bikes to people who are not into bikes.

But let's say he is successful and that there is a burgeoning market in cruisers. Companies like Trek, Cannondale, and Schwinn are not going to cede it to him. He'll be in a highly competitive environment, up against big names.

Finally, the idea of manufacturing his own internal gear hubs makes no sense. The Shimano and Sachs hubs are as good as you can get. If he can make the same quality hub and save money, the man is a genius, but I don't think it's possible. There are better things to do with start-up capital than compete with those two companies, but this industry is known for being able to suck a lot of money out of investors' pockets.

Financial analyst

Jean-Michel Valette
Managing director and senior analyst for Hambrecht & Quist, a San Francisco-based investment bank

I'm intrigued by Sortino's plan to bypass the traditional distribution channels, which has worked well for a number of companies. Starbucks, for one, has become the second-largest coffee brand in the United States without ever being in a supermarket. Going direct can be a powerful way to build a brand and a franchise. It gives him a direct dialogue with customers, which will allow him to know early on what works and what is appealing. Then he can adapt the product and the sales pitch to the needs of the consumer. If you're going through tiers of distribution, you quickly lose that feedback loop.

The big question mark is price. We'll see how many consumers are willing to fork over nearly $1,000 for what is not a technologically state-of-the-art product. Cannondale and others have proved that there are enthusiasts willing to pay $1,000 for a bike, but that's because it's lightweight, with leading-edge components. Sortino might have to find another compelling hook for the consumer.

On the dealer side, he might find some who will play along with his plan. If a dealer finds that a Chicago bicycle appeals to somebody who otherwise would not have bought a bike, that's an incremental sale that doesn't cannibalize his core business. If Sortino can't find those dealers, however, it will be tough to build a retailer network.

Last updated: Apr 1, 1996




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