2005: Business - Feeling the squeeze

The golf industry sure did grow up fast.

Only a decade ago, golf was a Wall Street darling – sort of the sports world’s version of the dot-com boom, before most people knew what a dot-com was. Newly public golf companies, flush with capital and guided by charismatic leaders, charmed investors with tales of exotic new equipment technologies and predictions of a rapid growth in the number of golfers.

At least that’s what everyone thought would happen. But golf reached maturity quickly.

It’s been seven years since the boom ignited by oversized titanium drivers began to fizzle. Over the past few years, dreaded terms like price compression and commoditization have begun to cross the lips of golf retailers, investors and even some manufacturers.

In some ways, the golf industry has never been better. Never have consumers gotten so much for so little from so many manufacturers. Drivers used on the PGA Tour can be had for less than $300 in your local golf shop – sometimes less than $200, custom fitting included. And by anyone’s reckoning, the products have never been better, the benefits never more tangible, the manufacturing never more precise.

But in other ways, golf has never been in worse shape. The industry, haunted by the participation boom that never happened, has seen a brief period of pent-up consumer demand for next-generation products give way to daunting oversupply. Don’t want to pay $400 for this new driver or $800 for those new irons? Wait a couple of months. Chances are they’ll be on sale for significantly less.

It’s a vicious, downward cycle for golf equipment companies and retailers, and a never-ending selection of bargains for consumers.

“It’s a consumer’s market, there’s no doubt,” says Jeff Leinhart, Nike Golf’s national sales manager.

Price compression – simply put, downward pressure on prices – “happens as an evolution of any business,” says Jim Koppenhaver, president of Pellucid Corp., an industry research firm.

Average selling prices for most products have been falling for years, most notably in the metalwoods category, golf’s big-ticket item. Consumers have shown a willingness to spend more only in the short-game categories – putters and wedges.

Declining prices, in part, reflect a healthy trend toward inexpensive and more efficient manufacturing, notes Tom Stine, a partner at

Golf Datatech LLC, which tracks retail sales. And arguably, prices are falling no faster in golf than

in any other industry. Randy Zanatta, chief executive of Golf Galaxy, a specialty chain, notes that consumer-electronics items that formerly retailed for more than $500 now can be had for less than $100.

But price compression also reflects fundamental problems: too many new golf clubs chasing too few customers in the marketplace, and a scarcity of unique, must-have products.

“The price pressure and commoditization is a byproduct of a lack of really true differentiation year over year,” says Eddie Binder, a former Top-Flite marketing chief who founded Apex Growth Strategies, a consultancy. “When you have a differentiated product, the consumer will pay for it.”

This isn’t a quality issue; as in other industries, such as consumer electronics, Binder argues that it’s hard for consumers to find a bad golf product these days. “But they think, if things are fundamentally the same, they’ll buy the one with the best price,” he adds.

Equipment companies have been grappling for the next big thing – a breakthrough like titanium clubheads, which every golfer had to buy in the 1990s because they were a clear advance over steel. TaylorMade generated excitement with its May 2004 introduction of the r7 quad driver – which has four weight screws that can be adjusted to change ball flight – and that product still commands a $500 price tag. But by October, its market share had begun to recede.

Leinhart says the “tangible effects of price compression” are most evident in drivers. “Where you clearly could command $500, now the sweet spot is $300,” he says. Like many others, Leinhart believes the U.S. Golf Association’s limits on the size and spring-like effect of drivers exacerbates this trend.

Casey Alexander, special situations analyst at Gilford Securities, suggests that computer-aided design, an innovation that has accelerated product cycles, also might be having the unintended effect of creating sameness in products.

“If everybody puts the same inputs into a computer, they’re all going to get the same output,” Alexander says. “Therefore, clubs are going to look more and more alike.”

At the same time, product life cycles, which used to be measured in years, now often are measured in months. That pace all but precludes the possibility of manufacturers producing clubs and balls that have dramatically superior performance characteristics than their predecessors.

But as Binder says, “When everybody around you is rolling (products) out faster than you, it’s difficult to say, ‘I’m not entering that fray until I have something that is substantively better.’ ”

Koppenhaver sees signs that this trend is leading manufacturers to initially price derivative products too high, then “mark them down to a more realistic value level and, in some cases, below the true value levels because they missed the initial opportunity with the consumer to establish that proper value level.”

This scenario, played out over and over in recent years, is straining relations between golf manufacturers and retailers.

There’s an old saying that goes: When they start talking about partnerships, I start reaching for my wallet. A golf retailer didn’t coin that phrase, but he could have. Golf manufacturers talk often about their “retail partners,” but in truth the two sides have never had less in common.

“You’re just afraid to go to bed with any of them,” Phil Upham, who operates four Edwin Watts Golf Shops in Massachusetts, says of equipment companies.

Manufacturers, understandably, want retailers to place large purchase orders, but retailers don’t want to see the marketplace flooded with product and subsequently awash with discounting. The rise of large specialty and sporting goods chains has prompted some manufacturers to create discounts for large purchases. But many retailers, particularly smaller operators, say they have been burned by those deals because they were still saddled with inventory when it was closed out.

“The numbers are too large and the incentive is not enough,” says Scott Peters, owner of three Golf & Ski Warehouse stores in New Hampshire. “We have to say ‘no’ (to manufacturers’ discounts) more than we used to. And that worries me, because at some point, will we stop being a preferred customer?”

When the golf business began to catch fire in the early 1990s, Bud Leedom chronicled it in a monthly newsletter called Golf Insight & Investing, and also tracked the industry as a San Diego-based analyst for Wells Fargo Securities. He recalls the energy and excitement the industry generated on Wall Street as young golf companies like Callaway and Cobra began selling their shares to the public. But the boom powered largely by oversized titanium metalwoods quickly fizzled, as did investors’ interest in the market.

“What really started out as an exciting and fun place to look, by 1996 and 1997 had really turned into a sinkhole,” says Leedom, now director of research for Comstock Investment Advisors.

He recalls how club manufacturers gained pricing leverage on component suppliers – including shaft and grip companies such as Aldila and Royal Grip, both publicly traded. And the price to advertise products escalated sharply along with the PGA Tour’s television rights fee at the advent of the Tiger Woods era.

Says Leedom: “The leaders by default separated themselves from the rest of the pack . . . and then there was a vast black hole (of companies) that just couldn’t afford to compete at those levels.”

No longer is golf viewed by investors as a growth industry.

“Golf has been such a zero-sum game that it makes the fallout more painful,” says an investment analyst who requested anonymity.

This analyst, like many, believes that the oversupply of product and the relatively flat participation rate are creating a unique dynamic.

“Something that has happened in this industry that hasn’t happened in other industries is that all of the savings are being passed along to the consumer,” he says. “In other industries, 75 percent (of cost savings) might get passed along, but in golf all of it is passed along, if not more than 100 percent.” That, he says, inevitably places increasing pressure on manufacturers’ profitability.

With the industry mired in stagnation, investors’ best bets are on consolidation – for instance, buying Callaway’s stock in the hopes that the company will be acquired at a premium – or shorting stocks – that is, gambling that a company’s share price will decline. Alexander, for instance, is recommending that investors buy Callaway shares, in part because he believes the company is an attractive acquisition target.

“The only way to combat price compression and commoditization at the corporate level is to increase the economy of scale where it comes to the sourcing of components so you can still earn an acceptable margin,” Alexander says.

That’s a reasonable investment rationale, if not quite the image that the golf industry wants to project to the world. Golf equipment companies want to be seen as innovators and technology leaders, constantly churning out products that capture the imagination of consumers.

The truth is somewhat less glamorous.

“There are still some people dreaming up the next generation of product and still thinking, ‘If we just have a better product we can get higher prices,’ ” Koppenhaver says. “Some people think they’re going to ‘productize’ themselves out of it. I think the consumer is telling us otherwise.”

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