Demand for cycling is inelastic
Frame and Wheel reads that demand for bicycles and bicycle equipment remains relatively strong despite tough economic conditions and speculates that this is because for many people, riding a bicycle for health, competition or transportation is an important part of their daily lives and something that they cannot do with out. An economist would say that demand for cycling is inelastic. Frame and Wheel observes that demand for telecommunications is also inelastic: individuals want very much to be able to communicate and are unlikely to terminate their cell phone subscription when times are hard. They will more likely stop going out for dinner and movies. People pay for cell phones so that they can have access to others in the form of voice calls or emails, which for most people is very important.
It is about the experience
Cyclists pay for their bicycles and gear so that they can have access to new and existing experiences on their bikes, stay fit or get to where they want to go. Frame and Wheel has always thought that cycling is about many things including the experience that occurs when you are on the bike: the reverie, the camaraderie, the freedom, the sunrise, the fox, the idiot driving the SUV while talking on the cell phone, the climb, the field sprint, the drama. In a funny way, we communicate when we are on a bike ride: we communicate with ourselves, with others and we actively or passively absorb the surroundings. Frame and Wheel has been caught thinking many times that a bicycle is very much like a communications device and believes that the Internet of Things will transform how we own our bikes, pay for our bikes, ride our bikes and dispose of our bikes. Indeed, Frame and Wheel's mission is to facilitate that change.
Please elaborate in a post
Frame and Wheel asked visitors to the blog if they would ever pay for their bicycles based on the number of hours they used it. Sixty percent of the 35 respondents said no, 20 percent said please elaborate in a post, 14 percent said yes and the balance said maybe. Frame and Wheel believes that the responses suggest that consumers cautiously open to the idea, but very much against the idea of paying an hourly rate for using a bicycle, perhaps because they want to own it. Frame and Wheel also asked blog visitors if they would pay for their bicycle the way they pay for a Netflix subscription. Seventeen percent of the 36 respondents said yes, forty-four percent said please elaborate in a post, 20 percent said no and another 20 percent maybe. The responses suggest that the market is curious about this idea, and prefers the option of paying a monthly sum rather than an hourly sum.
iTronski
This summer, Frame and Wheel made the mistake of leaving an Android smart phone on the beach below the hight tide mark. In the few minutes that the smart phone was astray, it was completely soaked and ruined (This earned Frame and Wheel an iTronski). Frame and Wheel discovered that this smart phone, an HTC Incredible, which had been given to Frame and Wheel free of charge by the cell phone operator at the beginning of a two year contract, retails for $700. The service provider informed Frame and Wheel that the only available options were to buy another new Incredible or buy one second hand somewhere. The experience crystalized for Frame and Wheel the fact that the cost of smart phones are loaded into the monthly cost of a calling plan, and shattered the warm and fuzzy perception that cell pone operators just hand out these beautiful smart phone for free. This experience also allowed Frame and Wheel to obtain a better understanding of how mobile phone contracts are structured and Frame and Wheel will digress for a moment on this topic.
High costs low usage
Cell phone operators have huge fixed costs. The largest one is the network of cell phone towers, exchanges and other equipment that allows calls to be made and delivered. Add to that the labor, the trucks and the offices and it becomes clear that running a mobile phone network is very expensive. The only way cell phone operators can cover these costs is by charging airtime to cell phone users, and the only way they can charge users airtime is by getting them to sign up and pay a for cell phone. In the early days, the subscriber had to buy the phone at retail (sometimes from the cell phone operator) and then pay for the airtime based on the number of minutes they used it. The trouble with this approach was that the phones were very expensive (as well as cumbersome), and those who could afford to pay them used their phones for only a few minutes each day because the batteries for the cell phones didn’t last long, the air time charge was expensive and by the minute and there were plenty of perfectly fine or better fixed line phones still available, Cell phones operators were in a situation where subscriber growth was slow, usage was low and network expenses were high and getting higher.
The virtuous circle
Everything changed when cell phone operators began to subsidize or absorb entirely the cost of the cell phone and integrate that cost into a two-year monthly calling plan. Suddenly, cell phones became much more affordable. Additionally, the monthly calling plan eliminated the perception of air time usage being expensive. The only wrinkle was the requirement to sign a two year contract with the cell phone operator, but consumers were fine with the commitment because they viewed a cell phone as a necessity (or their demand for telecommunications was inelastic). Subscriber growth and penetration increased, usage surged and cell phone operators were able to invest in expanding their networks, which led to a virtuous circle of growth and profitability. Frame and Wheel quantifies just how profitable the cell phone subsidy arrangement is for a cell phone operator below:
Rate of return for a subscriber paying $60 per month
| | Net cost of a phone ($) | Annual revenue ($) | Annual revenue ($) |
| Cash flows | (200) | 720 | 720 |
| Internal rate of return | 342% | | |
| Required rate of return | 10.0% | | |
| Net present value of subscriber | $954 | | |
Very high IRR
Frame and Wheel estimates that the internal rate of return on a single subscriber that pays $60 per month ($720 per year) for basic cell phone access is 345%. The rate of return is so high because the cell phone operator pays a wholesale price for the smart phone that it gives to its new subscriber. For some popular smart phones, the subscriber pays a token sum of say $99, which serves to lower the wholesale cost of the phone even more (Frame and Wheel arbitrarily estimates that the cell phone operator pays $200 whole sale for the smart phone in this example).
Smart phone cost earned back quickly
This cost is earned back in just three months, and the rest of the revenue for the two year period and beyond is pure gravy. Additionally, the cash flows are stable and predictable and the chances are very good that the subscriber will come nowhere near the monthly limit which is good for keeping the network clear for those who do (even if the limit is exceeded, the subscriber pays the per minute rate). Of course, the operator has to pay operating expenses and continually invest in the network, but this example shows just how profitable combining subsidized cell phones with monthly calling plans has been for the industry.
Nationwide calling plans AT&T
| | Plan 1 | Plan 2 | Plan 3 |
| Cost per month ($) | $60 | $80 | $100 |
| Minutes of talk time per month | 450 | 900 | 1,350 |
| Hours of talk time per month | 7.5 | 15.0 | 22.5 |
| Cost per minute | $0.133 | $0.089 | $0.074 |
| Cost per hour | $8.00 | $5.33 | $4.44 |
| Cost per year | $720.00 | $960.00 | $1,200.00 |
Could it work for a frame set?
If a bicycle is a communications device, could this model work for a frame set? Frame and Wheel believes it could. Frame and Wheel looks at monthly calling plans available in the market today and translates them into hours as that is how Frame and Wheel and other cyclists track how much riding they are doing each day. Plan 1 costs $60 per month and allows the subscriber 450 minutes of talk time per month. This works out to $0.13 per minute. In terms of hours, the plan allows the subscriber 7.5 hours of talk time at a cost of $8.00 per hour. Plan 2 costs the subscriber $80 per month and allows for 15 hours of talk time per month at an hourly rate of $5.33 per hour. Plan 3 costs the subscriber $100 per month and allows for 22.5 hours of talk time at a cost of $4.44 per hour. Plan 1 cost the subscriber $720 per year at a minimum; Plan 2 cost $920 per year and Plan 3 cost $1,200 per year. A key point to note is that the subscriber pays the per minute rate on any minutes in excess of the monthly threshold. For example, if a Plan 1 subscriber exceeds the 450 minute threshold by 10 minutes, the subscriber is billed $13.30 in addition to the $60 monthly cost.
Hypothetical monthly subscription plan for a performance frame set
| | Monthly subscription plan |
| Cost per month ($) | $59 |
| Minutes of ride time per month | 1,800 |
| Hours of ride time per month | 30.0 |
| Cost per minute | $0.03 |
| Cost per hour | $1.95 |
| Cost per year | $702.00 |
$59 per month for three years
Frame and Wheel believes that most cyclists consider telecommunications to be more of a necessity than cycling, but not by much, and thus estimates that a monthly subscription plan for a performance carbon frame set that retails for about $1,500 would be $59 per month. This plan assumes that the subscriber rides the frame set about 30 hours per month and thus targets dedicated cyclists. The key difference is that if the rider rides the frame set for more than 30 hours in a given month, there is no per minute charge in excess of the monthly cost. This is intended to incentive the the rider. The annual cost of this subscription is $7o2 per year.
Internal rate of return on a frame set subscription
| | Net cost of frame set ($) | Year 1 revenue ($) | Year 2 revenue ($) | Year 3 revenue ($) |
| Cash flows | (650) | 702 | 702 | 702 |
| Internal rate of return | 93% | | | |
| Required rate of return | 10.0% | | | |
| Net present value of frame set | $996 | | | |
Internal rate of return of 93%
The internal rate of return on a frame set subscription is estimated to be 93 percent. The net present value of the frame set is $996. At the end of the three year period, the frame set can be returned to the brand for a cash or credit payment. This mechanism keeps the rider on the road and keeps the frame set out of the land fills. Would there be a three year contract? Perhaps, and perhaps there would be a built insurance plan so that if the frame is damaged, it can be replaced at no cost to the rider. Another critical element of this model is how to implement it and monitor it. Frame and Wheel believes that subscribers will obtain this service through an existing on-line application provider. Frame and Wheel appreciates that this all sounds pretty outlandish, but the same could have been said ten years ago about the idea of uploading rides to the Internet moments after you finished them. Frame and Wheel will continue to refine this idea and think outside the bike.
