Dr. Dre Is Taking SKUL to School

NEW YORK (TheStreet) -- A herd of investors and analysts seems to have woken up as one to the fact that the consumer headphone market Skullcandy (SKUL) once dominated has become crowded with exciting competition.

I'm a believer in Skullcandy, but the ground has been shifting underneath it for quite some time. Competition is not just more plentiful but fiercer, redefining the headphone market.

As Gregg Greenberg notes in 5 Dumbest Things on Wall Street This Week: March 15, analysts leaped shamelessly to downgrade the stock this week, even as the company was listing all the right measures it was taking to correct its problems. I would add that changes in the sector should have been a red flag, long before now.

Dr. Dre's Beats Electronics entered the market in 2008 -- a full five years after Skullcandy -- but quickly became the dominant player. Its branded products are easily identified from a casual distance and a quick scan of any busy New York City sidewalk reveals a couple of sets of Beats headphones, that modest, identifiable little "b" right at eye level.

Beats are typically higher priced, in the $199-and-above area, compared to Skull's average $99 product. But Beats' compelling higher-end lines have siphoned off some of Skullcandy's lower-end consumer base, putting the prime mover on the defensive.

According to founder and interim CEO Rick Alden, Skullcandy's response was to push the lower end even harder, putting too much emphasis on off-price channels. Further missteps in revamping its packaging added to the problem, Alden said. The bankruptcy of a major retail customer in the UK, HMV, merely brought Skullcandy's precarious position to the forefront.

The company is working to overcome those mistakes, re-making its packaging, pushing into sports branding and global markets and marketing to video gamers, for instance. But those changes come at a price; earnings projections for the first quarter and full year of 2013 have suffered. The outcome from the changes will likely be a better company and a stronger stock, but that doesn't necessarily help traders right now and it likewise leaves questions hanging for investors in the long term.

To make matters worse for Skull, the phenomenal success of Beats has opened the door for others, including former Beats partner Monster and electronics accessories company Zagg (ZAGG). Monster is attempting to outdo Beats, ramping up the style-and-fashion angle with input from Italian pret-a-porter designer Diesel.

Zagg, for its part, specializes in protective covers and cases for electronic devices but is worming its way into audio via the tiny cracks left open by both Beats and Skull. Two new products touted on Zagg's most recent earnings call are great examples of this thinking: a small desktop speaker for music players and decibel-limiting headphones branded for young children. In addition, it offers headphones that directly compete with the main lines offered by Skullcandy and Beats.

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