I don't know what sort of profit margin you think LBS's have, Cig, but it's a lot higher than that, 40% or so if what I've heard is correct. Obviously they have to account for time to assemble, pay employees, provide free lifetime tuneups, etc... but I think your numbers are way low.

You point, of course, is still valid. There IS a point of diminishing returns though - the $30 (smaller margin, I'd guess) that you make on a $150 bike is not worth the cost that you'll put out trying to maintain a level of service worth your reputation. So in the sense you get what you pay for - Walmart sells cheap bikes and makes less on a bike than the LBS, but they don't have the same reputation for quality and service to maintain (which of course digs into your profits). This is true in other areas - I read an article about Snapper (IIRC) lawnmowers turning down a deal to sell with Walmart, because they felt that between the price concessions Walmart wanted and the lack of dealer support, that it would end up costing them more than the additional gross profit would bring (at least in the long run).

EDIT: That article: http://www.fastcompany.com/magazine/...n_snapper.html