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EDITORS NOTE: This note was first published using Twitter/X’s Article feature on August 14th.
This is not yet another negative Nike note. By now we have all likely read some of the ample Nike thought pieces that discuss the problems that John Donahoe is clearly responsible for. I am happy that everyone is coming out of the woodworks to share information. I didn't even know some of the background that is public today when I wrote Confessions Of A Sell-Side Analyst: Nike & John Donahoe back in mid-April. Alas, that is the perpetual problem of being a sell-side analyst; we always have a small subset of information to base our opinions on. Rather, I strongly feel now is the time to start thinking about the potential Nike recovery path.
The book Shoe Dog by Phil Knight is an amazing read even if you don’t care about the Athletic industry itself. You might think the natural ending to that story should coincide with the IPO in 1980, as it does in the book. The reality is the story wouldn’t be so great if it continued for the next several years. According to the NY Times, Nike’s earnings dropped 29% in 1984, the first drop in 10 years. Mr. Knight was quoted saying “Orwell was right: 1984 was a tough year”. 1985 was even worse with the company’s first quarterly losses in history.
So, Nike has been here before. And likely in a much worse competitive position than it enjoys today. You see, Reebok and Adidas dominated most of the 1980’s. Reebok even overtook Nike as the largest athletic shoe manufacturer in the US by mid-decade. But Mr. Knight himself oversaw the late 1980’s Nike turnaround. That’s not happening this time (and let’s be honest, he hit the jackpot with Michael Jordan).
I expect the topic of a Nike turnaround to intensify in coming months after the Paris Olympics. And this has nothing to do with the product they unveiled at the event, which doesn't seem to have been that big of a deal from a media perspective. The last time Nike had a major hit at the Olympics was Flyknit (a running shoe) back in 2012 and nothing they did this year compares. I am sure their marketing department will say engagement is the highest ever, but wonder if they ever compare to 2012, particularly on an adjusted baseline for how little social media mattered back then.
Here are my three most important topics to think about in a potential Nike turnaround:
Nike's brand originated with running performance. And yet, have they really been strong in that category for the last decade? We don't know how large that business is today but the last time they disclosed it they said it was $4.0 billion in FY21. That business had been under pressure almost every year since peak in FY16 (FY17 if you don't use restated figures). It's pretty interesting they stopped disclosing sales by product category afterwards.
Source: Nike 10K, $ mm
I also find it interesting that New Balance (private company) recently mentioned they had more than $6 billion in sales. New Balance doesn't do much in apparel so we are talking pretty much entirely footwear sales here. Asics remains a strong running shoe competitor today, as does Brooks. And now you have On in the mix, which seems to be much more hyper focused on new innovation than all the others.
There is another problem here. Nike has been so bad at innovation in the Running industry for the past decade that now they face competition from brands that don't really do footwear innovation, such as Alo, Arc'teryx, and Lululemon. The elephant in the room is that most running shoes are bought by people that don't use them for running. Regardless, these same people have demonstrated a historical propensity to buy "innovative" product over anything else when they have that option.
The last time Nike seems to have felt challenged in the Running industry was when Under Armour entered it. And I can assure you that Nike did everything in their ability to stomp that competition out (under Mark Parker's leadership). They were pretty successful doing so as they likely (my personal opinion) used all levers at their disposal to prevent major chains from carrying Under Armour's product (ahem, Foot Locker). They largely ignored the smaller brands (Asics, Brooks, New Balance) back then, and now that also seems to have been a mistake.
Rule #1: Never forget who you are and where you come from. Mark Parker, former runner, knew this and thats why he (likely in my view) went to war with Under Armour as they entered the Running category. Nike didn't care when Under Armour went into Cleats, just like they didn't care about the smaller old school niche running brands of Asics, Brooks, and New Balance. But once Under Armour quickly gained #2 market share in Cleats by its second season, Nike felt threatened and responded accordingly when they tried to enter Running. Nobody seems to have continued caring about defending this industry once Mr. Donahoe came onboard. The first thing Nike needs to do is re-establish its dominance in running innovation. Typically that would be a four year process as you can't really unveil that type of major innovation at any event other than the Olympics. But also, typically, a four year process as it probably will take that long to come up with something new that is meaningful. Here is a hint that Adidas provided with Ultra Boost: you don't have to have an Olympic Record time, you just have to feel good while running.
Most people have heard of Adidas Boost technology. Nobody remembers Springblade. The most amazing thing that I still think about today from the Herb Hainer (CEO) era at Adidas is that he seemed to prioritize Springblade over Boost. This was around the same time that Nike unveiled Flyknit – the 2012 London Olympics. Springblade was a highly differentiated product as compared to anything else in the market. But the shoe itself made you think you would break your ankle just walking in it. Boost, on the other hand, was highly comfortable.
Boost, or the later Ultra Boost, was prioritized after Mr. Hainer resigned from the company and ultimately went on to become one of the greatest shoe franchises in Adidas history.
I think about that last statement a lot because I am sure Nike has good innovation that is just waiting to be unveiled. It likely has been overlooked due to an internal bureaucracy that has been run for 5+ years by Mr. Donahoe, who has no background in product whatsoever.
Speaking of feeling good, that's what Nike never understood about Lululemon in apparel. And that's despite Lululemon's trademarked tagline "The Science of Feel". I find it perplexing that both Nike and Under Armour have perpetually talked about their opportunity to gain share in the Women's market, over my entire career, without ever addressing this issue. Kevin Plank himself admits that his former strategy of "shrink it and pink it" was not a good idea.
Here is the way I would describe this to investors back in the day. Nike's advertising used to be in black and white with a perfectly fit person that is disheveled and sweating profusely, but has a huge smile on their face because they just broke their personal best record by 0.01 seconds. Nothing wrong with that and in fact it is something to be admired. But it doesn't represent the broader population. Most people are not training to be athletes and just want to run to feel good.
At the same time, I understand where Nike comes from. They used to be a brand based on performance. But we really haven't seen much of that lately. Rather we see a bunch of new editions of Air Force 1 that was first launched back in the 1980's. The Nike Pegasus, created by Mark Parker, is now on its 41st iteration. It feels like Nike took a page from Disney and just redoes Star Wars, Marvel, or Indiana Jones movies perpetually.
Rule #2: Innovation requires an open mind. In this sense, it requires Nike admitting that most of their innovation today is total bullshit. Either their shoes will deliver a 0.01 second improvement to an athletes 40 time or they won't. But even if they did provide that improvement, they are only really appealing to 20% of the population unless they can find another hook. That hook has almost always been comfort or style. It's the reason why Skechers and Crocs are as large as they are today in terms of pairs sold.
Nike missed both Under Armour and Lululemon and it wasn't a big deal because they were so good at footwear innovation at the time. Now they aren't.
Under Armour was the first apparel heritage brand to crack the broader Athletic industry. All the other major Athletic brands up to that point originated in footwear. Apparel was always the stepchild in these organizations so you can imagine why these companies were not incubators for open minded innovation in the category. I used to describe the 1980's-1990's "Athletic Apparel" industry as basically a cotton T-shirt with a swoosh printed on it. The only iconic piece of apparel I can think of from that era is the Adidas tracksuit.
Kevin Plank changed all of this. Under Armour was founded the same year that Nike launched its Dry-FIT technology (1996). Yet, somehow, Mr. Plank, from his grandmother's basement, was able to achieve massive success in this new "Technical Athletic Apparel" industry. Somehow he was able to sign sponsorship deals with NCAA teams like Georgia Tech only three years later.
All the major Athletic brands to that date were competing in footwear through technical innovation. None of them were overly successful expanding that thought process to the Apparel industry. Nike's success in apparel over this time frame was likely more related to its overall brand halo and less due to any apparel innovation engine.
If Under Armour showed how unprepared Nike was for men's apparel innovation, then Lululemon single handedly destroyed their perpetual narrative towards the overall women's opportunity.
Lululemon is the first women's apparel heritage brand to crack the broader Athletic industry. Now to be clear, Reebok was the first athletic brand to crack the Women's market but they originated in footwear. What I find amazing, is how quickly Reebok achieved success after they launched the first Athletic shoe designed for women in 1982 (for Aerobics). It's a similar story with Lululemon in apparel and demonstrates how severely this demographic has been perpetually overlooked by Nike over its entire history.
Here is the way I used to describe the innovation process difference at Nike vs. Lululemon. Nike will have Lebron James run on a treadmill and measure how fast he runs. Lululemon will do the same thing but also incorporate neuroscience, to better judge the tactile "feeling" that people get from wearing their product. The Lululemon product isn't designed to shave 0.01 seconds off your record. It's designed to make you feel good while you run.
Now most of what I just said is simply a product design and marketing POV. Most of what we call "innovation" in this industry is simply a new manufacturing process that allows you to produce different technical product, at an economically scalable level, that appeals to a broader population.
Nike originated as a footwear performance brand. That's why their entire culture historically has been footwear innovation first. It's why they missed Under Armour innovating in apparel. And it's also why their internal culture has failed to understand the approach that Lululemon takes regarding "feeling" as opposed to "performance" (Under Armour, another "performance" culture, also perpetually misses this point).
The overall Apparel industry is double the size of the overall Footwear industry. Yet in the technical Athletic world, this ratio is opposite. This is a clear opportunity for Athletic brands to address, particularly as they continue to take market share from Traditional brands. It has been this way for my entire career, and yet never seems to change. The second thing Nike needs to do is figure out a viable strategy to compete in the Apparel industry as thats a much larger growth opportunity than anything they have in Footwear.
Surprise, surprise, there are massive structural boundaries to Nike's ability to address the broader apparel opportunity. Rule #3: Physical store operations are absolutely critical to any successful large brand today. Particularly those that sell "innovation", otherwise Best Buy wouldn't exist today. Nike has never built this muscle (they largely outsourced it to Foot Locker before), but I suspect that the BOD does understand the importance of DTC as that was the entire narrative behind Mr. Donahoe being hired. The only difference is, they tried to do it through an asset light manner with digital as opposed to learning how to properly operate a physical store.
This is a perfect opportunity to illustrate a major business model difference between Lululemon (entirely DTC) vs. Nike (majority wholesale). Lululemon really doesn't get involved in the sponsorship world while Nike feels the need to dominate it. Why does this matter? Nike spent a combined $4.9 billion (9.5% of sales) on Demand Creation and leases in FY24 with a 90/10 mix while Lululemon spent a combined $0.9 billion (9.2% of sales), with a 50/50 mix. At the end of FY24, Nike had $10.6 billion in endorsement contract obligations ($1.7 billion next year) while Lululemon's total future rent obligation is $1.4 billion ($0.3 billion next year).
Company reports, $ mm
To be fair, Nike is stuck in a hard place with its positioning as a "performance" brand, so they have to continue to play in the sponsorship game. And that severely limits their ability to take on lease expense to a similar manner as Lululemon. This is likely why the BOD of Nike preferred to grow DTC through the asset light digital channel. But even Under Armour eventually figured out that you need attractive product to sell if you are ever going to monetize those sponsorships. This by far is the single largest catastrophic failure of the John Donahoe era.
Company reports
Most of Nike's sales in the global physical DTC world are through outlets. They do also operate Niketowns, which in my opinion are probably the worst run retail stores that I consistently encounter on my channel checks. Here is a small list of why: 1) massive empty spaces throughout the store that demonstrates the store is being run more for branding as opposed to efficiency. 2) disinterested staff. 3) inefficient staffing allocation at various important "stations" in the store.
By contrast, Lululemon maximizes almost all of the space in their store. Almost to a fault as the checkout line is a bit too packed with random items that take away from the overall brand experience (I liken this to being a bit too much like Gap). Regardless, I don't think I have ever walked into a Lululemon store and not immediately been greeted within seconds. Their employees are highly energetic and typically well informed of the product. I remember Patrik Frisk, former CEO Under Armour, mentioning to me that Lululemon stores are run at a best in breed level.
Here is the bigger problem with Nike's existing wholesale distribution structure: It was originally built to sell product that we either play sports or workout in, not utilize for everyday fashion purposes. Why is that a problem? Well the world changed in the late 1990's to 2000's and we all now wear athletic product in everyday life. The old traditional fashion product that we used to purchase for everyday life was sold through specialty retail stores. Yet Nike's largest wholesale partners continue to be Foot Locker and Dick's Sporting Goods. They have tried to make some inroads at Nordstrom but its such a limited offering relative to what they need. Here is how I used to explain this to investors: Imagine someone that needs to buy an outfit for Sunday brunch - the last place they are likely to shop at is the warehouse format of Dick's Sporting Goods, with no customer service. Foot Locker doesn't even really sell much apparel to begin with, nor does it have the store size to do so.
The third thing Nike needs to do is build a physical DTC skillset. This is going to take some time and I hope they are prepared to poach talent from all the specialty brands that have ample experience with this (similar to how Apple poached talent from the traditional Watch industry before launching the Apple Watch). Alas, this will likely be both a cultural and educational barrier to breach. Cultural on the part of Nike. Educational on the part of whoever they poach as this is a vastly different industry that requires specific product knowledge when engaging with the consumer.
At this point, you can probably understand why it's not surprising Nike is doing whatever it can to win back Foot Locker. I can't think of another retailer that operates so efficiently that it can survive long term on a low 30's gross margin rate (maybe Best Buy...hint hint...who Apple, Samsung, LG, etc, seem to still need).
Mr. Donahoe's position today at Nike is untenable for many reasons. So I expect change to occur at some point now that the Paris Olympics has passed. The single biggest problem with change of this magnitude is that there really isn't anybody with the unique skillset to run a company like this. This is likely why Mr. Donahoe got the seat to begin with because at least he had been on the board for ~5 years and he was about as hyped a candidate as possible for digital growth outside of maybe Jeff Bezos. It's also likely why this succession process is going to take some time.
Under Armour has never been able to find a successor to Kevin Plank despite multiple attempts. Some of that might be because Mr. Plank (who still controls the company) never really wanted to step down, but some of it also might just be because there were no good options to begin with. The first attempt was with someone that had ample experience in the Athletic industry and yet that failed to deliver results. I can assure you that seemed a serious attempt at Mr. Plank passing the torch as he was uncharacteristically humble and deferential towards the whole thing from my own personal interactions. The last person was from outside the industry (Marriott), had never been a CEO, and didn't last very long.
Lululemon has also had a highly problematic history regarding succession. The first person to succeed founder Chip Wilson came from Starbucks and by all accounts seemed to be somewhat competent running the company. However, it doesn't really seem like Mr. Wilson ever actually stepped down (ala Mr. Plank and even Mr. Knight multiple times) and that led to some internal chaos. The next CEO hire was someone well experienced in the Athletic industry but he ultimately didn't perform. The actual turnaround in the company happened under a temporary team leadership structure: Stuart Haselden, current CEO of Arc'teryx; Sun Choe, current Global Brand President of Vans; and Celeste Burgoyne, current President Americas of Lululemon; with Glenn Murphy, former CEO of Gap, overseeing as Chairman. Calvin McDonald was ultimately selected to join the firm as CEO and proved to be an amazing cultural fit following his previous experience running Sephora Americas. But Mr. McDonald was not initially greeted by excitement within the investment community. I should know - I hosted the very first investor event with Mr. McDonald in Vancouver and it was super hard to fill the number of slots with quality investors that were willing to travel.
The best example we have of succession within the Athletic industry in the last 20 years (after Mark Parker) comes from Adidas. The Adidas story in the 2000’s comes down to one man: CEO Herb Hainer. It was almost like he intentionally wanted to destroy shareholder capital. The only other person over my career that I think of in a similar manner is Steven Tamares at Bed, Bath, and Beyond. Later in my life I learned a lot more about German institutional investors, particularly Union Investment. To their credit, they ultimately led the push to get rid of him. So, keep that in mind Nike, as I can personally attest there are large U.S. long only shareholders today that already want John Donahoe gone.
Adidas is the only company in the world that has a similar level of inherent competitive advantages as Nike. Most specifically, they have a catalog of historical iconic product that they can always revisit over time. But they also have a huge manufacturing scale advantage (much more important in footwear than apparel).
Let’s recap what Mr. Hainer did to Adidas. He was CEO of Adidas from 2001 to 2016. He came from a sales background, not product, while his main competitor at Nike, Mr. Parker, had a product background. Over the course of Mr. Hainer’s tenure, Adidas sales increased at a similar rate as Nike at ~230%. However, over this time frame, Nike divested Cole Haan, Umbro, Bauer, and Starter, while making no further brand acquisitions. Adidas bought Reebok, which generated more than $2.5 billion in revenue (approximately ¼ of the Adidas brand itself). The only meaningful divestment at Adidas was the small Solomon group (excluding TaylorMade). By the end of Mr. Hainer's tenure, Nike was back at a similar revenue ratio advantage to Adidas as what they enjoyed at the beginning of his tenure, even despite proactive efforts to reduce its portfolio to just the Nike and Converse brands.
Company reports, $mm
Mr. Hainer bought Reebok for $3.8 billion in 2005 and then proceeded to destroy the brand. There are so many stories to tell here but the one that stands out the most is Reebok had a strong presence with the NBA. Yet Mr. Hainer made the strategic decision to switch that out with the Adidas brand instead. As everyone knows today, Adidas branded basketball shoes never took off. And, even today, the Reebok brand continues to enjoy greater heritage in the basketball world with its iconic Reebok Pump that legendary Shaquille O’Neal is famously associated with. Ultimately, Adidas sold the Reebok brand to Authentic Brands this year for $2.5 billion, significantly less than what they paid for in 2005.
Over my lifetime, Adidas was always positioned more as a street and fashion brand than Nike, who has tended to rely more on innovation. Run DMC in the 1980's. Rave culture (Peace Love Unity Respect) in the 1990's. Kanye West and Yeezy. Makes tremendous sense that Adidas succeeded with Stella McCartney while both Nike and Under Armour perpetually seem to have no idea how to address women. And yet even with an internal culture most primed to address women, Adidas completely failed under Mr. Hainer's leadership, leading to the emergence of Lululemon.
There is a huge similarity between Nike under Mr. Donahoe and Adidas under Mr. Hainer. Both companies failed to press their underlying competitive advantages. Adidas had a fashion skillset that was perfectly positioned to attack the women's apparel market but Mr. Hainer thought it more important to address footwear innovation. Nike had a footwear innovation skillset but Mr. Donahoe thought it more important to focus on distribution, leaving room for On, Hoka, and others to take share. Mr. Donahoe has a long track record of looking towards M&A to solve his issues, and Mr. Hainer also seemed to lean into that direction. Let's hope Nike's BOD remembers the lessons the company learned from all the bad M&A it did in the 1990's and early 2000's.
All it took for Adidas to turnaround was new leadership under Kasper Rorsted. He came from Henkel, of all places. Reminds me a lot of how Hubert Joly, who came from the travel industry, turned Best Buy around. And Adidas did it quite quickly as they already had all the assets in place. They always had those assets in place yet they were just being mismanaged. I don't think this fact will be lost on the BOD of Nike. It certainly won't be lost on the large long only shareholders that Nike depends upon.
FIN