The Footwear and Outdoor Apparel Industry (An Analysis)

(I wrote this for a paper. I was a bit rushed in writing it - so the language and organization might not be best - but the information should give a feel for the structure of the entire apparel industry even though the paper is focused on footwear.)

The footwear industry is a large and growing industry: the estimated value of the United State’s share of the market was $54.1 billion in 2005 with 2.2 billion pairs of footwear sold and with sales volumes growing at a compound annual growth rate of 4.5% from 2001 to 2005. The United States is the world’s largest footwear market in terms of value, but it only makes up 33.9% of the global market in terms of revenues – indicating that there are plenty of opportunities for American footwear companies to expand internationally .

The footwear industry is composed of three major participants: designers, manufacturers, and retailers. The footwear industry, much like the rest of the apparel industry, has consolidated considerably in recent decades leading to each of the aforementioned categories of participants having strong dominant players. But, there are still many different international, national, and regional players actively competing in each of the roles.

The footwear designers primarily design, develop, and market footwear products and other brand-related apparel. The design companies vary largely both in their market share and in the number of brands they manage. Nike for instance, which has a 34% share of the sneaker market, relies primarily on its eponymous brand even though it competes in many different sports related market segments. Companies like Wolverine Worldwide and Deckers Outdoors, on the other hand, manage diversified portfolios of far more focused brands. There are also a number of small, recent entrants such as Crocs and Heely’s that have only a very narrow range of highly focused niche products that sell under a single brand. Despite the differences in size and number and types of brands managed, most of the footwear designers are similar in their limited amount of vertical integration into retail and manufacturing.

Retailing and Buyer Positional Power


Most footwear is sold to customers through retail channels that vary depending upon the market segment the product is aimed at. Though the retailers are still pretty fragmented, most footwear brands rely heavily on a small number of companies for purchasing the bulk of their merchandise. For instance, Foot Locker, the largest retailer of athletic sports sneakers, is Nike’s largest customer and accounts for 10% of Nike’s sales on average . The Finish Line, a mall based seller of sneakers is a close second with an almost equally large share of Nike’s sales. Outdoor hiking shoes and sandals are predominantly sold through a small number of outdoor outfitters such as EMS, REI, and L.L. Bean. Non-athletic products such as Uggs and Cole Haan are primarily sold through a small number of high-end department stores such as Nordstrom’s, Macy’s, and Dillard’s – with Nordstrom’s accounting for 11% of all Ugg’s sales .

The power of the retailers in the footwear industry varies based upon the segment of the market that the retailer serves. Generally though, the power of and risk associated with the retailers over the design firms is in proportion to the percentage of sales that they are responsible for. Companies like Foot Locker have been able to strongly increase Nike sales over those of its rival Reebok in the past through the amount and quality of retail space that they provide for each of the company’s products . A major benefit of the Addidas-Reebok merger, according to some analysts, is that it provided a lot more “leverage in dealing with powerful retail chains like Foot Locker.” According to the same industry analyst Reebok and Addidas were, “confronting a retail community with two huge companies, with 60% of the market.” The future further concentration of footwear retailers has the possibility of not only decreasing the margins of the footwear designers, but it also has the potential of increasing the credit risk of footwear designers which generally sell large volumes of their products to retailers on credit. Larger retailers, as they continue to consolidate, also have the potential of forward integrating into shoe design and marketing functions as evinced by the financial success of PayLess ShoeSources’ $35 Amp Runner and Steve and Barry’s $15 Starbury basketball shoe .

Possibly to reduce the power of, and risk associated with, their retailers, medium to large footwear design companies have been increasingly forward integrating by creating their own retail channels both domestically and internationally. In the United States, Nike has been expanding the number of NikeTown and factory stores that it directly operates. Decker’s Outdoors, a much smaller player, has recently opened up 3 direct retail outlets in California and an Uggs concept store in NYC. Both Nike and Addidas have been exclusively using dedicated branded stores as part of their strategy for expanding into the Chinese market to increase the amount of control they have over the experience surrounding the sales of their products . Additionally, almost all footwear designers regardless of their size have been conducting direct sales through the internet, though sales through the internet have yet to grow to a point where they rival tradition brick and mortar channels.

Suppliers and Manufacturers’ Positional Power


Footwear-manufacturing is very labor intensive and capital-light, which has led to much of the work moving from the United States and Europe where labor prices are high to low-cost labor centers like Thailand, Vietnam, Indonesia, and China in the past two decades. Though many of the long-established footwear designers used to engage in the manufacturing of their products, most converted to being strictly design and marketing firms in the 1980s to lower costs. The few footwear companies, such as Timberland, that own factories only in-source very small percentages of the volume of merchandize that they sell. Most footwear design companies rely upon independent, low-cost overseas contract factories for production. The design firms primarily provide design specifications, manufacturing instructions, and quality requirements to contract factories and then purchase finished products from the contract factories for resale to distributors and retailers. The footwear manufacturers are incredibly fragmented and competitive; most medium to large design firms source their products from multiple small production companies spread over multiple countries to reduce business risk, and most designers do not have long-term contracts or relationships with any of their manufacturers. Given that most footwear designers outsource their manufacturing overseas, the risks associated with doing so, including the threats of political instability, tariff-law changes, and currency exchange rate fluctuations, impact all of the designers. However, the risk associated with outsourced, overseas manufacturing is more easily mitigated by larger footwear companies that have enough scale to spread their manufacturing contracts over more countries and companies and have the resources to engage in financial hedging activities using instruments like currency derivatives. Many companies, such as Timberland, that don’t have a large amount of geographic diversity in their supply chain recently suffered severely when the EU decided to implement duties on leather footwear produced in China and Vietnam.

Due to the structure of the industry, the manufacturers of footwear do not currently have a lot of pricing power because of the lack of concentration in the sector. The largest of the footwear manufacturers is Pou Chen, a Taiwanese diversified industrial company that manufactures shoes throughout Asia using its Yue Yuen subsidiary. Yue Yuen produces upwards of 7% of Nike’s Shoes and large quantities of shoes for Reebok, Puma, Timberland, Addidas, Wolverine Worldwide, Dr. Martin, Asics, and New Balance. Some recent estimates indicate that Pou Chen was producing 190 million pairs of shoes a year as of 2006 . Despite Pou Chen’s size, there doesn’t appear to be evidence that it has any extra pricing power over other manufacturers given how many competitors it has. Pou Chen, like many other manufacturers, doesn’t have more than a 7% share of the volumes for any one company; as such its influence is spread over a very large number of design companies. Nike, for instance, is able to insulate itself from its manufacturers by working with over 60 independent contract manufacturers to maintain vendor and geographical diversity in its supply chain and Nike sources no more than 35% of its product from any single country .

Possible future threats to the footwear designers might emerge in the future if the contract factories consolidate further; forward integrate by developing designing and marketing skills of their own; or further develop their own distribution networks. The credibility of the threat of contract manufacturers moving vertically up the value chain was recently illustrated when one of New Balances contractors decided to design its own shoe and sell it first using New Balance’s brand and then using its own brand -- Henkee. The Henkee shoe, a low cost fashion sneaker, was a huge success in China in the late 1990s Another Chinese shoe manufacturer recently started selling shoes with the exact same design as New Balance’s shoes under their newly created New Barlun brand; New Barlun directly copied New Balance’s American targeted marketing material for its Chinese audience . Though, the threat of brands owned by manufacturers competing directly against American brands seems unlikely in the American market, the risk is definitely very real in the international markets – which are critical for many American companies’ growth strategies.

On the distribution side, Pou Chen, one of the world’s largest manufacturers has been actively buying up smaller factories as part of its growth efforts and it has been developing retail outlets throughout China. Pou Chen currently operates 600 stores in China and is planning on increasing that number to 1000. Pou Chen also has exclusive distribution rights for Asics, Hush Puppy, Converse, and Coleman in China. Its possible that as Pou Chen continues to grow both its manufacturing business and its distribution business that it will be able to use its size during pricing negotiations with the footwear designers or use its retail presence to sell its own brands.

Entry Threat and Internal Rivalries


Given that footwear design companies primarily engage in the design, marketing, and distribution of footwear, the entry barriers to the industry are limited to those areas. Entrant companies and brands have generally first emerged in market segments that the larger companies were either not competing in or were otherwise weak. For instance, recent entrants into footwear design, such as Payless ShoeSource and Dave and Barry’s have taken advantage of the relatively small number of powerful players in the budget segments of the market – which has been growing at 9% for the past 2 years.

Given the relatively low costs of entry into the footwear industry, the most successful strategy for ensuring business stability and growth for most footwear designers has been maintaining a broad product mix that appeals to multiple consumer segments, diversifying sales across as many markets as possible, and engaging in rapid product innovation. Diversification in terms of products and geography provides the best guarantee that the products of new entrants and existing rivals will not have an immediate and major impact on sales. Diversification also guarantees that if consumer sentiment shifts away from one product category due to climate or fashion changes that there are other products to carry the business. Product innovation, on the other hand, is critical because it helps to create entry barriers in specific consumer segments – though generally it matters far less for the non-performance and budget segments of the market. Universally, the ability of companies to rapidly and constantly introduce new styles is critical towards adapting to consumer demands and warding off copy-cat products from new entrants and incumbents.