For as long as we can remember, we’ve been reading comments such as these on the internet:
‘ Nike makes their shoes for $2 dollars.’
‘ The Yeezy Boost costs $10 to make and adidas sells it for $350. adidas makes a $340 margin’.
‘ Sneakers could be considerably cheaper if brands stopped paying all that money to Kanye West, Stephen Curry and Lebron James’.
‘I bought a shoe worth $200 for just $50 on Black Friday, and the shoe company is probably still making a lot of money.’
Frankly, we’re surprised that no one has published exact manufacturing costs for specific models, considering this is such a widely discussed topic, and the cost information isn’t particularly hard to get. There’s only one relevant precedent. Back in 2014, Matthew Kish, a journalist with the Portland Business Journal did write about the average cost to make a pair of $100 shoes.
We thought it would be even more helpful to tell you what are the exact costs involved to make specific models, and what kind of profits entities involved in the business ultimately end up making. Because as you’ll soon discover, factory costs happen to be only a tiny part of the entire story.
For fun, we’ll throw in the actual production costs of the adidas Yeezy Boost 750 and the D-rose Boost too to see how they compare to their counterparts in the running footwear category.
Not only that, we’ll tell you the financial workings of full price vs. discount retailers, and the kind of impact endorsement money has on a price of a shoe. The answers surprised us; the chances are you will be too.
The individual costs mentioned here are 95% accurate, and are factory or ‘ FOB’ costs. FOB is short for ‘Free-on-board’ (also called freight-on-board at times), which is the cost of shoe when loaded on the vessel at the port of origin – usually in the country where the factory is located.
The term is self explanatory – by quoting the FOB cost, the supplier means, ‘Hey, we’ll take care of transporting the finished shoes till the shipping port. It’s free till that point, and once the shoes are on board the ship, it’s your problem.’
However, what we don’t have is the material break down of each FOB cost. In the industry, this is known as the BOM – short for bill of materials. This itemizes the cost of each and every component used in the shoes, based on their consumption in a single pair.
Think of it as a list of ingredients in a cooking recipe, except that the list is marked with how much each ingredient cost you to purchase.
For a typical running shoe, the BOM will add the consumed cost of synthetic leather, mesh, threads, logos/inks, trims, midsole, outsole etc. The final costing sheet also includes the labor and overhead (LOH) costs. Very often, the cost of making the expensive sole molds is spread across/amortized a particular model too.
The BOM information is confidential, restricted to the product team involved in creating a particular shoe model. For that reasons, we do not have individual BOM’s and costing sheets.
Let’s get straight to the point, shall we? We chose 22 shoe models from adidas, Asics and Nike, and the infographic which follows shows you what it cost to make each one of them. We looked at the average cost of different colors across a single model, because factory costs differ based on the color.
It must be mentioned that individual sizes do not have their own FOB costs. If a shoe is available is sizes US 6-13, then the cost mentioned will be for the mean/median sizing, say a US 9 for men’s footwear.
So regardless of whether a brand is buying a US 11 or a US 7 for a specific shoe, the cost will stay the same across sizes. Similarly, a different mean costing size would exist for women’s and kid’s shoes.
The numbers you see below are the FOB costs for specific shoe models, based on Jan-May 2016 ocean shipping data. Publicly available US import data does not contain itemized FOB costs, nor is the database current/comprehensive, so we had to compile the data from international imports and exports. Hence the variation of 5% due on the account of currency conversions to the US dollar.
There’s a good reason why we chose adidas, Asics and Nike for this exercise. They are public companies, giving everyone the access to their income statements. That allows us to tie in other calculations to the cost of the shoe, and deduce the average profit made by brands on each pair.
Let’s kick into high gear, then. In the absence of any context, this infographic seems obscene. A shoe (adidas Energy Boost 3) which sells for $160 costs $30 to make? That’s a profit of $130 per pair! Shoe companies are truly ripping us off!
But that is as good as looking at a person who earns a salary of $300k a year, and say, ‘300k a year? That guy can save a million dollars in 5 years.’
That makes no sense, does it? Because out of the 300k salary, one will have to account for mortgage and car payments, education loans, insurance, food, fuel costs, taxes and what not.
So while $300k a year is a comfortable salary to live on, the actual savings left over after expenses is a mere fraction of that. An apt analogy would be to equate your salary to the retail price of a shoe, and your minuscule savings to a brand’s net profit after tax.
Last year, adidas made a paltry 4.1% in net income (read footnote #1) after taxes, and Nike made 10.7%. But remember that brand income statements are based on wholesale revenue and not retail price.
So if you had to calculate the brand margin as a percentage of the retail price, then adidas and Nike made a 2.05% and a 5.3% profit respectively. This is assuming that the wholesale revenue is half of the retail price. (We’ll explain those terms in a bit)
In other words, for a shoe priced at $100, adidas earned just $2.05 and Nike made $5.3. But didn’t we just say that a $160 shoe is produced for $30?
So where does the rest of the money disappear?
1) The big picture: Landed costs, wholesale revenue and gross margins
The factory cost only represents the first step of a finished product’s journey. As it leaves the country of origin (where it is manufactured), additional costs get piled-on, leading to the landed cost.
Since the FOB cost only covers the stage of transporting the shoe from the factory to the local sea-port, the brand has to cover the cost of transporting it from Asia to the United States.
It is also possible the ship might run into a nasty storm, and drop a few containers containing thousands of sneakers into the ocean (Yes, this has happened). So the brand has to pay for insurance to cover for any unforeseen circumstances. This works exactly like buying personal travel insurance with your air ticket.
At this point, the factory (FOB) cost has transformed into a Cost+Insurance+Freight (CIF) price. That’s before the shoe gets off the boat and meets Uncle Sam’s army of custom officers.
When the shoe finally reaches a US port, the shipment is assessed for custom duties. The custom duty calculation is extremely complex, relying on the elaborate harmonised tariff code (HTSUS) system to assess how much duty is to be paid.
There are different duty structures even for the same commodity. So one type of footwear can have a 10% rate of duty, and another could be as high as 20%.
At this point, the factory cost has turned into cost+insurance+freight+custom import duties. This is known as the landed cost, which as you can see in the calculation, is 21 % higher (approximation, could be lower) than the factory cost. In corporate business reporting, the landed cost is used to derive the ‘cost of sales’ or ‘cost of revenue’. (read footnote #2)
And what exactly does net sales or revenue mean for a brand?
When buying a pair of shoes, you might not necessarily do so directly from the brand. You’ll probably head over to the Roadrunnersports or Zappos website, or perhaps your local Footlocker, Dickssportinggoods or family owned running store. These stores and chains buy it from brands such as adidas and Nike, who in turn offers them a margin to cover their operational expenses and make a small profit.
The discounted rate offered to retailers is known as the ‘revenues or net sales’ for the brands. The industry average for retailer margins is approximately 50%, which means a brand like adidas or Nike sells a $100 shoe to their partners for $50.
(Update: We’ve got a lot of feedback saying that retailers do not get a 50% margin. The bottom-line is, the 50% number is an accurate representation.)
The calculations work differently when brands operate their stores or websites, because they are selling to customers directly. However, direct sales is still a small part of an athletic footwear brand’s business. For all practical purposes, one can assume the net sale to be the number arrived at after selling to retail or wholesale partners.
The difference between the landed cost (cost of revenue) and price offered to retailers ( revenue or net sales) is known as the ‘gross margin’ in accounting lingo.
As you can see in the infographic above, a $100 shoe ends up being $22 in landed costs and the brand sells it to a third party retailer for $50. For a brand, the gross margin in dollar value is $50-$22= $28.
In percentage terms, it will be $28/$50 x 100 = 56%. This gross margin number is included in income statements made available to Wall Street.
So far, so good. But we haven’t discussed other expenses, like the cost of running a shoe brand. What do those numbers look like? Fast forward to the next part, then.
2) The fine print: Other expenses, taxes and net profit
The gross margin of any respectable brand will be in its high 40’s. In 2015, adidas had a gross margin (Net sales – landed product costs) of over 48%, while Nike made 46%, a full 2% lower than adidas. Asics made 44%.
Numerically astute readers might notice a disconnect. Based on our first few infographics (containing the sample footwear assortment), it appears that some of the adidas running shoes cost much more to make than similarly priced Nike shoes. So if Nike running shoes costs less to make than adidas, how can they end up with a lower gross margin?
We can make an educated guess. Firstly, from a product standpoint, adidas sells a lot more apparel than Nike, and generally apparel is a higher margin business. Nike has always been a footwear brand, and that shows in their numbers.
For the combined sales numbers of footwear and apparel, Nike sold 68% of footwear and only 32% of apparel. In what’s a stark contrast, adidas’s sales split was 55% footwear and 45% apparel. The fact that Asics’s gross margin (44%) is lower than adidas and Nike lends credence to our theory. After all, Asics’s business is 84% footwear.
It is also possible that other categories like adidas Originals footwear delivers a higher margin than running footwear. The white adidas Superstar for example, sells for $80, but is produced for $16. That makes the production cost a mere 20% of the retail price, hence delivering a much higher gross margin.
But the footwear/apparel/category mix is just one of the many factors which can raise or lower margins. Actions like deciding who to sell products to – some sales partners or channels are higher margin than the rest – or making the supply chain efficient are some of the other ways to boost brand gross margins.
If a company runs its own stores, then reducing expenses and upping merchandising efficiency to decrease discounted sales and/or increase higher margin product sales is another way to help margins.
Out of the total gross margin, brands will have to pay for staff salaries, distribution costs, marketing, depreciation, taxes and other business related expenses. Fortunately, most of these numbers are available for everyone to see, as long as the brand is publicly traded.
It just so happens that adidas and Nike are public companies, so we have our work cut out for us.
Marketing forms a big part of a brand’s expenses, no two ways about that. In 2015, Nike spent over 10% of its net sales on marketing, and adidas spent even more, at 17% of net sales.
For all other expenses other than marketing, Nike spent 22% last year and in adidas’s case, the German brand spent 26%.
The taxman also needs his cut, so in 2015 Nike and adidas paid 22% and 34% respectively. After spending all that cash, what’s left is the net income. As mentioned previously, that happens to be 4.1% of net sales for adidas and 7.3% for Nike.
3) Putting everything in perspective
By now, we have a pretty good hang of the costs involved in the footwear business. But wouldn’t it be cooler to see all these slices as a part of a shoe’s retail price?
So let’s do exactly that; we’ll carve a $100 shoe into different costs elements, right from the factory cost to the retailer margin to the final profit per shoe. This reflect the averages based on adidas or Nike’s annual financial statements.
Looking at the overall picture doesn’t seem so rosy, does it? On a pair of $100 shoes, adidas just makes a profit of $2. Nike fares much better, making $5 as profit on a pair of $100 running shoes.
As it turns out, running a multi-billion sneaker business is not all it’s cracked up to be.
Other fun stuff:
By now, we’ve got a good handle on the financial workings of the shoe industry, at least on the brand side. But before we wrap up, it’d be nice to cover a few more topics. For example:
4) If a brand is paying retailers a 50% margin, then perhaps those guys are making tons of cash? What does the retailer profit look like?
Great question, so we’ll repeat the same cost analysis exercise here. Footlocker would be a great example to reference; after all, they’re one of the best performing companies in its category.
And much like Nike and adidas, they’re public, giving us visibility to their financial health. Without further ado, here goes:
When you look at the split here, you being to realize that retailers don’t make a great deal of money either, do they? To start with, it’s pretty obvious they aren’t able to sell what they bought from the brands at full sticker price.
Footlocker’s purchase price (read footnote #3) for every sale of $100 shows up as $66 in their financial reports, and not $50. In plain terms, Footlocker sells its merchandise for a 24% discount on the average.
And how does that happen?
Well, you know, black Friday and thanksgiving sales, promo codes, regular markdown discounts and the like. Needless to say, 24% of the shoe’s price goes to the customer who buys it!
And what happens if brands skip the retailers and operate their own stores? adidas and Nike already have their own shops, but direct-to-customer retail comes with its set of challenges.
Brands will incur costs otherwise absent in the wholesale business model; spends like leasing+manpower+operational costs, store set-up and periodic re-modelling cost, the entire risk of inventory, and costs associated with warehousing and distribution. That’s only at the store level, there will be additional off-site resources needed in the back-end to support retail operations.
The brands will make some extra margin selling out of their own stores, but the best case scenario will be an additional 10%, which is slightly above what a highly evolved retailer like Footlocker makes annually after taxes.
4.1 If all what we’re saying about wafer thin margins is true, then how does a bargain retailer with its discounted price model make any money?
Though the business model differs across brands, some basic principles apply in this retail model. Firstly, the factory store is located in an area with lower leasing costs. If you’re visiting a factory or discount store, then it is very likely that you’ll arrive at your destination after driving for 30 miles to the middle of nowhere.
Middle of nowhere means that brands have to pay lower rents and wages compared to full price locations. Some chain-stores like T.J. Maxx are located downtown, but far from the premium high streets. T.J. Maxx also leases cavernous amounts of retail space – their average store size is a mind boggling 28,000 square feet – so they can easily negotiate much better rentals.
Secondly, most discount chains also operate with lower staffing. After all, you don’t need production education in a bargain store. The only thing which customers need to be educated about is the attractively low price, and that’s right there on the ‘before and after’ price tag.
Factory/discount stores are engineered to accommodate a higher merchandise density. Instead of athletic mannequins and spacious footwear walls, factory stores are crammed with merchandise.
Combine this with healthy sales and lower retail costs, and you’ll likely achieve a better operational cost than full price stores. It must be noted though, that the square foot sales of a full price store like Footlocker is much higher than say, a T.J. Maxx.
And do you know much net profit a company like T.J.Maxx makes after taxes? 7.5%, which is more than what adidas took home last year.
What’s even more impressive is that they manage to do so at a gross margin which is exactly 20% lower than adidas, and 5% lower than traditional retailers (see below). This simply means that their expenses are lower.
And at a time when full price stores are shuttering down, discount chains are actually reporting sales growth and opening new stores, not closing them.
In terms of size, T.J. Maxx sold $30 Billion of merchandise last year. That’s bigger than the Nike brand, we’d like to point out.
4.2: What is the impact of the endorsement money paid to celebrities, athletes and teams on the price of a shoe?
The simple answer is: not as much as you think.
This year, Nike will pay a whopping $1 billion for all its endorsement needs. This includes all the superstar athletes, sports teams big and small, and the occasional celebrity. Sounds like a lot of money, right?
But that’s chump change in context of the big financial picture.
Last year, Nike spent $3.2 billion on marketing alone. That makes the $1 billion number 30% of the total marketing spend. We know that the marketing component is $5 in a shoe which retails for $100. Hence, 30% (endorsement spend) of $5.00 (total marketing spend) is just $1.5 dollars.
4.3: How can knock-off products sell for so cheap, though they look near identical? Are those products made in the same factory as the regularly priced shoes?
Running shoes, or for that matter any type of athletic footwear, is not a space rocket. If you remove the marketing, then all you have left over is a few pieces of mesh, foam, threads, glue and sole parts.
Anyone with the right kind of manufacturing equipment and skilled labor can reverse engineer a popular sneaker design. That said, there are a few differences.
The knock-offs are made in completely different factories, and with lower grade materials. The factory will have lower standards for everything, including wages. Wages as such are low in Asia, and in dubious factories even more so.
After Nike’s fiasco in Indonesia a couple of decades ago, big brands are doubly careful not to fall foul of public opinion. So all contract suppliers are rigorously audited and prodded towards making compliance related improvements. Brands do that not because of the goodness of their hearts, but to avoid another PR disaster.
Bringing up shoe factories to meeting compliance standards (labor, environmental and process safety) is an arduous process, increasing operational costs in the process. And even after all this, factories are far from perfect.
By adidas’s own admission, over 30% of their factories have compliance issues. Nike is in a similar position. Going by by their financial year ’12-13 corporate responsibility report, 32% of their factories are rated below Nike’s bronze (acceptable) standards.
But for whatever it is worth, brand factories are an expensive place to make shoes. Not an ideal place to make cut price knock-offs. That’s besides the fact that any approved supplier stupid enough to produce dubious merchandise will have them immediately struck off the list.
Also, there’s this whole myth of cheap Chinese labor. It used to cheap maybe 15 years ago, but not anymore. Do you know much of adidas footwear is made in China nowadays?
In their 2015 annual report, adidas mentions that Vietnam now accounts for 41% of their footwear manufacturing, followed by 24% in Indonesia and finally 23% (-4% down from 27% in 2014) for China. Vietnam is the last bastion for premium athletic footwear manufacturing before it implodes from a wages perspective.
4.4 What profit margins do factories make?
The median is between 7% to 10% (on the factory cost) before taxes.
#1. 2015 adidas net income was 3.8% because of losses from discontinued business. We have excluded that because we want to represent what a normal income scenario would look for continuing businesses. In this case, it was 4.1% after taxes, a number which we referred to.
#2. This article intends to describe a very top level overview of what goes on in the industry, so some terms have been simplified. We constantly refer to the cost of revenue as the landed cost. The accurate accounting description would be beginning inventory + purchased inventory – ending inventory, but in the end, it would just translate into the landed cost of the sold inventory. This simplification also applies to describing the gross margin to net income conversion, among other financial terms.
#3. Footlocker’s annual report reflects only the net retail sales, and not full retail price sales. So for the sake of this exercise, we assumed the cost of goods to be half of the full sticker price.