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WHAT DOES IT COST TO MAKE A RUNNING SHOE?

2018-02-13 10:46:07

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WHAT DOES IT COST TO MAKE A RUNNING SHOE?

 

Running shoes or sports footwear tend to be pretty expensive. Ever wondered what does it cost to produce them, and what kind of money do brands and stores make on a pair?

 

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 $200k a year, and say, ‘200k a year? That guy can save a million dollars in 5 years.’

That makes no sense, does it? Because out of the 200k salary, one will have to account for mortgage and car payments, education loans, insurance, food, fuel costs, taxes and what not.

So while $200k 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?

 

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 has historically sucked at making garments. 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.