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Nike: Just Automate It

Bertrand Eury, Consumer Discretionary Analyst

At Arnhem, we like consumer brands with global appeal, multi-year growth opportunities, enduring pricing power, control of their distribution and long-term margin drivers. Our investment in Nike, the U.S. athletic footwear and apparel behemoth, squarely fits the bill. Much has been written about their strategy to shift away from wholesale, and towards direct-to-consumer channels. However, a less talked-about long-term trend, factory automation and speed to bring new products to market, is emerging and has the potential to profoundly change the industry.

Several consumer trends are reshaping the footwear industry.
Consumer companies need to rethink how they design, manufacture and market products. The emergence of online and fast fashion retailers has created a “buy now, wear now” marketplace, disrupting the traditional production and buying cycle that typically spans months. Social media and brand influencers are also spreading new fashions and trends at a viral pace. Whilste big brands have struggled to adapt to this paradigm shift, Nike has been quietly investing to radically change its supply chain and manufacturing techniques. Nike boasts the biggest R&D budget in the industry and has always been at the forefront of technology.

The footwear creation process has not changed in decades… Traditional footwear manufacturing is slow, labour intensive and low tech. It currently takes 12-18 months to bring a new shoe to market and the manufacturing process of a shoe typically requires as much as 30 separate, manual operations. This is an eternity nowadays. In addition, companies such as Nike have had to absorb double digit cost inflation in Asia, while rising protectionism around the world could lead to much higher tariffs on imported goods.

…but this is about to change. Nike is at the forefront of innovation and ‘Speed Factories’ are becoming a reality.

Source: Nike

Industry experts see 20% or more of Nike production moving to automated factories by 2023 and automation and digitisation could shorten lead times to only 4-6 months. In just a few years, we think Nike will be able to connect a completely digital design process with a fully automated factory located in the end market. Shoe designs will be sent to a factory, where a computer will read instructions and direct machines to make the product.

While this may sound like science fiction today, Nike is already using 3D printers to make shoe prototypes and is opening a Speed Factory in Mexico. Nike has already been able to commercialise its Flyknit shoe 12 weeks faster. In addition to the cost benefits of automated production, digital technology will ultimately facilitate greater consumer engagement in the design process and foster customer loyalty.

There are many benefits of these supply chain changes. Firstly, the cost of manufacturing an athletic shoe could decline by more than 10%, leading gross profit for Nike to improve by as much as 5 percentage points. Avoidance of tariffs (once the plant is relocated in the end market) (we believe another big trend will be on-shoring production after years of off-shoring, due to rising geopolitical tensions), labour savings once the plant is automated, lower raw material usage, storage costs and shrink (lean and just in-time manufacturing) are all benefits that should accrue to Nike.

The second advantage is that automation will allow Nike to deliver goods in the right quantity. This will in-turn more effectively better align inventory with current demand and allow Nike to be more nimble and more “in-trend” with current fashions. Delivering goods in the right quantities and in the right geographies with limited discounting will and better protect the price integrity of the brand. By improving inventory turns, this will free up working capital for investment in even more R&D and marketing, and create a positive feedback loop. In addition, these new production techniques will allow Nike to customise products more easily and introduce new designs in almost real time. As a result, this will increase ASP and capture in-season sales upside on hot products.

In conclusion, we believe Nike has the scale, R&D background and first mover advantage to beat rivals in this race. As such, the company is well positioned to gain a disproportionate amount of share of the footwear market over the next several years. Being closer to customers’ needs and lowering costs will lead to a dramatic improvement in profitability and foster sustainable growth. We remain very bullish on Nike’s prospects and are working towards adding additional high-quality consumer companies to our global portfolio. Stay tuned!

This article has been prepared by Arnhem Investment Management Pty Limited ABN 17 129 606 775, AFSL 332484. It has no regard to the specific investment objectives, financial position or particular needs of any specific recipient. You should seek your own professional advice in relation to any financial product referred to. You should also obtain the product disclosure statement relating to any financial product referred to and consider the statement before making any decision about whether to acquire the financial product.

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© Arnhem Investment Management, 2017