This Global Retail Giant Can't Seem to Figure Out China

Over the past decade, the formula for success for U.S. businesses looking for new avenues of growth has been to turn to China.

China offers nearly everything a business could desire, including:

  • A rapidly growing middle-class eager to spend their wages on consumables and comfort items.
  • An impressive GDP growth rate that has averaged 10% over the past 30 years and is currently on pace for about 7.5% annual GDP growth.
  • Access to inexpensive labor as well as a central location for a number of tech and retail companies to improve the efficiency of their supply chains.

Because of China's growth, a number of America's biggest multinational companies are racking up sizable boosts to their top and bottom line -- except for one. Footwear and accessories retailer Nike (NYSE: NKE  ) is having the hardest time trying to figure out China.

Nike's Achilles' heel
In its third-quarter report released last week, Nike announced a 14% increase to revenue, excluding negative currency effects, led by a 19% jump in emerging markets revenue, a 22% pop in Central and Eastern Europe, a 19% jump in Western Europe, and even a 12% increase in North America. Way down on the list, however, was China, with total growth of just 7%, and Japan, where sales jumped 10%, but because of very unfavorable currency moves, it actually translated into a 9% decline! Not to mention that future orders from China dipped by 1%.

I know what you might be thinking: "7% growth in China isn't half bad; what are you complaining about?" In actuality, this is just Nike's second quarter over the past six that it's reported positive sales growth in China, which is a bit concerning for a country that's consistently grown GDP in the high single digits to low double digits and whose citizens are eager to buy branded goods.

What I find to be even more of a head-scratcher is that Nike's management fully expected the company to be able to nearly double its sales in China from close to $2.1 billion in 2010 to $4 billion in 2015 as recently as three years ago. Based on its current run-rate, Nike is likely looking at between $2.5 billion and $2.6 billion in total China sales in fiscal 2014. 

What's gone wrong?
Perhaps Nike's biggest issue is that it doesn't quite understand the Chinese action sports enthusiast as of yet.

In the United States, Nike's clothing and accessories are synonymous with our largest sports. Nike has also hired a number of well-known ambassadors to represent its brand, helping to boost sales. In similar fashion, Nike is very recognizable throughout much of Europe, hiring ambassadors and angling its marketing in effective ways to reach consumers in that region. China, though, presents a different challenge.

In China, censorship from the government plays a crucial role in what does and doesn't get on television as well as the Internet. This means Chinese citizens' ability to watch sporting/action events on TV has been compromised for decades. In addition, while Europe and the U.S. influenced each other in the development of some of their major sports, China has generally shunned much of the Western world's influence when it comes to sports. This simply means if Nike doesn't use the right brand ambassadors or target its marketing just right, it could fail to reach its potential.

Another problem for Nike is that it's being outsmarted by its rivals in China. Under Armour (NYSE: UA  ) , for example, opened its first China-based retail store in October of last year, which it refers to as its "Experience store." The point of this store is to educate the consumer about Under Armour's history and what the brand is about and then let them move onto the attached retail outlet to purchase products. With strong net revenue growth of 35% last quarter for Under Armour (the company didn't break out sales by region), it's hard to argue against this approach. 

Nike also appears to have underestimated its peers like Adidas (NASDAQOTH: ADDYY  ) , which grew its Asia sales by 15% in the fourth quarter, including 8% in Greater China, because of cited strength in its Adidas Originals and Sport Style segments. Normally, Nike and Adidas compete among a very similar active audience, but Adidas has done a markedly better job of corralling younger middle-class consumers in China than Nike in recent quarters. Furthermore, Adidas had 62% of its production sourced from China in 2013, according to its annual report, meaning it has a natural tie-in. Nike, on the other hand, recently negotiated a long-term production deal in Oregon.

Let's keep it real
What Nike investors should keep in mind here is that despite its recent underperformance, it has one of the most recognized brands in the world, and it's proved in the past that it can adjust to cultural difference in countries outside the United States. This likely isn't going to be an overnight fix for Nike, but it's going to need to come to terms with its unrealistic growth expectations set in 2011 of $4 billion in sales within the country. I would look for Nike to go the route of Under Armour and attempt to boost its brand through education, as well as focus on designs that would appeal to the rapidly growing young middle class in China that craves name-brand products.

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