Nike (NKE -0.81%) is one of the world's most iconic clothing brands. The name recognition, among other factors, gives it negotiating power with suppliers and distributors.
The pandemic is limiting Nike's ability to manufacture and deliver products to where consumers are buying. As a result, the company is using its power with wholesaler partners and reducing the inventory it is sending them. Let's look closer.
Nike is focusing on direct-to-consumer
Note that Nike's shift to reduced sales to wholesalers did not start at the onset of the pandemic. "Over the past four years, we have reduced the number of wholesale accounts worldwide by more than 50% while delivering strong revenue growth through Nike Direct and our remaining wholesale partners," chief financial officer Matt Friend said during the company's third-quarter conference call.
The move has heightened in importance since the pandemic started causing supply chain disruptions in manufacturing and logistics. Sales to wholesalers come at lower profit margins than sales directly to consumers. Therefore, Nike's shifted focus boosts profit margins. That is especially true when the company is constrained on output. Indeed, it noted that consumer demand has outpaced supply and might continue to do so.
In its most recent quarter, ended Feb. 22, Nike direct-to-consumer sales were up 15% year over year to $4.9 billion. Meanwhile, overall sales were up only 5% from the previous year to $10.9 billion. It's reasonable to assume that in the future, direct sales will make up a more significant percentage of overall revenue. Wholesalers that want to continue receiving Nike products will need to agree to more-favorable terms.
If Nike only has 100 units to sell and consumers demand more than 100 units, it only makes sense to sell through its highest-profit channels. But that strategy wouldn't work without strong negotiating power with wholesalers. Otherwise, the company might face blowback from the third-party sellers when supply chains normalize and Nike needs them to boost sales.
Nevertheless, the strategy is bearing fruit thus far. Gross profit margin was up nearly 200 basis points to 46.4% in the nine months ended Feb. 28. That was up from 44.4% in the year-ago period. Even more impressive is that it came during a period of rising costs for labor, materials, and transportation.
The strategy is not without risk
This move can backfire. Wholesalers allow Nike to sell more products that leverage its fixed costs. Nike invests in advertising, corporate overhead, and other expenses that it incurs regardless of sales. If Nike proves unable to get enough sales from its own channels, then it could reduce overall profits despite improving margins. On balance, that would be an undesirable outcome.
If Nike returns to the negotiating table with wholesalers it cast aside, it might have to accept unfavorable terms. But that seems unlikely with its long history of driving consumer interest through clever and effective marketing and product innovation. Still, investors should be aware of the risk and monitor how the strategy evolves.