Supply Chain Math Does Not Lie

The footwear margin-share equation between the US and Asia seems to be hitting a tipping point. As noted in last night's "Macro Matters!" comment, with ominous signs of Asian governments taking up rates to contain inflation, it's looking like we're facing both higher costs AND slower growth. Why does this have particular implications for the footwear industry? Consider the following...

1) Over the past 8 years, margins for Asian manufacturers have gone down by 8 points. Margins for the brands have gone up by 8 points. Retail margins have been flat. There's only so much margin to go around, so the direct inverse correlation is no coincidence.

2) In the early 2000s manufacturers had around a 15-20% gross margin, which was more than enough to offset the roughly 10% in SG&A and capital costs to turn a profit. This was especially the case given that the Chinese government rebated the VAT tax, which added between 3-7% in net profit for the manufacturers. All said, life was good as a manufacturer, which is why capacity grew at a mid-single-digit clip. Excess capacity = more pricing leverage on the part of the front-end of the supply chain.

3) Now what? Gross margins are approaching the break-even hurdle, VAT tax rebates are being phased out to stimulate local consumption as opposed to export, and costs are headed higher across the board. The result? Capacity growth heading closer to zero.


4) The kicker. 85% of US footwear consumption is sourced in China. No joke. There are few industries that are so married to one country. That's risky business.

5) So what's next? We're convinced that higher prices for US footwear imports will continue on a multi-year basis. An inflection in an 8-10 trend is likely to take a while. This is when the winners will be companies with a) pricing power, b) global revenue diversification, and c) little dependence on Chinese sourcing.

Check out the chart below. It pretty much sums it all up.
Something's gotta give.



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