Sneakernomics
By: Adrian Uthayagumaran & Steven Lo
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
He gazed at the rim, gathered himself, took two steps, and soared towards a breathtaking dunk. Michael Jordan had just completed another one of his signature gravity-defying slams. The camera pans down towards his feet, sitting in a pair of black and red Nike Air Jordan 1’s. During that thirty-second ad, Jordan influenced a generation who would grow up obsessed with his sneakers. “It’s gotta be the shoes” remarked an awe-stricken Spike Lee as his Mars Blackmon character.
Sneakers: Fad or Trend?
Sneaker culture dates back to the 1950s when James Dean popularized the Converse Chuck Taylor All Stars. The trend accelerated in the 1980s, when sneakers went from being athletic wear to an essential urban fashion accessory (thanks in part to Run DMC’s song “My Adidas”). At the same time, Nike partnered with Michael Jordan and released the Air Jordan, an iconic sneaker, which earned a loyal cult following. Twenty years later, 85% of sneakers are sold for fashion, compared to 15% for athletic purposes.
What has spawned out of this new fashion category is known as “sneakerhead” culture – a group of people that collect, trade, and admire sneakers. The community has vastly grown in size over time, as demonstrated by the growth in the Sneakernews Instagram page, which has over 1.5 million followers. Comparably, NBA stars Chris Paul and Dwight Howard only have 1.2 million and 440,000 followers respectively. Sneakerheads have shown extreme dedication to attaining valuable limited edition sneakers. In December 2011, customers in Houston, Texas lined up for five days in anticipation of the Air Jordan Concord XI, a throwback to a 1995 bestseller. Resellers often line up alongside sneaker collectors so that they can quickly turn a profit on the secondary market, selling sneakers for upwards of five times the manufacturer’s suggested retail price.
The Shoe Store
In 2012, Nike released the long anticipated Air Yeezy II, a sneaker made in collaboration with hip-hop star Kanye West. It was produced in limited quantities and sold in store for $245 per pair. On the same day, a pre-order auction of a pair of Air Yeezy II sneakers sold on eBay for $90,300. Was it the shoes? This egregious resale price clearly revealed the value that resellers have long been aware of: there are immense profits available in the sneaker resale market.
On any given day, 5,000 sneaker auctions are closed on eBay with an average selling price of $250 per pair. The value of shoes sold in the secondary market can be compared to the average price of men’s sneakers in the United States, retailing at $104 per pair. Remarkably, sneakers sold through eBay account for approximately $450 million in revenue per year, without considering offline private sales such as sneaker boutiques, consignment shops, and sneaker conventions. Conservative estimates suggest that the secondary market for sneakers could be as large as 25% of the entire North American primary sneaker market valued at $3.6 billion.
Sneakerheads are willing to pay significant premiums over the retail price to purchase their desired sneakers. Footwear manufacturers like Nike intensify this demand by grossly undersupplying the market through the release of limited quantities. This produces a secondary market with significant arbitrage opportunities. Market makers such as eBay are able to profit from special edition sneaker transactions by charging a commission on sales; the giant consumer-to-consumer corporation currently accounts for 13% of all sneaker sales in 2013. Original footwear manufacturers, however, are left out of the lucrative secondary market that they have created.
The Shoe is on the Other Foot
Footwear manufacturers have long resisted increasing the supply of sneakers because a commonly used and traditionally successful marketing strategy has been to limit supply in order to create hype and exclusivity around the brand. The strategy has been quite effective in building brand image, and justifying higher prices on the rest of the product line. However, with the advent of e-commerce and social networking, the secondary market for sneakers has grown larger and more efficient. Footwear manufacturers who were once forgoing a small amount of profits in order to create hype and exclusivity are now sacrificing even greater profits in order to maintain their strategy. Sneakers sold on eBay are roughly 2.5x the average retail price of sneakers sold in North America. Manufacturers have been so effective in producing high demand products that they have created an enormous opportunity for other retailers to extract value.
Market Mediums
Sneakers sold in the secondary market typically go through three main channels: eBay, sneaker boutiques and consignment shops, and sneaker conventions. eBay generates profits by charging the seller 2% of the spread between the initial offering and final selling price, offering a cost effective method for buyers and sellers to exchange sneakers for cash. Buyers will often perform numerous searches in order to find a desired listing to place a bid. Still, the biggest concern is that counterfeiters will take advantage of the online marketplace to profit off of the demand from buyers unable to purchase their desired sneakers in store. The presence of counterfeiters creates distrust in the secondary market and has remained a genuine concern for buyers.
Sneaker boutiques such as Flight Club sell sneakers on consignment to buyers and charge a 20% commission on each sale to the sellers. Buyers are able to acquire sneakers with confidence in their authenticity, as the experienced Flight Club staff will verify them. However, Flight Club only has two physical stores: New York and Los Angeles. For buyers outside of these two cities, they must order the sneakers online and have them shipped, adding an extra cost to the already premium-priced sneakers. Nonetheless, Flight Club demonstrates the extent to which boutique sneaker shops are profiting from the opportunities created by footwear manufacturers.
Sneaker conventions provide another medium for buyers and sellers to meet and conduct sneaker sales. However, most sneaker conventions only happen once a year in a given geographic region, limiting the timing and breadth of sneaker purchases.
The Opportunity for Retailers
Foot Locker is an organization that could benefit from entering the secondary sneaker market. With revenues of over $6 billion in FY 2012, of which $850 million were attributed to sneaker sales, Foot Locker holds approximately one quarter of the total sneaker market. As the sneakerhead culture has become more prevalent, the opportunity to enter the secondary market is becoming more and more enticing. The $450 million in secondary market sales on eBay is the equivalent to 7% of overall sales for Foot Locker. Foot Locker could capitalize on this trend and create a business model with the potential to grow internationally in the future, as the sneakerhead culture continues to blossom in emerging markets like South America, Eastern Europe, and China.
Does the Shoe Fit?
Foot Locker should follow a similar consignment business model to Flight Club by selling sneakers in the secondary market through select Foot Locker “House of Hoop” locations as well as online. This would likely necessitate Foot Locker entering into agreements with manufacturers, allowing it to access the secondary market without straining the relationships currently established. From a commission standpoint, charging 20% on each item sold through its stores is competitive with Flight Club’s fee structure. This business model allows Foot Locker to create a new revenue stream from a market that was previously missed by large licenced retailers. Furthermore, it can help legitimize the market by providing a guarantee of authenticity to any sneakers sold through its channels. If Foot Locker were able to capture 20% of eBay’s secondary sneaker market, it would increase sales by $90 million. Additional operating costs should be very low, as much of the infrastructure is already in place. These sales projections lead to an assumed $81 million in additional profit, which would represent a potential 11% increase in annual EBITDA and profits, making this an extremely viable and lucrative option for Foot Locker.
Typically, official retailers have not entered the secondary market as it could risk damaging their image by selling these products. However, Foot Locker is not positioned as a premium brand and therefore is unlikely to see the same brand erosion that Nike would see by selling sneakers directly in the secondary market. Furthermore, by selling these sneakers in flagship, high concentration stores, Foot Locker could take advantage of cross-selling opportunities that arise from the additional customers entering the stores in search of sneakers that were previously only found through other market mediums. Keeping the shoes sold on consignment near the largest communities of sneakerheads (Los Angeles, New York) and selling them through select stores, is the most effective way to directly combat Flight Club.
In addition to Flight Club, Foot Locker should mimic Ticketmaster’s TM+ business model. This platform allows customers to simultaneously browse through all the available products and corresponding quantities through other mediums, giving greater transparency to the secondary market. Pursuing this channel supports the value of Foot Locker’s platform; the ability to determine a fair price with official and documented market information.
Foot Locker has the opportunity to form new relationships with a profitable and growing population of sneakerheads, and provide them with the secondary market solution that they have been yearning for. In order for Foot Locker to grow its revenues and serve this demographic, they must focus on sourcing shoes from the secondary market and then reselling them to create hype to drive sales across product lines. Foot Locker must continue to focus on providing its customers with the products they want. Like Lee always says,”It’s gotta be the shoes.”
