Surviving in the Nike/Reebok Jungle
What should a small niche player do when its long-booming industry, dominated by intensely competitive giants, suddenly begins to contract? New Balance thinks -- hopes -- it has the answer
In June 1992 Jim Davis went to war. The chairman and CEO of New Balance Athletic Shoe Inc. assembled his top brass at a seaside camp to announce the onset of Operation Quick Strike. Decked out for the occasion in combat fatigues, "General" Davis delivered his "declaration of war" in the lingo of the revolutionary underdog. "It is not the large that will defeat the small," he told his high command. "It is the quick that will defeat the slow." Davis's choice of a military motif for his new campaign was appropriate. War had indeed broken out in the athletic-footwear business.
It's not surprising. Until the middle of 1991, the industry had been on a stupendous roll. It had surged with the start of the fitness craze, in the 1970s, and then rocketed through the 1980s, racking up annual growth rates as high as 20%. By last year footwear for running, tennis, basketball, and other sports accounted for 40% of all shoes sold in the United States. And all through that boom there was ample room for the top 25 brand-name manufacturers in the field.
Until the music stopped, that is. In the second half of 1991 and the first half of 1992, the U.S. athletic-footwear market suddenly contracted. Annual unit sales dropped from 393 million pairs to 381 million. Retail sales dipped by 2.6%. Analysts cited several reasons: the recession, market saturation, and a shift in consumers' tastes.
For all but the biggest names, a bare-knuckled brawl for market share has been under way. Nike Inc. and Reebok International Ltd. are the sneaker superpowers. Last year in the United States they had combined sales of sports footwear of $3.3 billion, more than half of the total market. But for the smaller players, and especially for those with less than 3% market share, the peril is great. "I think you'll see a number of them fade away," says analyst Gary Jacobson, who follows the industry for Kidder, Peabody & Co.
If any one of the niche players seems to have a loyal following, it's New Balance. For more than two decades it has made athletic shoes of quality comparable with the best in the industry. New Balance's special niche, however, is width sizing. All of its shoes come in true widths; some range from AA to EEEE. Few other manufacturers make anything beyond narrow or wide versions of selected products. Width sizing is difficult and expensive to do, but it makes for the most customized athletic footwear available.
"Among those who know the brand, the name New Balance is synonymous with quality," says Gregg Hartley, executive director of the Athletic Footwear Association (AFA). Unhappily for New Balance, those who know the brand are relatively scarce. In a New Balance consumer research study done in 1991, only 4% of Americans could identify the company as an athletic-shoe maker.
What's also unusual about New Balance is that it's one of the few companies still manufacturing sports shoes in the United States. Like virtually everyone else in the field, the twin giants Nike and Reebok long ago moved production to such countries as Korea, Taiwan, China, and Indonesia. But can a company that pays its factory hands $12 or $13 an hour, counting benefits, do battle with those whose Chinese workers make $80 a month? With lower labor costs generating higher margins, the industry leaders can afford to carpet bomb the country with advertising, fortifying their dominance.
This year alone Nike will spend about $120 million on advertising and millions more in payments to such athletes as Michael Jordan and Bo Jackson. Reebok is countering with an ad budget of some $100 million, including $20 million to promote Orlando Magic rookie star Shaquille O'Neal. Marquee names like those can bring in huge sales, particularly among the under-25 set.
New Balance has been hard-pressed to compete. A couple of years ago it ran ads claiming, somewhat forlornly, that it was "endorsed by no one." The company has always expected that people would buy its shoes because, quite simply, they fit better. But in an industry increasingly driven by slick ad campaigns, that hasn't been and may not be enough.* * *
Twenty-one years ago, on the day of the 1972 Boston marathon, a 28-year-old Davis bought New Balance. It wasn't much at the time -- six people in a Watertown, Mass., garage crafting 30 pairs of shoes a day. For a company founded in 1906 as an orthopedic-shoe maker, it hadn't gone very far. As an adjunct to its orthopedic line, New Balance started making athletic shoes commercially in 1962. Davis acquired it for $100,000.
His timing was superb. The running boom ignited in 1974, and two years later Runner's World rated a New Balance model as the best on the market. In fact, the company had 4 of the magazine's 10 top-rated running shoes. Suddenly, Davis had a hot product on his hands.
"Our biggest problem was getting enough product out the door," he says. "We went from doing $100,000 in 1972 to doing $60 million in 1982. Growing that dramatically, you're behind the eight ball all the way. It was out of control. We probably hit our peak in the mid-'80s, with sales of around $85 million and good profitability."
Then, between 1986 and 1989, even as the industry continued its expansion, New Balance's growth all but vanished. Davis blames himself. "We lost our focus," he says. "We didn't execute well. And we tried to chase Nike and Reebok in terms of design, which we never should have done. The result was a lot of closeouts, a lot of selling below the recommended wholesale price.
"What always sold," he adds, "were our core running products and our tennis shoes. But we never had enough of them because we had spread ourselves too thin in all these peripheral areas. We knew our brand awareness was low, but even if we'd had money to advertise, we wouldn't have spent it because of our failure to execute effectively."
The low point came in 1989. Davis's top managers urged him to shut down domestic manufacturing and join the stampede to the Orient. For a model of success, they said, you just had to look at Nike. Founded in 1972 -- the same year Davis bought New Balance -- Nike was already bolting past the $1-billion mark in U.S. footwear sales. With low labor costs and economies of scale, it was able to feed its big-gun advertising and marketing machine. New Balance was struggling to break even on sales of $95 million.
Although New Balance now makes some shoes and shoe components overseas, Davis has always felt strongly about manufacturing domestically. In his view, the virtues of doing so held sway over cheap overseas labor. "Initially, we manufactured here because when I bought the company, it was making shoes here," he says. "Then we realized that you can control the quality better from here. You can establish proprietary techniques to improve upon product quality. We'd be a bigger, more profitable company if we made everything overseas. Making a profit is important, but it's not the most important thing. To me, what matters most is making a product you believe in."
As Davis saw it, the key to reestablishing his company's niche was its work force. His people were skilled craftsmen, not like the teenagers mass-producing shoes in the gigantic Asian plants. Besides, direct labor accounts for 16% of New Balance's costs. The big bucks -- 53% -- are in materials, and that would be roughly the same overseas.
Today New Balance has four factories -- two in Massachusetts, in Boston and Lawrence; and two in Maine, in Skowhegan and Norridgewock. Together, their 800 workers turn out about 10,000 pairs of shoes a day (a number New Balance wants to double by 1994). Davis has eliminated old-style piecework manufacturing in favor of a team approach he calls modular manufacturing.
At the company's brick factory in the old mill town of Lawrence, where 90% of the workers are minorities, the team concept has revolutionized production. "This factory is well on the way to achieving a two-day through-put as opposed to what had been a six-week through-put," says plant manager Keith Stilling. "That's from the start of cutting the material to putting the shoes in boxes. Things are moving through faster because everybody works on fewer pieces and moves them through quicker, instead of working on a lot of shoes that are moving slower. And of course, inventory costs are lower. That's all because of teams."
Davis's goal is to slash the development time required to roll out a new model. "It takes us a year now, from concept to delivery," Davis explains. "We want to cut that to four months. That's very aggressive, but it's important because when you get retailers excited about a product, they want it now, not a year from now. And one way we're doing it is by involving the teams at the embryonic stage."
In 1991, as sales crept up to $100 million and profitability resumed, Davis began spending heavily on the plants and equipment: $2 million total for 1991 and 1992. For this year, the budget calls for investing $3 million in such high-tech gear as automated cutting and vision stitching machines.
By January 1993 the New Balance turnaround was in full stride, as was Operation Quick Strike. But Davis was attacking straight into a rapidly flattening industry. With competition for every crumb of market share getting ruthless, the question is, Is New Balance's special franchise -- width sizing -- impervious to attack, or even defensible? Can the pricing, marketing, and manufacturing strategies the company employed in an expanding something-for-everyone market serve it well in a war?* * *
Davis's Operation Quick Strike builds on New Balance's traditional strengths and incorporates tactics that he sees as competitive advantages. The main planks of his "wartime" strategy are these:
Width sizing. Manufacturing shoes in true widths has always been the New Balance cornerstone. For men, the normal width is D; for women, it's B. Everyone makes those, but few other companies offer much beyond narrow or wide versions of selected products. Even when they do, they frequently just cut the leather or synthetic upper materials tighter or looser, and then glue them onto average-width soles.
But all of New Balance's models -- for running, court play, basketball, fitness, walking, service, and "all-terrain" wear -- come in true widths. Width sizing complicates production because it requires shorter, more flexible runs and because workers must use multiple lasts, the molds on which shoes are built. Some New Balance shoes run the width gamut: AA, B, D, EE, and EEEE. With lengths from size 6 to 16, there can be more than 80 sizes for a single model. Width sizing is expensive, but it ensures a more customized fit, and Davis thinks well-fitting shoes will grow in importance as the population ages.
Production control. By controlling production in New Balance's factories, Davis eliminates a problem his competitors sometimes have overseas: leasing enough factory time to make shoes when they need them.
One company facing that issue, for instance, is Japanese-owned ASICS Tiger Corp., which is doing well. "If you don't have the space available to get into the factories, you're not going to get your shoes," says Nancy Larsen, public-relations supervisor for ASICS's U.S. division, in Fountain Valley, Calif.
Retailers notice that. "We do a lot of business with ASICS, but there have been times when they're out of stock and we can't get shoes for three or four months," says Phillip Schmidt, a buyer for Road Runner Sports Inc., a catalog company based in San Diego. "They can't control the factories the way New Balance does, because they don't own them."
Just-in-time retailing. By manufacturing at home, Davis says, he can better serve his customers. New Balance's conversion to team-based production has allowed him to respond faster to retailers' needs. Like everyone else in the industry, he prefers that retailers order six months ahead; it helps in planning. Still, with increased production speed, he can take and fill orders in 30 days or fewer. And in any case, his 14 most popular models are always in stock.
That's a big sales advantage. Listen to Joe Chichelo, a senior buyer for the Sports Authority, a chain of 58 stores based in Fort Lauderdale, Fla.: "When you buy from a Nike or a Reebok, you have to order six months in advance. Without a crystal ball, it's tough to project your business that far out. With New Balance, we're able to order 30 days out, and we're getting a 90% fill rate or better.
"That's fantastic," he says. "When you have 58 stores, a fill-in order can be $200,000. By having New Balance deliver as fast as on a weekly basis, we can buy to match our current needs. So we're not losing any sales, and we don't have to carry a big inventory."
Davis calls that "sharing the risk" with the retailer, a kind of partnership that's key to his growth plans. "We feel that with the better retailers around the country, we can take more business just by virtue of working more closely with them, making a better product, with better service," he says. "That means higher margins for them."
Capital improvements. By the end of 1994 Davis will have spent some $6 million in three years on high-tech equipment to enhance operational flexibility and speed. A new computer-assisted-design system, for example, is helping his research-and-development team cut the time required to introduce a new model from one year to four months.
In the factories, the new computerized automated stitching and cutting machines have increased productivity, maximized materials usage, and reduced the volume of work in process. At the Boston plant, robotics devices "inject" polyurethane soles onto certain styles.
Those investments have helped boost gross margins -- after labor, materials, and overhead -- from the mid-20% range in the late '80s to the mid-30% range today. Davis is shooting for 40% over the next few years, a margin that would compare well with what his competitors get abroad. Last year Nike reported gross margins of 38.7%.
Increased domestic production. At present the company cannot profitably produce in the United States a pair of shoes that retails below $50. Factories in Asia supply the lower-priced models. Some 36% of finished goods -- 1.3 million pairs -- are imported. And even for the domestically produced products, 68% of the soles and 29% of the uppers are imported. But the company's new operating efficiencies permit New Balance to manufacture more shoes at home as domestic-factory margins grow.
"Made in the USA" sales. Davis hopes to exploit the "buy American" fervor and plays up New Balance's preference for domestic production in advertising and point-of-purchase displays. According to retailers, more customers are requesting American-made shoes. "It's a big factor nowadays, especially in blue-collar areas," says the Sports Authority's Chichelo.
"The trend is growing stronger, not only out of patriotism but also because people have learned that the fit is more consistent on American-made shoes," says Bernard Short, proprietor of Career Footwear, in Hingham, Mass. "When shoes come from three or four foreign countries, they all fit a little differently, and that can be a real nightmare for the retailer."
Product quality. To reinforce New Balance's commitment to quality, Davis redesigned the compensation system for his factory workers so that 70% of their pay hinges on quality and 30% on volume. "Since their income depends so heavily on quality, it doesn't pay for them to go after the numbers until they've got the quality right," says Keith Stilling, general manager of the Lawrence plant. And indeed, 99.9% of the shoes now arrive at the packing point in shipping condition. Before, the defect rate had run as high as 8%. It's gotten to where the company's three factory outlets can't get by on irregulars anymore.
Quality also depends on top-notch components. Engineers design advanced materials into New Balance shoes for cushioning and support. A brochure on the New Balance "suspension system" features such ingredients as a "roll bar" that resists back-and-forth foot motion; the Encap midsole cushioning pad, which "disperses shock"; and the "contrabalance" heel design, which, "like an inverted trampoline . . . adds spring to your step."
To make sure the shoes perform well in the field, the company relies on Team New Balance, a collection of world-class athletes, including some Olympians, who assist in product development.
New products. Thirty of New Balance's 78 models are new this year. One is an off-track deep-treaded running shoe. Others include a brightly hued racing spike, four basketball models, and two hiking boots. A volleyball shoe is in the works.
But Davis seems most enthusiastic about his new American Classics line of dress shoes for men, six styles of bucks, wing tips, and casuals. "They're as comfortable as any athletic shoe we have," he says. "The same technology goes into them." The shoes will compete in shoe stores against Reebok-owned Rockport, the titan of the dress-comfort class. Still, Davis expects to sell 200,000 pairs -- $10 million worth -- this year.
American Classics are considered part of New Balance's growing line of walking shoes. It has 28 walking models now, versus 24 for running, reflecting Davis's belief that his walking shoes will outsell his running shoes in five years. Many baby boomers are giving up running as their knees start to go. Exercise walking is a good alternative for them, and they'll need appropriate shoes.
Increased advertising. In this business, it's no longer enough to have a good product. Davis has to raise brand awareness. "We feel that nobody even knows about us," says Paul Heffernan, vice-president of marketing. "We have nowhere to go but up with our message: A shoe that fits better performs better."
To send that message, Davis will spend $6 million for advertising this year, up from $1 million in 1990. Some of that is earmarked for co-op print and radio ads with retail accounts, in keeping with his commitment to building partnerships with them. And for the first time, the company is going into national TV, spending $700,000 for commercials on ESPN, TNT, the Sports Channel, and the Discovery Channel.
In magazines, besides advertising in the likes of Runner's World and Tennis, Davis is going into general-interest books. Esquire, Travel & Leisure, Smithsonian, and Men's Journal are in the media plan, along with Sierra and Outside. And pursuing the important women's market, he's buying pages in Self, Glamour, and Working Woman.
An additional half-million dollars is going to point-of-purchase displays and other devices to enhance brand identity.* * *
Will It Work?
Is the strategy outlined in Quick Strike strong enough to guarantee New Balance's survival, let alone achieve Davis's stated goal of doubling U.S. sales over the next three years from $100 million to $200 million? Industry experts aren't so sure.
Width sizing. No competitors seem eager to take on the expense and complications associated with making their footwear in true widths, but that's not because there are clear barriers to entry. Most industry players just don't see the need.
"If customers kept telling retailers that the reason they buy a particular shoe is because it comes in widths, then the manufacturers would all be making shoes in widths," says Gregg Hartley at the AFA. "But apparently people are satisfied with what's out there."
More to the point, the size issue can confuse buyers. "As an average consumer, you don't care -- AA, EEEE, most people don't understand that, anyway," says Tom Brunick, director of the Athlete's Foot's WearTest Center at North Central College, near Chicago. "They just want to know if you've got a shoe that runs narrower or wider. That's what Nike and Reebok, among others, are trying to do." Says Dusty Kidd, Nike's public-relations manager, "When you have 25 or 30 different styles in a particular category, width is not a big issue." That approach hasn't hurt Nike. Its basketball business grew by $100 million last year.
The downside to carrying New Balance, according to some retailers, is that with width sizing you have to buy many more shoes. "We used to carry the brand," says one store clerk, "but it comes in widths, and that was taking up too much space in our stockroom. So we dropped it."
Another hurdle for Davis concerning width sizing is the retail sales force. Most sports-shoe buyers make their decision once they're in the stores; only 29% walk in wanting a specific brand. "For width to be a real factor, you need a clerk to sit down and spend some time with you," says Mark Tedeschi, New England editor of Footwear News, a trade journal. "And a lot of times, that just doesn't happen."
Quality. Brunick, for one, does not think quality is a comparative advantage for New Balance. And he ought to know. At his test center, his 1,200 wear testers put virtually all the shoes through the paces.
"New Balance likes to say they gain a quality advantage by manufacturing in the United States, but I don't think so," Brunick explains. "If you're running good quality control wherever you're making shoes, you're going to get good shoes, whether you have Americans or people in other countries making them."
Expanding the line. If Davis expects his walking shoes to begin outselling his running shoes, he could be disappointed. His market instincts are sound -- walking shoes are one of the hottest segments of the athletic-footwear business. But because they are, competition is brutal.
"They are going up against some big people," says analyst Gary Jacobson. "Nike, Reebok, and L.A. Gear all have walking shoes. Even Keds positions itself as a walking shoe."
Bernard Short, owner of Career Footwear, is considering adding Davis's American Classics line to his inventory. He's seen them at trade shows and likes them. But he admits it's hard to sell anything against Rockport. "They have the name recognition, like Coke or Kleenex," he says. "They were the first in that market, and they dominate it. Women will evaluate something new, but men are not that open-minded. When a guy comes in, he's got to have Rockports or what he had before."
Increased advertising. A $6-million advertising budget is a major step up for New Balance, but it's still small beer in an industry that's driven more by marketing than by product. "You could take the stripes off half the shoes on the market and no one could tell the difference," says Tedeschi. "Nike and Reebok have succeeded pretty much on marketing alone. They both spend more on advertising than New Balance has in revenues."
Domestic production versus price. Although 100% domestic production is Davis's goal, he claims the biggest impediment to all domestic sourcing is that when the athletic-footwear industry's heavyweights moved to the Orient, the American infrastructure fell apart. Davis has had to decide how much domestic production is worth to him. He knows it drives up his costs and the price of his product, but he has no intention of changing his manufacturing strategy. "We don't need lower-price-point shoes," Davis says. "We are not going to go to $40 retail. We want to make higher margins on $70 shoes that we can make here."
Still, in the current retail climate, cost factors are more important than ever, and price is as big a consideration for sneakers as for any other product. Consider Saucony, a division of Hyde Athletic Industries. In a Consumer Reports analysis of running shoes published in May 1992, the Saucony Jazz 3000 model was judged best in both the men's and women's categories. The magazine called the shoes "best buys" at $68 a pair. New Balance's highest showing for men's shoes was the eighth-ranked M997 model, at $120. It was beaten out by shoes from Nike (at $125, retail), Avia ($70), ASICS ($85 and $55), Adidas ($85), and even another Saucony model, the Azura II ($82). New Balance fared better in the women's ratings; judges ranked the company's W997 model second. Partly owing to that report, Saucony's share of the 1992 U.S. running-shoe market shot up from 3.8% to 7.6%. And, according to Hartley, 64% of athletic footwear sold last year was on discount, up from 62% in 1991.
So Davis's insistence on maximizing domestic production may cost him some sales. Everywhere he turns there are niche players grabbing for shreds of market share, and there is always the specter of the seemingly unstoppable Nike and Reebok. (Even last year, as overall demand fell, both companies continued to gain market share.)
Right now New Balance is more than holding its own -- as of January, orders were running 24% above the levels of a year ago -- but Davis's $200-million sales goal may prove to be elusive. "New Balance has a very specific niche, width-sized running shoes, that they're very good at," says Gary Jacobson, the Kidder, Peabody analyst. "But in terms of growth as they go forward, I'd say it's limited."
And while New Balance models are competitively priced today, cost pressure is building. "Everyone is looking for the most efficient place to make their shoes," says Peter Goehrig, general manager of ASICS's U.S. unit. "All of a sudden, with the market like it is, cost factors are more important than ever. So I think for someone to stick to a strategy because of an emotion -- wanting to make shoes in the USA -- will become more and more difficult."
Still, New Balance has a few advantages, the foremost being that most retailers like its products. That's critical in a field where the vast majority of buying decisions are made in the store. "New Balance's shoes are excellent," says retailer Chichelo. "Its quality control has always been good. Nobody has been as consistent as or can compare with it over the years."
Jim Davis can only hope that kind of retailer support is widespread enough to continue to differentiate New Balance from a crowded, and narrowing, field.
FAXPOLL: IS NEW BALANCE HEADED FOR A FALL?
What do you think? Do the elements of New Balance's strategy, as outlined in the foregoing article, make sense? Will they be enough to protect the company's niche or even foster growth? What mistakes are being made? What would you do differently?
1. In general, do you think the elements of New Balance's strategy, as outlined in this article, will be successful in defending the company's market share?
2. Which of the following strategic elements do you think will be most (or least) effective?
"Made in the USA" marketing pitch
The quality pitch
New product lines
3. If you were Jim Davis, what would you do differently?
4. In general, do you think domestic manufacturing can be a competitive advantage?
Why or why not?
5. Do you think it is or could be an advantage in your business?
6. How would you describe your business?
7. What is your position within the company?
8. Besides yourself, how many people does your company employ?
More than 500
9. What revenues did your company have for its most recent fiscal year?
Less than $500,000
$3 million-$9.9 million
$10 million-$49.9 million
$1 million-$2.9 million
$50 million or more