Volume 192: Nike: From Brand Moat to Vicious Cycle.
Nike: From Brand Moat to Vicious Cycle.
tl;dr: Ex-CEO deconstructs moat, incinerates $52bn in value.
One of the things I talked about last week is the accelerating effect of brand strength on the business, which acts as a valuable economic moat. Unfortunately, it can be hard to pinpoint this accelerating effect because it takes years to establish and is hard to measure, during which time it tends to be taken for granted. However, for learning purposes, it’s easy to pinpoint what happens when these accelerating effects are taken away because performance declines kick in quickly.
This is why Nike's recent and spectacular failure of business strategy gives us possibly the single most important brand/business case study…ever.
Hubris, ego, and a surprisingly broad misunderstanding of how a brand-driven economic moat works appear to have led to a 30+% collapse (-$52bn) in company value while the S&P500 was rising 25%. What is truly mind-boggling is that we see astrategy where failure was a predictable outcome based on a basic understanding of consumer behavior and thewell-documented challenges of the current incarnation of digital advertising.
More importantly, however, it provides an excellent opportunity for me to utilize and then build on the framing of ' Big-B brand’ and ‘little-b brand’ I first saw proposed by Ethan Decker in his Brand Science newsletter.
What I love about this framing is how simple it is. Ethan posits that there’s a ‘little-b’ brand, which is bounded byyour distinctive assets—logos, characters, colors, taglines, jingles, distinctive product features, etc., which is what so many CPG/FMCG marketers focus on due to the work of the Fantastical Witches & Wizards of Marketing Science at Australia’s Hogwarts. And then there’s the ‘Big-B brand,’ which is bounded by the totality of your organization's activities and the perceptions said activities create.
As an example to put some meat on these bones, when I moved to the US 21 years ago, the long-running and distinctive HSBC tagline was its claim to be ‘The World’s Local Bank' (it’s ‘little-b brand’). However, even though I was a UK customer when I tried to open a US account, it proved to be even more painful than dealing with competing US banks; in other words, the customer reality of HSBC's ‘Big-B brand’ canceled out the claims being made by its ‘little-b brand.’
To truly understand Nike’s failure, it’s helpful to extend the ‘Big-B brand’ metaphor by overlaying it with some of the thinking of leading management thinker Michael Porter.
Massively oversimplifying and paraphrasing, Porter states that sustainable advantage is built less on the basis of a single differentiating feature because that’s easy to copy. Instead, he posits that it’s based on the much more difficult-to-copy interdependence of business systems. To his point, it may be possible to copy one thing relatively easily, but having even two interdependencies working together raises complexity and thus reduces the risk of being copied significantly.
Look no further than Apple for an example of this in action. While others have found it relatively easy to copy Apple’s approach to industrial design, they cannot copy its design and its proprietary chips, OS, retail network, product lineup, services ecosystem, software tools, brand assets, and customer relationships, all working interdependently with each other.
This is why a phone that looks like an iPhone costs $300, while an actual iPhone costs $1,300.
So, what does this have to do with Nike? Lots. Let me explain using the strategic terms du jour: flywheels and economic moats.
For Nike, the business accelerating effects of its brand represented an economic moat. Like other brands with an economic moat, it benefited from volume effects (attracted more demand) and pricing effects (commanded a price premium). Nike established this brand moat via a series of interdependent business systems that worked together to differentiate it from the competition. Another way of looking at this is through the lens of the flywheel these business systems existed to support:
The way the flywheel metaphor works in business is that it takes time and a lot of resources to get spinning. Overtime, it builds momentum, requiring fewer resources to keep going, with the added benefit of being very hard to stop. In the case of Nike, it built interdependent business systems to support a flywheel built on the back of three mutually reinforcing factors (in no particular order)
When it changed strategy, rather than building on the success of the existing flywheel, Nike decided to radically change its interdependent business systems to support a new flywheel, which I'm assuming they believed would be much more profitable. My attempt to describe the new flywheel is as follows:
It appears that the idea was to achieve higher margins by selling directly, utilizing the power of first-party data to drive marketing efficiency and personalization, supported by a newly consolidated high-speed, data-driven innovation engine.
The challenge is that it was a strategy riddled with hubris, arrogance, and ignorance. Nike appears to have wildly overestimated the attractiveness of the Nike brand and people’s interest in seeking it out online when unavailable on retail shelves, massively overestimated the value of its first-party data and its ability to leverage it, massively underestimated the difficulty of effecting such a radical shift in distribution, marketing, and innovation, made wildly incorrect projections based on pandemic-era purchase behavior, massively underestimated competitive responses, and clearly, and pretty obviously, no bodywho worked on it had read ‘How Brands Grow.’
Phew, now that’s a lot.
Breaking this down further, by exiting retail channels, Nike created two problems for itself. First, it reduced its brand's surface area, making it harder to buy. Second, it increased competing brands' surface area, making them easier to buy. Nike exiting retail is why Hoka and On Cloud have done so well. It had nothing todo with them per se; it was more ‘right time, right place’ when retailers needed alternatives to replace all the Nike SKUs they no longer had access to. Had Nike stayed in retail, this opportunity would never have presented itself.
To replace what it knew it would lose in retail sales, Nike doubled down on digital advertising to push more customers to its digital storefront, which lay at the heart of its strategic push toward DTC. By doubling down on digital ads, Nike created another set of problems for itself. First, margins declined because so-called ‘performance marketing’ tends to be heavily discount-driven. Second, the brand weakened because Nike was now doing less brand advertising. Worse, as a knock-on effect, new and infrequent Nike buyers declined as the brand weakened and was harder to get hold of. There was then further downward pressure on sales and margins, which led it to press the accelerator even harder on sales promotion to compensate for the shortfalls. And, as anyone will tell you, once you getsucked into a discount spiral, two more negative effects rear their ugly heads: First, you train price-sensitive consumers to expect a discount so they won’t buy when there isn’t one. Second, your brand becomes less desirable to less price-sensitive consumers because constant discounting signals desperation. And no consumer ever wanted to be associated with desperation as a brand value, especially not a brand like Nike.
In what appears to have been an attempt to both reduce costs and innovate faster, Nike eliminated its previous sports-centric centers of excellence (running, football, golf, etc.) and replaced them with a massive data warehouse tied directly into its storefront and 1st party marketing and sales data. Unfortunately, this created even more problems that it could not solve. First, it seems that it wasn’t able to draw out and then operationalize meaningful insights from this data, which combined with the elimination of long-tenured professionals deeply wedded to the fabric of core sports, meant Nike effectively turned off its radar, missing huge trends, including the post-pandemic rise of running. (Yeah, seriously folks, Nike, of all brands, missed running as a trend. Like, wow, that blows my mind). Second, as it lost its reputation for innovation, downward sales pressure increased further, leading to unsold stock piling up in warehouses, causing even more pressure to discount before the next product cycle rendered these unsold products irrelevent. Third, because the only part of the business that now looked robust was the retro-inspired part, Nike doubled and tripled down on AirForce One and other heritage lines, leading to diminishing returns as the overwhelming number of releases and sheer promotional pressure made these lines increasingly uncool to wear.
With the benefit of 20:20 hindsight, it’s hard to fathom the jaw-dropping value-destructiveness of this strategy. Nike, of all brands, traded one of the most successful brand moats in history for what can only be described as a vicious downward cycle of declining sales and margins. Obvious red flags over DTC appear not to have been considered, while oodles of empirical and anecdotal evidence pointed toward likely failure. I kid you not. Adidas, probably Nike’s primary competitor, had a public mea culpa a few years ago where it openly admitted the mistakes it made in pushing too hard, too fast, into digital advertising and DTC. Rather than learn from this failure, Nike went, “Hold my beer,” and bet the farm on it.
As we can now see, Nike used to have interdependent business systems that formed a flywheel that accelerated business performance and, over time, delivered a valuable and significant economic moat. When it chose to change its business systems (‘Big-B brand’), the existing flywheel broke down pretty fundamentally, rendering it impossible for its distinctive assets (‘little-b brand’) to do their job. This led to the new flywheel failing to replace the value lost when it eliminated the old one, crushing its brand moat advantage in an unprecedented act of self-sabotage.
So, where does this leave us? Well, Nike has a tremendously long slog ahead of it to try and regain lost ground. Will it get there? I don’t know. The sheer scale of what the former CEO broke means that fixing it will likely take years, possibly a decade. If the board had any integrity, it would contrast its fiduciary duty to shareholders with this unprecedented strategic failure on its watch and resign. But that won’t happen because that isn’t how corporate boards roll, and being on the Nike board is a status symbol, so no one is likely to walk away anytime soon.
For the rest of us, however, it’sperhaps the single most important case study we have about how ‘Big-B brand’and ‘little-b brand’ interact, how critical interdependent business systems arein delivering competitive advantage, the value of brand flywheels, performance accelerants, and economic moats, and the severe risks involved when you decide to deconstruct them. In the case of Nike, the ‘brand moat’ it so thoroughly deconstructed appears to have been worth circa $52bn because that’s how much less valuable the company is today. (Nike having dropped from a market capitalization of $162bn to roughly $110bn when this was written).
Oh, and yeah. You’re not alone if, like me, you’re gobsmacked that a marketing behemoth like Nike could so quickly forget the basic fundamentals of marketing and consumer behavior. I mean, wow, just wow. I lack the words.
When even formerly great brands like Nike get laid low by following the hubris of the Silicon Valley Tech Industrial Complex, you’re left with one of two conclusions:
If even Nike can screw up this completely, there’s no hope for the rest of us. We’re all doomed, and Scott Galloway is correct that the brand era is dead. Just not for the reasons he thinks.
If even Nike can screw up this completely, many others must be screwing up too. And if many corporations are screwing up, it means there’s swathes of competitive weakness out there, just waiting to be exploited for others gain.
Be smart. Land on conclusion two.