How much do you think it costs to make a pair of Nike shoes in Asia?

> But if we bump the cost of freight, insurance, and customs from $5 to, say, $28, then they wholesale the shoes to Footlocker for about $75. And if Footlocker purchases Nike shoes for $75, then they retail them for $150. Everyone needs to fixed percentages to avoid losses.

I don't understand this paragraph. If Footlocker was okay with $50 profit/shoe, why do they need to claim $75 profit/shoe in their costs per shoe go up? The costs of handling the shoes, retail space, advertising, and labor are all fixed.

Because the market recognized value add is the capital investment and returns, including the credit basis on which inventories flow. These people are operating on a per $ basis, not a per shoe basis. If the margins % lower then the capital will flow to something else more profitable and then prices rise until the margins are relatively flat across similar productive investments.

Gains and losses are measured in % not in quantity because a dollar (or ant currency) has no fixed value.

Sorry: I intended to reply to the grandparent.

That doesn’t really make sense to me.

The market cares about dollar returned vs dollar invested. If some piece in the middle of the chain goes up and end customer prices go up as well, that doesn’t directly affect investors at all.

The way it could and likely will affect investors is if people start buying fewer shoes, but that is a different process than what you are describing.

If I’m off base can you help me understand what you are saying?

But the cost of buying and holding inventory goes up. If a store has 10k shoes in inventory @ $50/each, they are carrying $500,000 in inventory. If the shoes now cost $75, they need $250k more for inventory. Capital for inventory isn't free.

The market cares about dollar returned vs dollar-x-time invested. A shoe sits on a shelf until it is sold. If it costs 1.5 times as much to stock a store with shoes, then you need to earn 1.5 times as much money after the same time-delay.

Think in the extreme. $1 billion can probably earn more in a saving account than as a shoe that generates $50 profit after 2 weeks.

Surely you can see that putting in $75 to make $150 for a $75 profit is significantly different than putting in $10075 to make $10150 for the same $75 profit, yes?

Short answer is return on investment. If I get $50 on a $75 investment when I used to get it on a $50 investment, my ROI goes down. My investors are now mad. They sell their stakes and buy into a company with a better ROI. My stock price goes down and now I'm mad.

Selling shoes that you purchase wholesale for $75 has costs that go beyond selling shoes that you purchase wholesale for $50. There's the cost of money to buy the inventory, the cost of holding the inventory (and insuring it), the cost of shrinkage, the risk of being unable to sell some of that inventory. Most of those costs scale with the wholesale cost of the product being sold, although not necessarily fully linearly. As a result, a top line $50 margin on a $75 product gains you less than a $50 margin on a $50 product -- in a world with cheap capital. If you're restricted to holding $N of inventory due to cost of capital, this becomes even worse -- not only are your bottom line margins going down as much as 15%, but you're able to do it on only two thirds as much inventory, which (depending on turnover rates, etc) can drive you even lower.

In theory, you're right, however it ignores some key points;

-Some of their costs are in fact linear based on the cost of the item.

Inventory cost doubles, perhaps now they have to take out higher interest debt to finance that. Things like insurance would also at least double.

Transaction fees (like card fees at about ~2%) and other parts (like returns risk) also increase linearly.

-Reduced sales due to increased prices.

If an item is less affordable people buy less of them. Theft will also go up. If trainers were $100 a week ago and are now $200 - you will sell less, they will be stolen more.

All in you actually do need more than the fixed $50 of margin if the wholesale cost of the item changes from $50 to $100 - it may actually be that $100 is the correct number, or even too little - sales volume would concern me the most, particularly on this 'luxury' item.

Because it's mostly wrong. Luxury goods like Nike's, iPhones, et.al. are priced to maximize revenue. If those started growing on trees for free it wouldn't appreciably change the price. They'd just bank the extra as profit.

Take this to the logic absurdity, you have a car you previously sold for $2 for $1 COGS. Tomorrow COGS is $1M for the car. Could you sell it for $1M+1? No you would lose your ass because your line of credit and investments would not be able to be supported by the returns, in fact if this is your only option you would probably stop making cars altogether and invest in another business and sell your assembly line, eventually enough car companies would go out of business until the supply curve met a high enough % profit to normalize with performance of other businesses.

Now this analogy has a LOT of problems but the point is it directly affects investors, even if the interpolations inbetween are imperfect.

I don’t think this is quite a sufficient explanation. If I were an investor / owner of a distributor or retailer, I think I would observe that these businesses don’t scale arbitrarily and I would care about returns as a function of cost of goods sold, operating expense, and of cost of customer acquisition. In this context, cost of goods sold will include actual wholesale cost as well as associated costs that scale along with it: insurance, shrinkage, samples, etc. Cost of customer acquisition will not scale as strongly with wholesale cost — one would need to advertise a bit more to convince people to buy a more expensive shoe, but this should be less than linear. And operating expenses (retail square footage, warehouse space, cashiers, shipping and handling) are almost independent of the cost of the pair of shoes.

All that being said, tariffs drive up the cost of living, which drives up wages, which makes everything more expensive.

They'll sell fewer $150 shoes than $100 shoes?

"putting in" is doing a lot of work.

A shoe doesn't sit for a year waiting to be sold.

It turns over quickly.

An aside: the actual functional Nikes aren't luxury items, just really good shoes. My wife’s a foot surgeon and she won’t run in anything else because they fit her perfectly.

I've never found Nikes that work for me, but Brooks seem custom made for me personally, so that's what I get. They're about the same price as my wife’s Nikes.

In addition to the points others are making, there is also the increased cost of inventory that doesn't sell. The flipside to the high markups from retailers is the high discounts you get on last season's fashion. This is the "fixed percentage to avoid losses"

Sure, I can see the difference.

I hope you can see how spending $75 to make $150 revenue and $75 in profit is a much better position than spending $50 to make $100 in revenue and $50 in profit, if you are limited to how many transactions you can make in a day by physical infrastructure.

I think it's understandable for the store to charge more for their shoes, and for the stores to make more than $50/profit per shoe to cover higher capital investment and increased risk of loss, but I don't understand the logical leap where the store now can make 50% more profit per shoe.

Every product is priced to maximize profit (not revenue).

Apple sells lots of phones at different price points. So there is some price sensitivity via a vis value for money or competitive pressure.

If you can make $5k/year by investing $100k into shoe-selling, then those profits have to rise at the same rate as base costs, otherwise, people will just invest into eggplant-selling, instead.

Another perspective is that Footlocker would sell you those $25 Nikes for $300 if they could-- but if they tried, someone else would get active in the retail business and invest into a slightly less profitable operation (with lower margins) to eat into their market share.

But if the costs for everyone rise, raising the prices proportionally (instead of by fixed amount) makes total sense because it is not really gonna cost you market share (only decrease total market volume depending on consumer price sensitivity).

Note: We just observed those exact dynamics with Covid/Ukraine driven price increases, where retailers and other middlemen actually came out really good instead of sacrificing their margins to keep consumer costs down.

Margin isn't profit. It's gross, before all your business expenses. If it's anything like the second example, they only see a few dollars out of that $50 as corporate profit.

I agree fully. Having comfortable shoes with reasonable lifespans isn't a luxury.

If you spend more money and get a proportional increase in quality, that's not luxury. A luxury good occurs when the marginal increase in quality cannot be justified by the increase in price. For example, you could buy a quartz Casio for $25 that's more accurate than a $10,000 mechanical Rolex. Both tell you the same time.

But you might not sell the COGS for $2M, you might do just fine with $1.5M.

There was a very good exploration of this in the context of boardgames here: https://stonemaiergames.com/the-math-of-tariffs/

From an investment perspective, $50 -> $100 is exactly the same as $75 -> $150. The difference in the number of transactions that actually occurred is trivial. I see the point you’re making but I don’t agree that it matters until the transaction value shrinks to the point where you’re selling things in huge batches (e.g a 5 cent part you sell for 10 cents, but you sell them by the 1000s)

My local produce store was complaing about this. The prices increased about 20 fold. What was once a small loss due to spoilage now became significant.

It's a great question, and the answer is that you're missing the change in demand.

Let's say Foot Locker tries to keep the same absolute profit $50 and retails the shoes for $125 instead of the previous $100.

Now demand goes down, because more people will skip a new pair of sneakers. So Foot Locker's absolute profit goes down.

But they still have the same fixed retail space, advertising, and labor as you said.

So to try to keep their profitability, they need to increase the price more, which reduces demand even more, but it settles somewhere higher. And the place it settles (where total absolute profit is maximized) tends to be around the same 100% markup as before.

It doesn't need to be exactly the same, but as a general rule of thumb, these things do tend to work in proportional terms rather than absolute terms. And we're fortunate they do, because when manufacturing costs fall, that means absolute profit per unit can fall as well (while percentage remains the same), because it's made up for by more people buying.

Presuming that theft rates will increase also if the item is more costly and affordable to less[edit*] people. Also if inventory is damaged in the warehouse or on the sales floor, lost or unsold then those cost scale with the cost of the item.

I seem to remember from many years ago in retail that you should double charges every step of the way, so if you are paying 20 dollars for a t-shirt you should be charging at least 40 for it, as a sort of rule of thumb.

I think it depends a lot. I remember working in retail for a summer and saw some of the prices. If you wanted to buy an alarm clock, that was 100% markup, but if you wanted to buy the Garmin GPS then it was 15% markup.

I would think that specialised and expensive shoes have less markup than cheaper and more common shoes. But if the cheaper and more common shoes become 50% more expensive then there aren’t really any cheap shoes left to feed the bottom line…

To less people? I think I touched on that but yes.

All of that would typically be tied together as inventory cost (aside from theft, though some people do).

Lots of fascinating things in retail. Around half of all theft will be from your own employees, for example.

There is also the fact that with each USD you can buy less and less as a private person.

So to have the same quality of life, you expect higher returns.

Which mean that you will choose to invest into companies that offers a better return, and for that, these companies will have raise their prices, which in turn, spirals into additional price raises.

Sure, but that has nothing to do with costs and everything to do with what the market will bear (while still recovering costs).

People will go and shop around for the best price on a $300 item, but for a $10 item they'll buy whatever's infront of them, so long as it's not clearly outrageous.

Isn't that pretty intuitive? Imagine if they had to spend one million dollars in order to make $50 profit.

The truly luxury Nikes, the ones that cost way more than $100 - $150 are not priced to maximize revenue, however. The evidence is their pricing on secondary markets, which often price them at multiples of the retail price.

Inventory costs money not just due to the cost of storage, but also because it’s bought on credit. The higher the price, the more money needs to be borrowed. The longer it takes to sell it, the more interest needs to be paid.

(If it's not bought on credit, there is still opportunity cost, since that money could have been used for something else.)

That's not the fundamental cause, though. Companies can't just raise prices to achieve whatever return they want, because once you go above the profit-maximizing price, the fall in demand outweighs additional revenue per item, and once you go above competitor's prices, demand similarly falls.

Yes investors look for maximal returns, but those are limited. Fundamentally the ceiling is set by demand and by your competitor's prices.

Every single person in the supply chain has a lever they can pull to change price, except the end consumer

The difference between selling every shoe at $150 and selling less than every shoe at $300 (or whatever the secondary market is charging) probably gets tossed around in pricing meetings.

Plus, higher secondary market prices drive demand for the less desirable shoes as everyone can't afford to spend a week's wages on a pair of shoes but can stretch their budget for the still-kind-of-cool models. I'd go so far as to say the secondary market prices drive more demand for the lesser models as the cool kids want to be seen wearing what the rich cool kids are wearing.

I'm sure they spend a lot of time discussing what price they can charge without people openly revolting against their 'predatory pricing' strategies.

The need for inventory decreases at the same rate as the sales throughout, e.g. if it takes twice as long to sell a pair of shoes than you only need to hold half as many.

> except the end consumer

You can usually change what you buy.

>why do they need to claim $75 profit/shoe in their costs per shoe go up?

A lot of the costs come from bidding against other retailers for employees and retail space. If you don't make as much as the rival retailer they'll outbid you.

You can sometimes get around that by buying direct from the internet.

Margin as a % is a key metric, more so than margin as a $. It's not always sensical but it's dominant in the business/investment community.

For example, you may announce to public markets that your profit has increased $10M despite margins eroding from 50% to 30%. You will likely be punished in terms of stock price. This is because you sold a lot more or trimmed some expenses (which is short-term good) but you are also now more risky because if sales decrease you will more easily run into trouble breaking even/covering operating costs (which is long-term bad).

Okay I think I understand, thanks for explaining.

So basically the money a business uses to produce the next tranche of goods (so to speak) normally comes not from income from sales of the last tranche, but rather from external funding sources such as loans or capital injection from investors?

Is that really so common as to be universal and affect investor behavior like you suggest? Like for certain types of business, and especially for early stage businesses, I do expect this to be the case. But does it apply to the market broadly? Scary if so, since it seems like a destabilizing force.

It tends to affect larger companies even more because their cash flow is heavily buffered by lines of credit on both sides, their vendors and clients. Their customers might pay them on net 30 or even net 90 but many costs - like salaries for the people to service those contracts - need to be paid on shorter time horizons.

IMO for the Garmin vs alarm clock example, it's less about costs and more about power & branding.

The retailer & the wholesalers involved all have a reasonable idea about what people will pay for the products in question. The portion of that final consumer price that stays with the retailer is just the result of negotiation.

The retailer can likely buy decent alarm clocks from anyone, so alarm clock makers & wholesalers have no pricing power and the retailer can demand high margins.

But the retailer can only get Garmin from Garmin. If Garmin has done a good job promoting the brand, such that the retailer feels they have no choice but to stock it, they will have to suck it up and accept low margins.

But profit for the investor is based on what they put in and get out, no? Profit calculated against the company’s cost seems like an implementation detail for the investor.

more expensive shoes will lead to longer lead times to sell inventory, due to downward slope of the Demand curve (less demand for more expensive shoes).

If you sell $75 shoes, you can sell 1000 units/mo, but if your shoes are $100 you can only sell 700/mo and it will take 1.5 months to sell 1000 units.

This effectively increases fixed overheads per pair of shoes and decreases net margin per pair, given constant demand

You can only raise prices so much before people look for alternatives to what you’re selling or do without. What we’re going to see with tariffs isn’t just price increases. We’re going to see some price increases, some reduction in selection, some stores closing, and some layoffs.

That’s actually the opposite. The consumer is the one dictating prices and preferences.

It's going to vary business to business, but if you have to spend money now to make money later, there's always going to be some preference to make sure that if the % return later is too small the money gets reallocated to something that can offer better returns.

Whereas a business that can figure out how to be paid significantly before it delivers can run on much slimmer margins.

> I don't understand this paragraph. If Footlocker was okay with $50 profit/shoe, why do they need to claim $75 profit/shoe in their costs per shoe go up? The costs of handling the shoes, retail space, advertising, and labor are all fixed.

Some extra costs are real and linear to their "factory" price (returns, insurance, stolen stuff, less people buying less shoes, so they need higher margins to survive, etc.).

On the other hand... they can raise their prices today by $whatever_tarrif_trump_mentioned, and blame trump for the price hike and pocket the extra profit.

Capital is capital. Just because you don’t need it for very long doesn’t make it free.

> Inventory cost doubles, perhaps now they have to take out higher interest debt to finance that.

I'm pretty sure Footlocker doesn't borrow money to pay Nike up front for inventory. Nike is smart enough to know that there's zero chance their shoes will be sold if they sit in a warehouse, so Nike might as well ship them to retailers and get paid gradually as the shoes are sold to consumers.

Additionally, their risk increases.

If the shoes don't sell, their losses can get much larger.

They need the potential to make more profit to offset this this potential for larger losses.

It's kind of like asking why Sears needs to make $200 in profit selling a refrigerator but only $2 selling a t-shirt.

Because that's just how it works...

There's cost based pricing and there's price based costing.

Food and clothing, anything with complex supply chains tend to be cost based pricing. As a rule of thumb, it's x3, maybe x4 for a well-branded item like Nike or Calvin Klein. Most innovations are on supply chain. E-commerce was such a big thing because it could cut out one middle man and lead to 30% price cuts or profit margins, and yet all these online shops ended up appearing in malls anyway.

Software is price based costing because there's no fancy supply chain. iPhones may be somewhere in the middle, hardware tends to have the worst of both worlds - high fixed costs and lots of middle men.

A McDonald's may have franchises and may own some restaurants internally, but they don't want to lose money, so they may base it on the lower profit margins - it makes no sense for a burger in one spot to be $4 and a burger in the franchise to be $5; both need to be $5.

Generally luxury brand do use more expensive parts, whether or not those parts add to the quality. And they do have higher profit margins. But the retailers, distributors, etc still take a 30% cut or so. And in the end, Louis Vuitton is still probably making lower margins than Plants vs Zombies.

That's just a for-instance.

The general point is that additional cash is tied up in shoes which cannot do something else. Who bears the burden of the loss of that additional cash changes over time (Nike to Footlocker to consumers) but the burden is bourn.

(And that's before you count the impact of the inevitable reduction in unit sales. There're various kinds of overhead that don't scale linearly units sold, or that have a long lag before scaling, or have a significantly-sized step function in the scaling.)

BTW, where did the cash go? Oh yeah, into the hands of the US federal government. We have a word for that: tax.

For every week, the shoe does not sell The price goes down 10%. So very quickly you lose your margin.

Which is why Derek [correctly] points out that everything is percentages, not fixed dollar amounts.

Not at the bottom of the supply chain. As a farmer, we get told what the price is. Our only lever is to opt out of selling if we don't like the price. Which is ultimately the same as the consumer opting out of buying.