October 19, 2014

SCHULMAN | Air Jordans Are Inflated by Hype

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About a year ago, my brother bought a pair of basketball sneakers — Air Jordan Retro 3s to be specific — slightly used for 100 dollars. I thought that was crazy, but that’s not even the worst part of the story: Nike designed the shoes in the 80s, so they’re like cinder blocks compared to newer shoes. My brother bought basketball sneakers for 100 dollars knowing he would never play basketball in them.

Apparently, he’s not the only one who will pay triple digits for used basketball sneakers. People who do it call themselves Sneakerheads. They buy and sell shoes in a system of buying and selling over Facebook, Venmo and Twitter called the Kick Game.

The Kick Game makes no sense. My friend — who considers himself a Sneakerhead — bought a pair of skateboarding shoes called the Nike Tiffany SB Dunks for 400 dollars a few years ago (of course, he doesn’t skateboard with them, just like my brother won’t play basketball with his Retro 3s). He could resell these sneakers for more than 800 dollars even though Nike released the shoes with high tops last May.

Increase the supply of anything, even the Nike Tiffany SB Dunks, and the price goes down. Sneakerheads are just speculators who dump hundreds of dollars into valueless shoes because they are convinced other people will pay more than they will. Although this is true now, eventually people will realize the shoes have no inherent value and when they do the speculative bubble will burst. This matters because when the hype dies down, prices for basketball sneakers and Nike’s profits will take a hit. Sneakerheads will pay Nike double what its competitors charge in hopes that the shoes will appreciate in value.

Obviously, it’s hard to say exactly how much money Nike makes from the kick game, but for arguments sake let’s limit it to Nike’s Basketball division. According to Nike’s 2013 annual report to investors, Nike’s basketball division contributed 2.5 billion in sales revenue last year. Nike will lose 1.3 billion dollars by selling the 2.5 billion of basketball shoe sales at 50 to 150 dollars, like their competitors, instead of 150 to 300 dollars. Although this doesn’t seem like much, Nike orders all of its product four to five months in advance from independent manufacturers, so costs are relatively constant. In other words, if Nike sold less, it would profits less because profit are revenue minus costs. And losing 1.3 billion in net profits would be huge for Nike, who only posted 2.6 billion in net profits last year.

Although it’s hard to say when the bubble will burst, I think it’s safe to say it will. Maybe you remember Beanie Babies? People who thought they were valuable paid through the roof for them in the early 2000s. Eventually, people realized stuffed animals are adorable but not worth hundreds of dollars and Ty disappeared with its Beanie Babies. People also bought ridiculous quantities of comic books in mid-90s speculatively. But when people realized the books were valueless, the publishers were stuck with the worthless supply and went bankrupt.

A smart investor would short Nike (if you’re not so financially savvy, that means you would borrow Nike stock and sell it with the intention of buying it back later — presumably at a lower price so you can repay your creditor his shares and pocket the rest) because the bubble will bursts and profits will fall. You can’t make the case that slightly used basketball shoes that aren’t even meant for playing basketball are worth hundreds of dollars. Most Sneakerheads are kids making minimum wage; it’s only a matter of time before they realize basketball shoes aren’t worth a week’s worth of full-time work.