Will Counterfeits Squelch These Sportswear Companies' Growth?

By Calla Hummel - June 7, 2012 | Tickers: LULU, NKE, UA | 0 Comments

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Sportswear companies Nike (NYSE: NKE), lululemon (NASDAQ: LULU) and Under Armour (NYSE: UA) experienced a huge run up at the beginning of the year and kept most of those gains while everyone else crashed during May. Nike is up 9% YTD while Under Armour held on to an impressive 38% YTD gain and lululemon has delivered an eye-popping 51% YTD gain. The companies’ earnings reports point to strong sales growth at home and abroad on the back of stellar brand names. In this piece, I look at one of the growing risk factors outlined in their 10-Ks: counterfeiting.

A Global Business

Counterfeiting is a massive and growing global business that generates hundreds of billions in profits annually, and far more prevalent than most people realize, argues Dr. Moises Naim, an economist at the Carnegie Endowment and author of Illicit. Modern counterfeiters reproduce nearly everything, from cars to malaria medicine to industrial machinery to toothpaste and running shoes. The quality of counterfeits is equally wide-ranging. Some counterfeits are simply extra units that an authorized factory produces after hours and sells on the side, others are made by former employees of the target brand while others are cheap and obvious items of only passing resemblance. Counterfeit sportswear run the gamut, but most appear to be made in factories set up by former employees of large factories in the legitimate sportswear supply chain, according to The New York Times. Anyone from Paraguayan smugglers to Italian high-end shoe store owners order counterfeit sportswear and uses normal commercial shipping channels for delivery.

Attitudes, Myths and Threats

The idea that counterfeits are uniformly bad because they steal new customers and peel away old ones through offering cheap, substitutable copies is too simple. Potential customers’ ideas about counterfeits determine whether and how counterfeiters threaten profits. Consumers attitudes towards counterfeits – the status conferred by original products, the safety of counterfeits and the ethics of buying from counterfeiters – vary by country, income, product, age, and gender. In some situations, counterfeits may help sportswear companies through free marketing, expanded brand recognition and a nuanced sense of status. For example, rampant counterfeiting has prompted wealthy Brazilians to buy more original, branded sportswear. Original sportswear is a clear sign of status and only proven, popular models are widely available as counterfeits in Brazil, so affluent consumers regularly purchase new models to stay ahead of the counterfeits.

On the other hand, middle class consumers may choose high-quality counterfeits over brand name sportswear. One survey conducted by the American Chamber of Commerce indicated that middle class consumers either replace or supplement brand name purchases with counterfeits. Middle class consumers, particularly younger consumers, in the U.S., India or China can afford the occasional pair of branded sportswear, but may choose to buy counterfeits instead so as not to stretch their budgets. In these cases, changing attitudes towards counterfeits is key.

Nike

The New York Times reports that Nike is the most counterfeited brand in the world: one in three pairs of Nike shoes may be counterfeit. The company recognizes that counterfeiting is a mixed blessing and aggressively pursues large counterfeiters by maintaining a corporate unit on counterfeit detection, which works with and trains local law enforcement and embassy officials. Nike loses millions of dollars in possible sales to counterfeiters every year -- how many millions is pure speculation -- but widespread counterfeiting also keeps Nike one of the most recognizable brands in the world.

lululemon

lululemon only has stores in the U.S. and Canada but has opened a showroom in Hong Kong and is seeing increased global demand as the hot new sportswear brand. Police seized a shipment of high-quality counterfeit lululemon pants in Ontario in 2011, signaling that suppliers are responding to demand for lululemon counterfeits. lululemon appears to have no or few anti-counterfeit measures in place, however, its social event and networking business strategy cultivates high brand loyalty amongst consumers, which discourages counterfeit purchases. If lululemon expands into new markets where counterfeits are readily available in all urban areas, such as the BRIC countries, it will see counterfeits increase. Counterfeits can serve as word of mouth advertising, which lululemon relies on, but they can also cut heavily into luxury good profits. At $100 for stretchy pants, lululemon straddles the sportswear and luxury goods segments. 

Under Armour

Under Armour is expanding into new markets and opened a store in China on December 31^st, 2011. With a bust in Baltimore last month, Under Armour is seeing a rise in counterfeit products in multiple markets. In the past, Under Armour has successfully enlisted consumers to track down counterfeits, however, the company would not comment on whether or how it has increased anti-counterfeiting measures. As Under Armour expands, the impact of counterfeits on its new markets profits will depend on if it can convince consumers that they are paying for healthy and reliable sportswear, and not just the brand name.

Bottom Line

As brands grow, they attract counterfeiters who offer consumers similar goods without the brand premium. Whether counterfeits pose a serious threat to the brand owners’ profits or not depends on consumers’ purchasing power and on consumer attitudes towards counterfeits. These sportswear companies face three counterfeiting challenges as they expand. First, their products may be luxury goods in new markets and thus subject to cyclical business, with counterfeits taking away more profits during downturns. Second, as brands expand, their products become more attractive to high-quality counterfeiters who can produce and market identical products. Third, to defend brands from counterfeiters, companies must change attitudes towards counterfeits in new and existing markets.

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