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New highs for Peak and Chinese Sportswear ahead?

by CKGSB Knowledge

March 30, 2010

This December, Peak Sport Products Co, a leading sportswear-maker and distributor in China, signed endorsement contacts with basketball players CJ Watson of the Chicago Bulls and Sam Young of the Memphis Grizzlies for a total of 12 National Basketball Association spokespersons.

The company traces its roots to a start-up led by the 55-year-old Xu Jingnan of Fujian Province. Xu started an original equipment manufacturer (OEM) business making footwear products in 1988 and then established the Peak brand in 1991.

After two decades of growth and development, Peak has become a well-known sportswear brand in China, and is gradually gaining an international presence through sponsorship deals with NBA, FIBA, the Women’s Tennis Association and Stankovic Cup.

In order to fund its expansion, Peak made a public listing on the Hong Kong Stock Exchange in September 2009, raising HK$1.9 billion in its initial public offering for advertising, brand promotion, boosting production and expanding its sales network. It had 7,619 authorized retail outlets across the country by the end of June.

The company has also revealed ambitions to capture market share in overseas markets by opening a research and development center as well as a sales division in Los Angeles in December 2010. It became the second Chinese sportswear company to set up a shop in the US, after Li Ning Co Ltd opened its first store in Portland, Oregon, the hometown of Nike, in January of 2010.

Peak’s revenue and gross profit grew by 24.7% and 32% to RMB 2.26 billion and RMB 899 million, respectively, in the first half of 2011 from a year earlier, according to its interim financial report. The company also announced in November that its sales fair orders’ value for the second quarter of 2012 has grown by 9.5% year-on-year.

“Despite the global economic uncertainties, we remain optimistic about the prospects of the sportswear industry and are confident that Peak will continue to grow stably in coming years,” said Xu Zhihua, CEO of Peak, a CKGSB alumnus.

BOOMING SPORTSWEAR MARKET

Peak, better known for its basketball shoes, stands alongside Li Ning, Xtep and 361 Degrees as the most-recognized home-grown sportswear brands in China, most of which set up their footholds in second-and third-tier cities. Their foreign counterparts such as Nike and Adidas concentrated on first-tier cities where their strong brands command high prices.

China’s sportswear market has seen tremendous growth over the past years, driven by urbanization of rural areas, increasing disposable incomes and substantial improvement in living standards. The market is expected to reach RMB 130 billion by 2012, growing at an annual rate of 26%, according to figures from Shenzhen Zero Power Intelligence.

Nike led the domestic sportswear market with sales revenue of $2.1 billion in China last year, followed by Li Ning and Adidas, which achieved revenues of RMB 9.5 billion and 1 billion Euros respectively during the period.

INTENSE COMPETITION

Along with the prosperity of the sportswear industry in China, competition is becoming more intense. Foreign sportswear giants like Adidas and Nike are accelerating their expansion into the country’s smaller cities, the traditional stronghold of domestic brands, with low-priced products specifically tailored to target local consumers.

Adidas aims to unseat Li Ning this year, targeting double-digit growth in China over the next five years and planning to expand its coverage to 1,400 cities from the current 550. Nike also has set a target of boosting its annual sales in China to $4 billion by 2015.

Meanwhile, domestic brands including Li Ning, Peak, Anta, and 361 Degrees are trying to expand their markets from small, middle-sized cities to big ones, as well as release high-end products to grab some market share from their foreign counterparts.

Li Ning changed its decade-old logo and slogan last year and also increased its prices, a move to bolster its brand value. But these changes have not gone down well with consumers. The company posted a 4.8% decline in revenue in the first half of this year compared to a year earlier.

“Chinese consumers tend to have low brand loyalty, especially in the lower-tier cities,” HSBC Holdings PLC said in a research report. “As Nike and Adidas are introducing lower-priced products, it comes into question whether the fans of domestic brands will continue to maintain their loyalty.”

CHALLENGES AHEAD

After years of breakneck expansion, domestic brands such as Li Ning and China Dongxiang (Group) Co Ltd are grappling with shrinking margins, slowing sales growth and mounting inventories of outdated products. Chinese sportswear companies are beginning to mature as the market for their products at home and abroad develops The change is marked by limited store growth and declining profit margins, Goldman Sachs said in a research note released in October.

Credit Suisse said the industry is facing declining profitability following excessive expansion over the past five years, lack of product innovation, rising costs and loose control over distributors. “Despite actions being taken by brands to prevent a sharp decline, we believe the worst for the sector has yet to come,” it noted.

Some sportswear companies have already felt the pinch. “We envisage the competitive landscape of the sporting goods industry to remain challenging next year, and the pressure to lower inventory levels continues to be high,” Zhang Zhiyong, CEO of Li Ning, said in a statement released in November.

CKGSB interviewed Xu Zhihua, CEO of Peak, to talk about the sportswear industry in China.

Q: Why did you decide to join the family business?

A: Well, I received an offer from a large telecommunications company when I graduated. My major had been computer science, and I had been president of the student union. The salary they offered me was comparatively high, RMB 100,000 per year. But after discussion with my father, I realized that Peak needed me to understand the fast changing market. And I quickly made the decision to join Peak. Still, I don’t think I joined the company because of my father’s request; it was rather a sense of personal duty that pushed me to make the decision.

Q: How long did it take you to learn the ropes and integrate yourself into the company after you joined?

A: Actually I’m still learning–and I keep learning everyday. I was an assistant to the CEO when I joined Peak, but to be frank I was, in fact, a sales person who coordinated with and visited many local sales agents. At that time, the company was adjusting its strategy.

Q: How did Peak adjust strategies to respond to new challenges?

A: One key factor enabling us to adjust our strategy was Peak’s brand recognition. From a consumers’ perspective, Peak’s branding doesn’t change too much, even as the market we face changes. The company has always been a sports shoemaker specializing in the manufacture of basketball shoes. That is our foundation.

In 2001, I joined the company after graduating from university. When I visited our local sales agents, I found that they almost all loved playing basketball. They, too, were our consumers. They have a very thorough understanding of our brand. I thought that this was necessary for Peak to do well.

The company gained new blood when my younger brother and I joined. We changed sales agents, extended out products line, strengthened our designing capability, and improved our execution ability. All these changes helped Peak. And I think consistent branding is essential. Without it we would not have been able to succeed, no matter how capable the team is.

Q: What was your understanding of the business when you joined?

A: My understanding came from the environment I lived and grew up in: each summer I either worked in our franchised stores or in our factory. My father took my brother and me when he met with sales agents, even though we could not actually help him with anything. My roommates and I set up a shop at our dorm when I was at university with a total investment of RMB 8,000, or RMB 1,000 each. Still, this did not give me a thorough understanding of the business, but I was getting to know some things.

Q: Why did Peak lead in brand building but lag in coming to the market with an IPO?

A: Although our brand does have a long history – it was the first Jinjiang shoe manufacturer with its own brand name – our company is not that big. And business was sluggish for a while. We restructured, and then we realized the importance of the capital market. The company is now listed in Hong Kong.

Q: You said business was sluggish for a while. When was that?

A: From 1997 to 2001. They were tough times. Competitors snuck up on us and competition intensified. So we decided to review our strategy. I am proud to say we could recover and expand our business again. Very few companies in China can make it. A person who falls not only has to pick themselves up, they have to run fast to catch up with the other runners.

Q: What was the reason for those tough times?

A: The main reason was that the structure of sales in China was changing. We’re one of the pioneers in the industry as we own our own brand. But owning a brand in 1991 was not at all a good thing. Think about China’s business environment in 1991. The country’s economy was still a planned one in nature, and we could only choose state-owned shopping malls as a place to sell our products. After 1997, especially in the wake of the Asian Financial Crisis, a great change took place in domestic market: state-owned shopping malls started to disappear as private players began to play a bigger role. It was a market in flux. It was a big challenge for us, but not for our competitors who entered the market later than us. That transition was a test for us, even though we were the market leader at that time.

Q: What was Peak’s sales revenue then, in 1997?

A: About RMB 100 million, which wasn’t bad for the late 1990s.

Q: What was revenue in 2001?

A: Still RMB 100 million. Business was stagnant. There were a lot of problems. Our competitors like Anta, on the other hand, were growing very fast. My younger brother also joined Peak in 2001, half a year before I did. He didn’t finish university.

Q: What changes did you and your brother bring to Peak as part of the generational handover?

A: First of all we implemented things, and the company improved its ability to execute plans after we joined. Ideas adopted by the board of directors were executed. That was a big change. Peak was not a company with a scarcity of good ideas. My father himself is both aspiring and entrepreneurial. He was adamant the force holding back the company was poor execution of plans. People were reluctant to change sales agents with whom they had worked with for years. They didn’t want to offend these agents.

The first thing I did was to go into the market and learn from it. Then I started looking for new sales agents. I learned things during this time, and what I learned gave me the confidence to plough on with reforms. When I returned to the headquarters in 2004, the first thing I did was to reform the sales strategy. Half of our sales agents were gone within three years, though I faced great resistance, even from my father. There were definitely risks in making such changes, since no one can know for sure what they are doing is right. But I was certain that the old sales agents were not right for us, and they would have ruined our business if we didn’t change. Fortunately my decision was vindicated.

Q: How has financing been for the company? Why did you decide to raise capital?

A: Capital is especially important for private companies. We experienced three crises since we started the business. The first one happened in 1992, when all private enterprises faced the question of transforming themselves into collective companies or not. The second came after the Asian Financial Crisis, when most manufacturing companies started shifting to other businesses. Then there was last year’s financial crisis.

Peak has faced capital issues since its establishment. When my father founded Peak in 1992, he asked a bank for a RMB 1 million loan. They asked him how he would use the money and he told them he needed it to pay for advertising. Can you imagine what the bank said?

Q: How did the financial crisis hit Peak?

A: Two new manufacturing plants started operation in 2008, and we had been continuing to grow ourselves. Previously we had only two ways to raise capital: bank loans and private loans. Now there are several more ways, for example private equity and bond issuance.

Q: Peak’s shares fell on their debut, surprising a lot people. Why did they fall?

A: That was due to the market’s overall performance. It had nothing to do with our business. We know our business well. When we publish our revenue report next quarter, the market will respond positively. It takes time for investors to get to know a newly listed company. I know that investors who target returns over the long term will add to their investment when the share price falls. They have confidence in Peak.

The price to earnings ratio of sportswear manufacturers in the mainland is about the Hong Kong’s market average, or even lower in some cases. It shouldn’t be that way, because, obviously, the mainland market still has a lot of room to grow, and our business is still in its infancy. That is why Sequoia Capital invested in us, even though they usually invest in fast-growing technology companies. And, apart from making shoes and clothes, Peak is also a company in China’s fast growing sports industry. Some people have forgotten this.

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