We Study Billionaires - The Investor’s Podcast Network - TIP655: Hustle, Trust, and Cash Flow: Nike’s Genesis w/ Kyle Grieve

Starting point is 00:00:00 You're listening to TIP. When I think about some of the most powerful brands in the world, it's hard to mention Nike not being very close to the top. Like other great brands, such as Coca-Cola, Apple, and McDonald's, the brand spends a lot of time at the top of its customer's mind. And it's easy to see why. These juggernauts spend billions of dollars on advertising each year. Additionally, Nike has generated vast amounts of wealth for its shareholders.

Starting point is 00:00:25 Over the last four decades, Nike has compounded its share price at 17% percent per annum since 1984 versus the S&P 500s, 11.7%. So today, I want to go into the early days of Nike before they spent much of anything on advertising and before Nike even existed as its own entity. We'll go over the peaks and valleys that Nike founder, Phil Knight, had to endure to even get Nike off the ground and to continue its succeeding into the future. We'll touch on why understanding a business's relationships with its suppliers is just so important and why the wrong relationship can cause vast amounts of pain on a business. We'll discover the importance of cash flow on young growing businesses

Starting point is 00:01:04 and why growth at any cost can actually be a detriment when you require large amounts of capital to grow. And we'll look at incentives through various levels of business, all the way from the salesman to the IPO process. Incentives are always underappreciated, and understanding them at a deep level will help you make better decisions, invest in higher quality businesses, and improve your analytical skills when looking at potential investments.

Starting point is 00:01:27 Additionally, we'll go over what happiness meant to Phil Knight, why his approach was so unconventional but rational in his own reality. Phil wrote this book very well, and it's highly entertaining, vivid and raw, while not holding much back. I think you'll enjoy this episode if you're a business owner, yourself looking for further inspiration, or if you're an investor who just loves learning about the intricacies of growing a small business and all the wild rives involved with generating massive amounts of success and wealth.

Starting point is 00:01:55 Now, let's get right into this week's episode. Celebrating 10 years and more than 150 million downloads. You are listening to the Investors Podcast Network. Since 2014, we studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now, for your host, Kyle Greve. Welcome to The Investors Podcast. I'm your host Kyle Grieve, and today I'll be doing a solo episode.

Starting point is 00:02:35 So Nike has been an incredible brand ever since I could remember. Little did I know that the backstory to the creation of Nike was so interesting and tumultuous. Today, I'm happy to share the origin story for you, as outlined by Nike founder Phil Knight in his excellent autobiography, Shudok. Just to give you a little background on the improvements in the fundamentals of the business, and went from sales of $8,000 in its first year, which was 1964, to sales of $140 million in 77,000. An incredible compounded annual growth rate of 77,000 percent, which is just my number.

Starting point is 00:03:08 mind-boggling. But let's get to the beginning of the Nike story. So Phil Knight was a real thinker. At the beginning of the book, he outlines how he was thinking about what would make him really happy in life. Was it money, wife, kids? Maybe he thought, but he wanted to go even deeper than that. Here's what Phil wrote about what he needed to be happy. Play. Yes. I thought, that's it. That's the word. The secret of happiness. I'd always suspected the essence of beauty or truth or all that we ever need to know of either lay somewhere in that moment when the ball is in midair, when both boxers sense the approach of the bell, when the runners near the finish line and the crowd rises as one. There's a kind of exuberant clarity in that pulsing half second before

Starting point is 00:03:54 winning and losing are decided. I wanted that. So not only was Phil a thinker, but he was probably a little bit crazy too. He calls his initial idea for Nike his crazy idea, and he attributes much of the success to the formulation and narrative of allowing that crazy idea to become something. He says the best advice he could give after all these years is to never give up on your crazy idea. So keep that piece of advice top of mind while listening to this episode, as I think you'll realize just how ambitious Phil was throughout the years to continue going, when clearly the easiest decision would have been just a close shop and take a cushy corporate job that he was fully capable of doing. So in 1962, Phil was 24 years old and ready to travel the world.

Starting point is 00:04:37 Phil wanted to see places like Egypt, Japan, Greece, China, the world. And his friend Carter would be joining him for the trip. So they decided that the first stop on the trip was going to be a one-way ticket to Honolulu. But Phil loved Honolulu so much that he decided to ditch the world tour and just stay in Hawaii. But the problem was that they needed money and took a job selling encyclopedias door-to-door. Now, Phil hated the job. But he also had an MBA. And he was pondering if he should maybe put that to use and get a job he might like more.

Starting point is 00:05:09 So he joined a boiler room in Hawaii. The way Phil describes it is like the very early days of the movie The Wolf of Wall Street. So Phil ended up quitting after a few months and decided to go back to his original quest of his world vacation. His first stop would be Japan. A country will be talking about a lot during this episode. Now while in Japan, he eventually got a meeting with Onitsuka, which was a Japanese shoe manufacturer that at the time was churning out close to about 15,000 pairs of shoes per month. Now, Phil's original intent to meeting with Onatzuka was to become the distributor of their

Starting point is 00:05:43 shoes in the United States at this time. But he had to lie to Onitsuka about his company because while he was talking with them, they actually asked him about the company name and he didn't have one at the time. This was how unorganized or, you know, how young he was and how he kind of flew by the seat of his pants when it came to business. And you'll be seeing this a lot throughout this episode. So when he was pressed by management there at Onatuka, he said he worked for a company called Blue Ribbon Sports. I believe he just made up the name on the spot. So they agreed to allow him to sell their shoes in the U.S. and they wanted about a $50 check just to send some samples to him back in the U.S. in his hometown of Portland, Oregon. So after he made that

Starting point is 00:06:20 deal, he continued on with his world vacation. One place he visited that was noteworthy was the Parthenon in Greece. So while there, Phil marveled at the temple of Athena Nike. Legend has it that it housed the goddess Athena, thought to be the symbol of Nike, which meant victory. While there, he observed, quote, on my left was the Parthenon, which Plato had watched the teams of architects and workmen built. On my right was a temple of Athena Nike. 25 centuries ago, per my guidebook, it had housed a beautiful freeze of the goddess Athena, thought to be the bringer of Nike or victory, unquote. Oddly enough, even though he noted this in his book, Phil wasn't even the one to come up with the name of Nike for the brand. much more on this later in the episode.

Starting point is 00:07:03 The following year wasn't very interesting for him. He had to wait nearly all of 1963 for the shoes to arrive. Four months after he'd visited, he sent them a letter asking, you know, what was going on with the shoes, what was taking so long. And they replied, quote, shoes coming in just a little more days, unquote. Phil's father believed that they would never show up just based on kind of the, I guess, the unprofessionalism of this message. But during that time, he had to make money because obviously Onusuka wasn't sending him

Starting point is 00:07:30 shoes to sell. So he once again had to fall back on his education and get a job, but he ended up deciding to go back to school and getting his CPA. He spoke with a family friend who gave him advice that if he had the CPA, he could continue kind of rotating jobs and having a very stable floor of earnings while he rotated through jobs. So even though Phil had gotten his MBA at Stanford, he would get his CPA at Portland State. He secured a job after getting his CPA, but it was very evident in his book that he wasn't very happy about it. He said he didn't enjoy the job very much. He said he didn't enjoy the job very much, but there were two consolation prizes from having the job. One was that he was making pretty good money. And two, each time he would go for lunch, he would walk past a travel

Starting point is 00:08:09 agency each day and was reminded of world travel, which he loved so much. Now, this part of the book was really interesting to me because it shows you that money isn't everything. Even though Phil was probably making a good living and many other people are making a really good living, money doesn't necessarily equal happiness. And as I mentioned earlier, Phil equated happiness with play, as he literally said for us. So I think traveling for him was his sense of play, which was why it was just such a good time of his life. But working as an accountant in the corporate world really sucked the play out of his life, and he had the awareness to realize this. So at the very end of 1963, his first shoes finally showed up. It seemed pretty strange that it would take well over a year

Starting point is 00:08:49 for the shoes to show up, but they finally arrived. He got about, I think a dozen pairs, and Phil ended up sending two pairs of these Onattsuka shoes, which will all, also be calling tigers to his running coach when he was at Oregon, Bill Bowerman. So during a meal he had with Bill, Bill actually asked Phil if he would cut him in on the deal because he really liked the look and feel of the shoes that he'd sent him. Bowerman was always tinkering with shoes to try and eke out the maximal performance that he could get out of them. So they ended up agreeing that Bauerman would get 49% of the business and leave the controlling 51% to Phil Knight. Now, the first order from Onatsook was 300 pairs of tigers. Bowerman contributed his portion, but

Starting point is 00:09:28 Phil was short. So he had to ask his dad for another $500, which his dad did not want to give, as his dad had been loaning him money throughout the years. Phil's mom pulled out a few bucks and told Phil she'd buy a pair and his father ended up ponying money as he got the message from his mom. Now, it's worth talking about his sales strategy at the very beginning because it's nothing like what you envision from a corporate juggernaut like Nike is today. So Phil attempted to get some retailers to sell tigers, but he just unfortunately didn't have much luck going that route. So he ended up just turning to roaming around the Pacific Northwest going to track meets.

Starting point is 00:10:01 He just shat everyone down in attendance about the shoes. And he said that with his strategy, he couldn't write orders fast enough. So his success as a salesman was a little puzzling. After all, I mentioned earlier that Phil had actually been hired to sell encyclopedias in Hawaii, and he was horrible at selling them. But I think this speaks volumes to why passion in business is just so important. Phil said that the reason he was so good at selling sneakers was because of his belief in running. Phil mentioned that his passion for running and his belief that wearing these sneakers would

Starting point is 00:10:32 make you a better runner altered his perception of selling and made him better at just selling them and selling his customers on them. So he wrote here that belief is irresistible. So he ended up selling out his first shipment in the first half of the year and was now ready for a $3,000 order. But as you'll come to see in this episode, his funds were very, very tight. His dad, who had been the source of funding previously was no longer going to loan him any money. So he wrote here that the bank of dad was shut down permanently, which I found pretty

Starting point is 00:11:02 funny. However, his father did him a great favor by being the guarantor of a loan with First National Bank. So because he got this loan, you know, Phil was feeling at the top of the world. He was doing what he really liked with his passion project and the shoes were flying off the shelves. He had a legitimate partner and now he had a banking partner to boot. So he decided that he wanted to start adding salesmen to help Blue Ribbon grow. So California would be his next target. But the problem of cash flow once again made pain to go to California to find salesmen very hard. But Phil had an excellent solution that I think really did a good job of showing his ambition about how much he wanted to make this business work. So every weekend, he put on his army uniform.

Starting point is 00:11:44 So at this time, he was in the reserves and he'd go to the airport. The military police would wave him through and he would get his flight at $0.00. So I think that's a very good sign of ambition. So these are just, you know, some of the types of stories that you'll hear from founders who just really live and love their business. But the first of many legal wrinkles was about to hit him. Phil had been ordered to stop selling on itsuka shoes from an East Coast competitor who had recently been to Japan and signed a contract to be the exclusive American distributor. Phil called this distributor the Marlboro Man. Phil immediately got onto a plane straight to Japan. to meet with Onatuka and try to hash things out.

Starting point is 00:12:21 He ended up getting a meeting with Mr. Onatuka and went into his pitch about how well sales were and how he partnered with a running legend who could help him continue selling shoes and really growing at just a fast pace. So Mr. Onatuka bought exactly what Phil was saying and said that Phil Knight could have the Western States and that the Marble Man would take the East Coast.

Starting point is 00:12:40 They gave him this deal for one year and then would revisit it after this time. Phil was ecstatic about the news. So now this story really makes me think of some of Warren's advice on dealing with people that he trusts. So in Lawrence Cunningham's book, Margin of Trust,

Starting point is 00:12:52 he talks about how Warren's built this circle of people that he surrounds himself with. And part of the reason for the success of Berkshire Hathaway is just this trust that he's built with his subsidiaries. So Lawrence writes, quote, margin of trust directs dealing with only those people you trust deeply.

Starting point is 00:13:09 Another rarity that warrants heavy reliance when found, unquote. But here's the thing about trust. Warren, you know, now is obviously at a point where he operates out of strength. People want to work with him because of his long track record of excellence and success. At this point, in Phil's career, he was doing less than five digits of revenue. So he was still a young man.

Starting point is 00:13:29 He was largely unproven in the world of selling shoes. And, you know, he was doing business, yes, and he was growing a little bit in the short period of time. But the thing is, he only had one supplier. So he had to try to impress that supplier as much as possible and hope that that one supplier, who basically his entire business model was working off of would continue doing business with him rather than doing business with somebody else. Now, while reading Phil's story, I can't help but think about the trust between him and Onatuka and how it was consistently tested over time.

Starting point is 00:13:59 And with this example, I just talk about, it's kind of seemed like Onesuka was going behind Phil's back and attempting to make deals with other distributors when they'd already been dealing with Phil. And if that isn't kind of a breach of trust, then I don't really know what is. So in Phil's first year of business, 1964, he made 8,000. of revenue. He was projecting for $16,000 in sales for a second year. Now, he was proud of this growth, but unfortunately, he was getting resistance from his banker. The banker told that growing from your balance sheet was just not a good idea. It was really dangerous. Doing this meant that

Starting point is 00:14:30 your growth would outpace your increase in equity. And if something were to go wrong and you had no equity, the banks had nothing to chase if their loans ended up having no value and were no longer payable by the people that they were lending their money to. So from an incentive perspective, I actually can see where the banker was coming from here. But Phil had a very different perspective being the entrepreneur. Phil writes, growing sales plus profitability plus unlimited upside equals quality company. In those days, however, commercial banks were different from investment banks. Their myopic focus was cash balances.

Starting point is 00:15:01 They wanted you to never outgrow your cash balance. Keep in mind that he said this before Silicon Valley was a big deal. So he really nailed it, I think, here with the comment on the bank's myopic view of cash balances. Now, Phil was in full growth mode in his early days, and he didn't want to put a break on it. Plus, he knew that in order to appease the folks at Onatuka, he was required to sell more and more shoes at a faster pace. He never mentioned them saying this explicitly, but I get the feeling it was probably, you know, an implicit agreement that they had. And, you know, if Phil couldn't outsell the Marlborough Man, then he knew that Onetzuka could hand the keys to the Marlboro Man in the U.S. and cut Phil out. and Phil's journey doing this shoe selling would be ended.

Starting point is 00:15:43 So there was a really interesting story here about Phil's relationship with bankers. And it actually kind of reminds me of John Malone's relationship with bankers that I outlined in TIP 619. And I think many people have really rocky relationships with banks, especially those whose business models don't align with what banks are looking for. And I think it just comes down to one thing, which is just a lack of alignment in incentives between the bank and the entrepreneur. Now, small business owners like Phil want to grow. They have to grow. And in Phil's case, it was grow or die. But the bank did not want to take part in the death part of that equation. Because

Starting point is 00:16:18 without any equity, if Blue Ribbon Sports died, the bank would not be able to recoup its losses. This is why many smaller businesses are forced to do equity issuances when they can't just, you know, raise funds internally or secure bank debts or they don't have the relationships with banks yet. I've noticed here that since I focused a lot more on smaller businesses, I can see why many of them have to end up going with the equity issuance route, even though I would prefer to own businesses that don't have to go that route. But Phil at this time was encountering a lot of friction, and he decided that he needed to do something to lean on

Starting point is 00:16:52 in case Blue Ribbon just didn't really work out for him. So since he'd finished his accounting exams, he emailed out his resume and ended up getting a job at Pricewaterhouse as an accountant. Like previous jobs that took his attention away from Blue Ribbon Sports, he just wasn't crazy about it. But the silver lining was that he got to look at the books of other small companies. He was realizing the strength of equity and how many of the small businesses that he was looking at were really failing and a big reason for this failure was due to the lack of equity,

Starting point is 00:17:21 which he, you know, I guess he didn't really believe in until he got to see it first hand. So Mr. Onetsuka and Phil's partner, Bill Bowerman, both shared a common ambition here at the time. They both felt that the everyday person could wear athletic shoes. Bowerman believed that behind every person was an athlete, but this dream Bowerman had would take many more years to come to fruition. So Bowerman was a role model, you know, and a coach to Mr. Knight, but there are other notable people as well, I think, that are worth mentioning here. Phil named people like Winston Churchill, John F. Kennedy, and Leo Tolstoy as some of his role models. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer.

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Starting point is 00:21:54 Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. Now, although Phil definitely wasn't a warmonger, he liked these people who were kind of in these extreme conditions of war and politics. But I think he really enjoyed learning from these people specifically because he liked learning about leadership under extreme conditions.

Starting point is 00:22:21 And I think, as you've seen already, he was kind of under these extreme conditions over and over again. So I think that's why he looked to these people for insights. An additional lesson here that Phil writes about is that they didn't say much. None was a blabbermouth. None micromanaged. Don't tell people how to do things. Tell them what to do and let them surprise you with their results.

Starting point is 00:22:42 So I think this does a really good job of explaining some of Phil's management tenants, mainly that he tended to be kind of hands off, maybe two hands off. One of his salesman, Jeff Johnson, was constantly sending Phil letters. about the happenings of his sales adventures. He was sending letters at a very rapid pace, like almost a daily. And Phil would rarely ever respond to any of these letters, despite the fact that this employee, Jeff Johnson, was constantly annoyed by it.

Starting point is 00:23:07 So, you know, the quote above, I think, really tells me that he probably just was taking that hands-off approach, letting Johnson do whatever he wanted to do in order to get the results that he wanted, and Johnson had gotten those results. So the Tiger's shoes at this time that Mr. Johnson was selling out of California and traveling around was now being sold in actually 37 states. So he was definitely encroaching on the Marble Man's territory, but he felt since the Marlboro Man

Starting point is 00:23:34 just wasn't doing much with his territories, it was fine and he would just allow these sales to continue. So he never actually told Johnson to stop the sales scope and stop expanding to new states. So at that same time, Johnson actually created Blue Ribbon Sports first resale store in Santa Monica. But Johnson's overzealousness in selling was actually becoming a problem. So through the track grapevine, Johnson found some very disturbing news. The Marlboro Man was trying to steal some of Blue Ribbon's clients. Johnson had done such a tremendous job here building the Tiger brand in the U.S. And the Marlboro Man was actually placing a national ad in an issue of Track and Field magazine

Starting point is 00:24:09 to try to poach clients from Johnson and Blue Ribbon based on the work that Johnson had already done. So Phil immediately went to California to speak with Johnson about it and they agreed that they just had to get the Marlboro Man out of the picture once and for all. So back to Japan, Phil went. Now, while in Japan, Phil visited Onatuka. So Phil really hoped that he would get to meet Mr. Onatuka, who obviously was the boss, to really appeal to his liking of Phil and the fact that Phil reminded Mr. Onatouka of himself when he was a younger man.

Starting point is 00:24:40 But unfortunately, he was unable to meet him. So he had to meet with a different representative. So he told Onetzuka that sales in 1966 were $40,000 and that the 1967 projection of sales was about double that at 84,000. But Katami, who was the Onusuka rep, said that they wanted to work with a larger distributor with offices on the East Coast. So going back to Phil kind of making things up

Starting point is 00:25:03 and going as he would go along, Phil actually replied that they had an East Coast office and that they were even looking to expand into the Midwest. But they didn't have an East Coast office. And so Onatzuka was really impressed that they had this East Coast office and they decided that they would go with Blue Ribbon as their U.S. distributor for the next three years. And so to add to the roller coaster ride that Phil had set up for himself here,

Starting point is 00:25:31 he placed an order for 5,000 more shoes, which would cost $20,000 that once again he didn't have. So Phil got his man, Johnson, in California, to head over to the East Coast to open up Blue Ribbon's first office over there so they could start accepting orders from Onattsuka. But even just getting this done was tough. So just a little bit of background here on Jeff Johnson, who was, I think, one of the top salesman for Phil at the time. He was a tried and true West Coaster. He just didn't want to leave California. So when Phil first tried getting him to move, Johnson first accepted, then he just threatened to quit. Johnson said he wanted more money and he wanted to own equity in Blue Ribbon.

Starting point is 00:26:09 But as I've discussed throughout this episode already, cash flows were basically always a problem. So paying more cash to Johnson was just not an option for, blue ribbon at this time. And then in terms of issuing equity, yeah, that maybe could have been doable. But unfortunately, Bowerman didn't want to give up any of his equity. And Phil obviously wanted to maintain his controlling interest of the business. So that basically meant that there was no way that they're going to be giving up any equity. And that wasn't an option. So Phil basically told him that he'd give him $50 raise, which was far, far below what Johnson was asking for. But Johnson ended up accepting it. And Phil wrote here,

Starting point is 00:26:49 that even though Johnson complained about Phil's hands-off management style, it was also probably what Johnson needed. Phil felt that he really unlocked Johnson's full skill set by giving him room to try things out. And while he probably could have gone and been a salesman at a different shoe company and make more money, he most definitely would not have had the same freedom that Blue Ribbon and Phil would provide him. So Blue Ribbon was lucky to really have Phil's running coach Bill Bowerman here, as he was a tinkerer, as I've previously alluded to. So in 1967, Bill had taken apart some of Onitsuka's shoes and combined the best characteristics of two different types. So they got Onetsuka on board and were offered to name the shoe. Initially,

Starting point is 00:27:33 they came up with the Aztec to pay homage to the Olympics that were to be held in Mexico in 1968. But unfortunately, Adidas threatened to sue them if they didn't change the name as they had a pair of shoes called the Azteca gold. During this time, Phil was developed. a dislike of one of his biggest competitors, which was Adidas. Here's what Phil wrote about his competition. I was developing an unhealthy contempt for Adidas. Or maybe it was healthy. That one German company had dominated the shoe market for a couple of decades and they possessed all of the arrogance of unchallenged dominance. Of course, it's possible that they weren't arrogant at all. That, to motivate myself, I needed to see them as a monster. In any event, I despised them. I was tired of looking

Starting point is 00:28:16 up every day and seeing them far, far ahead. I couldn't bear the thought that it was my fate to do so forever, unquote. So this creation of an enemy idea just kind of got me thinking that, you know, a lot of really good entrepreneurs and of a lot of really high profile corporations really had this enemy and had a rivalry. You know, Steve Jobs, for instance, he always had Microsoft in his crosshairs. Then you can look at other companies, you know, Coca-Cola versus Pepsi had huge wars of market in marketing. You can look at McDonald's and Burger King. I mean, the list goes on and on. I'm sure you could think of many different examples. But the key here for Phil was to continue innovating on his products and try to really beat his competition. And there was a lot of competition.

Starting point is 00:29:02 When you just think about the business model, you know, anyone with a manufacturing facility could theoretically compete with blue ribbon. I mean, obviously they'd have to distribute it. So, you know, there's that. But at this time, Onitsuka was essentially the brand. There was no brand. And Onatuka most definitely did not have the brand strength that Nike would eventually have. Brands require time to develop. And Onatsook at this point had only really been in the U.S. for a few short years. Now, due to Knight and Bowerman's dislike of Nike, they decided to comically name the shoe the Cortez as Cortez had beat the Aztecs as part of the colonization of South America. Now, it's important to take a second here and think about how busy Phil was

Starting point is 00:29:43 at this time. He had a family to take care of a full-time job at Pricewaterhouse and Blue Ribbon, of course. He was working six days a week at Pricewaterhouse and growing Blue Ribbon at a very, very fast pace. And I think this goes to show you how much focus and energy really has to be put into making a truly great business. I think much less than 1% of humans could endure this lifestyle for a very long time before breaking down and having to quit at least something. So life was tough here because all of his spare time in the mornings, late nights, weekends, and vacations were spent trying to grow Blue Ribbon. He had no friends, he wasn't exercising, and he had no social life.

Starting point is 00:30:18 But here's what Phil said about this time of his life. My life was out of balance, sure, but I didn't care. In fact, I wanted it even more out of balance, or a different kind of imbalance. I wanted to dedicate every minute of every day to Blue Ribbon. I've never been a multitasker, and I didn't see any reason to start now. I wanted to be present, always. I wanted to focus constantly on the one task that really mattered. If my life was to be all work and no play, I wanted my work to be play.

Starting point is 00:30:46 I wanted to quit Pricewaterhouse. Not that I hated it, it just wasn't me. I wanted what everyone wants to be me full time. So the point that really stuck out to me here was his point of their own focus. CEOs who lose focus on their business are not the types of leaders that I think you really want to align yourself with if you're looking for an optimal investment. Use Phil here as an example. So if Phil could have used his long work days towards putting in more time into blue ribbon,

Starting point is 00:31:13 could he have done a better job at it? I think the answer is yes. But the fact is he had to diversify his focus on two jobs rather than just one, which made doing either at a very high level difficult. Now, this is why having a CEO who is doing a million side projects is just not someone I'd want to invest in. Business is hard enough as it is, even when you are focused. So I would want my CEOs to, as Phil said, focus constantly on the one task that really matters. So if you see a CEO of a company that maybe you own or maybe that you're researching and they're doing things like writing books, you know, using social media excessively, you know, you see a million different tweets from them on a daily basis.

Starting point is 00:31:56 You know, if they're a guest on, you know, tons and tons of different podcasts, I think that you might see that as a red flag. And that red flag, I think, is kind of a signal that maybe they aren't spending enough time on the business that they're supposed to be running. And to me, that's a major red flag, especially that our incentives are not aligned. And I would happily pass on a business if I was researching it or if that was the case of a business that I already owned, I would be pretty happy having to let it go. So back to Phil here. He took another trip to Japan to meet with Onatzuka. And this time was very warmly welcomed by the rep Katami, who said that Onatuka was just delighted. by Blue Ribbon's growth and performance.

Starting point is 00:32:36 Onatuka had made him feel like family during the visit, even inviting him to a party where Phil would make a very valuable friend inside of Onatuka named Fujimoto. We'll go over why this ally was so important later in the episode. Business was really starting to take off. Blue Ribbon had just done 150,000 in sales in 1968, and Phil was ready to jump into the job full time. He happily quit his accounting job.

Starting point is 00:32:59 His Blue Ribbon partner, Bowerman, was an excellent person to do business with because of his position in the track community. So he was doing things like, you know, tapping all of the contacts he had in that community to find sales staff or just, you know, staff for Blue Ribbon from all of the connections that he had made. Now, it's worth noting here just a point on incentives.

Starting point is 00:33:20 The more I learn about businesses, the more I realized how much I underestimated Charlie Amonger's quote, show me the incentives and I'll show you the outcome. Incentives are everything. And while I don't think Blue Ribbon had a massively innovative incentive program, I think the melding of competitive athletes turned salespeople was actually a really intelligent strategic move. And I'm not even sure if they did this on purpose. But, you know, athletes are competitive. And if you have that same competitive drive in sales, you could see how that could

Starting point is 00:33:49 probably work out really, really well, which I think probably helped attribute to a lot of Nike success. So just a little bit on the incentive program, it was basically you just made a commission on the tigers that you sold. So every tiger you sold, you'd get two bucks. And that would be patting your pockets. So obviously you were incentivized to just continue selling more and more pairs of shoes. Phil said that the sales employees were burning up roads, hitting up every high school and college track meet within a thousand mile radius. And their extraordinary efforts were boosting our numbers even more. Now, Bowerman had actually been an assistant coach on the U.S. Olympic teams in Mexico. And so he came back with a ton of interesting information about two of

Starting point is 00:34:27 Blue Ribbon's biggest rivals in Adidas and Puma. So having someone on the inside, like Bowerman was a huge advantage for Blue Ribbon and Phil Knight, as they could see what bigger and more tenured competitors were doing and try to eventually steal their market share, which, as we all know, they ended up doing very well. But these times were very competitive during the Olympics, and I think Bowerman came back with some stories that maybe show some of the darker sides of the rivalry

Starting point is 00:34:53 and competitive nature here. So Adidas and Puma apparently were passing around large sums of cash in Manila envelopes and in running shoe boxes. It was even rumored that one of Puma's sales reps was thrown in jail as a result of being framed by Ediths. And then Puma had actually smuggled many different pairs of shoes into Mexico to avoid paying import tariffs. One of their strategies was to make some of their shoes at a factory in Guadalajara to avoid those import tariffs. Now, Phil was a competitor, and he realized that paying athletes was going to be key for the next leg of growth for blue ribbon. But the problem came down to one thing.

Starting point is 00:35:32 cash. The demand for their shoe was obviously there. Bowerman said that plenty of athletes had been training in tigers leading up to the Olympics, but unfortunately they weren't competing in them yet. So another need for Blue Ribbon was to continue improving the quality of their shoes just so that they could hopefully be worn in competition and not just in training. So right after the Olympics, Mr. Onatzuka and Kitami ended up visiting the Blue Ribbon HQ. Now, Phil as a salesman may have been a little overzealous in his description of the grand head quarters of blue ribbon. When they walked in there, they saw things like broken windows, wavy plywood room dividers and vibrating walls emanating from the jukebox that was playing.

Starting point is 00:36:13 So it clearly wasn't really this impressive beacon of professionalism and entrepreneurialism that Phil maybe had exuded when he discussed it with Mr. Onusuka. Once he saw Mr. Onatzuka see it and was kind of let down, I think he felt that maybe the deal that they had with them, would be cut off. Luckily, Mr. Onitsuka said that the place had character, which assuaged Phil's dark thoughts. Now, as a result of this event and the growth of the business, they eventually leveled up to a better location for their HQ in Tigard, Oregon, just south of Portland. As the 1970s rolled around, there was continued stress on Phil as the contract with Onetuka

Starting point is 00:36:53 was set to be renewed. Phil ended up signing a three-year contract with them and came away very happy about the deal. He also signed an order for $20,000 worth of tigers. And as for usual, he was batting way out of his league in terms of making large orders without having the cash to back up on. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business.

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Starting point is 00:40:21 This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. Now, I'd like to take a second here to talk about the importance of cash. So cash in the bank is obviously very powerful for helping you pay your suppliers on time. Also, having a business that constantly has cash on its balance sheets is a good indicator

Starting point is 00:40:45 that paying suppliers shouldn't be much of an issue as there is always some dry powder laying around. So, you know, when I'm just looking at a business, I'm looking for a business that hopefully has cash on its balance sheets. And, you know, that can be in a couple different things. It can be in literal cash on its balance sheets. But some businesses also have marketable securities, which are obviously liquid. And, you know, I'm not going to get too much in the details. Sometimes it's not liquid. And it's up to you to find out if it is because that can obviously be used as well for cash and a pinch. So, you know, cash can also be used to help bail out a business in a bad spot when that can be whether that That's, you know, if there's something going on with suppliers, maybe they want to put in a big order, or if they're just dealing with tough business environments, which we went through during COVID, for instance, where a lot of businesses with cash on their balance sheets ended up surviving and thriving throughout that time. And businesses that didn't have cash on their balance sheets, obviously ran through a lot of difficulty.

Starting point is 00:41:37 So the final thing I'd like to mention here about cash is it might be also worth looking at the cash conversion cycle of a business that you're researching. So cash conversion cycle is just the days it takes for a company to convert its inventory. and other resources into cash flows. So a lower cash conversion cycle obviously is generally better, but you're better off kind of comparing data from one business with other businesses that are in the same industry, just to get an idea.

Starting point is 00:42:02 You know, if you're comparing Nike, you'd probably compare it with something like an Under Arm or Adidas today. Now, to put a Band-Dade on the cash flow problem, Phil realized that perhaps he could actually tap into Silicon Valley. He figured that maybe he could sell shares of Blue Ribbon for about $2 and put up 30% of the business. He figured that he could raise about $300,000, which would value Blue Ribbon here at about a million. They sent out flyers to potential investors and unfortunately they just got crickets. The only person who bought it was a Blue Ribbon employee named Waddell and his

Starting point is 00:42:34 mother who combined to purchase 300 shares, not at $2, but at $1 each. He said his parents wanted to actually loan $5,000 after this disappointing attempt at raising money and that they wouldn't take no for an answer. So Phil went and visited Waddell's mother and asked, you know, why they want to do this. And Waddell's mother said, if you can't trust the company your son is working for, then who can you trust? To help finance the deals, Phil ended up partnering with Nisho E. Y, a hundred billion dollar trading company. While Phil finalized this deal with Nisho, he got a call from a distributor on the East Coast who had been approached by Onatzuka to do a deal with them. Frightened that he'd lose his product, Phil frantically reached out to his spy at Onatzuka, who I previously mentioned,

Starting point is 00:43:15 who was this gentleman named Fujimoto. So unfortunately, Fujimoto did confirm that they were looking elsewhere for business. Now, I want to take a moment here to discuss principles from one of my favorite books of 2003, which was what I learned about investing from Darwin by Poulac Prasad. Now, in it, Pooleck discusses some of the qualities he looks for in businesses and wants to be a part of. Now, one of these qualities is a fragmented supplier base. And I think, I think Phil's story does an excellent job of showing why having one supplier is so dangerous. When you're in this type of situation, your entire business is completely intertwined with the relationship with your supplier. In a hypothetical situation where Phil maybe had multiple

Starting point is 00:43:54 suppliers, losing one would just be a boon for the other suppliers who would probably have to pick up the slack. But losing all your suppliers simultaneously, which was the situation Phil was in here with Onatuka, would have been pretty much game over for Blue Ribbon. So Katami met with Phil and relayed the message that Onitsuka was actually unhappy with Blue Ribbon's growth, despite the fact that they had consistently doubled sales each year. Katami said that this was actually insufficient and that Phil should be able to actually be tripling it each year. So clearly other distributors had been whispering in Onusuka's ear about potential growth rates if Onusuka had jumped ship and left Blue Ribbon. And they were obviously also planting seeds of doubt in Onuska's mind regarding Phil and Blue Ribbon.

Starting point is 00:44:36 So Katami ended up secretly making these meetings with other distributors. distributors in the U.S., which wasn't so secret, Phil could tell that they were doing it, and ended up coming back to Phil and saying that the only way that the relationship between Blue Ribbon and Onatuka would work is if they sold 51% of Blue Ribbon to Onatuka. And unfortunately, if they did not accept this deal, then Onetzuka would set up distributions with somebody else. Now, selling here was just out of the question. So Phil turned to his contacts here at Nisho.

Starting point is 00:45:06 Nisho had been trying to find distributors for other shoes that Blue Ribbon was trying to trying to sell. Now, when they actually approached Onitsuka to allow a deal to go through, they're actually thrown out in embarrassing fashion. Keep in mind that Onatzuka was a $25 million company throwing out $100 billion company in Nisha. So this ultimatum basically meant that Phil had to either sue on itsuka for breach of contract or, you know, find other methods of distribution. So he took the latter option, although he did end up taking both, which we'll get into in a little bit here shortly. So he first turned to Mexico where he found a manufacturer to make some football shoes. But he needed a name and a brand for the shoes. So Phil really liked some silly names here.

Starting point is 00:45:50 He liked Dimension Six. That was his name. And another name that was thrown around was Falcon. So I really wanted to portray this thought of motion, which was where the origination of the Nike swoosh came from. So a few days before they had to file their patent, his sales rep Johnson had a dream and the name Nike had come to him and they just ran with Nike and so that's where the Nike name came from. So to fund their growth, Phil decided to try his hand at convertible debentures. It sold out and he raised about $200,000 for the business. The Mexican factory didn't churn out the quality, unfortunately, with the shoes that they manufactured. But luckily, Nisho had plenty of manufacturing contacts and they could find other distributors. So talking with one of Nisho's

Starting point is 00:46:32 representative, Sumeragi, he heard this term Shudog, which the book was named after. So Phil writes, shoe dogs were people who devoted themselves wholly to the making, selling, buying, or designing of shoes. Lifers use this phrase cheerfully to describe other lifers, men and women who had toiled so long and hard in the shoes trade. They thought and talked about it like nothing else. It was an all-consuming mania, a recognizable psychological disorder to care so much about insoles and outsoles, linings and welts, rivets, and vamps. So now that Nike had gotten some new manufacturing partners, they decided that they wanted to start partnering up with athletes to help bring increased awareness to their brand. After all, this was

Starting point is 00:47:15 the strategy that Adidas and Puma were doing, and that's strategy that Phil and Bowerman also wanted to try and chase. Phil greatly admired long-distance runner Stephen Pfeontaine and wanted him to be part of Nike, but unfortunately, funds were short and he couldn't make that work, but he ended up getting him a job with Nike instead. So the first contract that he wrote about in the book was with a Romanian tennis player, and that kicked off their journey into endorsements. In the spring of 1973, Phil had to meet with his recent investors of that convertible debenture and deliver some news that unfortunately he knew that they wouldn't like. So for the first time in Blue Rubin's history, they'd actually lost money.

Starting point is 00:47:53 Sales were growing very well. It was now at $3.2 million, but profits were actually showing a net loss of $57,000. So Phil walked away from that meeting thinking that he'd never want to take this company public due to the negative experience he just had. He said he'd rather just deal with the headaches from banks than Nisho. Now, Onetsuka had caught wind that Phil was planning to breach his contract and sued him in Japan. So Phil ended up countersuing for breach of contract and trademark infringement. The lawsuit ended up taking a lot out of him and made Phil very, very moody. Even daily sales would affect his mood as he knew that Nike could be on the brink of bankruptcy. He wrote, quote, we were leveraged to the hilt. And like most people who live from paycheck to pay

Starting point is 00:48:33 paycheck, we were walking the edge of a precipice. When a shipment of shoes was late, our pair count plummeted. When our pair account plummeted, we weren't able to generate enough revenue to repay Nisho and the Bank of California on time. When we couldn't repay Nisho and the bank of California on time, we couldn't borrow more. When we couldn't borrow more, we were late placing our next order. Round and round it went, unquote. But the lawsuit eventually settled with Onusuka ending up having actually payout blue ribbon to the tune of $400,000. Reading this book does a really good job of just showing how much blood, sweat, and tears goes into making a business great.

Starting point is 00:49:07 But it also shows how delicate growing businesses are. Now, I love growth markets and the market clearly does too. But it's important that growth also have the right base to work off of. And I think it's fair to say that Nike's early days was an absolute roller coaster. As an investor, there's no way personally I would have accepted having a business loaded with debt and having such rocky relationships with a concentrated supplier. Now, in 1974, Phil's bank were actively trying to suppress Phil from growing too fast. But Phil went out, you know, making more deals, opening more stores, and signing more

Starting point is 00:49:40 celebrity endorsements that they couldn't afford. And to top it all off, he ended up spending a quarter million dollars on a manufacturing facility he decided not to tell his creditors about. So the following year, things got even worse financially. The banks were just sick of nights brazen behavior and ended up cutting him off from financing. worse, his employees' checks were actually all bouncing. So there's an interesting story here where one of his employees actually had to get a loan from one of the customers that they had to pay the employees in cash at one of their plants.

Starting point is 00:50:10 To make things even worse, there was a probe by the FBI regarding possible fraud inside of Nike's books. This would be the end of Nike, but luckily, Phil had friends in high places. Edo and Sumeragi of Nisho wanted to see the books of Nike to see what the problem was. There they found out that Phil had secretly bought a manufacturer. plant that he never ended up disclosing to them. Edo had found out that Sumeragi had been delaying invoices to Nike so they could more easily pay back their debt.

Starting point is 00:50:37 Sumeragi did this because he liked Nike and he really wanted to see them succeed. To solve the bank problems, Ido ended up telling the banks that it would wipe off Nike's debts. But then there was still the FBI problem. So the folks at Nisho and Phil had figured out that the FBI probe probably was orchestrated by the bank and that probe would need to disappear if, if the bank wanted to ever do business with Nisho again. And because Nisho obviously did a lot of business with them, they had to accept that deal

Starting point is 00:51:05 and they withdrew the probe and the probe was gone. And so those two problems were solved. In the mid-1970s, Phil started to seriously think about going to public to help solve their problem of cash flow. But he would constantly worry about giving up control of his beloved company that he'd spent so much time, energy, money and love having to build. And he never wanted to let any of that go. The pain he felt from letting that first batch of shareholders.

Starting point is 00:51:28 down clearly also had a very big impact on them. And I think it's a good point to consider for any other business owners listening that maybe are going to think about going public in the future. 1976 was the year that Phil could see that Nike's brand was really starting to take off. He felt that Nike had turned from just an accessory to a cultural artifact. He thought that people would wear Nike's to class, the office, or even the grocery store. At that time, it was a revolutionary idea. And to kick off this process, he ordered his faculty. to manufacture the waffle trainer in blue and it really, really took off. Phil writes, we couldn't make enough. Retailers and sales reps were on their knees pleading for all the waffle

Starting point is 00:52:08 trainers we could ship. The soaring pair accounts were transforming our company, not to mention the industry. We were seeing numbers that redefined our long-term goals because they gave us something we always lacked, an identity. Now, another bonus about Nike making their own shoes and doing in-house manufacturing was that they could control the quality of their shoes. I mentioned earlier in the episode that Phil knew that Onitsuka didn't have the sufficient quality for athletes to wear in the Olympic Games. But in 1976, Nike was being worn by athletes competing in Olympic trials leading up to the Olympics. So riding this wave of enthusiasm, Phil's wife began screen printing Nike t-shirts that sold off very quickly leading to more apparel and more sales for Nike. As Nike grew, they still needed to outsource manufacturing overseas to keep up with the demand of their product.

Starting point is 00:52:52 because their product was so popular, unfortunately knockoffs also started being a problem. Phil received a pair of knockoff Nikes that he said had exceptional detail on workmanship. He wrote to this manufacturing plant demanding that they cease and desist or I'll have him thrown in jail for 100 years. And by the way, I added, would you like to work with us? Now, as an additional bonus, this diversified their supplier base outside of Japan, getting to move into Korea. As good as things were going, I'm sure you can guess what happened next. something bad and money related. Nike received a $25 million bill

Starting point is 00:53:25 from the U.S. customs that was backdated three years. Nike's competitors wanted to try and drown Nike by stirring up trouble with them through creating financial problems. This is a really good point about when you are successful, you get a target on your back.

Starting point is 00:53:39 Phil writes, quote, and its origin was sinister. Our American competitors, Converse and Keds, plus a few small factories. In other words, what was left of the American shoe industry were all behind it.

Starting point is 00:53:50 They'd lobbied Washington in an effort to slow our momentum and their lobbying had paid off better than they dared hope. They'd managed to convince custom officials to effectively hobble us by enforcing this American selling price, an archaic law that dated back to the protectionist days, which preceded, some say, prompted the Great Depression, unquote. This lawsuit would take multiple years to settle, but Phil would just keep grinding away, building Nike. In 1976, sales were 70 million, the following year they doubled to 140 million.

Starting point is 00:54:18 By 1980, Phila decided to try and settle this lawsuit and just get past it. So they did something brilliant. They started an ad campaign, which presented Nike as a small Oregon-based company fighting the big, bad government. Additionally, they launched a cheaper priced shoe, which would set a new American selling price standard in importing duties. To put the cherry on top, they countersued their competitors for $25 million, alleging that competitors and assorted rubber companies through underhanded business practices had conspired to

Starting point is 00:54:47 take them out. The government took notice of all this bad press and just wanted to move past this whole event. So Phil and the government had to haggle on numbers. And even though Phil felt the only reasonable number to pay was $0, his lawyers explained him that the government needed to safe face. And in order to do that, they needed their pound of flesh. So Phil reluctantly signed over a check for $9 million and put that headache behind him. Now to finish the book, Phil discusses the IPO, which I think went rather smoothly.

Starting point is 00:55:14 That is, other than Phil not wanting to do it. So the reason I've previously alluded to relates to control. He just didn't want to give it up. But some of his colleagues helped him find a way to go public without giving up control. And this was just to use a dual class structure of A and B shares. Basically, Phil, other insiders and original shareholders would get A shares with two voting rights per share, and the rest of the B shares would only have one voting right. Phil wanted to get the IPO done during good times because he was sniffing a recession and

Starting point is 00:55:40 wanted to maximize the cash that they could raise from the IPO. Now, I think this is a really good case study into why participating in IPOs is just generally kind of a poor idea. The incentives are just misaligned for the business going public, the underwriters, and the public. The incentives are misaligned for the business, the underwriters, and the public who are willing to invest in their shares. From the business standpoint, like in this Nike example, they just want to raise top dollar.

Starting point is 00:56:04 They want the most amount of cash that they can raise so that they can go and keep growing or doing whatever they need to do with that cash. When you look at the underwriters, they also want top dollar. But they also want the shares to sell so the number can't be too egregiously high. Otherwise, they won't end up selling any shares. And then from the public's perspective, they obviously would prefer to buy the shares as cheaply as possible so that they can get a good return. So you can see here how the incentives are misaligned.

Starting point is 00:56:29 Now, I went out and looked at some data from fact set that shows some of the returns after an IPO. So after one year of an IPO, 50% of IPOs return worse than 10%. after two years, that number goes up to 60%. And after three years, that number rises once again to 64%. I'm sure there are the right IPOs that can be highly good of probably many, many years, decades down the road. But I think it's really important to remember just what the base rates are, which I just kind of listed above here. I've always been to the opinion that if I really like a business that is going to IPO,

Starting point is 00:57:03 I'd rather just sit on the sidelines and see how things play out before taking a position. A high-profile IPO that many listeners will be familiar with is Airbnb. The IPOed in December of 2020 when market sentiment was very high. This allowed them to generate a high share price to raise more money for the business and collect fees for the underwriters. But how is the stock done since then? The stock's price total change is negative 1.52% for a compounded annual growth rate of negative 0.43%.

Starting point is 00:57:29 This despite a compounded annual growth of 41% and profits going from negative 4.5 billion to positive 4.9 billion. So the business has gotten much more valuable and much more powerful, but because of the pricing of the IPO, investors who partook in that IPO haven't had any meaningful returns. So after Nike IPOed, Phil got to retain 46% of the company and was now worth $178 million. Inflation adjusted, that was about $678 million. So he ended up doing very, very well. Now, that's the end of the chronological story here of Nike leading up to its IPO. But Phil leaves us with some very interesting lessons.

Starting point is 00:58:08 Phil's primary emotion after the IPO was regret, which I found very interesting. So he basically regretted that the narrative of Nike would never happen to him again. So he just absolutely loved the whole journey, even though it had all these very, very high highs and very low lows. In the kind of afterwards section of the book, he wrote that he had two regrets. The first one was not spending enough time with his two sons. But he also knew that this regret clashed with his second regret listed above of not living through the early days of Nike over again. so it's hard to say which regret would have been more powerful to him. And three, Phil wrote the book to share the ups and down so that anybody experiencing the same

Starting point is 00:58:45 could be warned and maybe find inspiration or comfort in the journey that Phil shared in the book. Now, I'd like to share a few quick hit primary takeaways from this book before I let you go. So cash flow matters and the timing of when it comes in and when it goes out will be vital to retaining good relationships, not only to your suppliers, but also to the people that supply you with money. If you can't appraise your creditors, you won't be in business for very long. A business with a product that is flying off the shelf is a great thing, but too much growth, too fast can cause a lot of headaches. Relationships with suppliers is very, very vital in retail. Having very few suppliers increases risk if you are distributing a commodity.

Starting point is 00:59:26 And lastly, company culture can really change when the founder loses a majority stake. So make sure to best understand the dynamics of this in companies where the founder may be, is losing control of the business for the sake of growth. That's all I have for you today. If you like this episode or have any feedback, please feel free to share it with me on Twitter or LinkedIn. If you don't use social media, please feel free to email me at Kyle at theinvestorspodcast.com. Thank you so much for tuning in. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to theinvestorspodcast.com.

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We Study Billionaires - The Investor’s Podcast Network - TIP655: Hustle, Trust, and Cash Flow: Nike’s Genesis w/ Kyle Grieve

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