17 Jun Phil Knight revisits U.S. customs battle that nearly ended Nike
Nike co-founder and board chairman Phil Knight on Saturday delivered the Address to the Graduating Class at the Diploma Award Ceremony for the Stanford Graduate School of Business in the Frost Amphitheater.
Knight, who graduated from the University of Oregon in 1959, earned his Stanford MBA in 1962. The graduate school has a tradition of inviting an alum to return to deliver the graduating class address. The Knight Management Center, where the graduate school is housed, is named for Knight who, along with wife Penny Knight, donated $105 million toward its construction. The campus also has another building named for Knight.
This is the second of three parts of a transcription of a recording of Knight’s 25-minute speech. The first part focused on the roots of his entrepreneurial venture; this, the second part, on company growth and a regulatory tussle with the federal government in which Nike had key assists from Stanford alumni; and the third, on life lessons.
As Knight begins this segment, he has just recounted his first-ever, impromptu meeting with officials of Onitsuka Co. Ltd., manufacturer of Tiger athletic shoes in Kobe, Japan.
So we end with me placing an order of 15 pair of samples. And after I leave, I sit alone on a chair in the chaotic Osaka Airport and ask myself again, “Where am I going?”
I’m very excited about the meeting with Onitsuka. A voice says, “This is exactly what I want.” I should race home and get this business going. The other said, “If you don’t go around the world now, you’ll not go for four or five decades.” I flew to Hong Kong. Which is a good thing. The samples didn’t arrive for 14 months.
When the samples finally came in I showed them to my old coach, Bill Bowerman, who was so impressed he asked me to let him in on the deal. We shook hands on a 50-50 partnership and each of us put up $500. We bought 300 pair of shoes. First year sales were $8,000. We made a $250 profit.
In 1964, my life got busy. By day I was a CPA for Price Waterhouse. My Army Reserve requirement takes up two Tuesdays a month and one all day Sunday, plus two weeks in the summer. Dating was a mixed success. And all along my real love was that little company that Bowerman and I had started. We get to $100,000 in sales. We get to $500,000, then a million. I multitask. I can drive a car, eat a McDonald’s filet o’ fish sticks and read a newspaper, all at the same time. I was pretty efficient for a couple of years until I rear-ended the car in front of me. Took a lot of time to get insurance companies lined up and my own car repaired and the cuts to my forehead fixed, so I don’t do that anymore.
By 1972 we got to $2 million in sales with a 3 percent net profit. But it hadn’t been easy. After all, $500 apiece doesn’t provide much equity, even for $2 million. I tossed in most of my Price Waterhouse checks for four years, but I was spending four days a week at the bank trying to convince them to give us a little more credit. By now I’ve quit Price Waterhouse and I’m going fulltime.
Somewhere in this process, my search for credit put me in touch with Nissho Iwai, the sixth largest Japanese trading company with annual sales of $100 billion. We began developing a positive relationship. Meanwhile, Onitsuka had brought 30-year-old hotshot Shoji Kitami in with the charge to expand export sales. Export sales were primarily us. So young Mr. Kitami brings me the following offer: sell us 51 percent of your company at book value or we’ll set up other distributors, regardless of what that piece of paper that we signed says. With Kitami’s ultimatum I did an instant cost-benefit analysis, which led me to this dilemma: How do you say ‘go to hell’ in Japanese?
So there I am, 34 years old, married, a 3-year-old son, 80 percent mortgage on my house, 45 employees, a personal guarantee of a $750,000 company loan, inventory growing more obsolete by the day, and no new product to sell. We had a team that had been nothing eight years before and had built it up to be recognized in the sporting goods world. And that team had designed the three top-selling Tiger running shoes. We had a large pot of coffee and the support of the sixth largest Japanese trading company. And that trading company could and did introduce us to every training shoe company in Japan and provided the financing to import those products.
But then there was the little matter of the lawsuits. Plural. One in the U.S., one in Japan. I get my cousin, Doug Houser, Stanford Law, 1960, to take our case on a contingent fee. It took three years. We won both suits. Meanwhile, we paid $35 to a Portland State college student to create a rendition of the side logo on the shoe, the logo now called the swoosh. Years later she was interviewed by the Portland Oregonian and they asked her what her second biggest project was and she answered, “Wallpaper for a Walla Walla motel.”
We asked each of the 45 employees to submit a suggestion for a brand name. Jeff Johnson, 1963 Stanford graduate, who I’d met on a workout at Angell Field, and who was our first employee, submitted the name, Nike.
“Well,” I said, “I don’t really like it that much, but it’s better than any of the other 44. Hopefully, it will grow on us.”
We were no longer limited to track and field shoes. So we brought in wrestling shoes, tennis shoes, basketball shoes as well. Sales grew to $3.2 million, but we had our first-ever loss, plus one other little problem. We got kicked out of our bank. Too much leverage, not enough cash. The state of Oregon only had two big banks and we’d been thrown out of the other one just two years before. Nissho Iwai stood in for the bank until we found one: The First State Bank of Milwaukie, Oregon. It was a small bank, but we made it work.
So there I was, sitting at my desk, more relaxed than at any other time in a decade. In the period of time of getting cut off by Tiger and establishing a relationship with the First State Bank of Milwaukie, Oregon, sales — thanks to the introduction of a running shoe with a waffle sole — had risen to $25 million with solid profitability. Oh yes.
But I found in the morning mail a letterhead that says, “United States Customs.” The announcement that this is an important letter. It turned out to be so. Attached was an invoice for past due customs duties of $25 million — the exact same number as our total sales for the year. I had no idea what they were talking about.
So what we find out is that there is a little-used part of the customs code, dated back to the 1930s. Duty in three categories: benzedine chemicals, cherry stone clams, and athletic footwear with synthetic uppers could be assessed not the factory cost of the goods but the American wholesale selling price of those goods. “Goods that were like or similar,” if you like that language, “to American manufactured goods.”
So here comes this invoice. And despite the fact we’d been charged and paid the amount at invoice that had been enforced previously, our prices based on that had long ago been sold. The $25 million was on top of that.
While things were fuzzy and unclear one thing was absolutely certain: No way were we going to be able to pay that amount of money.
So we go to Washington, D.C., reaching as high up in the political ladder as I can. When first contemplating nylon upper running shoes, we had asked customs for a ruling on what the duty would be. We showed the letter that had been signed by the assistant director of customs saying our duty would be 20 percent of factory costs, now to double that, the response of John B. Simpson, deputy secretary of the Treasury was, “Well, that letter is not binding on U.S. Customs.”
In other words, we lied to you. You screwed up. You trusted us.
Gradually, we began to figure it out. This obscure rule had been on the books for nearly half a century, and now U.S. shoe manufacturers — Converse and others — banded together to lobby the government and apply the additional duty on exports in general and us in particular.
They had to make something that met the test of a customs officer who’d never worked in a shoe factory, like or similar, and they then had to sell only a few of those shoes to hugely increase the cost of our shoes going forward if, in fact, the retroactive part didn’t put us out of business, which it nearly did.
Thus began the great ASP (American Selling Price) fight. The fight for our very lives. It lasted three years. This is the sneaker business and I’ve got to have a Washington, D.C., lobbyist. Most lobbying firms on K Street were more than willing to take our case — for a fee of $1,000 an hour. We hired Jay Edwards, Stanford ’68. He had just opened an office representing Portland General Electric, the Oregon public utility, the Nez Perce Indians, and now, for a retainer of $300 a month, us.
Any over, around and through, we fought like bastards.
Our cause was just, the government was aligned with the forces of evil and if we lost we were kaput.
But I believe that fight made a huge imprint on our culture that lasts to this day.
We joined the American Footwear Manufacturers and we sued them.
We made an inflammatory TV commercial which ended with the tagline, “If this little shoe company goes out of business, a little bit of Yankee freedom dies with us.”
No reputable TV channel or network would show it.
We got on the air on a New England religious channel between 12 and 1 in the morning.
It rated three letters, all of them positive.
That having failed, we took a portable TV set showing the ad during the presidential campaign of 1976 and showed it in cafeterias and diners and pizza parlors all over New Hampshire. And that managed to get the attention of the political establishment, at least a little bit.
There was lots of shoe leather in D.C. including plenty of my own. We had support from the Oregon delegation plus Al Gore and Jim Sasser of Tennessee, where we had our central warehouse.
At one of our meetings at Treasury, the official said, “You can tell your Senator Hatfield to quit calling us. It’s not doing you any good.”
I left his office and called Mark Hatfield’s office and said, “Keep up the good work.”
Our one in-house lawyer, Rich Werschkul, Stanford ’68, lived for two years in Washington, D.C. He and Jay Edwards simply outworked, outthought, out-emotioned the opposition and did a better job in this case than any of those K Street lawyers could’ve.
And in perhaps our best maneuver we came up with this one.
We had a factory in Exeter, NH, making 15,000 pair a month. What if we created a second line? Knocked off ourselves, selling to discount retailers at a very low but marginally profitable price. No one could copy us closer than we could copy ourselves. When this first came up in a brainstorming session, everybody laughed at its absurdity. Then we looked at each other. The whole law was absurd. And it evolved into, eventually, “Let’s try it.”
Thus was born the One Line, which for a couple years sold a couple thousand pairs and reduced the increase in our duties by two-thirds.
And after three years of fighting, we settled the great ASP customs battle for $9 million or approximately one-third of the former demand. In those three years our sales had grown to $440 million and we could actually pay the bill.
One year after the settlement, we got ASP eliminated from the entire U.S. Customs coding for benzedene chemicals, cherrystone clams as well as athletic footwear with synthetic uppers.
When we’d reached the critical mass to go public, throughout the ASP years we could not go public because we could not report earnings — which were very materially affected by the ultimate ASP resolution. With the resolution of ASP, a public offering was opened to us.
And in December 1980, we did just that. From that point, the only thing standing in the way of real success, with having our dreams come true, was ourselves.
NEXT: Words of advice for the graduates.