Apparel buyers miss out on commodity cost savings
Few buyers have managed to capture significant commodity-related savings from their suppliers
Apparel and footwear brands and retailers should be benefiting from tumbling commodity prices, especially for oil and cotton - but many are missing out on significant savings by failing to truly understand their value chains.
New insight from consultants at McKinsey and Company suggests that instead of focusing on where their products are made and moving production to lower cost countries and regions, companies should instead pay more attention to how they are made.
They point out that the prices of many commodities used for the production of yarns and the synthetic rubbers used in footwear – including cotton and oil – have fallen 30% to 50% in the past year.
In a typical mid-priced knit garment, the 30% drop in the price of raw cotton could be expected to lead to a 5% to 7% drop in apparel cost, they say, depending on the complexity of the garment.
But few buyers have managed to capture significant commodity-related savings from their suppliers.
"Some companies don’t have a structured process in place to ask for supplier cost reductions when commodity prices fall; others don’t know what cost reduction to ask for when they do. And of those that do ask, many receive small reductions of 1-2% from some suppliers, while others receive no savings at all."
In turn, suppliers may argue that the effects of raw material prices on their own costs have been smaller than estimated, have been diluted by other players in the value chain, or have yet to trickle through to them.
"Without a deep understanding of the whole value chain and such facts at their fingertips, companies find it very hard to counter these points," note Patricio Ibanez, an expert principal in McKinsey’s Cleveland office, and Eli Townsend, a consultant in the Minneapolis office..
They suggest companies need to develop a detailed picture of the end-to-end value chains of their products, and of the way input cost fluctuations percolate through that chain.
But they note "this is a complex business, requiring an understanding of the underlying chemistry of key raw materials, the structure of the industries that produce those materials, and the evolution of supply and demand over time."
In the case of polyester, for example, the fibre is made from PET (polyethylene terephthalate) that has been melted and spun. PET, in turn is made of two materials - Purified terephthalic acid (PTA) and mono ethylene glycol (MEG - both of which are made from oil, and their price tracks the oil price. MEG can also be made from natural gas, but the MEG price tends to follow the oil price rather than that of gas. However, PET prices are also skewed by overcapacity, which is likely to continue to keep prices down.
By taking a more fact-based and structured approach to supplier negotiations in response to commodity price changes, companies have been able to capture savings of 4-6% from their suppliers in a wide range of categories, McKinsey says. The consultant cites one large apparel retailer did this by building a "rapid response system" based on detailed analysis of the effect of commodity price changes on the costs of different yarn and fabric types.
Procurement best practices from other sectors, such as automotives and electronics, could also be adapted by the apparel sector, with approaches such as Design to Value (DTV) teardowns, cleansheet "should cost" modelling and supplier collaboration.
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