As cotton costs cool will garment prices fall too?
By Leonie Barrie | 4 August 2011
While selling prices are unlikely to rise further, they might not fall either
After more than a year grappling with soaring cotton costs, can apparel retailers, brands and manufacturers expect some relief now that prices are on a downward trajectory? Not according to industry executives, who suggest cotton is just one of a number of challenges faced by clothing companies when weighing up their pricing strategies for the year ahead.
Cotton forecast figures released this week painted a far rosier picture than anyone in the apparel industry would have expected just four months ago.
In New York, cotton for December delivery dipped to US$1.04 a pound on the ICE Futures US exchange - more than half the record high of $2.27 per pound reached in March.
And inter-governmental group the International Cotton Advisory Committee (ICAC) confirmed that prices are likely to continue to decline over the next year as production increases help to replenish stocks.
But while there's the temptation for retailers and their suppliers to breathe a sigh of relief that the roller-coaster ride may finally be over, industry observers warn it's not the end of the story.
Because of the timing of the fall in cotton costs, and the six-month lead-times to which many firms still work, any easing of sticker prices isn't going to show up until new merchandise hits the shelves next spring.
Indeed, the best UK fashion retailer Next was able to come up with when it released its first-half results yesterday (3 August) was that "2012 looks like it will be a more benign year for cost price inflation," and that "selling prices are unlikely to rise further for spring 2012."
Likewise, "there are a lot of other inflationary factors that people need to keep an eye on," points out Vinod Rangarajan, a retail strategist at consulting firm Kurt Salmon.
These include double-digit wage hikes in Central America, Vietnam and China - all of which will start working their way into the bottom line by the middle of 2012.
"Wages in China have gone up 15-20% this year, so that's obviously going to have a tremendous impact on the cost of goods," Vinod explains. "And who knows what's going to happen in terms of fuel costs and how that will impact transportation?
"So while cotton prices are coming down and commodity prices might be coming down, other factors are still going in the other direction."
Rangarajan believes another issue to watch in the longer term is factory capacity. "As we see these workers get higher and higher wages they're going to be more 'consumeristic,' so demand in those domestic markets where we're producing is going to increase.
"We're already seeing China shift some of their manufacturing capacity just to meet domestic demand. So that's going to have an impact too.
Volatility set to stay
So while there might be a little easing on fabric costs, all these other issues may mitigate some of the declines. "We don't know yet is if that enough to offset the other increases we're going to see."
Depending on the type of product, fabric can account for anywhere from 30-60% of the cost of a garment - sitting at the higher end of this range for T-shirt and underwear manufacturer Hanesbrands Inc where nearly two-thirds of its products are cotton-based.
"We're probably going to have to deal with a highly volatile situation for a long time to come," said chairman and CEO Richard Noll on a conference call with analysts last month to discuss the company's second-quarter results. "Where it's all going to settle out for 2012 is anybody's guess."
The company has already raised its prices twice to offset raw material inflation, and says cotton bought at between $1.70 and $2 a pound is now working its way through the supply chain, hitting retail stores in the fourth quarter and into 2012.
And it is also in discussions with retailers "about how to make sure that lower cotton prices don't adversely affect them from a negative comp perspective," Noll explains, adding: "We're developing programs to make sure we handle this volatility in a successful manner for both of us."
Wherever cotton prices eventually settle - if they do at all - they're still likely to be higher than the $0.60 per pound average seen during the last decade before this recent run-up.
But there's also a risk that lower cotton prices will lead farmers to switch to more lucrative crops like corn and biofuels, setting a cycle in motion where output is unable to meet demand and pushes prices up again.
"Cotton needs to be at least above $1.25 or so for it to maintain acreage relative to other crops," Noll points out, "so we might be seeing a little bit of a dip down that may actually not last.
"But in this world we've got to be prepared for anything and so we're clearly open to the possibility cotton could stay this low for the foreseeable future."
Impact of higher ticket prices
Another dilemma faced by clothing companies weighing up their pricing strategies for the year ahead is that the impact of higher ticket prices on sales is not yet clear.
"So far it's been a mixed bag," Rangarajan explains. "We started seeing higher cotton prices last autumn, so those higher prices are only starting to hit the stores about now and through the second half of this year.
"But I don't think we'll really know until we get deep into back-to-school and into holiday, when a lot of these ticket prices are going to be in the stores."
Most at risk are brands that focus on value-priced merchandise since their raw material costs make up a greater percentage of their total cost.
Anecdotal evidence from Hanesbrands, though, whose lines fall into this category, suggests shoppers have not resisted paying higher prices. "While still early, preliminary results support our assumption that units fall off less than the rate of price increases," Noll says.
Likewise, Eric Wiseman, chairman and CEO of VF Corporation, which owns more than 30 brands including Wrangler, Lee and The North Face, says: "Like everyone else, we're waiting to see how the second half unfolds as consumers come face-to-face with even higher prices in apparel and footwear.
"We don't know - no-one knows - how they will respond. So we're approaching the second half cautiously and controlling those things we can, including spending, pricing and inventories."
Looking ahead, the situation isn't helped by deepening economic worries, high unemployment and job uncertainties on both sides of the Atlantic.
While action earlier this week saw a last-ditch deal to raise the US's $13.4 trillion debt ceiling, new figures from the US Commerce Department raised the spectre that the country is heading for a second recession after consumer spending in June fell for the first time in almost two years.
And in Europe, sovereign debt worries - including fears of possible bail-outs in Italy and Spain - continue to weigh on the purchasing power of customers there.
Research carried out by Kurt Salmon suggests consumers expect to spend the same dollar-wise next year as they did this year, but that will probably translate to fewer units because of the higher tickets.
But as Rangarajan notes: "There are so many moving parts right now it's difficult to really get a sense of what's going on, but it's going to be an interesting next couple of months, that's for sure."
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As cotton costs cool will garment prices fall too?