Risk And Reward - who will be the winners and losers in the textiles supply chain?
As European garment suppliers are pushed harder and harder by their competitors and retailing customers to further stretch off-shore supply strategies, they are only following a path forced upon fabric manufacturers a quarter of a century ago. Perversely, technical advances in spinning and weaving now make the logic of cheap labor in this part of the supply chain less compelling, but Europe in particular has shed so many jobs and so much skill that the damage appears permanent. Fabric sourcing strategies now appear to be driven as much by the geography of sewing as by the economics of fabric production.
But how can any weaver or finisher plan the geography of its own production in the global environment that is today's sewing industry. Fabric production is increasingly capital intensive and is far from portable, but producers take their life in their hands when they finally choose where to put down 'some roots'. Right today almost certainly means wrong tomorrow; but right tomorrow can mean wrong today and wrong the day after tomorrow. Possibly the biggest risks of all in this industry are being taken by those fabric producers who are investing huge capital sums in largely immobile plants in locations that might seem to have a future now, but are likely to change at the whim of garment makers and specifiers.
The case of technology and capital versus geography is harder to argue in the activity of garment manufacture which, despite technical advances, is still relatively labor intensive. Indeed, many of the advances driving manufacturing today appear to be more focused on the long-distance communication between design and production than on the process of cutting and sewing panels of fabric together.
Control of the supply chain is being fought over between the garment design and merchandising teams based in the retail market and the eager businesses and governments that are investing in sewing facilities around the world. And increasingly, merchandising and sewing are separate commercial entities with their own customer-supplier relationships. But it is the merchandisers who currently control the end-market, and the story of the global garment trade over the last 25 years should provide a wake-up call to any garment making business, however cheap and skilled its labor.
Twenty-five years ago, Europe had a thriving sewing industry, but so-called economic development means that it is now uncompetitive in this activity. It is uncompetitive, yet it has millions unemployed and a huge domestic market ― it is uncompetitive because somewhere else is cheaper.
Twenty years ago, the total global export apparel trade was worth $40 billion. Twenty per cent of this came out of Italy and 15 per cent from Germany, traditionally one of Europe's best-paid manufacturing bases. With these fashionable exceptions, European nations sewed domestically, using their own fabrics to satisfy their own retailers' and their customers' demands. At that time, the 'cheap' global sources of sewing capacity were South Korea and Taiwan, who between them exported apparel and particularly sportswear worth 20 per cent of this global trade. China exported 4 per cent of this value, and Hong Kong was still a cheap source with 13 per cent.
Ten years later in 1990, the global export trade was worth $110 billion. Italy and Germany had grown their exports, but were smaller global players with around 9 per cent and 7 per cent respectively. Turkey and Portugal were new major players with a combined 6 per cent, but South Korea and Taiwan were starting to find other more profitable things to make and were then at a combined 10 per cent. Hong Kong was also down to 10 per cent, but China had more than doubled its world share to 10 per cent.
In 2000, the global trade is expected to top $200 billion. South Korea and Taiwan's share is in freefall, but the latter now produces two thirds of the world's total requirement for microchips. Italy, the UK and Germany's brands are holding their own and the great American marketing machine is beginning to swing into action with around 5 per cent. However, the USA has left the backdoor open and Mexico is now a world player with 3 per cent and Turkey has grown to 4 per cent, more than half of which goes to Germany ― reflecting the continued need for 'local' fast response sources. 1990's bulk outward processing sources have become 2000's satellite production; but what will they be making in 2010?
Inevitably, however, there is only one statistic that matters ― in the first year of the new millennium, China will have 20 per cent of the global apparel trade. More impressive still, and a sure sign that this growth is not over, is the fact that by 2010 China will have as much as one third of this trade, but still produce twice as many clothes for domestic consumption as it does for export.
In looking at these macro developments, it could be argued that, particularly in the cases of South Korea and Taiwan, SE Asian governments have been successful in moving their economies progressively away from low technology commodity activities, amongst which sewing must be counted, into higher technology product manufacture. Neither will go back to sewing garments but, on a micro level, both have terrible stories to tell of sewing businesses decimated by a combination of economic redirection and a precipitous inability to compete.
Since the 1980s, garment manufacturers have been forced to transform their businesses by becoming global sourcers. They are now the facilitators of supply, responding to the variable demand and abilities of their retailing customers to ride the consumer market roller-coaster. Today, garment suppliers must chase compensation for their low selling prices by seeking ever-lower fabric and labor costs. Every cost saving carries a risk, but each change of fabric manufacturer or sewing location is an opportunity to steal a temporary reprieve and to perhaps enjoy a better season than last. Yet the rewards of this risk are tiny compared to the downside to which new supply chain players can be naively exposing their businesses.
The chain now has zero tolerance, but those trapped on this merry-go-round have little option but to manage what is left of their own businesses as efficiently as possible and to pass the pressure down to their own suppliers. Inevitably, there are casualties, but there is no orderly queue forming at home to replace them and risk pouring new cash into a supply chain that holds so little commercial attraction. The accepted wisdom is that in virtually every sector and strata of the textiles supply chain, the big and well managed will get bigger because of their volume efficiency and ability to squeeze their suppliers on price and credit terms. In the meantime, specialist niche suppliers may survive and even prosper, but the moribund will go to the wall. However, this does not necessarily mean that the so-called 'big winners' will be more profitable, and ignores the almost certain dilution of overall return on investment due to the fact that additional cash and endeavor will have to be tied up somewhere in the extended supply chain.
Whereas a European supply of fiber, spinning, weaving, dyeing, finishing and sewing previously gave EU retailers the luxury of quality, control and fast response to market change and product cycles, their pressure on price has left them with a design and supply chain that can only tolerate right first time. This comes at time when consumers are as critical and diverse as they have ever been, and retailers are demanding that garment makers must provide year-on-year price reductions to satisfy their shareholders' and their customers' thirst for value.
Market fragmentation, mass customization and Internet trading are challenging established retailers, and it appears to be inevitable that retailers too will become global in an attempt to seize back control of their customers. Wall-mart's entry into the UK is a springboard into Europe, but even this move will be challenged by fragmented e-tail where it costs only $1000 to set up shop. If it is difficult for today's supply chain to judge style and demand from customers walking through the final link's stores, how can it hope to predict and service tomorrow's home-shopper?
Risk And Reward
To understand this issue, we need to identify where the margins lie in the supply chain, and the cash requirement that is the entry ticket to even spectate, let alone contend. At the same time, participants must understand where and how the locations of risk and reward have shifted and are continuing to shift. Crucially, their movement may not necessarily be in sympathy, or simultaneous, and by the time the last link in this supply-value chain is been mapped out another link will have changed sufficiently to adjust the profitability of all the participants. We may have to accept, therefore, that this is a picture that we can never fully understand and that survival is therefore only achieved by being ahead of the competition.
Traditionally, European suppliers have enjoyed a margin broadly proportional to the value they have added to their own businesses. This proportionality has been maintained by the scale and maturity of domestic textiles markets, with the only exception being the retailer or distributor who has enjoyed the premium still demanded of most final consumers. The American retail invasion of Europe threatens even this.
In most industries, margin is also a function of the commercial risk that has been taken. But there now appears to be scant additional reward to those volume textile businesses ready, or being forced, to extend their activities and cash around the world. The reward for established players is survival, but the penalty is complete dismantling of the proportionality of margin, added value, trading risk and return on investment. The rewards for the new entrants making fabrics and garments in North Africa, eastern Europe, Asia and China have the macro dimensions of economic growth, employment and foreign currency. However, the financial risks of exposure to so many vulnerable European customers are rarely understood and often poorly managed. The image of these European customers as being honorable and commercially secure is as naive as was the opinion that the UK textiles industry in the 1960s was as 'safe as houses'.
All this doubt and change in the retailing sector only adds to the uncontrollable exposure of the textiles supply chain to the vagaries of demand. How does a newly-formed sewing plant in Sri Lanka or textiles plant in Indonesia build a case for investment or even start to put together a five year strategic plan? The advice to managers in these businesses is to make themselves very familiar with the whole supply chain and not just the layers above and below. They must judge for themselves that they are backing and playing in a winning team; one that may be playing with ten at the back and only one striker.
Success Of The Many In The Hands Of The Few
Suppliers into Europe, as well as their governments, are being seduced into making massive investments into textiles and garment manufacturing by customers who, in the space of a few years, have moved from manufacturing themselves to being purely designers and distributors. The value added by suppliers outside Europe cannot yet be converted into proportional margin and return on investment because their European customers are still in control of the ultimate sale into retail. This same customer is exposed to the vagaries of fashion and demand, increased working capital to fund fabric and/or garments to or from distant suppliers, as well as continual pressure on prices.
Something had to give, but as well as manufacturing casualties at home there have been casualties overseas. When a Marks & Spencer supplier closes a factory in the UK, the story makes headline news and the production usually moves to commission CMT capacity overseas. However, if the company itself goes totally out of business, it is the newly developed overseas suppliers of fabric and sewing who are the true, if not entirely innocent, victims. The supply chain is being front-end loaded at an unprecedented rate and scale, and it is the new entrants who are being asked to fund their customers' strategic shift and take the financial risk whilst this shift consolidates. If this were not enough, these entrants are also having to cope with the shifting sands of world trade agreements and quota availability.
Whilst the market is clearly full of risk, there are many who have no option but to stick with what they know and remain a part of the chain. However, there are practical measures that all too many businesses and governments fail to take when seduced by the prospect of the new or growing trade on offer.
In the 1960s and 70s much of the textiles trade between European countries was undertaken within secure payment terms such as letters of credit. Such trade is now virtually non-existent and most ongoing supply is provided on open credit terms. This is not because Europe is a haven for secure businesses or that all Europeans are gentlemen, it is because secure payment terms are one of the first casualties of a competitive and then collapsing market. Open credit is the first benefit to be requested by a customer with cashflow difficulties and the last negotiating chip to be put on the table by a supplier desperate to win business. The rest is just a slippery slope since, when one supplier moves out of desperation, the rest must do so to even participate. The bargaining chip is given away once, discounted once and can never be played again.
Open terms mean exposure to the risks of cashflow stagnation and bad debt. The margins in this industry and complexity of the supply chain make domino effect collapses a reality, and it is a fact that in western economies it is poor cashflow and not poor profitability that causes most business failures. In the place of the letter of credit and a securer textiles trading environment, another industry has grown up fast. Factoring, invoice discounting, credit insurance and business information providers may be sucking the last margin out of some textiles businesses, but there are just as many others who would not be around today without these services.
And now, as the chain stretches itself further, there are signs that trading pressures are forcing today's long distance letter of credit suppliers to consider trading with western customers on open terms. Perhaps an Asian weaver could be reassured by many years' l/c trading with a western garment supplier, but it is more likely that a competitor has broken ranks and muttered the immortal words: 'for the customer's convenience'. In either case, the supplier is probably doing so at considerable risk and without any quantifiable basis for exposing its business to a new danger.
The author of this article, Peter Hamilton, is a founder director of Marshall Hamilton Limited.
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