Minimum wages in China are set to rise at a double-digit pace this year

Minimum wages in China are set to rise at a double-digit pace this year

Pricing pressure and increasing competition mean apparel sourcing executives may have to deal with higher gross margins and flat average unit costs this year, according to a new UK report.

The 'Sourcing Survey Volume 3: The Merch Margin Environment Remains Perilous' report by the Cowen Group reveals that maintaining flat average unit costs will be difficult in 2014.

Indeed, its survey found 67% of respondents indicate costs may rise at a low to mid-single-digit rate in the second half of the year.

Around 67% of the 15 executives surveyed also said they see labour as the biggest headwind to Freight on Board (FOB) costs and average unit costs.

Minimum wages in China are set to rise at a double-digit pace this year, while wages in Vietnam are set to rise 17% and Bangladesh wages are set to rise nearly 80%.

"During the past 13 years China, Vietnam, Indonesia and Bangladesh have gained significant market share in the $80bn United States apparel import industry as retailers aggressively moved production into low cost emerging market regions," the report noted.

"While each region has seen wage increases for the past several years, our sourcing contacts suggest that the trend will continue. Each region is likely to see a more significant shift higher in labor costs and minimum wages over the next several years."

Given the more difficult sourcing environment, the report also revealed that pricing power will become more important to offset higher costs, but added: "The competitive environment and historical precedence suggests little pricing power for most retailers."

In addition, as retailer and vendor supply chains become more complex in order to offset the trend of higher sourcing costs, new forms of competition are also changing the complexion of average unit retails in the sector, according to the report.

Given the low barriers to entry in the sector, apparel inflation has been non-existent the past 15 to 20 years, with few brands able to maintain dominant pricing power.

Popularity of fast fashion concepts such as Forever 21, H&M, Zara and Uniqlo have also contributed to a deflationary trend in apparel pricing, as well as altering the way consumers perceive and shop for value.

Emerging e-commerce retailers are also likely to continue to gain share. The report authors estimate Amazon, in particular, generates over $8bn in clothing and accessories revenues.

The percentage of consumers who shop at Amazon for fashion apparel has grown 40% year-on-year, according to the Cowen Consumer Tracker.

Competitive pressure from these retailers, the authors noted, is only likely to increase over the next several years as they continue to grow their store base and gain market share.

"Given the headwinds surrounding long-term sourcing costs, and increased competition, gross margin expansion may become more difficult for retailers and brands without strong customer loyalty and pricing power. In reality, merchandise margin has already begun to show signs of weakening from peak levels across the sector."

Cowen said it was lowering its gross margin estimates given the lack of a relevant traffic-driving fashion trend, the likelihood of higher promotions year-on-year this spring, and the high probability of a more difficult unit cost environment in the second half.