The great 2005 garment debate
As sourcing specialists are about to learn, success in the post-2005 quota-free world does not simply translate as moving garment production to China. To succeed, writes David Birnbaum, retailers and importers must develop new strategies to work with the most qualified factories and to take advantage of existing overcapacity.
There is an ongoing debate about the effects of the 2005 quota phase-out on FOB prices. There are now three schools of thought:
- The minimalists who argue that 2005 will bring almost no change in FOB price.
- The middle-of-the-roaders who argue that 2005 will bring FOB price reductions related to, but somewhat less then, the quota premium.
- The extremists who argue that 2005 will bring the price reductions far beyond the cost of quota.
Each side brings to bear their logic, their data and whatever else they can throw in. But this debate is somewhat more than academic – for both importers and exporters, getting the right answer is a matter of survival.
The minimalists take the position that the EU and the US have already phased out quota both from some exporting countries as well as for some categories. The minimalists’ logic goes like this. The phase-out has already begun. We can draw our conclusions from events that have already taken place. For example, in 2001 the EU phased out quota from Sri Lanka. During that period there was no substantial drop in FOB prices from Sri Lanka. This is quite true. For example, from 2000-2001, the FOB price of synthetic ladies’ jackets fell by 3 per cent, but the FOB price of synthetic skirts rose by 2.5 per cent and ladies’ suits rose by over 12 per cent. From this and other similar data, the minimalists conclude that 1 January 2005 will be just one more day, with the same old prices.
The middle-of-the-roaders look to China for their evidence to prove that FOB prices are related to the quota premium. This also makes sense. China, as the world’s largest garment exporter, has the greatest impact on FOB prices. Furthermore, Chinese garment quota is openly traded in Hong Kong. The Hong Trade Development Council maintains a website where quota prices are listed daily. We know the price of the quota. Of course, we also know that most buyers do not pay the full quota premium. They reserve space and quota in advance and secure a preferential price. We can estimate that the average buyer pays 50-70 per cent of the listed quota premium. If the quota premium averages 20 per cent of FOB, the normal buyer pays 10-14 per cent for quota and this is the amount the middle-of-the-roaders expect FOB prices to fall in 2005.
The extremists reject both arguments. To them, the important factor is not the quota premium but rather the quota itself. Their logic goes something like this. Factories operate to maximise profit. In a normal market, competition for market share acts to reduce prices. The supplier earns less per unit but this is offset by increased market share. However, since quota places a ceiling on the number of garments a factory can export, the factory cannot increase market share. The factory can increase profit only by raising prices and reducing demand to the point where they orders sufficient only to cover their quota. How much does the factory raise price to bring demand in line with supply? Nobody knew – until now.
In 1994 the United States, along with the other major garment importing countries, agreed to phase out all quotas over a ten-year period. The US back-loaded its schedule – phasing out first the unimportant categories and waiting until the last years before phasing out the serious categories.
At the end of 2000, the US ran out of trivial categories and finally started phasing out the more serious items. Among the ten categories phased out on 1 January 2002, six were 800 numbers – garments made of silk blends and other-vegetable fibre – and were of the trivial type. However, four were serious, totalling annual imports of over $3.6 billion.
Import figures released by the US government covering the first five months of 2002 show what has happened to Chinese exports of these four categories:
In these four categories, Chinese suppliers cut FOB price by well over 40 per cent. At the same time they increased exports by 490 per cent (as measured in units) and 205 per cent (as measured in dollars).
This is more than even the most extreme of the extremists estimated. In fact this is a more than a little frightening
For ten years, FOB prices have been falling annually. Professionals have always assumed that there exists a floor, below which FOB prices cannot fall. If, after a decade, the world’s largest garment exporter is still able to cut prices by more than 40 per cent, then we had better rethink our entire costing process.
Once we recover from shock, we should ask ourselves four questions:
- Who are the big winners?
- Who are the big losers?
- What must we the importers do, to take full advantage of the situation?
- What must we, the non-China suppliers, do to meet this challenge?
The following are the winners in order of size:
- The biggest winner by far is the American consumer, who saves $312 million at retail. (FOB savings for the four categories totalled $94 million. Given the level of competition at the retail level, it is fair to assume that almost all of these savings will be passed on to the consumer. To calculate retail from FOB, I estimated FOB to be 30 per cent of retail (which is very conservative indeed).
- Second place goes to China, which increased exports by $119 million.
- Third place goes to the US balance of trade, which benefited from a reduction of imports totalling $72 million.
- Fourth place goes to the US domestic industry, which actually benefited from an import reduction of 688,456 units. China’s export increase came totally at the expense of other exporters, not from domestic producers.
The big losers clearly come from the ranks of the non-China exporting countries.
Taking into consideration only the largest exporters of these categories, the following are the suppliers who face the greatest challenge:
While the selected four categories may not be representative of all garment products, they do provide valuable data.
First and most importantly, the reduction in Chinese FOB prices, while substantial, does not make Chinese garments cheaper than those from all other countries. Getting rid of quota – and the quota premium – simply returned Chinese prices somewhere close to the average.
Consider these figures:
The Chinese price for infant and young children's wear is about 3 per cent above the world average. The Chinese price for the other 3 categories, while 12 per cent below the world average, is still higher than the price of the same products from Philippines, Bangladesh, Indonesia, Thailand, and the CBI countries. Clearly, in the garment industry, price alone does not determine demand.
To compete today, customers require something more than low FOB price. As we can see from these figures, Mexico is not providing this ‘extra’. The same holds true for most of China’s Asian low labour cost competitors. Philippines, Bangladesh, Thailand and the other developing countries must take urgent steps to develop their industries further.
To take the best advantage of this situation, importers must do more than rush off to Guangzhou, Shanghai, and Dalien. The entire sourcing game is about to change and to win, players will need a brand new play-book.
For years garment importers have been waiting for quotas to be lifted. We were like a bunch of long-distance runners at a starting line, anxiously waiting for the race to begin. On 1 January 2002, the starting gun was fired for the first heat. Immediately, the China-maniacs rushed off, order book in hand.
As any experienced runner will tell you, victory in a long distance race does not go to the fastest person, but rather to the most skilled person. For example, infant and small children’s wear is the most important of the newly freed categories. China has always been a major player in this category. However, as any professional will tell you, the world’s largest children’s wear exporter is not China but rather Thailand.
Children’s wear is a very difficult product, requiring specialist factories. It is also a highly competitive product. A children’s wear factory does not produce a product, but rather an entire range of products. Thai suppliers understand the product and the market. While the China-maniacs have run to push orders into already overloaded factories, the experienced children’s wear specialists have remained with their reliable – now somewhat frightened – Thai suppliers, taking the opportunity to knock another 10 per cent off FOB price.
As sourcing specialists are about to learn, success in the new quota-free world does not simply translate as moving to China. To succeed, retailers and importers must develop new strategies to work with the most qualified factories and to take advantage of the existing overcapacity.
The buyer/seller relationship will no longer be sufficient to achieve the full benefits of the 2005 quota-free world. Retailers and importers will have to enter into strategic relationships not only with individual suppliers but with entire industries working together create in selected developing countries, modern industries capable of providing not just the required product at the required price and within the required time, but more importantly providing the required service.
Export factories face the greatest challenge of all. 2005 will change their world. Most factories will not survive
Fully 50 per cent of worldwide garment making capacity is excess to demand. In the period immediately following 2005, more than half the factories in the world will go out of business. This is unavoidable. The first to go will be those suppliers who insist on relying solely on cheap labour. They will be followed very shortly by factories who insist on competing on their own.
To compete effectively, a local garment industry will have to create and implement plans for strategic development. Local garment suppliers will have to come together and work with their government, with their buyers, with up-stream suppliers, international institutions, and NGOs to build a viable modern industry.
In its simplest form, a garment industry must go to its customers and ask those customers, “what do you want?”
And having received an answer, the industry must work to provide what customers require.
Those local garment industries that can plan and implement on a strategic level will not only survive the 2005 challenges, they will prosper. For a garment industry in any developing country, this is the only way forward.
By David Birnbaum.
Companies: TJX Companies Inc
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