The Flanarant: Apparel sourcing forecasts miss the point
There are a number of reasons why apparel buyers continue to focus on the top 20 exporting countries, according to Mike Flanagan. With little room left to manoeuvre on price, sourcing decisions depend on a whole range of different parameters - which is why forecasts for new supply bases are usually wide of the mark.
It was a particularly stupid and self-satisfied consultant who first provoked me into sharing the Flanarant musings with you all.
Close to a decade ago, at a conference about the future of the garment industry after the 2005 removal of quotas, the consultant announced the winners would be China, India, Russia and Brazil.
Russia and Brazil? Only a really well-paid consultant could be so profoundly ignorant of the markets he's advising on to suggest anything so wildly improbable - and I just HAD to correct those extraordinary misconceptions. One thing led to another, and I was soon using just-style to correct all kinds of confusions. Most often, though, from three sources:
- There still seems to be an inexhaustible supply of uninformed consultants determined to display how little they know;
- A disturbing proportion of the world's politicians either misunderstand their country's trade laws, or think they can get away with spouting nonsense because their local press never challenges them; and
- National trade associations can usually be relied on to over-claim for their country's advantage.
It's tough to forecast - especially if it's the future you're forecasting. That's a piece of wisdom attributed to almost everyone from Confucius to Yogi Berra. And there seems almost no limit to the sources of misconceptions about the garment industry.
Since around 2009, the industry has undergone a profound series of changes - and as a result, we've seen lots of problems in manufacturing countries. The local explanations for those problems rarely stand up to more than a couple of seconds' investigation. Nor do many of the lists of countries that are going to do well.
Why are they all so wrong? Western garment buyers are adjusting to a world where prices can't be further reduced by moving production to another country - but that's a change buyers face whether they're in Australia, Japan or Germany.
The knock-on effects of this change differ massively between manufacturing countries - but in ways that don't lend themselves into those trite "ones to watch" lists. Options for dealing with this change vary by both retail and production environments.
Four key facts seem to miss a lot of amateur commentators altogether.
1: No new sources are emerging right now. Apart from some major new factory investment in Haiti, a smattering of small new plants in Serbia, and a lot of interest in new factories in Burma, no significant new facilities are being built anywhere outside the 20 or so key countries that dominate garment making. The top 20 apparel exporting countries accounted for 92.2% of rich countries' garment buying in 2009, and slightly more (92.8%) in the first quarter of 2012.
2: Buyers' options for dealing with buying challenges vary by market. In Q1 2012, US buyers increased the volume of garments they bought from China to 35.7% - up from 34.3% a year earlier - and by April 2012, those buyers were paying 5% less for Chinese clothes. But China's share of EU apparel purchases fell to 37.8% (from 40.5% a year earlier) as prices for Chinese garments rose 23%.
Europe's buyers bought a slightly larger proportion of their garments from their immediate neighbours in Q1 2012 than a year earlier, or even three years earlier. Yet the combined share of US apparel imports (measured in square metres of fabric) held by Central America, Mexico, Haiti and the Dominican Republic keeps on falling.
Yet US buyers screamed about Chinese prices just as much as anyone. Why the difference?
It doesn't have much to do with Europe's more or less flat retail demand. Instead, it's the result of five quite separate differences between the options facing US and European buyers:
- Distance. For an American buyer, anywhere in Asia is further away from a US port than China. For a European, everywhere is closer. With rising container rates and slower shipping speeds, production in Sri Lanka, say, means slower delivery and higher freight costs than China for an American; but it's cheaper and faster for a European.
- Duty. Almost everywhere in Asia attracts lower duty for European buyers than China. Everywhere in Asia (except Singapore and Australia, which aren't really serious production options) attracts the same duty as China for American buyers.
- Service. During the height of buyer dissatisfaction with China (late 2010 to mid-2011) requests for our consultancy services were particularly strong from smaller European buyers, who were often far more concerned with collapsing Chinese reliability than with rising Chinese prices. The problem was they had moved production to China a year or two earlier, when many Chinese factories were accepting lower minimums. When demand exploded in late 2010, those smaller buyers were often let down. European order sizes are typically smaller than orders from US clients: even the world's biggest garment specialists (Inditex and H&M) typically spread their volume over more SKUs than similar-sized US chains.
- Neighbourhood buying. US rules on duty-free procurement from neighbouring countries often require either US-spun yarns (which add to cost) or a complicated pitch for a "short supply" dispensation from US authorities (which can add to time). Almost always, Europeans have a much wider choice of sources for getting raw materials which still qualify for duty-free entry when made up into garments in a neighbouring country.
- Currency. The relationship between currency rates and the prices people charge is pretty complicated. But between the first quarter of 2011 and the first quarter of 2012, the euro devalued twice as fast against the Chinese yuan as the dollar, but increased its value against most other garment producing currencies, like the Indian rupee or the Bangldeshi taka. So China is now more expensive for people trading in euros than for people trading in dollars. The case for moving production out of China is stronger for Europeans than for Americans.
Dissatisfaction with China is greater among Europeans than Americans - and when a US buyer looks outside China, he's got to make trade-offs in prices or timing that a European doesn't. Strategies that ignore the greater practical difficulties faced by US buyers in moving production away from China are just simple-minded.
That's not to say those difficulties will never be overcome. America's apparel and textile industries are having a huge debate about possible rules for Vietnamese garment production if their planned Trans Pacific Partnership (TPP) ever comes to fruition.
It gets heated at times because Vietnam is the only Asian country with any credible apparel production capacity that has a chance of duty-free access to the US in anyone's lifetime.
Personally I doubt there will ever be duty-free Vietnamese garments in America. Vietnam's making almost no progress in developing its own spinning and weaving infrastructure and the US Congress won't approve duty-free access for Chinese fabric assembled into garments in Vietnam.
The fact that America's garment importers are spending serious money lobbying for something so deeply unlikely demonstrates how keenly US buyers want a real alternative to China. Which is another way of saying there isn't one right now. And it's all made worse by:
3: Options for meeting buyer needs are changing in different ways in different countries. Pakistan is an extraordinary example of this. Listen to some of its spokespeople and it sounds impossible to do business (or at any rate make garments for export) there.
Yet its share of the EU's apparel imports has been rising steadily (if slowly) over the past four years - while its share of US apparel imports has been falling just as steadily and a great deal faster. One fundamental reason is that Pakistani factories serve completely different markets in the EU and US.
Pakistan has a huge problem with power supply, especially in the Punjab region (the area round Lahore and Islamabad close to the Indian border). This is catastrophic for much of its upstream textile industry, since spinning and weaving require continuous electricity supply. It's a problem in assembling some garments as well - but potentially manageable. It's relatively easy to buy private generators and for garments with high labour content, manufacturers might be able to work with the extra cost of energy, since it's a small part of their expenses anyway.
European customers mostly buy jeans and other woven outerwear; Americans buy knitted shirts/blouses and hosiery. The epidemic of unforeseen power cuts makes spinning, weaving and knitting almost impossible in the Punjab (40% of the country's circular knitting capacity currently lies unused, knitwear exporter MI Khurram recently claimed).
But that epidemic is a lot less severe elsewhere in Pakistan - and its disruptive or inflationary impact on woven garment factories isn't as extreme as the devastation it's causing knitwear operations.
With the possibility of short-term duty waivers on some apparel exports to the EU, and maybe even of a permanent EU duty-free programme for apparel, Pakistan might even become more attractive to Europeans over the next few years (though personally I wouldn't hold my breath).
But, with no likelihood of reliable energy supply for years, and no serious improvement in US access policy in prospect, Pakistan's set to become an even more unattractive source for most US apparel buyers.
4: Customers differ, supplying countries differ - so the same stimulus can have completely different results in different places. To take one example: at the end of 2009, the US withdrew its duty-free access concession from Madagascar, concerned about the country's record on political rights. Nine months later, the EU withdrew a similar concession from Sri Lanka for similar reasons.
The volume of US apparel imports from Madagascar is now about 80% lower than before the concession was withdrawn. But EU imports from Sri Lanka are slightly higher than they were.
Duty levels almost always hit sales to the US more than sales to Europe (American duty levels are generally higher), and they were unusually unimportant for Sri Lanka. It depends heavily on selling lingerie to the EU, which carries exceptionally low duty levels. Moreover, since 2010, Sri Lanka's central bank has devalued its currency more savagely than Madagascar's.
Devaluation helped Sri Lanka, because the country concentrates on garments requiring high, intricately skilled, labour content: a cheaper rupee makes all those hours of work cheaper in euros or dollars.
But devaluation has hurt Bangladesh, because the extra cost of the raw materials it imports outweighs the reduction in the hard-currency value of its low wages.
The recent collapse in cotton prices has helped factories that buy their fabric from outside - but it's devastated the profitability of vertically-integrated business like India's Reliance, which is why its weaving and garment assembly operations are up for sale. Almost any change in the business environment will hit different producers in different ways.
So here's one confident forecast. There'll be no reduction in the number of ways naïve commentators can spectacularly misinterpret how our industry's evolving. Our supply base is just too complex.
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