Retailers are struggling to adjust to too much inventory

Retailers are struggling to adjust to too much inventory

Significant structural changes are needed across the apparel supply chain in order to create a more consistent, faster and efficient sourcing model that will help retailers improve margins, analysts have said. 

They believe the fashion retail industry requires improved execution out of design and sourcing functions, as inventory is turning too slowly and design processes and lead times are too long. This lack of speed is contributing to weakening merchandise margin, return on investment, and free cash flow.

Fresh from a tour of Hong Kong and Bangladesh "to gain a further understanding of the complex retail supply chain", the analysts at Cowen & Co say capacity utilisation at factories in China and Bangladesh is running at 2008 and 2009 levels as retailers adjust to changing consumer behaviour, a proliferation of brands and too much inventory, uncertainty over holiday and category trends, and the reality that the retail industry is overbuying from vendors.

They also suggest retailers and brands are "pushing factories to the limits" in terms of demanding lower prices for goods as they face lower AURs (average unit retail). "With raw material costs controlled, FOB costs in general have a benign outlook despite labour cost increases, as factories have conceded lower prices – with little room for additional improvement in AUC (average unit cost)."

They point to the major off-price and fast fashion retailers as "playing a major role in importing deflationary prices to North America, particularly from low-cost Bangladesh. 

Anecdotal evidence also suggests e-tailers are aggressively building their supply chain capabilities and relationships with agents to build private label businesses and access factories. Agents are helping with product development, compliance and logistics.

They believe, however, that the supply chain provides significant opportunity for improvement and value creation. 

"Improvements in merchandise margin, inventory turn and ROIC (return on invested capital) starts with a faster mindset throughout the design process and supply chain, which could lead to executing shorter lead times and quicker response times with on-trend product," explain John Kernan, Krista Zuber and David Buckley.

"Many of the suppliers, factories and agents we met with see margin degrading inefficiency that can be removed over time. Over the next five years there will be major strides in digitising and automating the supply chain in Asia with less reliance on labour costs, which are compounding higher at double-digit rates. Design, product development and execution in the supply chain will remain critical."

The analysts highlighted a number of structural changes they believe are needed in the supply chain in order to mitigate margin pressure and achieve a more efficient sourcing model.

  • Faster design times with shorter lead times in both core and fashion offering;
  • Closer relationships with key suppliers enabling the booking of upfront capacity and fabric platforming at factories;
  • More automated manufacturing;
  • Improved data and customer analytics to rationalise SKU count.

Notably, Ralph Lauren has said an overhaul of its supply chain is at the heart of its recently announced restructuring plans, which will include a new test pipeline, shorter lead times, reduced inventory and a focus on fewer styles and more on-trend merchandise. Indeed, two of the four engines of its turnaround plan are related to sourcing and the supply chain. 

Faster supply chain is key to Ralph Lauren turnaround

"One clear competitive advantage in brand management is the efficiency and development of a brand's supply chain," the Cowen analysts explain.

"Increasingly, we see the more sophisticated companies, particularly those that are technologically advanced, investing behind their supply chain innovation to positively impact speed to market, localisation, labour and raw material costs, and inventory management. These efforts are helping to expand the competitive moat, providing further separation among branded category leaders and their peers."

Nike and Adidas are two example companies the Cowen analysts believe are advancing their manufacturing and production capabilities to drive productivity improvements. 

The former's 'manufacturing revolution' initiative, launched in May 2014, is aimed at redefining its production processes in order to innovate, get leaner and increase modernisation and customisation, while gaining productivity and, ultimately, margin and market share benefits.

Nike to accelerate product and manufacturing innovation

Likewise, Adidas is gearing up to begin large-scale footwear production next year at its "industry-changing" Speedfactory facility in Germany – and plans to extend the concept to the US. The initiative "heralds a new era in footwear creation," Adidas says, by using robotic technology in automated modular production cells to combine "the fastest reaction to consumer needs" with the flexibility to offer products that are uniquely customised for individual consumers.

Adidas Speedfactory gears up for large-scale production