In the first five months of this year, the average unit price for US garment imports has risen by 2.2%. So what must factories do if they are to gain a slice of this higher-price market? David Birnbaum believes the best opportunities will be had by factories that carry out everything from design to distribution.

Customers are now paying higher FOB prices to their supplying factories. In the year to May 2006, the average FOB price for US garment imports has risen by 2.2% compared to the same period in 2005.

However, these increases have not been across the board. Average FOB prices from some countries such as the Philippines, Cambodia, and Pakistan are still falling.

Other countries such as Bangladesh, China, Dominican Republic, El Salvador, Honduras, and Philippines show increasing FOB prices but are still well below the average for all countries.

Nevertheless, some factories in these countries have been able to increase FOB prices, while their neighbours down the block have been forced to accept price reductions.

So what are the factors that allow for FOB increases? And more importantly, what must factories do, to join this exclusive higher-FOB club?

One point is clear: the old price-quality-delivery paradigm is gone. There was a time when customers were willing to offset higher prices for more reliable delivery and/or better quality.

Today price, quality and delivery are no longer variables. Today, the buyer has a fixed target price, a fixed quality standard, and a fixed garment delivery date.

If the factory cannot meet the buyer's target price, the buyer will go elsewhere. Likewise, if the factory cannot achieve the buyer's quality standard and meet the buyer's delivery date, the buyer will go elsewhere. Conversely, the customer will not pay a higher price for better quality or faster delivery.

The ability to ship a quality garment, on time every time, and at a reasonable price is no longer an asset. They have become pre-requisite.

These factors no longer guarantee an order. They simply allow the factory to join the ever-growing line of potential suppliers.

The new paradigm is product - service - value

Product
Buyers accept that they must pay a higher FOB for more difficult products than for easier products. This is simply a question of supply and demand. Not only are the more difficult products more costly to manufacture, but there are fewer factories capable of manufacturing these products.

As factories move up the product scale, the number of competitors declines. There are more casual pants factories than tailored pants factories. There are more casual jacket factories than tailored jacket factories. The customer requiring these more difficult products must trade up to a higher level factory, and these factories can, at least to some degree, chose their customers.

A factory at the bottom of the product-scale, making basic T-shirts, basis underwear or basic cotton casual pants for example, faces real difficulties. It is competing with uncountable factories. If it cannot meet the customer's target price, the customer has no difficulty finding a replacement.

While the basic T-shirt factory will struggle to net 5%, the tailored jacket factory will look for 10%+.

Service
This is a cost factor in transition. All buyers want more service from their suppliers. They certainly all talk about the need for more service from their suppliers. However, few are willing to pay their suppliers for these services.

In the pre-production process these include

  • Patternmaking, grading and correcting
  • Designer samplemaking
  • Other design assists
  • Material sourcing
  • Material and trim purchase
  • Direct communication and follow-up

In the production process these include

  • Control of the production process
  • Independent in-house inspection

In the post-production process, these include

  • Shipping
  • Delivery Duty Paid (DDP) facilities
  • In-store delivery

All import customers want factories to provide some, if not all, of these services. They understand that each service performed by the factory is one less service that the customer or his agent must perform. The transfer of service from New York to Guangdong reduces costs. Making a pattern in China is less expensive than making the same pattern in the United States. This much is obvious.

The import customers' problem, however, is that based on current costing systems, these added services will not reduce their costs. In fact, each time the factory performs a specific service, the cost of the garment rises.

Customers and their agents (or wholly-owned buying offices) add a fixed percentage loading or commission to every garment. This covers their product related costs, such as patternmaking, design samplemaking etc. If the customer has his own in-house patternmaking department, the cost of that department is included in the loading, regardless of who actually makes the pattern.

This makes sense so long as the pattern is made in-house by the customer. However, when the factory makes the pattern, or the designer samples, or another designer assists etc, the same loading is added to that garment.

Hence those styles are charged twice for these services - once because the factory must add these costs to its FOB price and again because the customer includes these services in its loadings.

To put it another way, under the present system, the full-service factory subsidises the zero-service factory, with the result that the worst factories seem more cost effective than their more competent competitors.

The solution is to replace the customer's loading and its buying office's commission with a series of fees to cover each specific service.

Under this system, if the factory makes the pattern, the pattern is 0 - it has been included in the FOB price. If, however, the factory does not make the pattern, the cost of making that pattern by the customer is added to the factory FOB, with the result that the full-service factory becomes more cost effective compared with its zero-service competitors.

To my knowledge, no importer or retailer has yet quantified the cost of services. However, some are taking at least small steps. Here are a few examples.

  • Many customers have discontinued working with zero-service factories. CMT factories and Latin American maquilas are being phased out.
  • Customers have started to impose minimum factory service requirements. For example, all factories must be able to provide their own patterns, salesmen samples, etc.
  • Some customers have stopped garment inspection altogether, relying on the supplier to deliver the correct quality. To ensure the factory takes full responsibility, some customers are now placing orders on a Delivery Duty Paid (DDP) basis, with open account with 30-60 days credit.
  • A few customers have changed their buying offices from commission based to cost based. Under the new system, buying offices are judged not on how much profit they make, but rather on how little cost they add to the garment.
  • A very few customers have created strategic relationships with their main suppliers which call for a full range of services. This is more prevalent in Europe.

The inability to change the system to encourage factories to provide more services lies with senior old-school sourcing management. It is very difficult to change the mindset and culture which puts FOB price above all else. However, the good news is that retirement is taking its toll. New people are slowly moving into senior sourcing positions. Some progress is being made.

Those factories currently providing a relatively full range of services look for net profit of 15%+.

Value
This is a cost factor which has only just begun to move from the off-the-wall category to the more reasonable impossible.

To understand value, you first must consider a full value costing. The cost of a garment is defined as the difference between the full retail price and the profit (net retail markup). The FOB price accounts for 20% of the cost, with CMT accounting for only 6%.

click table to enlarge

Supplying value involves two interrelated strategies:

1: Reduce the number of links in the value chain to a minimum. The current value chain has four links:

 

As the factory provides more services, the need for the agent and private-label importer (or retailer's import office) declines. At some point they become redundant.

In the costing above, the agent's commission is 75¢. The private label importer adds $2.86 (the markup $4.28 less the retailer's chargeback $1.43). Cutting both out of the value chain saves $3.61. This is a great deal of money, particularly when compared with the 37.5¢ that the factory expects as normal profit on a pair of jeans.

If the factory is able to provide the full range of services, the customer could well afford to double or even triple the factory profit and still save a considerable amount of money.

2: Reduce markdowns. This by far the single greatest garment cost. In the costing above, retail markdown totalled $11.01, an amount greater than DDP.

Markdown is directly related to lead-time. If the retailer requires 48 weeks from first design sketch to in-store stock garment delivery, it is inconceivable to provide garments which follow the latest fashion trends, and substantial markdowns become a certainty.

The longest delays occur in pre-production, particularly in design. The solution is for the factory to take over the entire pre-production process. This must include the bulk of the design work. To fulfil these needs, factories are beginning to provide a full range of in-house design facilities. Some factories are opening design rooms in customers' countries.

The most profitable factory I know produces T-shirts, albeit fashion T-shirts. It offers customers the complete range of services and provides full value options. Its net profit is exceptional by any standard.

Full range of services
In the new paradigm, factories are bringing new designs to their customers, or designing groups following broad instructions from their customers and then carrying out the entire process up the point where stock goods are delivered to the customer's warehouse and even to the individual branch stores.

The ability to provide the full range of services finally places responsibility for all costs in the hands of the factory.

For the first time, the customer will be able to determine which factory provides the lowest cost. This is not the lowest FOB, or the lowest DDP. This includes all costs up to and including markdowns. The factory of choice is the factory which provides the customer with the greatest profit.

This new paradigm includes not only fast turn and quick response. It also includes trial orders, with material backups and the entire array of services required to reduce markdowns.

This paradigm is not a theory nor is it a dream. Some very few factories are currently providing this full range of services to selected customers. All work exclusively with European customers.

Moving to the full value paradigm has many problems, among which are poor strategies and systems.

  • No one is trying to reduce full-value garment costs because no one is responsible for full-value garment costs. The buyer is responsible only for FOB or possible DDP. The buyer is excluded from problems of markdown. So too is the factory.
  • Senior management does not relate markdowns to lead times. Most senior management still thinks that markdowns are the result of poor design or incompetent merchandising.
  • Current strategies assume the problems of increasing markdowns are insoluble. The "solution" revolves around the need to increase margins, usually by reducing FOB prices.

However, the greatest problem is fear. Those professionals who are aware of the fundamental problems recognise that any solution requires not only a shift in the relationships between customer and supplier, but more importantly a massive change in the skill sets required by professionals on both sides. As skill sets change, the old jobs will disappear.

Factories are moving to meet the changing needs of the industry much faster than their customers. Factories know their industry is rapidly consolidating and the best are moving fast to ensure their survival.

Customers seem trapped in a state of inertia where everyone is fighting for his or her individual survival and no one is looking to save the company.

Meanwhile US retailers and brand importers seem trapped in a downward spiral. Unless the situation changes, outsiders will step in, takeover, and everyone will lose their jobs.