Different pressures take different businesses in different directions

Different pressures take different businesses in different directions

Last week's announcement by Adidas that it expects its costs to rise sharply over the next five years underlines some crucial changes buyers in different countries have seen in their sourcing operations since the beginning of this century, explains Mike Flanagan.

When I started commenting on the world's garment trade here on just-style some 15 years ago in October 2000, there were some pretty clear principles:

  • Clothes buying was for rich people: shoppers in the world's established rich countries – the US and Canada, Western Europe, Japan, Australia and New Zealand  –  bought about 77% by value of all the clothes sold in the world.
  • Labour was the highest single cost for a Western garment maker. Moving production to a low-wage economy potentially cut that cost at least 75% – and often up to 95%.
  • The price of most other garment making inputs, though, seemed about the same in China as in the US or Europe.
  • Labour in low-wage economies looked likely to get relatively cheaper, since for most of the previous 50 years, poorer countries had constantly been devaluing their currencies against the West.

Some of those principles still apply: those rich countries accounted for around 84% of all the world's cross-border trade in new clothes in 2000 – and still accounted for 80% in the first nine months of 2015. The apparel market overall, though, has been transformed in one crucial way: growth in developing countries – especially China, Russia, Brazil, India and Turkey – now means that those rich consumers bought less than 40% by value of the world's clothes in 2014.

Some more subtle changes, though, have had rarely-acknowledged impacts on sourcing.

1: Making garments in low-wage countries means labour is no longer the biggest cost. A recent costing of Bangladeshi jeans, for example, showed wages accounting for just $0.22 per pair, while fabric cost $3.69.

2: Wage rises don't have to trigger huge cost increases: Chinese wages have increased five-fold since 2000, but the average cost per square metre of Chinese apparel landed in the US has fallen 15%.

3: In the past few years, most non-wage manufacturing costs in developing countries have fallen:

  • Crude oil has dropped 55% from its 2012 peak;
  • Raw cotton is about 35% down from its early 2011 peak. Man-made fibre prices didn't peak as crazily back then – but they're still 30% down from their high in early 2012;
  • Container freight prices are less than half what they were in early 2012;
  • Interest rates in manufacturing countries haven't all moved in the same way; some increases have destroyed the profitability of some factories, while others have improved their profits through local rate cuts.

Developing-world currencies have recently increased in value against some hard currencies. The euro especially – but the Japanese yen, the Swedish krona and the British pound almost as much – have lost value against most Asian currencies in the past five years.

Between 2000 and 2008, the euro more than doubled in value against the currencies of major garment manufacturers. But it has fallen 30% since – and about as much against the US dollar.

The effect of all this is messy:

  • Buyers in different countries have seen prices moving very differently. In September 2015, apparel brands and retailers in the EU were paying 25% more per square metre of imported apparel than they were in 2010; but buyers in the US were paying 32% less.
  • Is this hitting factory profitability? Unsurprisingly, European and Japanese buyers have been reluctant to increase their prices, though US buyers have sought to see suppliers' cost reductions reflected in lower buying prices. Manufacturers have inevitably been far more vocal about costs that have grown than about those that have fallen – but clearly some factories being paid in euros are worse off, while cheaper energy and fabric might make many with receivables in US dollars better off in spite of falling receipts.
  • Though many manufacturers are convinced Western buyers have been cutting their orders since the Great Recession in 2008, the truth is that the volume of apparel imported by Japan, the US and the EU between 2001 and 2008 grew 5.4% annually, and 1.7% annually between 2009 and September 2015. Westerners are still buying more every year.

These changes mean different pressures take different businesses in different directions:

  • Depending where they're buying for. Adidas – trading in euros and quoted on the Frankfurt exchange – sees cost increases that US rivals probably don't at present. A decade ago, though, the then-rising euro meant it was benefitting from cost reductions that its US competitors weren't getting at the time.
  • Depending where they're based. Adidas's announcement added that it was moving much production out of China. This coincided with Hong Kong-based TAL's announcement it planned to close its Dongguan trouser factory 15 years earlier than planned – and came a week after Taiwan-based Pou Chen revealed that 42% of its worldwide shoe production this year has been in Vietnam. But a day later, Shandong-based Weiqiao Textile announced unexpected profit growth from its Chinese manufacturing operations. "Flying geese" – the Chinese term for businesses elsewhere in East Asia investing in Mainland China – are moving out: businesses based in Mainland China itself generally aren't.

These effects can't be guaranteed to go on:

  • The price falls in the euro, raw materials, energy and freight aren't the result of falling demand or some boom in productivity: they're all the result of exaggerated growth expectations five years ago triggering over-ambitious capacity investments or speculator bubbles. They could move in a different way.
  • Chinese official policy is encouraging its firms to invest abroad – though absolutely not to cut employment at home.

But it's still folly to expect the rules of sourcing to remain unchanged from 2010. The past three years have started to show far greater divergence between the ambitions and plans of rich-country buying firms than we saw in the first few years of the move offshore.

Those divergences will only grow. Changing strategies from individual buyers will impact sourcing at least as much as changes in manufacturing circumstances in individual countries. 

How will rising costs impact Adidas sourcing strategy?