In his take on the key apparel industry issues to watch in 2015, David Birnbaum homes in on the problems facing those brands who have set their sights on developing markets in China and Russia; and a solution for the new model full-service factories.

THE CUSTOMER SIDE
A Russian billionaire, driving his Ferrari in Moscow hits an oncoming Russia-made Lada. The billionaire starts screaming at the Lada driver: "My Ferrari! My Ferrari! Do you know how much I paid for my Ferrari?"

The Lada driver is stunned. He points to the gutter, where the billionaire's severed arm is lying. The billionaire looks down at his severed arm and starts screaming: "My Rolex watch! My Rolex watch! Do you know how much I paid for my Rolex watch?"

Welcome to the world of status where all is not well either with our Russian billionaire, or with his suppliers.

Here is the problem. Three factors determine consumer garment demand:

  • Function: How well does the garment perform? Think Gore-Tex skiwear.
  • Aesthetics: How much do you like the design? Think Vivienne Westwood.
  • Status: How do others perceive you? Think A&F and Nike.

Both function and aesthetics are all about the product. A customer looking for a ski jacket can choose a GoreTex model or another ski jacket model. That customer will not choose between a Gore-Tex ski jacket and a Genesis Equilibrium Ti bicycle, even though both function extremely well.

Likewise, a woman looking for a dress might choose one designed by Vivienne Westwood or a dress by another designer. However, the woman will not choose a Ming vase. Again, the Ming vase might well be more aesthetically pleasing than the Vivienne Westwood dress, but the all-important difference is that the woman cannot wear the vase.

Status is different. Because status is all about perception, the product itself is of secondary importance. Ask yourself, which offers higher status: an A&F T-shirt or an iPhone 6, a pair of Nike Air Max trainers or a Harley-Davidson motorcycle.

The problem is that many brand importers and retailers have opted for status over function or aesthetics because it is easier to sell status than to continually develop innovation or quality design. 

But selling status has problems.

First of all, if you are a brand importer or retailer and your products are based on function and/or aesthetics, your competition is limited to those who sell the same products. However, if you are concentrating on status, your competitor is everybody.

Secondly, status is relative. It changes for any number of reasons, often outside the control of the brand importer or retailer.

A&F is going through serious problems (and has recently fired its CEO) not because the quality of its products has fallen or its current designs are not good, but rather because its target customer thinks the iPhone is more impressive than any article of clothing. There is little that A&F can do to overcome the problem. Developing an A&F cellphone to compete with Apple is not a viable option.

The brands at the high end of the market face even more serious problems. They have bet their companies on developing markets in China and Russia - with hindsight not a good gamble.

China is a country undergoing a social revolution where, at this very moment, 5 and 6 star hotels are petitioning the tourism authorities to allow them to move down to 4 or 5 star status, because due to political factors a reservation at a 6-star hotel may suddenly be transmogrified into a reservation at Gulag #6. In a country where, in the near future, possession of designer clothes may become prima facie evidence of corruption and where the reimposition of medieval sumptuary laws may well become a reality; future sales of $1500 bottles of brandy, let alone $15,000 handbags do not look good.

Russia is facing its own problems. The market for super-luxury goods shows declines similar to China, albeit for different reasons. The fundamental economic problems facing the country have sharply reduced the pool of potential customers.

In a sector based on reversed elasticity - where the higher the price, the greater the demand - recent events in China and Russia can be a real killer for those labels relying on high-income low-taste consumers.   

2014 brought us Ebola, ISIS, European economic stagnation and the $1,900,000 Hermes handbag. 2015 should bring some positive change. However, for the status suppliers, 2015 may be remembered as a most painful year.

THE SUPPLIER SIDE
A man, walking down 5th Avenue, sees an old school friend alighting from an enormous stretch limousine. He is surprised, because his friend had been known as the class idiot. He goes up to his friend and says: "Sol it is so good to see you after all these years, clearly you are doing very well. Tell me, what is the secret of your success?"

To which his friend replies: "It is true; I never did well at school but I did learn one lesson. You buy for 1. You sell for 2. You make 1% profit. And that is enough for me."

Some garment factory groups are about to strike it rich, not because they are management geniuses, not because they possess some great strategic plan, but because they are moving in the right direction.

For years customers sourced on the basis of lowest FOB. To meet customers' demands, some factories cut their margins. Many went out of business.

However, some few medium and large factory groups created strategic solutions:

  • Investing in worker training and capital equipment to increase productivity thereby reducing costs.
  • Developing services that reduced customer costs, thereby allowing for a higher FOB price:
    - Product development;
    - Speed to market;
    - The ability to produce literally 1000+ small orders per month;
    - Post production services; e.g., open account, export credit, DDP and beyond.
  • Increasing corporate social responsibility:
    - Ensuring high level of compliance by avoiding the outlaw cheap labour countries;
    - Developing sustainability, e.g., the zero-carbon footprint factory.

These investments in workers, capital equipment and services brought dividends. Some major customers did see the benefits. However, even with the best customers, FOB remained an important determinant, with the result that factories have never received anywhere near the full benefit.

The best factories have reached the point where their customers need only carry out the initial design and market the product. The new model full-service factory is competent to carry out everything else. 

The problem is that the current importer business model has no need for the full range of services that the new model full-service factory is able to provide.

However, there is a new garment customer that desperately needs these services; would be willing to pay a more than reasonable price; but as yet is unaware that the new model full-service factory model exists.

The internet-based virtual retailer is a growing sector. The companies are small. Their quantities are minute. To make matters even more difficult, since their goods will have to be shipped directly to the consumer, they need pick-and-pack.

The upside is that most of virtual retailers are trying to re-invent the wheel. Once they realise what the new model full-service factory can provide they will pay a premium for the services. 

The new model full-service factory on the other hand, by providing the same services to a large number of internet based virtual retailers, can achieve economies of scale.

The irony is that these services, which were created for the traditional major importers who do not want them, will be transferred to the new internet based virtual retailers, who need them, but as yet do not know these services exist.

As Sol said, it is all very simple. You buy for 1, sell for 2 and make 1%.

Bad addition - but a great idea.

I am not sure the penny will drop in 2015, but eventually someone, somewhere will put two and two together and get 20.