A Thought Leadership Report from AT Kearney
By Sanjay Srikanth, Esteban Bowles, Chris Callieri, and Deepa Neary
Apparel retailers have been on a sourcing roller coaster for nearly 30 years. The 1980s brought a significant shift of manufacturing to China, where labor and raw materials cost less and were readily available. A few years later, quotas, labor practices and technological advancements spurred a need to find new low-cost countries, new sourcing partners, and new ways of designing and producing garments. Today, as factory capacity declines and raw-material costs and wages rise, retailers are looking for a smarter approach to apparel sourcing.
As the sourcing landscape changes, more retailers are chasing the last penny by trying to find new partners or countries to which to move production. But the problem is that all the new countries already have been “found,” and U.S. retailers are struggling with global labor-force changes and raw-material price volatility. Some now wonder whether the answer is to avoid the problems of international sourcing altogether and move production back (or at least closer) to the United States—bringing the roller coaster ride full circle.
There is no silver-bullet solution for today’s tough sourcing problems. But there are smart steps retailers can take to prepare for—and respond to—the market’s changing landscape.
Price and Supply Fluctuations
China is the largest exporter of apparel to the United States, accounting for more than 35 percent of total market share. The country is attractive due to its strong infrastructure, low production costs and easy access to an array of raw materials. But costs continue to rise in China as the exchange rate becomes less favorable, labor rates increase (along with inflation) and shipping becomes costlier (Fig. 1). Factory closings and labor shortages in key production regions have led to higher prices and less capacity. Indeed, during this past season, factories canceled orders, catching many retailers by surprise and scrambling to find new suppliers or increase quantities on existing orders. Other countries, in Asia and elsewhere, are suddenly looking more competitive.
In addition, cotton prices reached an all-time high earlier this year as production struggled to meet demand and countries with excess cotton production (and sufficient domestic demand) were limiting exports. Just as fast as cotton prices increased, they have now returned to year-ago price levels. Other materials prices are also experiencing volatility—the price of petroleum-based fabrics, for example, rose by up to 20 percent. Fabrics once readily available now require longer lead times, and cut-and-sew vendors are sometimes asking for up-front payments to cover higher materials costs. Given the cotton spike from earlier this year, retailers were forced to decide how big an increase to pass along to consumers for the fall season, or whether to absorb some or all of the losses.
Weighing the Strategic Options
There are several options for overcoming these challenges; they include value-engineering garments, using more fabric blends or shifting to cheaper fabrics, taking early positions in fabrics, shifting sourcing to new countries, and, as a last resort, increasing prices.
Before exploring these various options, however, it is wise to first view the sourcing strategy within the context of your overall corporate strategy. Is the goal to be first to market on fashion items or to have the lowest prices? To sell only the highest-quality items or be the most sustainable? To market a particular “made in” designation? In any case, segmenting products by volume, style, complexity and destination country will help answer these questions and identify differentiated supply chains for key segments. Then, understanding the unique goals of each supply chain will help determine the right choices, and ensure sourcing portfolios are developed with an appropriate country mix and with strong supplier relationships. Retailers that create differentiated supply chains with diverse footprints are able to combat cost inflation while seeing only modest price increases.
Importantly, the current landscape is not temporary. China’s middle class continues to grow and, along with it, domestic demand. China will remain a key player in most sourcing portfolios, so the importance of rebalancing supply chains, expanding sourcing footprints and building three- to five-year sourcing plans cannot be overstated.
Exploring Lower-Cost Countries
Opportunities in low-cost countries should be evaluated from a total cost of ownership (TCO) perspective. This not only includes raw material costs, cut-make-trim (CMT) and duties, but also capabilities, quality, lead times, environmental impact, and inventory and markdowns. Taking a TCO perspective involves looking at today’s landscape and at all expectations of future costs and capabilities. Many countries can offer lower costs than China. For example, in Bangladesh, costs are as much as 15 percent lower than China’s; in India and Cambodia, costs are up to 10 percent lower (Fig. 2).
These costs are already changing, however. Last year, the minimum wage for garment workers nearly doubled in Bangladesh after months of labor disputes—and more increases are possible, although, with India’s continued investment in textiles, Bangladesh’s access to raw materials will probably increase and offset the reduced labor advantage.
Beyond the TCO perspective, factors such as political stability and socioeconomic risks must also be considered. For example, Madagascar’s relatively low labor rates and duty-free status to the United States once looked attractive, but a 2009 political coup led to changes in duty-free status and altered the picture significantly. Unrest in Tunisia and Egypt has left retailers scrambling to address supply disruptions. The moral here is that the landscape is always shifting, which necessitates taking a portfolio approach for sourcing partners and countries, and using monitoring mechanisms to shift production appropriately.
Sourcing: A Portfolio Approach
You might be thinking that taking a portfolio approach is a no-brainer—obviously the concept of managing risk-reward is not new. However, many retailers know this and still have not acted on that information. There is a need not only to take a portfolio approach for managing manufacturing countries, but also for managing the supplier base.
We see three distinct supplier segments:
Lowest-cost suppliers. If basics or entry price-point items make up a significant portion of your assortment volume, it may make sense to shift some assortment to least-cost countries. Remember that lowest cost means lowest total cost (including duties, tariffs and quality control, among others). Over time, lowest-cost suppliers can become low-cost, stable suppliers. They must be monitored regularly to ensure they make investments in machinery and staff in order to remain competitive and maintain quality.
Low-cost, stable suppliers. For updated basics with some level of complexity, maintaining some production with suppliers season after season may help ensure quality and supply continuity. And sampling costs will likely fall as suppliers gain a better understanding of their customers’ needs. Test the market regularly, however, to ensure that these suppliers truly remain low cost.
Strategic suppliers. For complex products requiring new fabrication or finishing techniques, it is important to maintain a stable of suppliers that work collaboratively, contribute to the design process, and remain open to improving processes jointly. Such suppliers are worth investing in—they will go beyond the tangible elements to share an intangible “meeting of the minds” with a retailer’s design and supply-chain teams.
Maintaining the right supplier balance requires a supplier relationship management (SRM) program that reviews suppliers, sets joint targets, collaborates on big- and small-run items, and provides transparency and regular feedback to vendors.
A similar portfolio approach should be applied to source countries. Factors to consider include labor costs, access to and transportation costs for raw materials, factory efficiency and overhead rates, freight, duties and tariffs to destination country, design and talent capabilities, domestic demand, and political stability (Fig. 3).
Figure 3: Across production costs, there are numerous levers that apparel retailers can pull to drive efficiency, including changing their country mix (click here toDownload Fig. 3 chart)
New York-based Coach recently announced plans to shift its accessories production from China to Vietnam and India, countries not known for producing accessories. But Coach management believe that Vietnam and India can provide low-cost, high quality and stable product supply. In four years, Coach hopes to reduce production in China from 80 percent to 50 percent. Tal Group, a Hong Kong-based apparel supplier, is working closely with its retailers on fabric innovations, developing wrinkle-free, stain-resistant, moisture-wicking and deodorant technologies, and prompting Brooks Brothers and Lands’ End to consider Tal as a strategic supplier.
A Word About Sourcing: Agents, Factories, Mills
The correct sourcing mix will vary for every retailer, based on overall corporate strategy and other factors. Sourcing through an agent can provide volume consolidation for smaller orders, a broader footprint, the ability to test new-product categories, and an in-country staff to handle issues quickly. Sourcing directly through factories can lead to more cost transparency and stronger relationships. (It can also help avoid some of the problems of working with an agent, such as a lack of understanding of the retailer’s business.) Going further back in the chain and sourcing fabrics from mills can increase cost transparency. Clearly, in low-volume categories it is usually more cost-effective to work with an agent, while in higher-volume categories it is more advantageous to work directly with the factory. Retailers that have introduced fabric platforming often take positions in fabric directly with mills.
Closer-to-Home Production
Moving production near- and on-shore can be part of the balanced strategy for certain product categories. Several near-shore countries, including Honduras, El Salvador and Mexico, are increasing their share of total U.S. imports, Haiti has also seen additional investment since the earthquake, although it remains a risky proposition. Advantages of near- and on-shore production include:
- Accelerating manufacturing and shipping lead times (by up to four weeks)
- Tapping into market trends with quick repeat orders
- Reducing inventory-planning misses
- Capturing “Made in America” branding benefits
In addition, favorable trade agreements and tariff exemptions make Central American countries particularly attractive for high-duty items. This is somewhat offset by higher production costs, sometimes 25 percent higher than in China. U.S. retailers can take advantage of duty-free imports from countries in the Central America Free Trade Agreement (CAFTA) by first exporting U.S. yarn or fabric to a CAFTA country; once production is complete, garments can enter the United States duty-free.
Los Angeles has replaced New York as the hub of U.S. apparel manufacturing, but New York’s Garment District has been revitalized and is still used by many high-end designers. For example, Nicole Miller manufactures half of its apparel in New York, while vF Corporation, Carhartt, Brooks Brothers, Dickie’s, Hanes Corporation and Lands’ End all maintain some level of U.S. production.
Stop the Ride
For years, China has been the place for apparel sourcing. But as the roller coaster ride slows down, the question now is how to get off. Should you be smart and weigh the strategic options? Explore lower-cost-country options? Evaluate closer-to-home production? Yes, yes, and yes. All options should be on the table. While the future of apparel sourcing might not be clear, one thing is perfectly apparent: The rapidly changing sourcing landscape—whatever direction it takes—requires a combination of strategic and analytical thinking and getting smarter about apparel sourcing.
A.T. Kearney is a global management consulting firm that uses strategic insight, tailored solutions and a collaborative working style to help clients achieve sustainable results. Since 1926, it has advised the world’s leading corporations across all major industries. A.T. Kearney’s offices are located in major business centers in 38 countries.
About the Authors
Sanjay Srikanth is a partner in the Washington, D.C. office. Esteban Bowles is a partner in the Sao Paolo office. Chris Callieri is a principal in the Washington, D.C. office. Deepa Nearyis a consultant in the New York office. The authors would like to acknowledge the generous contributions of their colleagues, Stefanie Gebauer and Alexandra Breedlove.
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