What’s the biggest challenge facing the apparel business today? Inflation, inflation, inflation. Everyone we’ve talked to, in every step along the supply chain, is worried about the impact that rising raw materials costs – particularly the price of cotton, which comprises the lion’s share of all apparel sold in the US – will have on cost of goods sold in 2011.
The Concern Is Real. Cotton prices have risen 140% in the past year. This threat to margins, which had just begun to recover from the effects of the recession, is coming at a pretty bad time for the industry.
Time To Tweak Blend Levels? Not so fast – prices for synthetics, whose demand has been driven up by cotton’s soaring price tag, will soon be increasing as well. Polyester staple producers report being sold up for the first time in decades, and they’re raising prices in the hopes of recouping some of the damage done to their ingredients costs by rising oil prices. And then there’s labor. Labor rates in China, where most of our apparel comes from, have risen up to 40% in the past year. Although many apparel companies claim to be moving production to Vietnam, Cambodia, India, the Caribbean and elsewhere, this cannot be done overnight.
Who Will Pay? First of all, forget the claim that manufacturers and retailers will be passing along the cost increases in the form of higher consumer prices. There is still too much capacity chasing too little demand, and far too much pressure on retailers to deliver total and same-store sales gains month-in, month-out. Think about it. Is the beleaguered and value-conscious consumer, whose home value, paycheck, and overall psyche have become decimated in the past two years, going to pick up a pair of jeans, whose price was $19.99 last year and is now $24.99, and say to herself, “Well okay. Cotton prices have doubled this year and wage rates in China have increased, so I’m just going to take these right over to the cash-wrap.”? I don’t think so. More likely than not, she’ll do what she’s been trained to do for the past several years, which is wait for the product to go on sale.
Unless you are the most powerful brand in the business, with customers so loyal they’re addicted and a product so compelling it flies off the shelf (there are a few out there, I know, but not very many, and they don’t comprise a big part of the market), you’re going to absorb the cost increase.
What Will Happen Instead? Companies will continue to search for ways to engineer cost out of their products and companies. Some will merge or forming strategic alliances with other companies to lower overhead and leverage capabilities and expertise. Others will enter into exclusive licensing and brand deals like Material Girl at Macy’s and Liz Claiborne at JCPenney. Still others will acquiring their licensees, their suppliers, their customers, like Ralph is doing.
One thing they won’t do, if they want their brand to survive, is to engineer quality out of their product. The consumer won’t stand for it. Coach has come dangerously close to this, and may be suffering a bit of tarnish on its image. Old Navy is another culprit in this arena.
Some retailers will decide going private is the way to roll. J. Crew’s merchant prince, Mickey Drexler, has often said that he wishes he could stop worrying about getting bigger so fast and focus on getting really good, even if it takes a little longer. Maybe the TPG deal is a way to do this.
Small brands – and some big ones, too – will get acquired by larger companies. Deckers Outdoor relies on UGG boots for almost all of its revenue. At what point are shareholders going to say, “That’s too risky?”
Is there a Light at the End of the Tunnel? There usually is. Cotton prices will not stay high forever. As in previous cycles, more farmers will plant cotton instead of other crops to take advantage of the price premium. Those who are stockpiling cotton will sell off when the price starts to fall, flooding the market with supply. Factories will move from the high-wage-region of coastal China to the interior. Factories in Cambodia, Vietnam, Honduras, etc., will expand their capabilities. Costs will come down, if you’re prepared – and healthy enough – to wait.