Curious about the next big sourcing hub, China's future role in the apparel manufacturing business, the dubious wisdom of relying on low-cost production, and evolving business models for retailers? We asked industry veteran Bob McKee to weigh in on these topics and more.
Apparel: Bob McKee, you have spent so much time in Hong Kong that you've said it feels like home. Speaking from that perspective and as a supply chain expert, what lies ahead for companies that outsource from China?
Bob McKee: From recent experience, we tend to think that China is the be-all and end-all for outsourcing and manufacturing. But if we read history, we find that the fashion industry has always been an economic engine, wherever it is based, and manufacturing tends to be based in low-cost areas with active government support. So where does it go after this? What will the impact on China be when it does?
China will continue to dominate for quite some time, obviously, because of its significant investments in textile and apparel manufacturing and infrastructure. China currently meets some 70 percent of the world's needs in terms of both apparel and footwear -- a higher percentage of footwear than apparel, actually. The reality is that that dominance is not going to disappear overnight. However, because of a few factors -- rising wages and the currency revaluation, primarily -- Chinese manufacturers are increasingly going to find it more economically feasible to produce planes, trains and automobiles than to produce apparel and textiles.
Q: So where do we go from here? Where is the next China?
A: Who knows? Until the recent floods, Bangladesh looked like a prime candidate. I'd keep an eye on Africa. If you look around and find an underdeveloped economy, manufacturing will probably go there next, especially if brand owners continue to rely primarily on low labor costs for their margins of profitability. (By the way, I think that reliance is unwise, but that's a different topic.) If there is significant growth of apparel manufacturing in Africa, the companies that make it happen will be owned by China, I believe.
Q: Why do you say that?
A: Three main things: export numbers, Chinese expertise in outsourcing, and the development of the domestic market.
First, Africa currently counts for approximately 4 percent of global apparel production, while Asia accounts for 71 percent. Of China's total apparel exports (equivalent to $120 billion annually), approximately 7 percent goes to Africa and the Middle East, while 24 percent goes to the Americas, 42 percent goes to Europe, and 27 percent goes elsewhere in Asia. So Africa has a long way to go, both as a labor market and as a consumer market. What it lacks is investment capital. China is already investing substantially in Africa -- and African infrastructure construction -- to secure much-needed natural resources. Africa's proximity to the European market is a logistical advantage that China is unlikely to ignore, especially as shipping costs are so oil-dependent and the oil supply is increasingly volatile.
Second, the Chinese know more about how apparel industry outsourcing works on the supply side than anyone in the world. They are now beginning to outsource work that they used to perform internally to Cambodia, Vietnam, Bangladesh and Sri Lanka. So they have played on both sides now.
I'll give you just one example of the possible impact. Consider that Li & Fung is not only a trading company -- and not only the largest sourcing company in the world -- but also a brand owner. Its major growth area for the last few years has been buying brand names. [Li & Fung] got into it because several of their customers ran into financial difficulty paying for merchandise that they had ordered from L& F. In order to make good on what was owed, Li & Fung took a portion of the business, essentially exchanging debt for equity. From that point, slowly but surely it began investing in many different apparel brands. Li & Fung saw what got the original brand owners into financial difficulty, and in spite of it, the company took a strategic ownership stance. This will change the playing field for outsourced operations.
Q: What about the third factor you mentioned: the development of China's domestic market?
A: Hong Kong will continue to be at the center of the fashion industry from the perspective of the supply chain and logistics. But there's another side of the industry -- the creative side. The interesting dynamic, in my mind, is that while the stalwarts of the industry think that Paris, Milan, London, and New York are the creative centers, I see Shanghai coming on very quickly as a center for creative excellence as well. They have a great verve in design. There's a vibrancy coming out of Shanghai that you don't often see any longer in Milan and Paris and London -- they've become a little complacent.
Since the Chinese domestic market includes a sixth of the world's population and incomes are rising for city dwellers across China, I see some real incentives for both design houses and contract manufacturers to begin shifting their focus from the export to the domestic market or striking a new balance between the two. If, as seems likely, textile, apparel and footwear manufacturing moves inland from the coastal areas to make way for heavy manufacturing and electronics, the domestic market becomes ever more attractive.
Q: Earlier you said that you think it is unwise for brand owners and retailers to continue relying mainly on low-cost production to make their margins. How does that bear on the issues we have been discussing?
A: This is a huge topic, and one recently addressed in a Lawson whitepaper called "The Next Normal," so I will not attempt to capture all aspects of it here. Basically, we at Lawson believe that fundamental changes are occurring in our industry, and that the industry will not go back to "business as usual" even when the economic recession ends.
Only a small number of retailers are making good money today, and they are the ones that have taken a hard look at their business models and adapted to the new realities. Right now, the consumer is in the driver's seat, not the retailer. The consumer has learned to wait for markdowns, which are essentially price concessions, and to search and shop for bargains over the Internet. If you rely on squeezing out production costs in order to cover these markdowns, you are shifting risk to your supply chain partners in order to afford a major -- and to my mind, unnecessary -- dilution of margin.
This is not a sustainable practice for a number of reasons. One obvious reason is that there are fewer producers left since the economic crisis hit, so they have more leverage. China did not suffer to the same extent that its trading partners around the world did. For another thing, there is a very practical side to the Golden Rule, "Do unto others as you would have them do unto you."
Q: So where are the profit margins of the future going to come from?
A: Let's look at which business models did best during the last three years; that's probably a good indication for the future. There are basically two successful models: brands with multichannel sales and distribution, and "fast fashion" companies that turn inventory into cash quickly by giving consumers what they want, when they want it, at the price they are willing to pay.
Smaller, more frequent collections are an important inventory-hedging strategy to preserve working capital, but successful, profitable execution on this strategy depends on technology. IT is much more than just tactical execution of orders. IT enables the rapid collection and analysis of data -- sourcing and production data; supply chain, regulatory and logistical data; point-of-sale data feeding back into design and line planning -- to enable businesses to change as necessary.
Evolving business models put the emphasis on coordination, control and collaboration throughout the entire value chain. In the industry environment that is emerging from the recession, you win or lose based on your customer intimacy and the strength of your partnerships. That is the "new normal."
Robert (Bob) McKee is industry strategy director for fashion at Lawson Software. Bob was one of the first U.S. apparel executives to start sourcing in China in the early '80s. He has more than 35 years' experience of working with textile, apparel, footwear, home textiles and accessories companies as well as 12 years with Lawson. McKee has held a variety of positions including VP of operations, VP of manufacturing, VP of sourcing, VP of materials management, materials manager, production control manager, production planner, DC manager and DC supervisor in addition to being an independent consultant to the industry. Considered by many as a guru, he is a regular speaker at industry events and writes a blog: www.just-style.com/lawson.