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10/26/2011

Sourcing in the Western Hemisphere

Apparel sourcing in the Western Hemisphere has suddenly become a hot topic, earning a special — and well-attended — focus at the 2011 MAGIC show and bringing renewed attention to several trade preference programs, both existing and proposed, designed to help foster such activity.

How important is this development, and what does it mean for the future of the industry?

Textile and apparel imports from the Western Hemisphere have been on something of a roller coaster ride over the past two decades, according to data from the Office of Textiles and Apparel (OTEXA) of the U.S. International Trade Administration (USITA). They grew rapidly in the early 1990s, skyrocketed after 1994 when NAFTA came into effect, peaked in 1999-2000 at about 33 percent of total imports, and then fell steeply to about 16 percent of total imports in 2009.

In absolute dollars, the roller coaster ride was even more dramatic because the total volume of imports grew rapidly during most of the period. Imports from Western Hemisphere countries increased more than seven times from 1989 to 2000, from $3 billion to $23 billion, then fell nearly by half over the following decade.

By comparison, over 20 years, imports from most other major trading partners have been on much smoother trajectories, whether rising (China, Vietnam, Bangladesh) or falling (Taiwan, Japan).

Since 2009, the free-fall in Western Hemisphere imports has stopped, in both absolute and relative terms — though the data aren’t entirely conclusive about whether growth is resuming. In Central America, where apparel sourcing grew until 2004 before falling off, there does seem to be a resurgence under way.

Whatever the overall trend, a number of U.S. and global apparel firms are giving more serious consideration to sourcing in the Western Hemisphere and are trying to define the circumstances in which such sourcing makes economic sense.

Costs
Sourcing shifted from the Western Hemisphere in the past decade, primarily for reasons of cost. Labor rates in the Western Hemisphere are considerably higher than in Asia, and fabric is also more expensive.

However, the Western Hemisphere has some compensating cost advantages. First, transportation costs for goods shipped to the United States from the region are obviously lower than when they are shipped from Asia. For products that require only low-skilled labor — t-shirts, for example — these lower transportation costs may counterbalance higher labor and fabric costs and make production in the Western Hemisphere cost-effective. However, Tom Nelson, vice president for global product procurement at VF Asia, says that FOB prices for goods requiring higher-skilled labor — outerwear, complicated jeans, high-fashion goods — are still higher for Western Hemisphere products than for Asian products.

In addition, many goods are sold outside the United States. As a global company — with FY2010 revenues of almost $8 billion — VF aims to reduce its overall costs by making all its products as close to their markets as possible. And VF isn’t the only company with this goal. As Nicole Bivens Collinson, president for trade and legislative affairs at the law firm of Sandler, Travis & Rosenberg, P.A., points out, “Forward-thinking companies, looking down the road, see that there could be carbon taxes instituted, so that taking ships across the ocean multiple times could subject you to higher taxes.” For that reason, she says, many companies are trying to organize their activities so as to bring production closer to their markets.

Nelson believes that, given favorable trade regulations, VF could increase its production in the Americas by an additional 4 percent to 5 percent; however, because the company has large markets in Europe and Asia, manufacturing all its products in the Western Hemisphere will never make sense.
 
Another factor that compensates for lower Asian labor costs is preferential tariff treatment for Western-Hemisphere goods. U.S. trade agreements such as NAFTA (with Canada and Mexico) and DR-CAFTA (with Central American countries and the Dominican Republic) make certain imports duty-free, which succeeds in equalizing costs in many instances. Nelson says the tariff preference level (TPL) for woven trousers that was instituted for Nicaragua in 2007 persuaded VF to build a factory there that now employs 1,000 people. (Under CAFTA, Nicaragua received the competitive advantage of being the only Central American country to negotiate a Tariff Preference Level (TPL), allowing its textile industry to use 100 million square meter equivalents (SMEs) of fabric from any part of the world to manufacture garments in Nicaragua and still meet rules-of-origin requirements for duty-free import to the United States.)

VF also purchases goods from other factories in Nicaragua, which Nelson calls “a key play for us,” and it owns factories in Mexico, Honduras, the Dominican Republic and Haiti. Altogether, the company spent more than $225 million in sourcing from North and Central American countries during the year ending July 2011. Because U.S. trade agreements generally call for using a specified percentage of U.S.-made yarns and fabrics, this type of sourcing also helps sustain jobs in this country.

However, the Nicaragua TPL is set to expire in 2014, and action on a new agreement does not appear to be top-of-mind for the Obama Administration. Nelson says VF needs to know by the end of 2012 whether a new agreement is in the works. If the TPL is not renewed — or if the U.S. government delays action on it — VF may be required to move a lot of production it currently sources out of Nicaragua back to Asia. Without the TPL, according to Nelson, the company cannot make products in Nicaragua at costs that are competitive with Asia’s.

Finally, prices in the Western Hemisphere are somewhat more stable than they are in Asia — if only because Asian prices are being driven up by China’s burgeoning consumer demand. “Costs here [in Guatemala] have risen more slowly than in Asia,” says Carlos Arias, president of Denimatrix, a supplier that produces jeans in Guatemala primarily for American companies.

Some niche apparel businesses are not primarily cost-driven, and these may continue sourcing in the Western Hemisphere despite the price differential. Allen Edelson, president of Fashion Sources, which represents many Western Hemisphere factories, tells of a client that specializes in high-end men’s khakis and other casual wear and is able to source in the United States as a result. “Dickies sells more pants in 15 minutes than this guy sells in a year,” he says. “His market is better men’s specialty stores. He wouldn’t even accept an order from Macy’s, because they wouldn’t be in it for the long haul.”

But why would even a niche business pay a premium? There are a number of reasons:

Risk diversification
Recent events — political, financial and climatic — have impressed upon many companies that diversified sourcing could reduce their overall risk. The tsunami in Japan, uprisings in Asia and the Middle East, and volatility in supplies of raw materials have all confounded companies’ plans in the past year or two. Arias says, “During the tougher parts of the cotton crisis, there were mills in Asia that simply could not deliver because the yarn positions were not there. … These major disruptions created an awareness that dependence on just one region for sourcing is not the best for a company.”
 
Compared to other regions, the Americas are, at present, very stable. While the Western Hemisphere is far from risk-free — Nelson identifies the Mexican drug wars as a serious issue for VF — the risks are at least somewhat independent of risks in other parts of the world. As Nelson says, “It’s easy to move products from one country to another. We spread our sourcing throughout the globe so we can move from one country to another as these situations arise.”

Still, not all companies can move with the ease of a well-oiled sourcing machine such as VF’s. For smaller or less experienced companies that do not have similar resources to pick up and move with speed and flexibility to new sourcing locales, it can be more important to establish a few long-term collaborations that serve their needs. Given greater stability, the lower-risk region may offer a distinct security advantage, assuming the necessary skill sets and materials are available.  

Speed to market
One advantage of sourcing in the Americas is faster response time — due not only to faster shipping but to more flexible manufacturing practices. “If you’re in this hemisphere and have three-day shipping time, you can have your products in six weeks. In Asia, it’s maybe six months,” says Collinson. “Sourcing in this hemisphere speeds up the whole supply process, and helps in the long run as far as inventory costs.”

Edelson says, “With China, you have to make a commitment way in advance. If you buy a loser, you eat it.” One of his clients has a seasonal business making gowns for high-school pageants. It sources in the United States because it can’t predict which styles will sell out each fall. To meet the demand for hot items, “They can call the factory and get them back in three to four weeks,” he says. If the company were sourcing from Asia, it would have to buy more of each style and would end up with leftovers of the styles that didn’t sell.

Arias agrees, adding, “Most of the retailers and brands are expressing aversion to holding inventories, especially in troubled economic times when they don’t know how consumers will react, so the speed to market for Central America is a plus.”

Ease of collaboration
For U.S. companies, being able to work with manufacturers in the same hemisphere can be a big plus. Their counterparts are in (or close to) the same time zone, and they can fly back and forth quickly for visits.

“It’s not uncommon to have customers come in for quick two-day trip, and then they’re back in the office,” Arias says.

Skills and infrastructure
Mexico and Central America have traditional strengths in certain categories of apparel production — mostly categories requiring fewer labor skills, such as t-shirts, denim and underwear. During the past few years, up-to-date plants for producing these items have been sitting idle, and workers were in plentiful supply. “There was an important capacity that was available in the region to be utilized by customers coming back,” says Arias. “That’s why you may be seeing double-digit growth.”

In addition, Central American factories have made efforts in the past few years to catch up in areas where they were traditionally less competitive — for example, product development and innovation. “Customers can come and work with us for a few days and leave with products,” says Arias.
   
For the most part, however, factories in the Western Hemisphere — including in the United States — have less-skilled workers and offer fewer services than those in Asia, and full-package production is relatively uncommon. Edelson says, “You actually have to know something about apparel manufacturing to make apparel here. Besides being able to draw a picture, you have to know about construction, be able to make a spec sheet, and make a prototype. … In Asia, you just send them a drawing and they’ll do it for you. They’ll buy the fabric for you, finance the raw materials and use contract labor to make the product. … Obviously, there are exceptions, but this is the general rule.”

Edelson points out that as U.S. apparel companies have become accustomed to sourcing in Asia, they have lost the skill sets they once had on tap, such as pattern making. “Most people have no idea at all how a garment is constructed,” he says. “Now they’re interested in fashion and glamour. They’re designers and distributors.” Thus, they are ill-equipped to source from the Western Hemisphere, where factories expect to receive complete specifications.
 
Not only skills but raw materials have disappeared. “There’s no fabric here anymore,” Edelson says. “If I have to bring fabric in from China, I might as well make it there.” Another of Edelson’s clients continues sourcing woolens in the United States and in Latin America only because it owns woolen mills in the Pacific Northwest. “They can give a factory 10,000 units to make and get it back in six weeks, door to door.” He adds, “For cottons, they go to Asia.”

Bryan Riviere, head of global sourcing and manufacturing for yoga-wear company lululemon athletica in Vancouver, wants to do more sourcing closer to home but has also been stymied by the inability to find all the necessary materials and skills. “It makes it a logistical nightmare to bring fabric in [from Asia] and then make it in the Americas,” he says. He hopes to develop relationships with mills in Central America that specialize in synthetics and also look to develop garments for manufacture in a highly machinery-intensive operation in the region where, for example, a seamless machine can cost more than $100,000. Such machines are best run by engineers vs. sewing-machine operators, so it could be viable to get cost value by making this type of product in the Americas. “It’s difficult to compete on labor with labor,” he says. “We’d have a better advantage getting the efficiency and effectiveness in North America, plus the lead-time advantage. … That makes a lot more sense than trying to compete in normal cut-and-sew product types.”

Riviere has set himself a task that has never been successfully accomplished — assessing the true cost of a garment made in the Western Hemisphere. “FOB to FOB, there’s an advantage in Asia,” he says. “Landed cost to landed cost, it’s a little closer, but Asia still has the advantage. But I’d like to compare what the true cost is at the point our guest makes the purchase and walks out the door. What happens when you factor in higher inventory turns and fewer markdowns, for example? Those don’t normally get factored into overall manufacturing costs, but they impact your overall profit margin, which is the ultimate financial driver. And that’s the exercise we’re doing now.” 

Masha Zager is a New York-based free-lance writer who specializes in business and technology.