High Costs, Weak Demand Impact Textile Industry
February 10, 2011 Two years ago, when the financial crisis swept the world and decreased apparel demand in the major developed markets, the textile and apparel industry experienced sharp declines in exports and production, massive layoffs, and even factory closures.
Marginal players dropped out and industry consolidation, which started in 2005 with the end of global quotas, continued apace. These conditions have finally started to stabilize, thanks to massive stimulus policies adopted by governments around the world, but the textile and apparel industry is facing significant new challenges brought about by skyrocketing cotton prices.
To counter the recessionary forces, major central banks adopted expansionary monetary policies and injected massive amounts of liquidity into markets to bolster growth. This has led to realignments in world currencies, particularly a weakening U.S. dollar, and sharply rising commodity prices.
In the case of cotton, the lowest stock-to-use ratio since 1993, reductions in the Pakistani and Chinese crops due to flooding and poor weather conditions, India’s restrictions on cotton exports, and speculative buying fueled by abundant liquidity resulted in historically high levels for the price of cotton, with the peak more than tripling the price of early 2009.
On the other hand, although the major economies have stabilized with the support from the stimulus policies, consumer demand in developed economies is still weak. Retailers are concerned about consumers’ resistance to price increases, and along with the textile and apparel industry, face some severe tests. They will be forced to watch their margins get squeezed by the skyrocketing prices of cotton and yarn, which will translate into significantly higher costs for apparel.
What lies ahead? In our view, the cotton crisis of 2010 will see some “market adjustment mechanisms” kicking in next year. According to estimates from the International Cotton Advisory Committee, cotton production in 2010 could actually reach a record high of 27.3 million tons, thereby outstripping total cotton usage of between 24.6 million tons and 25.3 million tons. The stock-to-use ratio will therefore rise next year from its 2010 low, and the high prices in 2010 will also be a great incentive for farmers to plant more, resulting in a larger cotton supply. These factors should have a calming effect on cotton prices going into 2011.
There’s no shortage of labor … just cheap labor
Unlike cotton, the labor issue is not cyclical but structural. There is now a popular saying that China is facing a labor shortage. But how can a country with a population of more than 1.3 billion and an active work force of almost 800 million have a labor shortage?
The fact of the matter is, China’s rapid growth over the last 30 years has brought about rising per capita productivity as well as income. Between 2002 and 2008, the average income of Chinese workers increased by more than 130 percent. Workers are more selective in where they relocate to find a job, and aspire to earn more. This does not, however, spell the end, or even the beginning of the end, of China’s offerings in textile and apparel manufacturing. There is actually a virtuous cycle of “higher productivity, higher value-added, and higher pay.” The essence of competitiveness is not cheap labor, but productive labor.
Also, China is not unique or alone in being confronted with challenges on the labor front, as evidenced by the recent labor issues in Bangladesh, Cambodia, India, and Vietnam, just to name a few. The underlying social and economic forces are the same, albeit at different stages of development.
With the congruence of rising commodity prices, increasing labor costs and soft external demand, turning to the rapidly growing domestic market appears to be a logical alternative for some manufacturers. Large, emerging markets like China and India present double-digit consumption growth, urbanization, an expanding middle class, market proximity, and local knowledge. Nevertheless, many new skills are necessary for manufacturers to succeed in the fiercely competitive retail market: design, merchandising, store operations, and marketing and branding. There is no quick fix, but the opportunity is there for those willing to devote the time and resources to cultivating the domestic market.
An opportunity to thrive
All of these challenges are re-shaping the textile and apparel industry in China and the rest of the developing world. Facing the “double whammy” of cost inflation and weak consumer demand, survival for industry players might very well depend on how efficiently and productively they can utilize scarce and costly resources. While these are huge challenges, there are also opportunities for the successful players not only to survive but to become even stronger. In the last five years, the share of the top five apparel-exporting countries to the United States has increased from 40 percent to 70 percent. Without the artificial restriction imposed by the quota system, the forces leading to industry consolidation have been unleashed, and the developments of late will add further impetus to consolidation.
Rising material and labor costs increase the pressure and incentives for manufacturers to invest in research and development, productivity increases, waste reduction, and innovations to counter the margin squeeze. Vertical suppliers will also be in a better position to take a holistic approach to doing product development, improving quality control, reducing lead-time, and streamlining production processes, all of which add value to customers.
When workers earn more from being more productive, and factories benefit from more productive uses of their materials and resources, sustainability then walks hand-in-hand with profitability for the company. That is how industry players could survive and prosper in this new era.
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