Developing Countries Face New Challenges In Global Cotton Market
December 30, 2013 A good friend, who I met recently in Qingdao for a cotton conference, told me the story of his “cotton adventure.”
Right after graduation, he was fortunate enough to be employed by a very reputable international cotton merchant. He was still in his first year when the cotton futures price went on a roller coaster ride. The whole industry was shaken and the one-time, U.S.-based cotton powerhouse was forced to sell its entire cotton operation.
My friend then decided to return to his home country, where his family has been selling cotton to international shippers for generations.
“Things were really messy then too,” he said. “Prices were still very unstable and everybody was working on defaults rather than selling or buying cotton.” As the cotton prices started to fluctuate less and situation began returning to normal, cotton demand gradually picked up and his family business finally started to make a change for the better.
Then, unexpectedly, the Indian government banned cotton exports, sending another round of frenzy into the cotton market, especially in India. Because outstanding contracts could not be delivered, the cotton futures price took a sudden hike again.
To make matters worse, at the very same time, the U.S. economy was hit by a big recession, dampening U.S. demand for textile products.
“You know, in my five-year cotton career, I have been through events that have not happened in the industry for decades,” he said. “Am I ‘lucky’ or what?”
Change Is the New Normal
Since then, there have been even more drastic changes in the centuries-old cotton business. Thanks to the vast improvements in communication technology, globalization has become the industry’s biggest game changer.
Once a cash crop that was planted, ginned and traded locally, cotton has become a commodity whose finished product is the end result of an intricately orchestrated assembly line that spans continents.
The good part of globalization is that it creates opportunities for people across the globe, vastly improving the efficiency of the industry.
However, as the industry becomes more import- and export-dependent, we become more susceptible to changes both at home and abroad, such as domestic and international policies, economic situations, and futures price swings.
Although these challenges are endured by all players, the impact of the problem varies. Developing countries where the majority of cotton growing and cotton product manufacturing take place, are less equipped to deal with the consequences of globalization: volatility in prices, foreign exchange rates, and sudden swerves in export/import policies.
They are further crippled by the lack of government support. Compared to the likes of the United States, Australia and many European nations, the growers and manufacturers in these developing countries have to work in much less conducive environment.
As a bystander, we often see these players treated as “dairy cows” that are continuously milked for taxes and hidden costs by corrupt governments. Nonetheless, they have become accustomed to this type of treatment and have so far managed to survive.
However, we fear that soon it will too difficult for them to face these widening globalization challenges on their own.
The appreciation of the U.S. dollar throughout 2013 impacted international businesses all over the globe and sent varying levels of shock waves to the different markets. The Euro’s appreciation against the dollar has been kept at a maximum of 6% so far, but the dollar’s exchange rates against developing countries went up by more than 25%.
As the most common currency used in international trading, such appreciation in the USD can be devastating. Indonesian spinners who have to import 99% of their cotton were put in a very difficult position, especially when their gross profit margin is roughly only 20%-25%.
The situation was worsened when sudden inflation hikes propelled labor unions – in what is a very labor-intensive industry – to demand higher compensation. In Indonesia, for example, labor demanded more than a 60% increase in wages.
With all these challenges – especially the absence of proper and fair government support – only a handful of companies that enjoy special privileges from government are able to thrive and grow stronger.
The big get bigger, the small gets smaller, and many companies are starting to lose their purchasing power. If this situation is allowed to develop much further, many companies in the textile industry will be in a dire situation.
Is Elimination the Goal?
The board game Monopoly, in which the ultimate goal is to eliminate competitors until one player hold a monopolistic rule over the board, has been popular for generations.
However, as much fun as it is to play the game, in the real world, it is a dreadful situation to be in. Monopolies are generally considered illegal in modern business practices. They create imbalance in the market by exercising price discrimination and distorting market interactions through the power to charge high prices as a seller or dictate prices as a buyer.
That type of dangerous situation is going to become a reality if the current situation in developing countries is allowed to continue.
In a country such as Indonesia, we already have many medium to smaller spinners who are either on the default list or are struggling with debts and daily operating expenses. If their numbers keep growing, it will become overwhelming and soon it may only take a single move by one major company to acquire and start a monopolistic reign.
This situation will be largely disadvantageous for us as cotton sellers because if we do not sell to this particular company, it might mean that we lose the opportunity to sell in the whole market completely.
In other words, we could be forced to accept whatever price the company insists on – or we don’t do any business at all.
The Difficulties of Direct Selling
The current trend of direct selling is not helping the situation. Direct selling from merchant to spinner could be a short-term solution for profitability. After all, every sector in the cotton industry took a beating these last few years. Cotton merchants in particular had to absorb considerable losses from many defaulters.
However, without the help of cotton agents, merchants typically concentrate only on larger-scale spinners who have high volumes.
There are obvious reasons why agents play a small yet important role in the cotton industry. Unlike merchants, cotton agents go all-out to sell to all sizes of spinners indiscriminately. Our focus is to sell horizontally to as many credible spinners as possible. Through professional discretion, cotton agents may compete and push to sell to medium or smaller – yet still financially capable – spinners that cotton merchants do not bother to even consider.
Such selling dispersion gives an opportunity for smaller and medium spinners to compete in the marketplace, as a group or as individuals, against their larger counterparts. This encourages a good balance of players in the market and thus ensures market competitiveness.
Furthermore, it provides an opportunity for a new, financially sound spinner or manufacturer to enter the market and grow. Even the ladder of a big corporation starts with a single rung, and it would be a waste of opportunity for the cotton industry if sellers only concentrate on bigger players.
As agents with a small role to play in this vast cotton chain, our voices may be inaudible to some. But if they can catch the ears of wise industry leaders and officials with influence, it would help maintain a healthy and competitive business environment for cotton. Whether this hope becomes reality or remains just a dream will depend on your wisdom. Truth only takes root in the minds of those with wisdom.
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