Elizabeth Holmes at the WSJ explains how apparel retailers like Coach (NYSE:COH), Guess (NYSE:GES), and Ann Taylor (NYSE:ANN) are starting to look around Asia for sources of low-cost labor as wages in China grow in the low-double digits.
That prospect has sent retailers scrambling to find new ways to reduce production costs. If they fail, they will have to absorb the higher costs, battering their margins, which have just begun to recover from the recession. Or, they could pass the costs along to consumers, a risky move at a time when shoppers are beginning to regain some of their appetite for spending.
A New Day for Labor
It is a sucker bet that this is going to get worse, and fast. Labor relations in China have entered a new era over the past month. The Foxconn suicides and the Honda (NYSE:HMC) strikes, resulting as they did in significantly improved wages, look to be the impetus of a wave of copycat labor actions around China.
And why not go out on strike? The past four years have proven that China’s supply of labor, while large, is not bottomless. Workers are starting to feel like they have less and less to lose, and the government, determined to nip any public display of discontent in the bud, is siding with the workers in a growing number of these cases (particularly those involving foreign or non-Mainland-based companies.)
This could all peter out, or we may witness a massive increase in labor actions, with the result that 2010 could witness not just a significant increase but a large jump in labor prices.
The Only Substitute for China?
At the moment, there aren’t many ready alternatives for the schmatte business. Indian labor is even more expensive than China’s, and transit times (and costs, as fuel prices rise) add to prices. Vietnam is limited in what its workers can do with a piece of fabric. And Mexico is most notable in the article by its absense: one can only assume that the escalating violence and unrest in the country’s border regions are making buyers in the rag trade say “maquiladora” with much less excitement than before.
You would expect Li & Fung’s Rick Darling to deliver the money quote: “The only replacement for China is China.” And for now, he’s right. But that will change, and despite the protestations of China’s leaders that they want to lead the nation out of the realm of low-end work like textiles, in truth China wants and needs to keep the mid- and high-end apparel industry right here at home.
In the near-term, this is going to mean that the industry will migrate to the west and north of China as long as shipping costs and transit times are held in check. That’s not a given for China: the expense of moving products manufactured in China’s interior to a major seaport can make up as much as 40% of the products FOB cost, and physically getting the goods to port can be time-consuming and fraught with delays. The nation is building superhighways and railroads to help address those challenges, but we are years away from a time in which it is as easy (and fast) to move a container of goods from Gansu to Shanghai as it is to move that same container from Seattle to St. Louis.
Eventually China will fix the logistics problem, but in the meantime I am betting that we have found the bottom for apparel prices in China, and those prices are about to start rising. I also think we are on the cusp of a major restructuring of the industry in the PRC based on several trends:
- Consolidation among manufacturers, leaving in place those with appropriate scale and with the most efficient operational processes.
- A shift in focus away from exports and toward a greater emphasis on serving the local market.
- For manufacturers still focused on global markets, a renewed effort to move parts of the process offshore to Vietnam, Southeast Asia, Southwest Asia, Africa, or Mexico.
- Vertical integration of manufacturing to incorporate the full process from threads all the way through to branding and marketing (“looms to labels.”)
- A wave of new or enlarged domestic apparel retailers similar to Li-Ning, Zara, or Giordano who become the primary locus of domestic fashion design. (Expect design in China to be retail-driven, rather than following the European model, which is somewhat the other way around with its design houses and haute couture.)
- Government assistance (tax breaks, etc.) to manufacturers to relocate to rural, remote, or revitalizing parts of the country and away from higher-cost regions like Guangdong and the Yangtze River delta.
We have to be realistic: the China price will not sustain the apparel industry here, but Shanghai is not going to become Paris or Milan anytime soon. The industry in China is entering an awkward adolescence that could either kill it or see China become the fashion capital of the world. Getting to the latter won’t be easy, and it is still not clear that the industry – even with the above trends – is capable of getting there.
The easy days are over. The Chinese apparel business is about to grow up. Whether it will do so in time to remain the manufacturing capital for the global fashion retailing sector is another matter entirely.