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McKinsey Survey: Sourcing Costs to Rise

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The current debate in Bangladesh over the minimum wage underscores a worrisome trend for retailers globally: the costs of sourcing is certainly to rise in the near future. According to a new report issued by the McKinsey & Co., booming wages will be the principal mover of rapidly accelerating costs all along the supply chain.

McKinsey & Co. conducted a survey, entitled “Outlook on Expected Cost Development in Apparel Sourcing,” of twenty-nine chief purchasing officers who collectively oversee more than $39 billion in sourcing business, employed by companies in both the U.S. and Europe. Of these, 76 percent anticipate that the general costs of sourcing will rise an average of 1.7% and 14 percent think there will be increases that exceed 4 percent.

After years of enjoying industry wide deflation that helped to offset the progressively higher costs of doing business in China, sourcing seems to have arrived at a historic inflection point, poised to experience a protracted stretch of ballooning costs. McKinsey & Co. partner Achim Berg said, “We have now reached a tipping point and it will become even more difficult to keep consumer prices stable.”

The primary culprit behind the rising costs is labor. Once a reliable source of heavily discounted work, China’s expanding middle class, and the wages they increasingly demand, has transformed it into an expensive and sophisticated manufacturer. And especially with the newfound emphasis on social compliance following the Rana Plaza factory collapse, the costs of sourcing to bargain basement destinations like Bangladesh, Vietnam and Cambodia are widely forecast to go up.

Also contributing to the upward swing in price will be the increased cost of raw materials. Cotton prices have been aggressively climbing and no abatement of that trend is on the far horizon. Both polyester staple and polyester filament continue to become more expensive as well.

Sourcing executives will likely start to scour the globe for viable alternatives to costly China and politically risky Bangladesh. Problematically, there are no obvious choices cheap enough, sophisticated enough and capable of handling enough production capacity to soon emerge as obvious candidates. Cambodia and Vietnam have asserted themselves as inexpensive and technologically savvy, but can only absorb very modest capacity in comparison to China or Bangladesh. Many are attracted to Africa but that’s more a long term solution than short term strategy since they currently lack the infrastructure to be a major player. And there’s plenty of promise in India, Pakistan and Indonesia but only promise, still largely unfulfilled.

It is a testament to the growing desperation of Western retailers that they have turned their eyes to Myanmar, a diminutive nation historically cloistered by tyranny. Now suddenly open for business, Myanmar is too small, technologically rudimentary and  unskilled to buoy the spirits of sourcing executives. Berg addresses the prospect of Myanmar: “When we asked a similar question two years ago, Myanmar did not even show up on the list. Now Myanmar shows up as number four on the list. Myanmar will be on the map, but given where it is at the moment, with a relatively small number of factories, and an overhaul of the economic system…it’s going to take time. I doubt it will happen in that five-year frame.”

While both China and Bangladesh pose their own challenges to retailers, at least for now they remain unavoidable. “China is becoming more expensive and companies have become more sensitive about risk. Bangladesh will continue to be important and to grow despite the problems that have occurred there, and with the acknowledgment by the industry that conditions must improve.”

 

 

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