The collapse of the Rana Plaza garment factory in April has apparel executives concerned about rising costs next year, according to a Cowen & Co. survey of 15 executives and agents. Apparel unit costs have been declining since 2012, but many of those surveyed expect an increase in the low-single-digits next year. Over two-thirds of respondents are anticipating higher costs, and 20% are expecting high single-digit increases.
The biggest headwind for apparel sourcing is rising labor cost, according to 56% of respondents. China has had a 61% compounded increase over the last three years, and most countries in Southeast Asia have seen steady and substantial increases, even in low-cost markets like Bangladesh.
Compliance costs were cited by 33% of executives, including the need to reduce and regulate subcontractors. Those subcontractors, who have been increasingly important in the fast-fashion driven apparel export market, often operate outside regular safety controls. They allow big, compliant factories to parse out large orders to smaller, uncertified makers, facilitating lower costs. That trend is being challenged by the spate of recent disasters at uncertified factories.
John Kernan, a Cowen analyst, said, “Manufacturers are increasingly subcontracting unit orders to factories that are not approved by American and European retailers to manufacture goods. Changing compliance is likely to raise the pricing matrix in those regions, whose unit costs can be 20% to 30% cheaper than China. As manufacturers are forced to reduce subcontracting, there could be order delays and higher costs surrounding the need to airfreight goods.”
Retailers in Europe and the U.S. have committed to improve factory safety. An agreement signed by most European retailers and a few Canadian and U.S. companies will require factories to share the cost of safety upgrades and third-party compliance. A separate agreement, spearheaded by U.S. companies, would not require firms to pay for safety upgrades or independent compliance. Instead, it would strengthen current commitments and spend a small amount of money on safety training in factories.
Both agreements could add significant costs to the bottom line for firms, as they are forced to share the burden of performing upgrades at factories that they don’t own. The costs, in the retailers’ estimation, will be balanced out by the guarantee that their brand will not be associated with a devastating fire or building collapse.
Profit margins may suffer, as intense industry competition for shoppers has made it more difficult for retailers to raise prices. At the sourcing level, the illegally subcontracted factories may have allowed prices to fall below the actual cost of compliant production, putting some firms in a bind. Gross margin expansion may be at risk, according to Kernan. If demand fails to keep up with inventory increases, retailers will have significantly less room for discounting, making inventory management critical this season.