Costing might seem like something that should come as common knowledge for apparel companies, but many aren’t well versed in its inner workings or the implications that changes to things like trade policy and tax reform would bring.
“There’s a huge gap in most of our companies—especially at the headquarter offices—when it comes to understanding the nuances of costing,” Ed Gribbin said at Alvanon’s Apparel Costing Insights in an Uncertain World workshop, hosted by Sourcing Journal in New York City last week.
And understanding those nuances is now more pressing than ever.
The industry has been dealing with deflationary apparel prices for so long that there’s been little pressure on companies in the sector to overly concern themselves with costing.
“People at brand and retail headquarters are focused on getting an IMU [initial markup], so if I get my margin I’m not going to worry about the rest,” Gribbin explained.
But now that the customer owns retail rather than vice versa, every point along the supply chain is vital—and not just product relevancy and to time to market, but things like costing wider fabric versus narrow fabric or darker colors over lighter ones.
“When you’re thinking about the granularity of costing, you’ve got to turn over every stone,” Gribbin said.
Apparel Costing 101
Costing is about grasping the basics of what goes into a garment and how trade-offs in materials, labor or location can affect desired outcomes. Knowing this and knowing it well, is what gives companies a leg up in negotiating with suppliers and agents.
Fabric, trims, embellishments, labor and local freight to port are the key elements of an FOB cost, and fabric is typically the most significant portion, accounting for as much as 65 percent. That’s why considerations like fabric content, construction, weights and yarn counts are key to keep in mind. Naturally, markers should be laid out to achieve maximum efficiency and minimize fabric waste.
The ever-emphasized IMU is also a critical component of a retailers’ financial plan. It has to be sufficient to cover the cost of running a business, meet projected profit targets and also factor in any necessary promotions, markdowns or closeouts that could happen once the clothing hits the store or the distribution center. Promotions and markdowns deplete IMU by 35 percent, on average, today—which ultimately weighs on margins.
“Cross functional teams all have input into controlling IMU. The team’s goal has to be the most cost effective garment that retains the intrinsic value of the style and maintains the brand’s overall value,” Gribbin said. “When I first started in the industry, cost was driving price. Today it doesn’t work that way. The price should reflect the perception of value to the customer. It’s related to the product position, the brand strategy.”
If you have cost-led pricing, Gribbin went on, product tends to be automatic, uninformed and rigid. Price-led costing, on the other hand, enables value because it not only requires more effort and thought, but yields better business results.
But costing goes beyond just those considerations, and thinking about how trims and embellishments and processing and freight costs and duties all play in.
“There’s more to costing than chasing the lowest FOB vendor,” Gribbin said. Innovation will have an impact on costing decisions, and getting the product to the customer significantly faster also carries its own value. “There’s very little markdown at Zara because of its 80 percent full-price sell-through. Speed is more important to them so they can afford to pay for everything air freight.”
Tax reform implications for costing
The Republican-proposed “A Better Way” plan for tax reform includes the much bemoaned border adjustment tax, and if that tax takes effect, retailers could face a whole new set of substantial costs.
Under the proposed plan, the corporate tax rate would fall from 35 percent to 20 percent. What’s more, companies wouldn’t be able to deduct the cost of imported goods from their taxable income, which will send tax bills soaring.
With the current tax law, sales of $10,000 less $5,000 for imported goods and $2,000 for labor would result in a $3,000 profit, which, when taxed at 35 percent would yield $1,950 in after-tax profit. With the proposed border adjustment plan, that same $10,000 in sales, with the same costs for imported goods and labor, would still result in a $3,000 profit but the taxable income would be $8,000 since the cost of goods can’t be deducted. With a 20 percent corporate tax, that means after-tax profit would be a much lower $1,400.
“It will cripple most apparel retailers and brands,” Gribbin said. “It’s going to affect how we decide where we’re going to source product. Big time.”