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How Garment Factories Are Vetting Customers During COVID-19

As COVID-19 ravages retail, factories are taking more steps to protect themselves from risk.

Historically, brands and retailers have held more of the power in the supplier-customer relationship, but that is changing courtesy of the pandemic. Recognizing the heightened potential for non-payment or client bankruptcies, factories are doing more due diligence to determine if a retailer is a worthwhile partner before taking on a purchase order.

“I’m not sure if it’s going to be a short-term or long-term change, but there will be an increased push towards strategic partnership between the suppliers and the buyers,” said Peter Maerevoet, global chief financial officer and senior executive officer of trade financing firm Tradewind. “At this moment, I don’t think the big buyers can expect their suppliers to do everything they want and then ditch them the moment things get tougher for the retailers or the brands. So, I think that suppliers have a little bit more power now with negotiations and in deciding with whom they work.”

One of the factors that has tipped the power toward brands and retailers in the past was the imbalance of capacity and demand. While some of the biggest manufacturers could be selective in who they worked with, most were left fighting over the same business, predominantly by offering better pricing than the competition. With many suppliers expected to disappear, this field of factories could be reduced.

“I think [the remaining factories] will be very careful in selecting customers; we see this already,” said Guido Schlossmann, president and CEO of sourcing group Synergies Worldwide. “There is a hesitation to basically bring onboard new customers, because…there is no history or relationship. And with regards to existing relationships, they definitely cherry pick the people to continue doing business with who have actually behaved during the COVID-19 period as a trustworthy partner.”

But as factories go out of business, so too will retailers. The pandemic has uncovered the financial instability of even the biggest retailers, as a string of companies succumb to bankruptcy. Many will be able to recover after restructuring, but some will disappear.

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“The most shocking thing that has emerged is that companies that are giants in retail are buckling under with a mere three months of chaos as a result of this pandemic,” said Ritesh Nair, co-founder and director of India-based manufacturer Iipi Sourcing. Nair added that due to these bankruptcies, quality customers are rarer, and he foresees  factories’ reliance on brands continuing.

Even if factories can’t afford to be picky, they are still going to change their approach.

At the top of the list is making sure that companies are actually able to pay for orders. Experts see suppliers conducting more thorough vetting to ensure that potential clients are financially credible by looking at their results, inventory numbers and payment history. Along with the suppliers themselves, banks and insurers are also expected to adopt a ramped-up review process.

“Almost any factory owner that I speak to, or have spoken to in the recent past, is very clear that they would rather shut the factory and sit at home than work with a customer where they don’t have a guarantee of payment,” said Nair.

Not all retail has been affected equally, and factories will be looking to work with the players that are faring better. In the current environment, that includes retailers with an online business and those who sell essentials such as food, per Schlossmann. Additionally, brands that reside in either the value or the luxury segment are typically seeing healthier performance than those in the middle of the market. Nair says an appealing brand partner would be strong in their category with a strategic business model.

“I think we’ll get to some kind of a polarization whereby strong brands and retailers will get strategic relationships with strong factories, and then the weaker brands and retailers will have to go to the weaker suppliers,” Maerevoet said.

Even though many retailers are publicly listed, it can be a challenge for manufacturers to gain a clear view on the financial health of a brand. HSBC’s Serai, a platform connecting fashion suppliers and buyers, is launching a solution that will make this information more easily digestible for factories by giving brands a simple color-coded rating.

“We’ve evolved into this really unhealthy equilibrium where the manufacturer carries all the risk,” said Vivek Ramachandran, CEO of Serai. “And that risk is mitigated with bank loans in some cases, but in many cases the manufacturers just carry that risk and work through that. And in good times, that’s a risk everyone’s happy to live with. But when there’s a shock to the system as we’ve had, that becomes a very expensive risk.”

After dealing with non-payment or delayed payment, suppliers also want to make sure they are not left with the financial risk.

“What we are seeing now is basically an increasing gap of what customers need in terms of payment terms, because they have been scrutinized in terms of their retail operations by the effects of COVID-19,” said Schlossmann. “And actually what the factory or the supplier is comfortable working with.” He noted suppliers are seeking out cash in advance, payment upon delivery or payment after inspection, while customers are increasingly after open account terms.

Factories are also seeking to mitigate risk by leveraging factors or trade credit insurance. Tradewind has seen an uptick in requests for trade finance due to the uncertainty surrounding payment terms.

Ramachandran sees the opportunity for the industry to shift to phased financing, where amounts become accessible to factories at specific stages in production, guaranteeing that they get paid in a timely manner.

“It’s no longer that all demand is good demand, and ‘I’m happy to deal with anybody on their terms,’” said Ramachandran. “Manufacturers are going to become more demanding on transparency into the financial strength and potentially insuring or financing the risks.”

Whereas before suppliers might have previously entered into a contract blindly, they are now scrutinizing terms and requesting additional protections. Schlossmann has seen an increase in the use of a retention of title clause, which enables the factory to hold onto goods until payment, even in the case of a retailer bankruptcy.

Another aspect that is coming into play is factories trying to circumvent restrictions on branded merchandise. As brands default, suppliers are seeking permission to sell their goods to third parties.

Rebuilding trust

Due to COVID-19, there has been a breakdown of trust between suppliers and their customers, which has been worsened by the fact that the parties cannot physically visit each other.

One step toward rebuilding the relationship is taking ownership of orders or paying for goods. After avoiding their invoices earlier in the pandemic, some retailers including Primark have committed to making good on their overdue debts to suppliers.

There is also the potential for partners to form long-term relationships. According to Maerevoet, ideally, retailers will be transparent about their financial forecast, while also outlining future orders to provide peace of mind for the factory that it will continue to be profitable.

Per Nair, potential new strategic alliances could include factories offering flexible payment terms and faster production to ease some of retail’s pain points.

“There is both the fear in the market, but there’s also optimism that there is a possibility for new engagements and new alignments to emerge between factories and retailers,” said Nair.