While a “phase one” trade deal between the United States and China may be “coming along very well,” according to President Trump Monday, it won’t yet roll back already in place tariffs the countries have imposed on each other, and it will do little, if anything, to appease the crippling uncertainty that has displaced supply chains and roiled the retail business.
As such, any plans to tariff-proof supply chains should continue as scheduled.
“It’s a moving playing field and one that presents a lot of complicated issues in terms of how you deal with it,” Harold M. Grunfeld, partner at GDLSK trade law firm, said of the current trade landscape during an interactive panel discussion at Sourcing Summit New York Thursday.
For many apparel and footwear brands and retailers, the reaction has been a slow and steady break up with China, with the hopes of embracing sourcing in other countries where the relationship might be less costly or contentious.
Mitigation by moving
Already, a live poll of the audience at the Sourcing Summit found 40 percent of companies saying they had less than 25 percent of their production still in China. Just 22 percent said more than 80 percent of their manufacturing remains in China. Over the next year, 35 percent of Summit attendees from major global apparel brands and retailers, said they plan to reduce their China sourcing by more than 50 percent.
Either way, as many companies have discovered, cutting ties is far from simple.
Michael Kors realized more than five years ago that keeping the status quo for its China sourcing wouldn’t be sustainable. And while the company has been able to cut the bulk of its handbag manufacturing out of China, footwear—where China still holds the lion’s share of expertise—has been a bigger challenge. Just four years ago, as much as 80 percent of Michael Kors footwear was still made in China.
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“By year end, less than 20 percent of our footwear will be made in China and hopefully in 2020 it should probably be down to about half of that,” Nathan Serphos, Michael Kors SVP of accessories and footwear production and sourcing, said.
However, he said, “It hasn’t been easy, particularly in footwear as footwear has been in China for a long time, they have it down pat. The sample rooms and the development centers are still in China and everything is contracted out to Cambodia, Vietnam, India, Bangladesh and the other countries.”
That means a lot more “handholding” and management, Serphos said, with a supply chain that’s less streamlined being manufactured in countries with less manufacturing savvy.
Naturally, Michael Kors has been testing the sourcing waters to see where else it can make shoes.
Ethiopia, despite the attention it has garnered for manufacturing in recent years, was a failed attempt.
“We’ve moved production to Ethiopia thinking that was a slam dunk duty free to the U.S., but it was a disaster and we moved away from that,” Serphos said. “You’re dealing with a lot of different parts, Ethiopian workers and Chinese manufacturers and how does that all come together, and it did not work for us.”
Michael Kors has, however, been successful in Cambodia and Vietnam, and is doing smaller production runs in India and the Dominican Republic, with Nicaragua next up for consideration.
“It’s again, just kind of mitigating the risk, but between Vietnam and Cambodia it’s still the largest portion on the footwear side,” Serphos said. “It’s just the scalability as well that you have to keep in mind.”
Both scalability and capacity have been among the key concerns with moving manufacturing to Vietnam—where the majority of surveyed Sourcing Summit attendees said their biggest sourcing partners are outside of China—and if you ask Michael Zakkour, CEO of China BrightStar and a consultant on China/APAC retail strategy, these pose a larger problem than the industry is prepared for.
“You can add capacity to Vietnam, sometimes successfully, sometimes not, but the bottom line is that there are no new roads, no new rail systems, no electrical grids, no new ports and the number of berths at the ports haven’t changed, which is why you end up with three-day lines of trucks coming from the country side waiting just to get to the port area,” he said. “Everybody wants to go to Vietnam but I guarantee you Vietnam is not going to double its population in the next five years. It’s not going to happen.”
Beyond Vietnam, the supply chain diversification isn’t made much simpler when its raw material supply means there is no altogether eliminating China.
“For final production and assembly, often you find that the component and raw material supply chain is still in China and so nor you’re going to have to…import your hardware and your fabric from China to Mexico just to make something,” Serphos said.
It’s a conundrum Michael Kors has encountered, too, which is why the company is investing in greater verticality for its non-China supplier countries.
“In Cambodia, we’re in the process of opening up a hardware factory so at least we can take that stress from the supply chain out of China,” Serphos said. “We’re opening up more tanneries in Vietnam and Indonesia and fabric mills…so at least we have more components localized and are not dependent on importing as much.”
Mitigation by valuation
For companies still in the early stages of their China scale-back, or for those that know going anywhere else isn’t really a viable option, there are more granular actions that could also have an impact.
Re-classification of your goods isn’t really one of them, however.
“It’s great to be able to shift from one category to the next, except you find the next category, in most cases, is also included in the 301 tariffs,” Grunfeld explained. “The real option if you’re in China is really all about valuation.” It’s about finding the first sale opportunity, he said.
First sale is a program designed to reduce the dutiable value of eligible products by paying them on the “first sale” rather than on the value of goods purchased from a middleman, which would include that middleman’s markup.
Whereas the factory of 40 years ago was often one room with an owner who lived and manufactured there, today’s factories are more sophisticated—and their costs are, too.
“They have marketing arms, they have financial arms, they have a separate department to acquire the raw materials,” Grunfeld explained. “Many of these things can be stripped out of the factory cost and before you know it you’re looking at potential…value reductions of 20, 25 percent, which at the [current] duty rates becomes a meaningful savings.”
One of GDLSK’s clients, which was doing $70 million to $80 million in business on an FOB basis with a factory in China, found that the factory had a second building with administrative, financial and other support staff, none of whom were doing production. So, they changed the structure of the company to reduce the valuation for the client’s product.
“We actually split the two companies apart and were able to create a first sale opportunity that moved a significant portion of the price out of the FOB value for customs purposes,” Grunfeld explained. “There are options and it really becomes an issue…of thinking out of the box, looking at your sourcing partners and determining what options may exist to at least ameliorate some of the effects of these 301 tariffs.”