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Apparel Research Study & Analysis
August 2010
A Sound, Flexible Sourcing Strategy ast year at this time, the U.S. economy was in the midst of the longest recession in the post-World War II era with little hope of a recovery on the near horizon. U.S. unemployment was at 9.4 percent and consumer spending was down 27 percent in 2009 vs. 2008. Apparel imports were at their lowest dollar volume in more than 10 years, and as retailers continued to reduce costs and tighten budgets, the key themes of cost reduction and risk management were lifelines for companies struggling to stay afloat. Today’s picture is only marginally better — one of slow recovery, if one wants to even declare the economy is in a recovery. With the economic news varying significantly from day to day, it is not surprising that retailers are dizzy from the frequent shifts between optimism and pessimism. Unemployment rates are still uncomfortably high at 9.7 percent; and yet, consumer confidence has been slowly rising since February. Overall consumer credit increased 0.5 percent in April, while home starts declined in May to their lowest level since December 2009. At the same time, retail same-store sales increased in May to 2.7 percent, but this was still lower than expected given the far greater gains earlier in 2010. Analysts tie retail sales, consumer credit and housing together when evaluating the economy. With such mixed results in these economic indicators in recent months, even the most seasoned sourcing professional is left wondering how to operate in this turbulent environment. As resilient as apparel companies can be, what specific sourcing activities are companies taking to help them manage in these uncertain times?
L
The results of this year’s Excellence in Sourcing survey focus on the impact the economic uncertainty is having on sourcing strategy and the emphasis placed on cost reduction and risk management. The analysis examines the course corrections being taken, and which levers are being pulled as apparel sourcing executives seek to ensure on-trend products make their way to stores at expected quality and cost levels to meet consumer demand. This year’s survey investigates these themes, offers sound suggestions and identifies forward-looking opportunities for apparel companies to consider as they navigate through this uncertain economic environment. Survey Methodology and Respondent Profile The sourcing survey was comprised of 40 questions covering sourcing activities from the post-product development stage to delivery at the final destination. Survey respondents break down as follows: 440% Retailers and 60% Manufacturers 481% of respondents work in corporate operations, product development or sourcing/procurement 425% of responding companies have greater than $1 billion in annual sales volume 447% of responding companies have less than $100 million in annual sales volume 458% of the responding companies have a centralized sourcing group in their home country or corporate headquarters, while 40% are split between having separated sourcing by division in their home country or using agents/other external partners.
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Apparel Research Study & Analysis
Additional Pressures Facing Apparel Sourcing Executives Apparel imports continue to rise slowly, now exceeding 2009 comparable months but not yet reaching 2008 levels. Trade legislation and free trade agreements (FTAs) are as important now as ever for identifying new sources of supply or new regions in which to conduct business and support the successful execution of sourcing strategies. FTAs will continue to evolve in the year ahead and organizations must navigate through the ever-changing landscape to identify sourcing opportunities. At the time of last year’s article, FTAs with South Korea, Panama and Colombia were a constant in the news and the effects of these agreements were yet to be realized. As this article went to press, those agreements were still stalled and not yet in Congress despite President Obama’s January 2010 State of the Union address calling for doubling exports in five years by strengthening trade relations with South Korea, Panama and Colombia. With China still commanding significant product volume, it comes as no surprise that its export policies were identified as the single most monitored trade legislation by survey respondents, followed by Latin American/Andean and Trade Preference with Vietnam (see Figure 1). In addition to trade agreements, fluctuations in commodity/raw material prices are significantly affecting global business — particularly cotton and oil. Companies having spent the past year focusing on cost reduction are now faced with rising cotton prices and fluctuating oil prices. According to current index reports, April 2010 cotton prices have increased in excess of 55 percent over April 2009 levels, further increasing the pressure to find additional low cost sources of supply. With the job outlook still causing consumers to question their purchasing decisions, the marketplace has seen retailers reduce inventory to protect their margins and reduce financial exposure until they are confident that a rebound is truly here and consumers are ready to open their wallets. With inventory turn rates increasing in 2010 as compared to prior years (see Figure 2), companies are now challenged with ensuring that their supply chains operate more efficiently in order to maintain these lower inventory levels. Historically, the common practice was to have a wide product assortment (size and styles). Today’s economy is trending in the opposite direction, toward smaller more targeted assortments for the consumer at the point of purchase. This trend causes concern for apparel executives as they worry about missed sales opportunities — a potentially devastating result considering the fragility of consumer purchasing and confidence. As a result of this apprehension, cycletime reduction will play a key role by delaying order 2 EXCELLENCE IN GLOBAL SOURCING
FIGURE 1 – 2010 Trade Legislation Being Monitored (% of respondents) Panama Trade Promotion Agreement 2% Other 2% AGOA Trade Preference 2% Korea Free Trade Agreement 4% Haiti (HOPE) 10% China Export Policies
45% Vietnam Trade Preference
14%
Latin America/Andean 20%
decisions until more accurate forecasts are available. Additionally, sourcing executives will focus more on countries with shorter lead-times to be able to react quickly should the inventories run lower than demand. Success will depend on robust, flexible planning capabilities that will maintain inventories at a constant level to avoid stock-outs. What This All Means for Sourcing – Key Sourcing Trends Given the uncertain macroeconomic environment over the past year, what does this mean for sourcing? KSA’s analysis shows that sourcing organizations are being challenged to identify how best to source product and still meet stringent product and cost expectations. FIGURE 2 – Inventory Turns (% respondents by year)
<2007 <2008 <2009 <2010
<1.0
1.1-2.0
2.1-4.0
4.1-6.0
Inventory Turnover Rate
6.1-8.0
>8.1
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Apparel Research Study & Analysis
While cost reduction and risk management were major areas of focus in 2009, this year’s survey respondents indicate that their organizations are increasingly questioning whether to outsource sourcing activities, in part or entirely. As part of this process, organizations will continue to analyze their sourcing vendors and regions to make sure performance across various metrics (cost, lead time and quality) meets expectations. Lastly, organizations also are examining their current internal sourcing skills and capabilities to ensure they are flexible enough to succeed in this difficult environment — especially when headcount budgets are under significant scrutiny for reduction and workload certainly isn’t reducing at the same rate. The Decision to Outsource Sourcing The need to raise cash, reduce fixed costs and manage mounting supplier complexity is forcing retailers to consider outsourcing their sourcing activities to agents. The decision can be a monumental one. If it isn’t done with a clear understanding of how to manage product development and supply with a new partner, a retailer can find itself locked in a deal that may result in higher product costs or longer lead times. Comprehensive due diligence is necessary for retailers to turn the use of a sourcing agent into a marketplace advantage. In the past few years, KSA has found that about a quarter of its clients were working with agents for some or all of their sourcing programs and that the success of using agents for these retailers was directly linked to their ability to clarify their sourcing strategy, establish the right sourcing operating model and optimize their side of the relationship. Strict attention to product costing is required to ensure all costs (e.g., material, trim, labor) are in line with budgets and expectations, resulting in appropriate commissions earned by agents. Additionally, robust vendor identification and management is required in order to give retailers confidence that their agents are utilizing vendors in line with their overall sourcing strategy while at the same time achieving target costs, product quality and delivering products when and where expected. Putting sourcing into someone else’s hands runs the risk of additional delays and missed handoffs, especially if both organizations lack the technology to link their systems and product development processes. To ensure an effective and efficient working relationship with an agent, appropriate due diligence is required, including selecting the appropriate products, processes and approvals to transition to agents. Products that are critical to a retailer’s brand are less likely candidates for outsourcing. Similarly, processes where in-house expertise or product knowledge drives marketplace distinction and advantage are less likely candidates to turn over to agents. 4 EXCELLENCE IN GLOBAL SOURCING
Products bring customers in the door, both physically and virtually. A sourcing relationship that goes sour can have a devastating impact on a business. In light of the magnitude of what’s at stake, KSA strongly believes that turning over sourcing to agents is a board-level decision. Successful deals would include the following: 4Specific performance expectations along with agreed upon quantitative and qualitative performance metrics. 4Clear definition on which organization executes what activity. 4Optimizing the potential financial and strategic benefits without putting the product offering at risk. Implication to Sourcing Strategy Creating and executing a solid sourcing strategy has always been the backbone of the sourcing function. To ensure success in the current economic environment, the elements within a sourcing strategy and the approach and tactics used during execution must be flexible. This means potentially altering the strategy from previous years. Otherwise, sourcing will struggle to realize its stated goals. Survey respondents agree that intense cost
Apparel Research Study & Analysis
FIGURE 3 â&#x20AC;&#x201C; Risks to Sourcing Strategy 41%
Increase in source country labor costs
39%
U.S. economy/domestic consumption
28%
Depreciation of U.S. dollar
19%
Supplier capability/capabilities
17%
Potential trade agreements
16%
Stability of countries/regions
14%
Financial viability of supply base
11%
Product quality/recall risk
reduction focus areas must be adopted in order to incorporate long-term growth opportunities and ensure that product quality and time-to-market are not sacrificed while achieving cost targets. Survey respondents recognized the immediate need for risk management during tough economic times and indicated it will remain a significant area of focus. Of the major risks that sourcing operations need to proactively manage (see Figure 3), the No. 1 risk from survey respondents was increased labor costs. Increases in labor costs are forcing sourcing executives to seek out less expensive labor countries (such as Vietnam and Bangladesh) to provide products at expected quality, time-to-market and cost. Other significant risks to sourcing strategy include the U.S. economy and depreciation of the U.S. dollar, the latter of which drives costs up across countries whose currency is strengthening. FIGURE 4 â&#x20AC;&#x201C; Future Sourcing Regions (% of respondents) Thailand 2% Indonesia 2%
Other
3%
South Korea 2%
Americas/ Central America
13%
Sri Lanka 3%
Sub-Saharan Africa
Middle East & Turkey
10%
5% Pakistan 5%
Vietnam
10%
Eygypt 5% Haiti 5%
Bangladesh Cambodia 6% India 8%
10% China (includes HK)
19% 6 EXCELLENCE IN GLOBAL SOURCING
These risks are forcing sourcing teams to rethink their vendor matrix and their penetration in various regions. The changing global landscape, increased labor costs and future trade legislation are all factors when choosing a region from which to source product. Generally this will result in a more balanced or risk-averse portfolio of sourcing options. Survey respondents indicated China and South Asia as regions with a significant percentage of product purchases, representing 47 percent of current product purchases. However, Central America, Vietnam and Bangladesh are the top regions under consideration for future sourcing (see Figure 4). Most companies considering Central America are looking to reduce lead times and create the requisite flexibility to quickly respond to product or inventory needs. When considering new sourcing regions and partners, it is important to prioritize the many short- and longterm sourcing objectives (e.g., cost reduction, enhanced quality, execution capabilities) with the strengths and capabilities of the new partner. Overall, survey respondents indicated that similar to 2009, the top factors to consider when choosing a sourcing partner are cost and quality, (see Figure 5). This year due to the economic challenges, lead time significantly increased in importance whereas product development/execution capabilities, critically important in 2009, dropped off significantly. The increase in lead time is important to note, given that the shorter the lead time, the greater the ability to delay product and purchasing decisions, which ultimately drives improved vendor production efficiencies and lowers the resulting inventory. As a result, products offered to consumers will be more closely aligned to designer and consumer demands. The factors for choosing a sourcing partner mirror the results of metrics that define success for the sourcing function (see Figure 6). Quality improvement and
Apparel Research Study & Analysis
FIGURE 5 – Factors for Choosing a Sourcing Partner/Region (% respondents by year)
<2010
40
<2009
<2008
<2007
35 30 25 20 15 10 5 0
Cost
Quality program
Lead time
Social compliance
Mature region/history
reduced lead time remain the top two metrics, similar to 2009, and have increased significantly in importance from the previous year. Delivery performance, although still a top metric, dropped slightly and is now in line with cost reduction in terms of importance. With 100 percent of the companies surveyed responding that their organization has undertaken an overall cost reduction effort in the past year, the increase from 2009 to 2010 comes as no surprise. As a result, sourcing must use a balanced approach that incorporates the emphasis of each of the top metrics (quality, lead time, delivery and cost) to manage its performance as well as managing its relationships with its key vendors.
30
Raw materials access
Trade preferences
Other
Financial terms PD/execution capabilities
Implication to Internal Sourcing Capabilities Sourcing departments, after struggling through 2009, are being forced to figure out how to do more with less, particularly given the organization-wide scrutiny being placed on headcount and the fact that workload will not reduce anytime soon. Slowly but surely, sourcing executives are realizing that current staffing levels are becoming the ‘new norm’ and will not return to prior staffing levels anytime soon. Efficiencies realized in turbulent times will be expected to remain —– both in the supply chain (reduced cycle times and costs) and in headcount (doing more with fewer resources). Survey respondents who have undertaken a cost reduction effort are seeing
FIGURE 6 – Top Metrics that Define Sourcing Success (% respondents by year)
<2009
<2010
25
% of respondents
20
15
10
5
0
Quality Improvement
Reduced Lead time
8 EXCELLENCE IN GLOBAL SOURCING
Delivery Performance
Cost Reduction
Increased Margins
Improved FOB$
Pricing/IMU Improvement
Improved Inventory
Lower Risk
Apparel Research Study & Analysis
FIGURE 7 – Cost Components Captured (% respondents) Fabric
67%
Trim
66%
Packaging & Labeling
64%
Duties & Taxes
52%
Factory Overhead/Markup
47%
Washing & Finishing
44%
Packing Charge
41%
Inland Transport to DC
39%
Transport to Import Port
39%
Insurance
38%
Landing charges
36%
Belt & Embroidery
36%
Vendor Overhead/Agent Commission
34%
Entry Customs Clearance Charges
34%
Hanger Cost
31%
Yarn
31% 30%
Freight to Export Port
28%
Finance Charge
17%
Deconsolidation
14%
Hanger Duty Other
5%
an average sourcing cost savings of 3 percent to 6 percent. Their challenge will be to sustain the momentum gained in cost reduction — with the remaining sourcing resources having the requisite cost management expertise — without sacrificing product quality and lead time. These companies are addressing the importance placed on cost management by supplementing their current capabilities with additional deeper costing, quality and product capabilities. As expected, the majority of companies surveyed are capturing fabric, trim, packaging and labeling along with duties and taxes during their costing process (see Figure 7). However, companies looking beyond today’s costs are also capturing factory overhead and mark-up, washing and finishing and packing charges. Once cost components have been captured, sourcing organizations are sharing results with other functions within the organization (e.g. design, product development, merchandising) to educate and collaborate on cost tradeoffs and using the cost components to negotiate top-line costs with vendors. These cost components are critical to ensure that decisions on product design meet margin expectations prior to line approval — for example, identifying the cost implications for selected trim and 10 EXCELLENCE IN GLOBAL SOURCING
fabric. In addition, having a cross-functional discussion on cost components will help improve vendor efficiency by reducing reworks and improving approvals to product specifications. The majority of the survey respondents are capturing costing components via a PDM/PLM system or an integrated template with other forms/templates. This is a key opportunity to improve costing capabilities given almost one in five respondents indicated they capture cost components manually. Conclusion This year has proven to be an exciting yet challenging one — especially for those who forecast the economy and attempt to predict the future. For apparel sourcing executives, attention and focus is best placed not on the various economic reports and whether housing starts have recovered to prior levels but in keeping an eye on how flexible their sourcing strategy is and how sound their sourcing execution is to accommodate such uncertainty. As first century Roman philosopher Seneca, said, “Luck is when OPPORTUNITY meets PREPARATION.” These words still ring true today, with sourcing using its preparation to help organizations seize future opportunities.
Apparel Research Study & Analysis
ABOUT THE AUTHORS Alan S. Pincus Senior Manager, Kurt Salmon Associates alan.pincus@kurtsalmon.com Alan Pincus is a member of Kurt Salmon Associates’ (KSA) Retail and Consumer Products Practice with a focus on product development and sourcing. He has almost 20 years of experience helping consumer products companies address their most significant product development and sourcing issues. Alan has worked with many clients to realize significant quantitative and qualitative benefits in establishing effective sourcing/category strategies, improved strategic sourcing process and organization redesign, improved vendor management, enhanced supply chain collaboration as well as improved sourcing and supply chain systems utilization via package evaluation, selection and implementation. A resident of Succasunna, NJ, Alan works from KSA’s New York office.
ABOUT APPAREL MAGAZINE Apparel magazine has been the industry’s leading publication for 51 years. It offers technology and business insight from concept to consumer, providing competitive, actionable information to executives representing the world’s most successful apparel brands, retailers and manufacturers. Apparel’s targeted content addresses Retail Intelligence, Supply Chain, Sourcing & Logistics, Concept-to-Spec and Fiber-toFabric. An Edgell Communications publication, Apparel also produces Apparel’s Sourcing Summit, the Apparel Executive Forum, Apparel’s Tech Conference, Apparel’s Tech Conference West, apparelmag.com and numerous web seminars, research reports and newsletters.
Amy L. Burns Senior Analyst, Kurt Salmon Associates amy.burns@kurtsalmon.com Amy Burns is a member of KSA’s Knowledge Research Services. With more than 10 years industry experience, she has worked with leading retail and consumer products manufacturers to conduct market analysis, benchmarking and best practices in product development, sourcing and supply chain strategy. Amy was instrumental in the development of and actively manages KSA’s product benchmarking database. She is a member of the Society of Competitive Intelligence Professionals (SCIP). A resident of Villa Rica, GA, Amy works from KSA’s Atlanta office. Kristie L. Tippner Senior Consultant, Kurt Salmon Associates kristie.tippner@kurtsalmon.com Kristie Tippner is a Supply Chain Management professional with more than 10 years industry and consulting experience in the product development and sourcing areas. At KSA, Kristie's work has focused on consumer product categories in product development and sourcing. She has helped clients realize benefits through cycle time reduction, raw material planning, vendor management, organization design and integration of product development and sourcing processes.
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EXCELLENCE IN GLOBAL SOURCING
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