With cost increases across materials, shipping and labour, are rising prices the only way for retailers to protect profit?
The rising price of cotton has been front of mind for fashion retailers for months, but it is not the only business cost that is soaring.
Labour costs in the Far East are rocketing, too, as is shipping. As retailers hunker down for continued tough trading next year, there are fears that all these factors may combine to create a cost crisis, putting hard-pressed retailers under even greater pressure.
Labour costs have jumped, particularly in China, over the past year. UBS economists say there has been a 20% wage increase across many Asian countries in 2010 and they expect a further 20% next year.
Wages rose after many workers were laid off at the peak of the economic crisis as Western companies reduced demand, and factories were simply not equipped to cope with the resurgence in orders they booked in 2010. Many migrant workers who returned home have been reluctant to work in factories, and demand is so high that workers can command greater salaries.
New Look chief operating officer Will Kernan says increasing labour costs are an even bigger worry than escalating raw material overheads.
“Cotton prices will rebalance themselves but it will take time. Farms in the US and India are vastly increasing as demand increases,” says Kernan.
“What’s more difficult to account for is the wage increases in the Far East. At the moment, more than half of our stock comes from the Far East and the rest is in Europe and the UK.
“We are looking at playing with those balances so we are not so reliant on the Far East. We are also looking at some new emerging markets that weren’t there three years ago.”
Many leading retailers have already moved production because of wage rises in China. Debenhams has shifted some of its production to Vietnam and Bangladesh. A director at one international logistics firm confirmed the relocation trend.
There has been a big rise in output from rural northern China, where it is still possible to trade advantageously as it is less developed than traditional centres in the south and on the coast.
Manufacturing hot spots are also emerging in countries such as Bangladesh, Cambodia, Mauritius and Sri Lanka. However, rising labour costs are not limited to China.
One fashion chief executive says: “It’s not just a problem in China. Labour is rocketing across Asia. China raising its prices is a clear signal to other countries they can follow suit.”
Social unrest has erupted in some places as workers petition for a higher minimum wage. Bangladesh, where recently the rate has almost doubled, is one prominent example.
In the aftermath of the recession the delivery of goods has also become costly and difficult to organise. Freight costs plummeted after the financial crisis hit in 2007, driving many container vessels out of the market.
Grant Liddell, retail director of logistics firm Uniserve, says now business is back, a shortage of ships has resulted in a carriers’ market. Retailers are experiencing hefty 85% rise in prices and that is likely to get worse.
“Some shipping lines and carriers are parking up vessels and pulling off services,” says Liddell. “This operates like a commodity market and forces pricing up due to the supply and demand balance. The shipping lines, and to an extent, airlines, control the supply and then push up pricing.”
Further price increases of as much as 20% - termed rate restorations - are likely to be imposed from January 1, cautions Liddell.
Retailer frustration has become increasingly obvious. In August it emerged that Argos had filed a claim against Maersk Line. Argos accused the shipping company of reneging on a contract to ship 5,000, 40ft containers from the Far East to the UK and attempting to impose a “unilateral” three-fold price increase.
The £8m claim came after Maersk Line increased rates between the Far East and the UK, the Far East and west Africa, west central Asia and Europe and on transatlantic routes.
Additionally, many shipping lines have persisted with so-called slow-steaming, a reduced speed of travel implemented at the height of the fuel cost spike. Ships are still on a go-slow on many key trade routes, and some retailers have had to transport more goods via air - a costly option.
Such costs are on top of cotton, which is in short supply because planting was cut back when prices were low. Natural disasters such as the floods in Pakistan and droughts in Russia have compounded the situation.
As retailers have moved away from cotton where possible, demand has soared for other materials leading to a rise in their costs. One Chinese textile manufacturer told customers last week that rayon had soared by 80% and polyester by 70% over a three-month period. The Zhejiang-based manufacturer said its yarn supplier could simply not get the raw fibre, even when full payment had been made.
The short supply is exacerbated by the boom in domestic demand. The economies of China and India, two of the world’s largest textile exporters, remain buoyant and manufacturers have seen a surge in local orders.
China’s new five-year plan, which comes into force in March 2011, aims for double-digit growth in domestic consumption over the period, suggesting this trend is likely to continue.
Rising business costs will also come head-to-head with an increase in VAT next year, leaving retailers wondering how to minimise price increases.
Singer Capital Markets analyst Matthew McEachran says some retailers are trying to curtail overheads by moving production to Europe. Static labour costs and lower transportation rates have resulted in a revival of Turkey’s textile industry. However, less developed infrastructure holds the risk of unreliable delivery and delays to production, which could be perilous to fast-fashion retailers.
Kernan says New Look has pushed out some lead times for cost purposes, although it has managed to shorten others from European production centres.
He says the retailer is searching beyond its supply chain for savings. “We have been looking at staff hours profiling, which improves service levels. We are looking at procurement costs, and making our space work harder in stores,” he explains.
Product over price
Retailers are also being urged to make the most of their buying power to control costs and ensure they have a super-efficient supply chain. Centralised purchasing and consolidating shipping orders can help mitigate these costs according to some in the industry, but McEachran is unconvinced - such measures are already commonplace, he says.
Retail price rises are inevitable according to McEachran, who says that fashion retailers will increase prices by between 5% and 10% to offset inflation. UBS economists agree and forecastbetween a 3% to 5% pre-VAT increase will be required to maintain cash gross profit and a 10% rise to maintain gross margin.
Some well-known retailers have already warned of price increases. Next chief executive Lord Wolfson said an 8% hike would be introduced next year to protect profits. He pointed out that the fashion retailer stood to lose £60m profit if it did not pass the spiralling cost of production on to its customers. New Look has also predicted a rise of between 6% and 8% on price tags and Debenhams predicts 4% to 6%.
So it seems clothing retailers are likely to impose the first big price rises since the early 1990s. But some in the industry think that is not necessarily a bad thing.
“A meal you would have paid £20 for 18 years ago would cost £40 now -the same does not apply in clothing,” one fashion executive says. “Price increases have been coming for a while. You can’t have 18 years of cost depreciation.”
An ICM survey conducted on behalf of Retail Week revealed that 92% of the 2,038 polled expected a rise in prices next year. Yet positively for retailers 57% of those asked thought that current prices on the high street represented good value for money.
To justify increased price tags retailers are focusing on adding value to garments. River Island said it would add more design detail into some items to justify slightly higher price points where appropriate. Some, such as Marks & Spencer, will maintain entry prices and New Look intends to maintain those of some core lines.
Many observers and industry insiders feel fashion retailers are united in the belief that it is product rather than price that sells. Some even wonder whether changed circumstances could prompt a renaissance in British clothing manufacturing.
Gifi Fields, founder of fashion design and supply company Coppernob, says: “Great product and speed to market proved to win the day in the early 1980s. The level of imported inflation should open the way for a resurgence of British manufacturing as demand in the developing world of Turkey, China and India outstrips supply. On the whole, flexibility and quick response are not in their DNA in any case. UK manufacturing is one area we have been looking to expand.”
Whether large scale production can ever return remains to be seen but what few would dispute is that when prices go up, shoppers need to be convinced of the value and quality of the product.
“At the end of the day the most important thing is compelling product,” says Fields. McEachran concurs: “The better retailers know it’s about product first and price second. You can afford to put prices up if you have a fantastic product.”