Rising Cotton Prices

High Cotton
By: Lisa Horn, CAS
From the January 2011 issue of Promotional Consultant magazine.

As 2010 came to a close, the promotional products industry was breathing a collective sigh of relief as sales for the year continued to rebound from the bust of the 2009 recession. While overall demand for promotional products was up, there was one problem with supply: A global cotton shortage was threatening the price of apparel, the industry’s largest sales segment.

But rising cotton prices aren’t the only factor affecting overall apparel pricing; labor costs are also on the rise in Asia. The combination of these factors is creating a perfect storm that has resulted in increased pricing across soft-goods categories, from t-shirts and caps to bags and towels.

The Cotton Crisis
Severe weather played havoc on the cotton crops in 2010. China, the world’s top producer and consumer of cotton (more than 40 percent of the global harvest, in fact), experienced a severe drought that not only delayed planting as well as harvesting of cotton but also damaged the quantity and quality of the crops. The result, according to Customs General Administration figures, was that China had to double its cotton imports in the first eight months of 2010 to offset the losses.

And the losses were extreme. The U.S. Department of Agriculture reports that Chinese cotton production will have a shortfall of 17 million bales for the fiscal year that began August 1, 2010. Not only is this China’s 12th consecutive year with a deficit, but it’s also the lowest China’s stockpile has been since 1995.

Unfortunately, China wasn’t the only country with cotton crops in trouble. In August 2010, Pakistan’s Indus River flooded to levels unseen in the country’s history, and 30 percent of the cotton crops were destroyed.

But Mother Nature wasn’t the only unexpected force to effect cotton prices. In April 2010, India’s government restricted cotton exports in an effort to boost the country’s domestic supplies as well as protect itself against price increases. While the country began exporting limited quantities again in November, its strategy negatively affected the market outside India by further exacerbating the worldwide cotton shortage.

And here in the U.S., domestic cotton supply (more than 80 percent of which is exported) dwindled as farmers switched from cotton to more lucrative crops such as soybeans and peanuts.

Overall, the USDA estimates that global cotton consumption will exceed cotton stocks for the sixth consecutive year.

As a result, the Financial Times article “Cotton Prices Surge To 15-Year Peak” (September 2, 2010) reported that the average global cotton price would rise 15 percent in the year that began August 1 from the previous year, as the ratio of cotton stockpiles to mill demand falls to the lowest level in 21 years, according to the International Cotton Advisory Committee, an intergovernmental group.

With raw materials comprising anywhere from 25- to 50-percent of a garment’s cost, according to an interview with Andrew Jassin, managing director of retail consultant Jassin-O’Rourke Group LLC, in The Wall Street Journal (“Cotton Tale: Apparel Prices Set To Rise,” May 19, 2010), it’s unreasonable to think that apparel suppliers will be able to absorb the increases without passing along some of the costs.

The Labor Business
But raw materials are only part of the equation; labor costs play a significant role in price decisions. In the USA Today article “U.S. Prices Could Rise With Chinese Workers’ Salaries” (June 18, 2010), an Economist Intelligence Unit study indicated that labor can comprise up to a third of all production expenses in the textile industry. And these expenses are rising dramatically.

In the China Daily article “Companies Warned of Increasing Labor Costs in China” (June 10, 2010), Cai Fang, director of the Institute of Population and Labor Economics at the Chinese Academy of Social Sciences, said that “wages for 150 million migrant workers increased 19 percent in 2008 and 16 percent in 2009.” In 2010, “14 provinces and regions raised minimum wage levels, with the highest at more than 20 percent.”

And in November, Supply & Demand Chain Executive published the article “India’s Manufacturing Labor Costs Top China in 2010.” The IHS Global Insight study “Global Manufacturing Compensation Watch” was the basis of the story, which indicated “manufacturing labor costs in India have risen nearly 20 percent this year and will eclipse those in China as Indian workers have seen their wages increase sharply over the last year on the back of high inflation and a recovery in domestic demand.” One significant reason for the steep increase is from the rise in benefits, which comprise roughly 36 percent of Indian wages and 27 percent of Chinese wages.
Additional Factors Shaping Price
Jeremy Lott, vice president of sales, marketing and purchasing for Issaquah, Washington-based SanMar (UPIC: SNMR), says it’s been a remarkable year for pricing, but there’s more to the situation than cotton shortages and labor issues.

“Coming off 2009 and the recession, there was a lot of capacity taken out of the world of production because many sewing factories, yarn manufacturers and textile companies went out of business,” he says. “Additionally, there has been a very significant resurgence in demand that has taxed the existing capacity.”

But this revival in demand isn’t limited to the U.S. “A big piece of the demand has come from China, India and other parts of Asia whose economies are growing significantly,” Lott says. “The overall demand is quite robust when you add up the return of sales in this country and the jump in demand from the ‘local’ Asian market. All of these factors are leading to higher textile costs across the entire supply chain.”

A New Price Structure
If raw materials make up 25 to 50 percent of a garment’s cost and labor adds another 30 percent, then there’s only 20 to 45 percent of the price available to cover transportation, product safety testing and any other incremental costs—and that’s before a profit margin is factored in. Clearly, suppliers have little room to absorb rising costs before losing money. There is no other choice but to increase prices.

In the article “Cotton Shortage = Pricey T-Shirts And Jeans” (September 9, 2010), Ilse Metchek, president of the California Fashion Association, a nonprofit group representing the state’s apparel and textile industry, told CNN/Money that consumers should expect to “add $2 to that $12 t-shirt next year.” And she notes even steeper price increases once higher labor wages are factored in to the overall cost analysis.

An October, Los Angeles Business Journal article reported that American Apparel (UPIC: AMER9421), which produces nearly one million garments a week for both retail and wholesale use, has experienced increases in production costs to the tune of $250,000 each week for several months. While retail prices had remained stable at the time, CEO Dov Charney told the Journal that wholesale prices had been raised three to five percent.

SanMar’s Lott notes that the major t-shirt mills that support our industry—Anvil, Fruit of the Loom, Gildan, Hanes and Jerzees, for example—raised prices twice in 2010, approximately five percent each time, and another increase in early 2011 is possible.

While the classic white t-shirt fell as low at 80 cents per shirt in 2007, the exact same shirt is selling closer to $1.40 at press time. “This is a very significant increase from where we were just a few years ago,” Lott says. “But the reality of the situation is that at some point the cheapest labor has been found, the trade barriers have come down and there is no new technology available that saves a significant cost in the process. Manufacturing a shirt isn’t fully automated; there’s still a person involved that must be paid. At some point, the market hits bottom in terms of pricing, and there’s literally only one way to go—and I think we’re there.”

Jeff Solomon, MAS, business construction foreman for Santa Clarita, California-based All American Marketing Group (UPIC: ALL-AMER), says that while no one wants to pay more for promotional apparel, clients will have to be accustomed to the “new normal” in pricing. “For years, this industry was spoiled by very low prices,” he says. “But this was unsustainable. Fabric must first be knit then sewn into a shirt, which is then sent to a mill, followed by an apparel wholesaler, who then ships the garment to us (often with free freight)—all for a buck and change! Really? That party couldn’t last forever … and now the party is over.”

The Truth About Price
Dan Collins, chief operating officer for San Diego, California-based AddVenture Products (UPIC: COMPREST), recognizes that price is an essential component of the buying process but believes that buyers are rarely only concerned with price—even in times of scarcity.

“Naturally, price is the most communicated and discussed topic because of the nature of budget restraints and concerns,” he says. “However, most buyers recognize that apparel is a preferred product due to the enormous advantage it provides in how many people see it, wear it, talk about it and enjoy it. People love promotional apparel, and this is not going away any time soon. Even as prices rise, a percentage of every informed buyer’s budget will continue to be allocated to apparel because of the distinct differentiators it has.”

Jonathan Isaacson, CEO of Lawrence, Massachusetts-based Gemline (UPIC: GEMLINE), agrees. “Price is just one part of the total value equation,” he says. “Great design, compliant product, excellent service and overall value must also be considered. In any discussion with customers, the key point should always be about value. If the discussion is strictly about price, then one is simply selling a commodity. It is important to show the value-add for customers and how the product chosen can help them meet their marketing objectives.”

For industry practitioners to successfully address pricing concerns and remain viable in the new economy, Headwear USA’s Karlicek believes salespeople must move away from simply selling a tangible product and move toward selling what the tangible product can do through the creation of comprehensive marketing initiatives.

“In the last five sales meetings I’ve had, we didn’t touch product, talk about price or have anything to do with the catalog until the very end of the meeting,” he says. “Instead, the conversation was focused on how distributors can get in front of customers, utilize virtual samples, ask the right questions, penetrate the accounts further and become more of a resource. The goal is to structure the sale so that by the time price comes up it is simply what becomes necessary to complete the purchase order rather than a negotiating factor as to what the customer is going to do.”

While discussing a price increase may make some uncomfortable, higher prices can be healthy for the industry. “The same amount of work is involved whether a t-shirt is sold for 80 cents or $1.40,” Lott says. “If margin can be maintained as costs go up, then your actual gross margin—and real dollars—should increase. This is positive for the industry in the long run.”

The New Sales Reality
Moving forward, conducting business as usual could not only cost you profits, but it could also cost you customers. To boost sales—not lose them—follow these tips:

• Understand The Quote Process Has Changed
Historically, distributors contacted suppliers for quotes who in turn consulted a spreadsheet and had a price in no time. But this isn’t necessarily the case today. “Because price is determined relative to the cost of raw materials and these costs are in a state of constant flux, all of the price lists we used to work off of when quoting custom jobs are now in the garbage,” says Dana Zezzo, CAS, vice president of sales for Pittsburgh, Pennsylvania-based Pro Towels, Etc. (UPIC: PROTOWEL). “Literally, we have to get quotes on every job, which is time consuming. Distributors are not used to this, but it is the new reality.”

• Confirm Quote Validity Dates
It’s been standard industry practice for quotes to be valid for 30, 60, sometimes even 90 days. But this is no longer realistic. “It is hard to hold pricing because of the rapidity of increases that are occurring weekly,” says Shawn Kanak, vice president of sales for Baltimore, Maryland-based Towel Specialties (UPIC: TOWLSPEC). “We have taken the rising costs into account for our custom import business and are implementing faster expiration dates on the quotes. Distributors and suppliers alike must communicate with the factory to confirm price quotes more than 30 days old and be up front with the customer when doing so.”

• Recommend Multiple Solutions
Because of inventory shortages and the resulting longer production times, the one product you thought would be perfect for a client’s promotion simply may not be available. It’s essential to have options. “You can’t tell your customers one thing will be perfect for their goals, mission and message because the minute you do, the item will be out of stock or the price will fluctuate out of budget and you’ll be starting over,” says Zezzo. “To make the best use of your time, develop three solutions that fit your customers’ needs and explain that it is realistic that one of them will be available to ship because of the fluctuations that are happening in the industry.”

• Plan Ahead
Timing is of the essence, especially when price-conscious buyers are involved. Depending on the quantity required, many suppliers offer offshore programs that feature less expensive products—but they require more lead time. “Taking advantage of overseas production and sea freight can save buyers a significant amount compared to ordering domestically or using expedited freight,” says Headwear USA’s Karlicek. “But it typically takes at least eight to 10 weeks for delivery to receive the most economical price. Explain to your buyers that you can help maximize their spend if you plan programs much further in advance.”

• Think Twice About Direct Importing
In a perfect world, distributors would always order from industry suppliers rather than going direct to overseas manufacturers. But, alas, the world isn’t perfect and some distributors choose to import directly in an attempt to save money. However, the ever-changing overseas business climate is more perilous for distributors than ever before. “Suppliers import for a living and have better control over most situations,” Kanak says. “Count on them to do their job and don’t risk losing a customer over a situation that can go bad very quickly.”

The Strength Of Cotton
“Prices go up and down over time for various reasons, and because of the pressures overseas, certain fabrics such as cotton are somewhat more expensive than in the recent past,” says Gemline’s Isaacson. “That said, our experience is that cotton-based products continue to do well for long periods of time and we believe this trend will continue.”

AddVenture Products’ Collins agrees. “Apparel represents the lion’s share of promotional products purchases as a percentage, and it has maintained this position through numerous economic and supply side conditions, cycles and disruptions,” he says. “Most businesspeople recognize the fact that products based on a fluctuating commodity, whether it be petroleum-based hard goods or cotton-based apparel, will see changes in pricing as the commodity fluctuates. No one likes price increases, but in the case of cotton, apparel will continue to maintain a very strong position as a preferred means of branding and advertising.”

Apparel remains the preferred means of advertising and branding because recipients tend to keep garments and wear them for years. “I have promotional t-shirts in my closet that are five years old, and I think that’s fairly typical,” says Jason Black, CEO of Austin, Texas-based Boundless Network (UPIC: Bound784). “The lifetime value of apparel is really powerful. Consumers gravitate toward promotional apparel, so it has become a de facto campaign that businesses know how to use and many of them will continue to hit the reorder button even if prices rise. If the objective is to build a brand, stick with a product that’s proven even if it costs $4 or $5 versus $2 or $3. Just because prices may be 20-percent higher doesn’t mean buyers are going to stop purchasing.”

Obviously, higher prices affect everyone’s bottom line, and it is essential to have consistent communication from suppliers to distributors to end buyers so each member of the supply chain understands what is happening in the market. “That’s why we talk a lot about education for the end user because prices are increasing and we understand what that does to the bottom line,” says Lott. “But there is such value in promotional apparel, and if done right, it is a great marketing tool that represents brands well. Buyers must look at promotional apparel as an investment in their brands. The more we can do to convince buyers of this, then a lot of the price resistance goes away. This doesn’t mean that they don’t have a budget, however, because they do. But understanding the value of the product is what’s essential in any pricing environment.”
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