U.S. Companies Reassess China Sourcing Strategies

China's steamrolling of global apparel manufacturing finally may have hit a roadblock.

WASHINGTON — China’s steamrolling of global apparel manufacturing finally may have hit a roadblock.

This story first appeared in the February 15, 2008 issue of WWD.  Subscribe Today.

American apparel importers aren’t making any sudden moves yet, but rising costs in China and potential punitive action by the U.S. are forcing companies to review the risks associated with sourcing billions of dollars in apparel from the manufacturing powerhouse.

Rapid economic growth in China has sparked inflation in several sectors, driving up prices for energy, raw materials, transportation and labor.

“The overall climate in China has become difficult,” said Rick Darling, president of Li & Fung USA. “Price increases are real and here to stay, production has begun to migrate to the western provinces and U.S. protectionist attitude is not diminishing. All speak to a more difficult market to navigate over the next few years. That said, there are significant opportunities to expand sourcing bases.”

Darling said the sourcing giant is always challenged to develop alternative sources of supply in reaction to cost, quota or political pressures.

“Most good supply chains are constantly reviewed for balance across many countries,” he said.

The significant rise in prices and labor costs in China, combined with an appreciation of the yuan against the dollar of about 13 percent since 2005, have taken a bite out of margins, forcing U.S. companies to recalibrate their sourcing strategies in the event they will have to further diversify. Many vendors were forced to reassess their manufacturing plans after being caught with too much production in China when the U.S. first imposed safeguard quotas in May 2005 and then struck a deal with China to limit imports on a range of products through the end of this year.

The explosive rate of import increases seen throughout the decade and particularly after global quotas were lifted on Jan. 1, 2005, has slowed, although, as figures released Thursday show, China continued to strengthen its position as the largest supplier of apparel and textiles to the U.S. in 2007.

The country increased the volume of apparel and textile imports to the U.S. by 14.8 percent to 21.37 billion square meters equivalent compared with 2006, according to the Commerce Department’s December and year-end import figures. China’s import growth in 2006 compared with 2005 was 11 percent.

China had a 40.2 percent share of the U.S. apparel and textile import market in 2007. But the country’s import growth last year was tempered by ongoing limits on 34 product categories.

U.S. apparel importers showed their move to diversify to other countries last year. Imports from Vietnam, the eighth-largest supplier of apparel and textiles to the U.S., increased 31.3 percent to 1.5 billion SME. Imports from India, the third-largest supplier, rose 2.5 percent to 2.7 billion SME; shipments from Indonesia, the sixth-largest supplier, gained 1.6 percent to 1.62 billion SME, and imports from Bangladesh, ranked seventh, rose 4 percent to 1.55 billion SME.

Total apparel and textile imports from China in December compared with a year ago fell 0.7 percent, with total apparel imports declining 11.5 percent and textile imports increasing 5.7 percent. Part of this was due to a rush last year to fill quota categories, but also could be evidence of a shift in strategies.

China’s economy will continue to grow at a fast clip this year, according to most economists, which will not ease the pricing pressures on Chinese manufacturers or U.S. companies in the near future. A severe winter snowstorm in China last month led to coal shortages and power outages in many manufacturing hubs, leading the government to suspend coal exports, which in turn drove up coal prices by 34 percent.

China’s Producer Price Index, which measures inflation for manufactured goods, rose to 5.4 percent in December, up from 4.6 percent in November, according to the U.S.-China Business Council. The full-year increase for manufactured goods was 3.1 percent, and PPI inflation for raw materials, fuel and power rose by 8.1 percent in December and 4.4 percent for the year.

“Chinese companies have been dealing with two things — one is the cost pressure from their inputs and the other is the exchange rate, which has been appreciating,” said Todd Lee, managing director of the Greater China Group at Global Insight. “So far, they have been able to absorb both and not pass it on to U.S. companies, but I’m not sure how long they can hold on without passing the costs on.”

Lee warned that the rising trend in the PPI and an increase in wage rates to $1 an hour on average could hurt U.S. companies. While there has not yet been a major shift in apparel production out of China, Lee said the government’s latest five-year plan “tries to discourage the low-value-added processing exports that Chinese companies do.”

That paradigm shift in manufacturing, seen in all industrialized countries, eventually could translate into a migration of commodity apparel business out of China, according to Gary Ross, former corporate vice president of global manufacturing and sourcing for Liz Claiborne Inc., who now has his own consulting firm, GERoss Consulting.

“We will see a culling of the herd in China,” said Ross. “I believe there will be significant closures and consolidation [in the apparel sector in China], beginning now and running through 2008 because the pressures are there.”

Ross said many countries will benefit from the rising costs in China, including Vietnam, Indonesia, Cambodia, Bangladesh and, to a lesser extent, Pakistan. He said apparel manufacturers will begin shifting production from the coastal cities in China to the interior and the north, as they begin to phase out the production of commodity apparel products altogether.

Despite the changes, Ross said China will maintain the lion’s share of apparel sourcing because it offers the best prices, consistent quality, completeness of orders and on-time delivery.

“When price is the only differentiator, it goes to the lowest common denominator,” Ross said. “Somebody can always do it cheaper and there will be bidding wars on commodity products.”

A major offsetting factor for U.S. companies making apparel in China would be the elimination of quotas on 34 Chinese apparel and textile import categories. The quotas, part of a bilateral deal between the U.S. and China, are set to expire at the end of the year.

“It will have a positive impact, which is good,” said Ross.

But Ted Sattler, executive vice president of foreign operations at Phillips-Van Heusen Corp., said the benefits accrued from lifting the quotas on Chinese apparel imports might be undercut by potential antidumping and countervailing duty cases in the U.S.

“If the safeguards go away, antidumping and CVD cases could happen,” said Sattler. “So it will be the same risk assessment, and, in certain ways, safeguards are more predictable and transparent.”

Sattler said rising costs in China are a reality today, but they have not forced PVH to modify its already diversified sourcing strategy.

“Between the currency revaluation…energy and fuel cost increases, a new labor contract effective Jan. 1 and export rebates being removed, it certainly has put pressure on costs,” Sattler said. “But in our case and probably for most large apparel and/or retail companies, we have tried to keep a balanced sourcing strategy where there are no tremendous risks in any one location.”

In addition to its China portfolio, PVH also has a “large position” in Vietnam, he said.

As for pending punitive legislation in Congress that could lead to higher duties on imports, Sattler said: “It’s no different than when you see a candidate assassinated in Pakistan or when you see the bird flu affect a region of the world or a tsunami. Unpredictable things happen and you have to filter them into your risk analysis position and not get overly exposed in any one area.”

Mark Jaeger, senior vice president and general counsel at Jockey International, said companies are anxiously awaiting the removal of quotas on the specific apparel and textile imports from China.

“They resulted in additional costs and uncertainty in sourcing from China,” he said.

As a result, Jaeger said there have been some production shifts to other countries in the region, such as Vietnam, Thailand and Indonesia.

Jaeger said the removal of quotas will be a net positive for companies. But he doesn’t expect “quite as dramatic an adjustment” in imports from China once quotas are removed this year, as was the case in 2005, when Chinese imports surged by 1,000 percent in many apparel categories.

“While safeguards will come off of apparel, the overall trade relationship between the U.S. and China will be uncertain,” he said, pointing to possible punitive currency bills. “Certainly, the risk of a currency bill going forward and an increase in import costs is a factor and results in uncertainty.”

Darling said Li & Fung does not believe the import restrictions will go away at the end of this year.

“Our feeling is that they will continue until 2013 and, if not, other trade barriers like antidumping actions will be used to replace the old quota regimen,” he added.