By  on March 8, 2011

WASHINGTON — Apparel executives are raising the specter of a prolonged increase in raw materials and labor costs as they grapple with a new inflationary cycle that has sent them scrambling to find ways to offset staggering price hikes that are bound to impact their bottom lines.

Facing historic highs in raw cotton prices, which hit $2.33 a pound last month in a key index, as well as significant increases in wool and synthetic fibers, executives attending the American Apparel & Footwear Association’s annual executive summit here aired their concerns and discussed strategies to determine how long the price inflation will last — and how high it will go.

Price increases in cotton, driven up by a host of factors — from a tight global supply and flooding in Pakistan last year to nervous Wall Street speculators — are not expected to diminish until the Western Hemisphere crop is harvested, beginning in September and October. The consensus was that, while a fresh infusion of cotton into the global market will stabilize prices, it will not bring them back down to their annual long-term average of about 65 cents a pound.

Over the last year, prices have jumped by as much as 160 percent for cotton and 44 percent for wool. The steep price increases also have forced companies to use cotton fabrics blended with synthetic, resulting in higher demand and price hikes for man-made fibers.

Apparel brands and retailers, wary of consumers’ unwillingness to absorb the price increases, are bracing for an expected hit on unit purchases and tighter margins.

“Our team was aware and abreast of the problems associated with this escalating crisis, not only in cotton but also in labor,” Mark Weber, chief executive officer of LVMH Inc. and chairman and ceo of Donna Karan International, said in an interview. “Early on, we decided on the alternatives we might have, such as changing blends, adjusting products and understanding that we had an obligation to make sure that, if prices were to go up, our products deserved the price increases.”

Weber said the luxury company is “well positioned” despite expected price increases of 5 to 10 percent, depending on the category.

“We haven’t really seen [inflation] through this first half of the year,” Weber said. “Spring is performing very well. For fall, we’ve arranged our prices. Retailers purchase in dollars, not in units, and they will be forced to plan their assortments based on whatever inflation in prices exists.

“There is always a shift in share of market, and retailers get paid to pick the best,” Weber added. “If they find us to be more fashion correct and more relevant, we will get a larger share of their openness to buy and that is what we are seeing. We are doing more business, and our expenses and cost structure are under control.”

Rick Darling, president of LF USA, noted that the industry is coming out of a 30-year period of price deflation on the wholesale side, driven primarily by China’s market entry, which had a major impact on lowering labor rates around the world.

“That day is over,” said Darling in an interview. “[Last year] marked a complete turnaround…when China started to encourage significant increases in labor and that is going to continue, in our opinion, in the foreseeable future.”

Darling said the spike in commodity prices has added more pressure and is being driven by demand around the world outside of the U.S. and Europe.

“It’s a fundamental change in supply and demand that is driving up those prices,” he said. “Are they sustainable at this level? We’re not sure. Certainly in the short term the industry is struggling with how to react and how much of those costs will be passed on to the consumer and how much of those costs the retailer versus the wholesaler will bear. It’s having a significant impact.”

Demand for cotton products has been growing significantly in China and India, said Kevin Burke, president and ceo of the AAFA.

“Here in the U.S., where we grow a lot of cotton, there has been a lot of pressure on farmers to grow other cash crops like corn for ethanol,” Burke said. “I don’t believe cotton prices are going to go back down to where they were a year ago, so the challenge for our industry will be how to keep the product reasonably priced with commodity prices so high.”

J. Berrye Worsham, president and ceo of Cotton Incorporated, told executives at the summit there might be some relief in prices on the way.

“Traders are telling us that this upcoming crop will probably sell at a cheaper price than the current crop is selling at the moment,” Worsham said. “But they are also telling us not to expect massive reductions in prices.”

Cotton Inc.’s economist, Jon Devine, said last week that early projections for the August crop season are for “the largest cotton harvest ever recorded” worldwide, at 127.5 million bales, representing 6 million bales more than have ever been harvested. Devine said a composite average of forecasts from the U.S. Department of Agriculture, the International Cotton Advisory Committee and the Cotlook A index are for a 10 percent increase in supply in the 2011-12 crop year from the previous 12-month period.

While that should help stabilize prices, for now, apparel brands and retailers are facing some difficult financial times, Worsham said, noting that a 100 percent increase in cotton prices translates into an average increase in apparel retail prices in the Consumer Price Index of 6 percent.

“A theoretical 6 percent increase in the CPI would be massive and we would see a big hit on volumes this year,” Worsham said, adding the industry’s overall margins could take a 1 percent hit as a direct result of higher cotton prices.

“It’s pretty fragile out there,” said Worsham. “Consumers will be hit with price increases and we do believe it will have an impact on unit volumes.”

Companies like Hong Kong-based supply chain giants Luen Thai Holdings Ltd. and LF USA are on the prowl for new sourcing opportunities to help offset the rising costs of labor in China and raw materials worldwide.

Henry Tan, ceo of Luen Thai, who gave a presentation on the changing face of sourcing in Asia, said the Chinese government, which recently doubled the nation’s minimum wage, plans to double it again in its next five-year plan. Tan said apparel companies are “running out of cheaper wage countries and we are also running out of duty free countries that are viable.”

He said China will remain the most competitive country in the world over the next five years, but apparel firms will have to continue to move inland away from the Pearl River Delta and coastal manufacturing hubs.

But with diversified sourcing the mantra in the industry, Tan said he is continuing his search for new sourcing opportunities in the dwindling supply pool.

“I believe Indonesia is close enough and too many people are going to Vietnam and Cambodia,” said Tan, adding there is not as much competition for the labor force from high-tech companies in Indonesia as there is in other developing Southeast Asian countries.

Tan is also backing legislation that would give duty-free treatment to apparel produced in the Philippines, a country he believes could significantly increase business through a preferential trade arrangement.

LF USA’s Darling said Vietnam, Cambodia, Indonesia and Bangladesh are “big beneficiaries” of the price and labor increases in China. He said a regional trade deal known as the Trans Pacific Partnership currently being negotiated by nine countries, including the U.S., could provide new opportunities, particularly if Vietnam is given duty free status on apparel.

“It’s a great production country with a very hard working workforce and strong management capabilities,” Darling added. “One of the reactions to rising prices is to seek out duty free environments.”

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