How to Tackle the China Trade-War Challenges
In the past year, it has become increasingly more challenging to be an apparel manufacturer, importer or retailer in the United States as uncertainty surrounds trade with China.
Ten percent tariffs on Chinese imports have raised the price of bringing in fabric, handbags and fur into the United States from that country. Now there is a threat that those imports could be subject to a 25 percent tariff starting in early March. When you consider that 34 percent of all clothing imported into the United States comes from China, that’s a big burden on business.
At the same time, the Federal Reserve raised benchmark interest rates four times last year, which means that interest rates went from 1.25 percent to 1.5 percent in December 2017 to 2.25 percent to 2.5 percent in 2018. No one is sure if there will be more interest-rate hikes this year or not.
With all of these added costs piling on, the California Apparel News asked factors and other finance professionals who work with the apparel and retail businesses this question:
With interest rates rising and U.S. tariffs threatened on Chinese-made clothing, what do apparel manufacturers need to do to make sure their revenues don’t decline this year over last year?
Darrin Beer, Western Regional Sales and Portfolio Manager, CIT Commercial Services
Certainly apparel manufacturers are facing some headwinds, including rising interest rates and potential U.S. tariffs.
Since the beginning of 2018, interest rates have increased at least 1 percent, adding costs to apparel manufacturers who use factor financing and revolving lines of credit to fund operations. I believe a much bigger concern than interest rates would be a tariff increase of 25 percent for finished apparel imported from China. The higher costs associated with such a tariff could have a significant impact on the bottom line of companies using China as a major source of production.
Since last year’s announcement of potential tariffs, some of our clients have already shifted some production away from China to countries like Vietnam and India. If tariffs are assigned to the apparel sector, all parties—including the exporter, U.S. manufacturer and retailer—will likely share in the increased costs. Some or all of those costs would almost certainly be passed along to the consumer.
Apparel makers must continue to manage expenses and inventories carefully and invest in technology to better manage their supply chain and operations, which is where an experienced and agile funding source can help. Ultimately it comes down to manufacturers having innovative designs and the right merchandising programs to deliver on-trend products to the consumer at an attractive price.
Mark Bienstock, Managing Director, Express Trade Capital
We have always preached to our clients to be proactive and not keep all of their eggs in one basket. Those apparel companies that are 100 percent reliant on sourcing from China will put themselves in a difficult situation moving forward.
There is no question that China is the leader in providing production for the apparel and related industries. However, with the new and possibly additional tariffs forthcoming, those importers that have other sourcing options available will be a more desirable alternative for the retailer in choosing a supplier moving forward.
This issue is not only related to tariffs. Importers must also take into account such items as political instability, labor availability, weather trends, electrical-power capacity and other things when picking a country for sourcing. Being nimble and proactive are the keys to staying alive in this very difficult industry.
Sydnee Breuer, Executive Vice President, Rosenthal & Rosenthal
Apparel manufacturers are facing pressure from many facets of the business. It is a difficult retail environment as consumer preferences are shifting to more-experiential purchases rather than apparel.
Retailers continue to require better pricing on the goods they carry; tariffs are increasing and threatening to increase on imports from China; and after a long time of steady interest rates, they have risen steadily over the past 12 to 18 months.
Therefore, it is a challenge to increase sales—or at least keep pace—and maintain profitability as margins erode. In addition to staying on top of the market and having product that consumers want to buy, many of our clients have employed a direct-to-consumer sales focus.
In addition to selling to the retailer through the traditional wholesale channel, they are selling to third-party websites (Amazon and Shopbop), subscription services (FabFitFun and Stitch Fix) and through their own websites. Some of these alternative selling channels provide better margins (albeit with higher expenses, too) and are keeping topline revenues from dipping.
Gino Clark, Managing Director, Originations, White Oak Commercial Finance
Given the substantial indications that the economy is begin
ning to slow, apparel manufacturers need to focus on solid business fundamentals.
As a first step, companies should try to diversify their supply chains. It will also be important to retain profits and invest in technology that reduces expenses and expands distribution channels. With these potential economic speed bumps, top line revenue growth may be difficult to achieve, but bottom-line profitability is certainly achievable if measures are put into place quickly.
Joshua Goodhart, Executive Vice President and National Sales Manager, Merchant Financial Group
We have seen many of our clients and prospective clients reacting in different ways to these threats over the past six to eight months.
The first example, which is the most common, is that manufacturers have gone out months in advance and been proactively seeking other production sources in other countries, including Vietnam, Cambodia, Mexico and Bangladesh. We have seen an uptick in letters of credit and cash against documents requests from our clients due to these new factory relationships. Our clients also need to produce goods further in advance than they have before, which is stretching their cash-flow needs. We continue to meet with clients and assist with planning and addressing these cash-flow crunches so they can hit the ground running
Another scenario is that manufacturers continue to work with Chinese suppliers but develop arrangements with their suppliers to participate in these potential tariff costs. Some of our clients have met with their factories far in advance to plan for this as they don’t want to lose these longstanding relationships to other countries.
We have also seen an increase in domestically manufactured goods. The timing of production is quicker and the price points are higher sometimes when working with domestic contractors and factories. This shift to a more domestically produced product has, in some cases, lowered the production costs for some manufacturers as well.
Overall, our clients need to be smarter about cutting overall operating expenses on items such as research and development and marketing. The shift to these other production alternatives has improved many clients’ gross margins, which means clients don’t need to achieve the same sales revenues to maintain profitably.
Manufacturers are finding that by cutting expenses and improving margins they can achieve a better profitability at lower sales revenues.
Rob Greenspan, President and Chief Executive, Greenspan Consult
This is a difficult and complex question. Rising prices can make it more difficult to maintain your sales revenues. However, these rising prices are affecting the majority of apparel importers so almost everyone is in the same position. Retailers will have to pay more for their products due to the increase in prices.
The bigger question, is how this will affect the buying consumer as these costs will ultimately be passed through. Retailers and manufacturers/importers need the buying consumer to keep spending. The question becomes, will these price increases slow down consumer spending? Only time will tell, but if consumer spending slows for apparel, retailers will cut back their purchases from manufacturers/importers and everyone’s top line and sales revenues will fall.
The question also becomes, what is more important—sales revenue or gross profit margin? If the manufacturer/importer doesn’t pass through much or any of the increased costs, their products might become more price competitive. Therefore, the top line could grow or at worst not decrease. But that would mean less gross profit margins.
So I am not certain just focusing on sales growth is meaningful without serious consideration being given to maintaining gross profit margins. There is a balancing act here that each company needs to understand before it makes any significant decisions.
Lastly, remember, it’s all about the product. If your product isn’t right for the market, whatever else you do will not have much effect.
Kee Kim, President and Chief Executive, Finance One Inc.
This year will be a particularly challenging period for the apparel industry because business circumstances are against U.S. manufacturers and importers.
Both the rising interest rates and the continuing U.S.-China trade war will increase the cost of doing business. Tariffs are a part of the cost of importing goods, and the higher interest rates for borrowing means more financing cost.
Since buyers will resist absorbing the additional costs, importers are likely to pass only a fraction of the increased cost to them. In addition, a trade war presents a new layer of uncertainty to both importers and retailers.
One way to keep a lid on the cost of goods sold is to find alternative sourcing other than China. This is easier said than done, however, because many non-Chinese companies do not have the technical proficiencies and resources to scale production at China’s level. Sourcing the right suppliers takes time, and other Asian countries often require a longer lead time.
Nonetheless, it makes sense in the long run to diversify your production base to include Vietnam, Cambodia, India, Pakistan, Bangladesh, Indonesia or Mexico.
On a separate front, rising interest expenses can be mitigated by managing the accounts with shrewdness. Request longer terms for fabric, trims or other vender payments and target customers with shorter payment terms. Longer payable terms or shorter receivable terms will ease the strain on cash flow and help reduce interest expenses. While retail department and chain stores have extended their payment terms over the years, some retailers with payment terms of net 45 days or less include Nordstrom, Stitch Fix, Fashion Nova and Five Below.
Sunnie Kim, President and Chief Executive, Hana Financial Inc.
Possible tariffs have driven many manufacturers and importers to look to other venues for production, including Latin America, Vietnam and Cambodia, while the anticipated tariff issue has been discussed within the industry for quite some time now.
It also appears that many American companies are dealing with the Chinese tariff situation in a multitude of ways, including bringing in goods earlier in order to avoid a possible 25 percent tariff, negotiating price concessions, changing product mixes, cutting orders and/or passing costs on to customers.
Even if price negotiations are successful, relief will be short-lived as pressure from higher interest rates will eventually widen the price gap narrowed through negotiations as companies tend to utilize their respective credit facilities with financial institutions to purchase goods overseas.
According to the U.S. Trade Representative, if the two sides cannot reach an agreement by March 1, tariffs would increase to 25 percent on an estimated $200 billion worth of Chinese imports.
While interest rates in the U.S. have risen throughout 2018 and will probably see an additional rise of 25 basis points by the end of this year’s second quarter, these cost increases in the end will be pushed down to the consumer.
Don Nunnari, President, Flintridge Financial Solutions
The direction of interest rates and tariffs is out of their control, so I recommend apparel importers focus on what they do best—work closely with customers to ensure they are providing the best-quality product, at the best price, along with the best service while preparing for the possibility of softening sales. Review every expense category including cost of goods and adjusting overhead and operating expenses to maximize profit.
Also, create cash. Take a close look at slow-paying customers and try to bring them in line with terms. Also, look at old inventory and make a plan to reduce it. Use the cash this brings in to reduce your liabilities, especially those you pay interest on.
Dave Reza, Senior Vice President, Western Region, Milberg Factors
The potential for additional apparel-related tariffs and increased interest rates already has, and continues to compel apparel importers to consider shifting production to other locales, negotiate lower pricing and/or to carry additional inventory in order to mitigate the negative impact of increased costs.
Of course, the challenge is to offset potential increased costs while at the same time ensuring that any adjustments to sourcing do not result in higher costs from lengthened production cycles, higher inventory levels, quality and/or delivery issues.
While tariffs and higher interest rates can hurt the bottom line, production and delivery problems can take a significant toll on revenues.
In the current environment, passing along higher costs to consumers will not be easy. But because tariff concerns have been widely publicized, consumers might be more willing to bear slightly higher prices. Prepared importers will have already made changes to their sourcing, and, in fact, may be positioned to both increase revenues and gain customer share because they have the ability to deliver product at favorable prices.
Ken Wengrod, Co-founder/President, FTC Commercial Corp.
With global slowness and low inflation (including in China and Europe), interest rates will probably increase less than 10 percent this year, and it will not have a significant impact on U.S. apparel importers.
As a matter of fact, overall import prices continue to fall, and it has been the largest year-on-year drop since 2016. According to Reuters, prices for imported goods from China fell 20 basis points during 2018. This coupled with a strong dollar, which gained almost 10 percent to the Chinese currency in 2018, gave a strong benefit to U.S. importers and manufacturers who imported part of their cost of goods sold, such as fabric. Currently, the tariff effect has been minimal to apparel importers bringing in goods from China.
The real impact of the so-called tariff war created a wake-up call to all U.S. importers and their foreign strategic partners to review their entire supply chain. A recent McKenzie study highlighted the importance of reviewing all costs in the supply chain, not just labor prices.
For years, U.S. importers have emphasized manufacturing costs and haven’t focused or included idle time, shipping time, local freight time, customs and clearance time, which also significantly impact their costs. Currently, shrewd U.S. importers are focusing on these costs and moving production utilizing near-shoring and to other global geographic areas that result in low-cost production.
Nevertheless, a potential decline in revenue could come from a shift in consumer buying trends, which significantly affected the fast-turn, low-price market. Today’s Gen Z and millennials are focusing on sustainability, authenticity and value, not just low prices. Smart retailers promote their conscious manufacturing to tailor their market to these new consumers, who are purchasing less and purchasing items that are more timeless and with greater value. They recognize how “throwaway” clothes pollute our waterways.
Modern manufacturers need to focus more on changing consumer habits and adapt to changing times. The old formulas don’t work anymore. Companies that are more agile and have a strong connection with their ultimate customers are flourishing. To develop that strong connection, the employment of proper social media and marketing tools is critical. This is not just about the use of “influencers,” which only detracts from the authenticity of the brand. Progressive apparel companies need to delight their customers with all the right ingredients: a well-designed item at great value; an authentic, legitimate story; and fantastic customer service.