The footwear industry is facing a new pricing paradigm, with vendors struggling to absorb higher costs at all stops along the supply chain.
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The Cost Crisis
WAYNE NIEMI
April 21, 2008
LOS ANGELES — The footwear industry is facing a new pricing paradigm, with vendors struggling to absorb higher costs at all stops along the supply chain.
Many firms are bracing for steep increases in the costs of raw materials, labor, ocean freight and transportation. Skyrocketing petroleum prices, the weak dollar, new labor policies in China and increased competition for workers in the Guangdong region are all pinching the bottom lines of many companies. And some say the end result for consumers could be price increases of 5 percent to 20 percent at retail.
While most experts said the impact of pricing pressures wouldn’t fully hit home until the spring ’09 season, some are already feeling the sting.
“It’s a reality going forward,” said Pat Devaney, chief of sustainable initiatives for Deckers Outdoor Corp. “I don’t see oil getting cheaper. Labor will not get cheaper in southern China.”
Jim Issler, president and CEO of H.H. Brown, said the footwear industry is entering a new era, where cheaper labor will no longer be an alternative to raising wholesale prices. “It’s definitely a turning point in our industry and it’s not going to be solved easily,” he said. “We chased labor around the world. Now, we’re at the end of the maze and there is nowhere else to go.”
Sterne, Agee & Leach analyst Sam Poser said these factors, combined with new labor enforcement initiatives by the Chinese government, are presenting footwear companies with a number of challenges. “This is about as bad as things can get,” he said. “What I’m hearing is that fixed costs in China are going up at least 10 percent [this year].”
New taxes in China and the loss of incentives for shoe companies exporting abroad are also adding to the cost dilemma, according to Collective Brands CEO Matt Rubel. “A confluence of unprecedented events has led to a material shift in the cost of sourcing in China,” he said.
Ted Gedra, president of Wolverine Footwear Group, a division of Wolverine World Wide, said that labor and component costs started to climb right after the first of the year and have continued to escalate. “It’s been substantial,” he said. “In general, there has been anywhere from a 7 to 10 percent increase in component costs.”
For the time being, Gedra said, his division has been able to work with its manufacturing partners to absorb costs and keep them off the company’s balance sheet. Wolverine is also reexamining its sourcing strategy and looking for savings wherever possible. “Competitively, we constantly have to try to find ways to do things better because it’s very difficult to pass it along to the consumer,” he said.
Still, price increases have been necessary. For fall, Gedra said his division raised wholesale prices 3 percent to 4 percent. He added that spring ’09 presented too many variables to guess what the company’s pricing structure might look like. “It’s very difficult to understand the ramifications going forward,” he said.
Devaney, too, said he expected the company would increase its wholesale prices for spring, though he didn’t yet have an estimate as to how much they would rise.
Skechers CEO Robert Greenberg said prices at Skechers could rise 3 percent to 8 percent. However, he won’t be looking for ways to substitute lower-cost materials. “We’re certainly not going to sacrifice our product just to make them cheaper,” he said. “[If the product is right] consumers will pay the prices and retailers will make more per pair.”
Looking ahead, many observers said that as costs continue to rise in China, smaller companies will be more heavily impacted than larger firms such as Nike and Adidas, which have more advanced manufacturing capabilities and diversified production.
During a March 5 earnings call with investors, Adidas AG CFO Robin Stalker said the company was well situated. “We believe we are extremely well positioned competitively, vis-à-vis our competitors, in terms of lean manufacturing and engineering of our product. Nevertheless, we do see some potential for negative pressures at the end of 2008.”
Nike execs on a March 19 earnings call likewise said its efficiencies would mitigate cost increases. “Continued progress on gross margin initiatives and favorable selling currencies more than offset the impact of sourcing cost pressures such as higher oil prices, labor rates and stronger Asian currencies,” said VP and CFO Donald Blair.
Still, some smaller vendors are optimistic they, too, can overcome pricing obstacles.
K-Swiss President and CEO Steven Nichols said his company — which manufactures the vast majority of its product in China — could manage increases with a solid sourcing strategy, lessening the manufacturing cost difference between it and its larger competitors. “Obviously, we are a significantly smaller company than Nike, but we purchase our rubber, leather and labor in economic units that makes the difference between us and bigger companies not that much,” he said.
While many footwear firms are tweaking sourcing plans for China, few plan to leave the country anytime soon.
“Going farther north may be an interim approach, but the reality is that as we see economies changing in China, it’s what the future is going to be, and we’re going to have to adapt as an industry,” said Devaney. “Everybody has looked at India and talked about India, but there isn’t an infrastructure of support there to make it more cost effective. Yes, they make shoes and there are leather suppliers, but it’s not up to where it needs to be.”
At H.H. Brown, Issler said the economics of relocating manufacturing to India and Vietnam wouldn’t likely yield any significant savings. “The problem is that even though the labor costs are less, they don’t have the same productivity,” he said.
Greenberg agreed. “There is no moving to another country,” he said. “People talk about India, but that is light years away. There’s nowhere to hide anymore.”
It’s clear that pricing pressures aren’t going away, and the end result may be higher costs for everyone. “The consumer is going to have to learn to pay for things, and companies are going to have to learn to adjust,” said Poser.
Greenberg, however, was unfazed by current cost increases, noting that strong businesses will continue to find ways to thrive in even the most difficult times. “We’re going to be fine,” he said. “It’s about adjusting to new ways of doing business.” |
