The big news story coming out of the trade shows last week was expected to be about the weather and how it was affecting a specialty business starved for a more normalized weather cycle. At the Outdoor Retailer Winter Market expo, the weather story – punctuated by near-record snowfall in California and Utah – took a back seat to a story that will have a much longer-lasting effect on the market.
Sports Executive Weekly editors barely made it inside the Salt Palace before the story of the changes in Chinas labor laws and their impact on brands in the U.S. quickly became story number one for executives searching for answers and solutions to a rapidly changing supply chain situation.
But the supply chain issues facing American companies in the sporting goods and outdoor market go far beyond the implications of two new laws enacted on January 1, the Labor Contract Law and the Employment Promotion Law, which seek to provide workers in China with more protections in the workplace. The issues surrounding those new laws, which are expected to hit the smaller factories and smaller brands harder than the bigger guys like Yue Yuen on the manufacturing side and Nike, Inc. and adidas Group on the brand side, are exacerbated by other realities of todays marketplace.
The new laws were developed to provide workers with more collective bargaining rights and puts in place minimum wage and overtime rules that are designed to give workers more protection from predatory factory owners, but those new rules may also been seen by the workers as too restrictive and would limit their ability to put in the hours required to support their families in the interior provinces. That impression is expected to result in a sharp decline in the availability of experienced workers after the Chinese New Year. That issue alone could lead to footwear shortages.
The other major issue is the Chinese governments efforts to “encourage” factories to move closer to the labor pool and out of the coastal provinces, primarily Guangdong province, home to many of the key cities for footwear manufacturing in China, including Donguan, Guangzhou, and the Nanhai District District of Foshan City.
The close proximity to significant port facilities and Hong Kong created the manufacturing jobs in the region, along with government incentives that provided tax rebates of upwards of 15% for manufacturing in the area. Those rebates were reduced to 7% last year and were recently zeroed out.
Couple these issues with the shortage of labor resulting from competition for workers from higher paying jobs in other sectors and the rising costs of materials from the jump in oil prices and the impact of a U.S. Dollar that continues to weaken, the effect is seen as a perfect storm that promises to make this coming year very interesting as companies attempt to maintain margins and retail prices in the face of mounting fears of an impending recession.
There are reports out of China that as many as 200 to 300 factories have already been shuttered in Guangdong province, a number that could swell well beyond 1,000 after the Chinese New Year. The numbers include not only smaller factories, those employing up to 3,000 workers or so, but also the supporting mechanisms, like mold shops.
In conversations with a number of key industry executives from both athletic footwear and outdoor companies, SEW found that the impact of these measures are expected to have a significant impact on the landed prices of product coming in from China. The estimates ranged from one dollar a pair to percentage increases in the 10% to 20% range. The principal of one supply chain consulting firm estimated that factories will see labor and operating expenses jump 18% under the new realities in the market — even before the exchange rate gets jacked up again, as expected after the Olympics.
The price increases could impact average prices to the tune of $5 at wholesale. So how does the vendor react and respond? Larger brands that have been closer to their factories have been planning for these changes and have been adjusting their pricing in anticipation. The laws enacted at year-end were actually passed in June 2007, so should have come as no real surprise to anyone, according to key sourcing execs that spoke with Sports Executive Weekly. Nike, Inc. and adidas Group have been investing heavily in supply chain improvements for the last few years, pushing their factories hard on working conditions and lean manufacturing, which is estimated to reduce labor coasts by 30% to 40% in footwear factories. The impact of the new laws and other inflationary issues on these factories and brands is expected to be less of an issue. But smaller brands that have been using agents and trading companies may just be waking up to the short- and long-term effect of the changes. Their factories are more likely to just throw more cheap labor on a new line instead of improving processes. They will be hurt hardest or cease to exist altogether. The bigger manufacturers are reportedly already breaking ground on new factories in the interior provinces.
Guangdong province, which is estimated to contribute about 12.5% of Chinas national economic output, is considered the most populated province in China, due in large part to the influx of workers from the interior provinces. The province is estimated to see its population grow by 50% due to the migration of workers into the factory dormitories. Those workers generally head home for Chinese New Year and return afterwards. That is not expected to happen this year at the same as in years past.
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The issue is not just the evaporation of the factory base or the reduction of workforces by the factory owners. The workers themselves may be more reluctant to make the trip into Guangdong if they are restricted from working overtime hours at the same rate as before, thereby limiting their earning potential.
So what can the industry do? Nothing, but adapt and adjust, say many of the executives SEW spoke with on the matter. The industry must embrace lean manufacturing more widely and work more closely with their factories to ensure a smooth transition in pricing. The problem for many brands will come from conversations with their retail partners, conversations that many have not had regarding fall 2008 pricing, according to a number of the smaller brands that SEW spoke with last week. The good news is that big retail guys are most likely experiencing much of the same type of pressure with their private label programs, so it will not come as a total shock to the system.
The problem will come when and if the retailers and the brands attempt to pass the costs along to the consumer.
In light of the recent concerns over an impending recession, a tightening credit market, and inflationary pressures in other sectors of the economy, an extra $10 for a pair of sneakers may just not figure into the equation.
All this comes as athletic footwear starts to soften at retail. Retailers are citing a lack of freshness and the fashion athletic trend may finally be playing itself out. Anecdotally, SEW hears from retailers that the current slump is “the worst we have ever seen.” While the conditions may not be all that dramatic, the retail point-of-sale data compiled by SportScanINFO data does indicate a significant slow down. The 2007 retail first quarter was up in the low-single-digits and Q2 and Q3 were both up in the mid-singles. Then the bottom dropped out as November came in flat and December declined in the mid-single-digits. Recent earnings warnings and pre-announcements also bear out his negative trend.
The prognosis from brands and retailers alike is that this negative trend will continue well into 2008, perhaps until after the elections, but all bets could be off if prices start to jump.
