An interesting article on Wall Street Journal explores how the premium denim labels cost $300 or more. For those who buy $50 jeans from Levi’s , it is at many times unpalatable to see that the jeans are priced at $300 +.

The market had started moving  in a direction since early 2000’s when a  good amount of manufacturing started happening in the US. A True Religion jeans which costs $50 in US can end up being wholesaled at $150 and retailed at $335!! 
The margins in the chain are very high to cover the huge marketing budgets and other costs of working the line  in the US and with retail markups touching 2.6 to 3 times.. But there are also benefits for the manufacturers to produce in the US – keeping a close tab on fashion and reacting quickly. When Jeff Rudes, founder and chief executive of J Brand, saw designer Jil Sander’s electric colors in New York’s Jeffrey boutique earlier this year, he asked his designers to come up with a hot pink and an emerald green color for jeans. Five days later, the first, small run of jeans were shipping into Barneys New York. It would have taken months to get the same product out of a manufacturing unit in China. This kind of quick turnaround is a major factor for the premium brands to survive despite high prices.

But it is not that the prices of premium denim have not taken a hit due to the ongoing recession. Most of the brands have reduced their average prices below $200 and $150 is claimed to be about the minimum level to be qualified as a premium label – though we still have companies like Gap selling their 1969 jeans at around $70 or even Uniqlo selling at lower prices with fabrics still being from Japanese mills ! .  It is anybody’s guess at what can be termed as premium jeans. If only very high priced labels are termed as premium jeans, we would have a very small % of jeans in US qualifying for the same – maybe around 1% – though their sales value at over $1 billion would not be insignificant.

It is also interesting to see the results from the WSJ poll on what average price the consumers are ready to pay for their jeans. Interestingly , about 15% consumers in the poll are still ready to pay over $250 for their jeans.. So the craze for premium denim continues !!

The retailers worldwide are resorting to increases in prices to make up for the increased costs – most of which have been attributed to the increase in cotton prices. Though the cotton prices have started to ease, the impact on the supply chain will be visible for some time to come.  As previously mentioned , GAP announced its forecast of reduced earnings leading to the largest fall of share price in over a decade . Businessweek now reports that the apparel brands are finding that they do not have much pricing power over budget conscious consumers and the only way to fight the increased prices is to cut costs .

Companies are resorting to “Deconstruction Experts” – companies who help to reduce the cost of the garment . These companies , eg Kurt Salmon – are helping a number of their clients to find the ways to cut costs without making the change felt to the consumers.

Various suggestions being given by these experts to cut costs. Fabric comprises as much as 50 percent of a garment’s costs. Cutting it more carefully to reduce waste can reduce by a few cents, Zippers that come in a big roll are cheaper than ones custom-made for specific garments .Brown – Vice Chairman , Kurt and Salmons ,  recently examined a pair of men’s khakis that sell for $29.50 and spotted a coin pocket. Eliminating it zaps a nickel, he says. Watch pockets are an easy cut, since few men use them anymore. So are logos and decorative stitching inside the waistband—visible to men only when they put on their pants.

However, this cost cutting cannot be taken beyond a point . The customers can easily switch over to another brand if they find cheaper plastic buttons, smaller pockets  or reduced quality of waistband or other visible changes.

However, i feel  that the brands/retailers which have been able to absorb these increased costs and have not made significant changes to their prices or product quality will be able to get the benefits in the next one year. The impact of increased prices of cotton is  going to go away as we are seeing the prices of cotton falling and the retailers will not have to work too much on cost reductions. We might see GAP’s share price rising in the next 6 months again !!!! 

The denim players have seen some tough times in the last 1 and half years. With the cotton prices going through the roof (having almost doubled), the mills were  previously hard pressed to make their buyers understand the increase in costs and tried to get the prices increased. The process was slow as getting sharp increases in prices from buyers is never too easy. However, the awareness of the cotton price increase was there among buyers and many of them , reluctantly , agreed to increase the prices . Now, with cotton prices crashing, the strike by garment manufacturers against govt. duties , reduced demand etc has suddenly led to a situation of oversupply of denim fabric with prices falling . According to reports, most of the mills have large stocks   and the next 2 months look tough for the denim market. The players who were specializing mainly in the polyester denims and with no exports have been hit more hardly. The prices of polyester denim seem to have fallen about Rs 15-20 per mtr (35-45 cents/mtr)  and those of cotton in the range of Rs 10 (2o cents approx). However, with festive season sale starting from July, it is expected that the demand would stabilize during this period.

Cotton Prices

Cotton price increase in the last one year  have actually played a spoilsport and have not helped anyone – neither the mills, nor the retailers and of course not the consumers. It has created a lot of uncertainty in the market and is still doing so. The cotton prices  had increased dramatically last year and peaked during Feb this year. However, suddenly the prices have started crashing with a better forecast of cotton production.  In India, the prices have come down from almost Rs 65000 a candy (35 to Rs 42000 a candy – about 33% fall  in 2 months !! Internationally , also prices have been reducing on a similar note :

The movement of international cotton prices over the last year can also be seen here.

The outlook of future prices of cotton also do not look that good. The crop for 2011-12 is expected to be very good at about  127 million bales with cotton planting around the world projected to rise by 7% in 2011/12 to 36m hectares– the largest in 17 years.. The cotton futures market in US is projecting prices much lower than current levels . See below :

The international retailers too had to bear the brunt of the cotton price increases. Many of them could not pass on the price increases in the denim and other fabrics to their consumers.  Eg GAP management said late thursday

“….second-half product costs per-unit, factoring rising cotton and other costs, are now expected to rise about 20%, more than it anticipated, as it began to purchase goods for the holiday season. Its lower-priced channels such as Old Navy and the outlet stores that compete on price would be hit the hardest and would have the least room to pass on any cost increases…..”

As a result the share price of Gap plunged 18% – its biggest fall in a decade -on hearing this news of increased costs.  Chief Executive Glenn Murphy said

  Gap has been testing the depth, frequency and length of discounts to help offset margin pressure. It plans to be less promotional and experiment with marketing ideas to drive traffic that do not involve discounting.For instance, at the company’s struggling Gap brand in the U.S., instead of having a 40% off the entire chain, the company plans to have promotions such as 40% off women’s products excluding denim, he said.

Similarly , many other retailers have not been able to pass on the increase in sourcing costs to their consumers and are feeling the heat of increased costs.

Now, with falling prices of cotton, the mills will be faced with the prospect of reducing prices for the retailers and other customers when already many of them have a stock of 3-4 months of cotton at higher prices. It would be a double whammy for the mills as they try to deal with their customers again and try to hold on their prices as costs have not gone down.

Another problem related to exports for denim mills in India would be the DEPB – a scheme under which they got incentive of about 7.5% on exports is coming to an end and being replaced by Duty drawback scheme where they would get almost 4% less. This would further shave off another 4% from the margin of exporters and will not give any help .

As mentioned before, the strike by garment manufacturers in India – which lasted about a month , left a huge impact for both fabric and spinning mills. The companies are reeling under the impact of the reduced production for this time which can hardly be covered up . Most of the spinning mills are running under capacity and holding huge stocks with prices of yarns falling on a daily basis.
It is hoped that the market would get some sanity after end of June when demand starts to pick up for festive season .

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This is a guest article by Robert Antoshak – Managing Director , Olah Inc.

This week, cotton futures prices topped $2.00 per pound. A year or so ago, the big debate in the cotton world was whether cotton could reach the history-setting level of a $1.00 per pound. How things can change!

For jeans and denim companies, the recent run up in cotton prices has significantly impacted costs and at a time when consumer demand remains uncertain in the U.S. and elsewhere.

So how did this shortage sneak up on us?

Simply stated, there is a shortage of the stuff. Causing the shortage were a number of factors that came together to create a supply imbalance not seen in cotton since World War I.

1. First, global stocks of cotton were drawn down sharply as less cotton was grown and shipped through the global supply chain due to competition from other crops. Many farmers switched to different crops when cotton was below 80 cents per pound. In particular, the ethanol boom of a few years ago convinced many farmers it was time to switch into corn production as corn paid better than cotton. Previously, cotton had been stuck in an anemic price range of about 40 cents to 70 cent per pound. Corn, on the other hand, soared when government support of ethanol production pushed that commodity up to unheard of price levels with corn now worth more as a fuel additive for our cars than as fuel for our stomachs!
2. Next, there was bad weather. Flooding in Pakistan, a poor crop in China and a bad Monsoon in India combined to seriously undermine global cotton production in the season leading up to the recent surge in cotton prices. As much as one quarter of the global cotton crop was somehow affected by this bad weather and at a time when there was less cotton grown because it was more profitable for farmers to grow other crops.
3. Finally, government actions further aggravated the situation. India, one of the world’s largest cotton producers, slapped export quotas on raw cotton and yarn in an attempt to maintain a good supply of moderately priced cotton for its textile industry. But cotton prices in India did not moderate and all this policy did was to cause an acute shortage of cotton and yarn in China, the major export market for these products. What a way to treat you customer! As a result, stocks of cotton in Chinese government warehouses began to run low. Without the ability to freely import cotton and yarn from India, and faced with a poor domestic crop and low country-wide inventories Chinese mills have had little choice but to enter the world markets and buy everything in site.
4. And there’s more. When the grip of the global recession began to ease on economies everywhere, demand for textiles and apparel rose. Over the past 50 years or so, the U.S. and Europe often led global recoveries. But this time something was different. China played a major role as an end consumer of products. The Chinese government pumped huge amounts of money into their economy in an effort to ward off recession. It largely succeeded. Domestic demand soared, a recession was avoided in China, but demand for cotton jumped to levels not seen in years as local mills struggled to produce enough product to not only meet restored demand in the U.S. and Europe — but the demand of local consumers as well. Chinese textile producers are no longer solely reliant upon the global markets for their livelihood. Domestic sales have now become a new standard for the world’s largest textile industry and have placed even further demands on the cotton supply chain.

There are also other factors that have contributed to the run up in cotton prices, some more obvious than others. Higher energy costs have played a role not only terms of shipping cotton but also to physically grow the crop. There’s another factor too – speculators in the cotton market. A weak U.S. dollar has helped to inflate commodity prices. It is often said that the wherever gold goes so does cotton. During this run up, a safe haven for investors has been gold and other commodities. When the stock markets were shaky during the recession, there was a lot of money to be made betting on higher commodity prices. In terms of cotton, sensing a quick buck, hedge funds swooped into the market just as the run up in prices began and the sheer size of their positions elevated prices well beyond what has normally been the case in the cotton markets.

And, yes, there is one other factor: psychology. Panic is driving the market these days. Fear of not being able to secure a supply of cotton has left many clothing companies scrambling and even more mills wondering if they can stay in business if the price continues to rise and if there will be a consistent supply of cotton to be had at any price. It is this panic in the marketplace that has helped to elevate cotton prices even more. For many years, the retail and apparel side of the textile supply chain set the rules for what it was willing to pay for its raw materials be it fabrics or raw cotton. But the panic in the market has weakened the grip of these companies. Raw material suppliers appear to have at least temporarily gained some ability to push higher costs on their customers and, indirectly at least, to the customers of those customers.

Needless to say, all of these factors have put the cotton industry in the precarious position of meeting soaring demand from a reduced production base.

The bottom line: There’s simply not enough cotton to go around.

Of course not all textiles are made of cotton and the fabric is only one component of the final price of the item. Unfortunately, polyester and other synthetic fabric prices trend to track with cotton and have risen significantly as well. Labor has become more expensive as has electricity, and pretty much all of the input costs of producing a final product. Sounds like an end of the world scenario…

But there’s hope on the horizon. Production will return. $2.00 cotton will move many farmers back into the game. A few years ago, many in the cotton trade forecast a reduction of U.S. cotton acreage from about 10 million acres to just six million. Funny how things change: Today, most analysts feel the US market will actual grow to about 13 million acres this year. As the U.S. is the world’s largest exporter of cotton, that’s a good thing.So all is not lost. Production will return and prices should moderate over time.

Will we go back to 40-cent cotton anytime soon?

No. Cotton prices will remain high for next couple of years — certainly above $1.00 per pound and it is possible that the record run-up in cotton prices will continue. But eventually prices will moderate as more supply comes on line. It just takes time. It takes almost 200 days to grow a cotton crop. Because of this long lead-time it will take time to bring production to a level that meets world demand.

But, then again, there’s only so much acreage to grow cotton. Perhaps that’s best left for another discussion on another day!

About: As Managing Director of Olah, Inc., Mr. Antoshak supervises the firm’s global cotton marketing and consulting services. Olah Inc runs the famous Kingpins Denim  Shows besides other activities. Mr. Antoshak has more than 30 years of experience in the fiber and textile industries. He has held analyst positions with the Fiber Economics Bureau as Editor of the Fiber Organon, American Fiber Manufacturers Association as Director of International Trade, American Textile Manufacturers as Associate Director of International Trade,  as President, Werner International as Vice President of Information Services, . Most recently, Mr. Antoshak was Managing Director of the Fibers & Textiles Division of FCStone, LLC.  Mr. Antoshak has strong experience in trade negotiations and worked as a FBI-cleared industry advisor to the U.S. government on numerous bilateral quota trade agreements, NAFTA, the MFA and the WTO.

Contact him on this email address.