What’s Really Going On With Sourcing Costs?
Fashion may be built around navigating rising sourcing costs, but the hikes over the last 18 months have been unheard of, even for those who have heard it all before. Costs have climbed more than tenfold in some cases.
There are hikes in fiber prices and increases in ocean freight, spikes in air freight, upticks in trucking costs with more fees for port congestion, demurrage and yard storage, and even increased spend for chassis because they’re being occupied for longer. Container costs are up, as is capacity in ocean freight, though it’s down in air, but planes are back in flight — though soaring to Miami or Mallorca doesn’t help with moving goods from Shanghai to Los Angeles. Add to that, demand is surging and little has changed when it comes to delivery delays since the onset of the pandemic.
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The collective sentiment among those in the supply chain could perhaps be best summed up by Grandmaster Flash and The Furious Five, with their 1982 rap “The Message” when they said: “It’s like a jungle sometimes, it makes me wonder how I keep from going under.”
And the message, according to experts, is that though supply chain cost surges have moderated somewhat, there’s no expectation of a return to “normal.” Especially with Delta lurking.
First, the Fiber
Furthest upstream, cotton prices are climbing.
In July 2021, the Cotlook A Index (a representative reflection of offering prices on the raw cotton market) had the price of cotton at 97.70 cents per pound — nearly 43 percent above the index average. Early this month, the index crossed $1 per pound for the first time since mid-2018, according to Jon Devine, senior economist at Cotton Incorporated. For comparison, the price was 75.54 cents a pound pre-pandemic in July 2019.
When it comes to yarn, the average price in Cotlook’s yarn index was 150.54 in July 2021, compared to 122.75 in July 2019.
“Yarn prices have moved in step or even beyond the increases in fiber prices since the lows set last April,” Devine said.
And the uptrend in prices is expected to sustain, at least for now.
“Despite an outlook calling for strong economic growth for the remainder of 2021 and into 2022, the Delta variant has proven that COVID-19 remains a threat. It has already led to the shuttering of factories in several manufacturing countries,” Devine said. “If it continues to impede order completion, it could possibly weigh on fiber demand and cotton prices.”
The Situation at Sea
Talking ocean freight, a general rule might have assumed high rates meant low capacity, but on major trade lanes like the Trans-Pacific or the Far East Westbound to Europe, capacity is up over what it was in the last two years.
So, if capacity is up, why are rates up, too?
“One, it’s straight demand,” said Nathan Strang, senior trade lane manager of operations at freight forwarder Flexport. “More people are buying more things and we see that across the market. The other one is the delays. The delays are causing artificially low capacity.”
What that means is, actual capacity (how many ships are deployed, en route, in work) is up “something around 30 percent over 2019,” according to Strang. What he calls effective capacity is “far lower.”
“It’s probably 10 to 20 percent less than what we’re seeing and that’s only against like 5 percent more demand,” he said. The best way to explain it, he noted, is that because a routing from Shanghai to Los Angeles, let’s say, now takes 60 days compared to its previous 25, the doubled time makes several messes of things.
“If it’s taking twice as long to get there, that also creates kind of an artificial demand within the system in that it takes two vessels now to make up for one and that’s what you’re really seeing in the market,” Strang said.
That artificial demand is making for very real increases in pricing.
Comparing pre-COVID-19 to current rates for 40-foot containers, Flexport said the average rate from the Asia to the U.S. West Coast trade lane, for example, went from between $1,600 to $2,100 in July 2019 to between $21,000 to $23,000. That’s a staggering more than 1,200 percent increase. Where equipment and space add-ons ran between zero dollars to $500, now they’re between $3,000 and $13,000.
Looking at Asia to North Europe, the average rate in July 2019 was between $1,400 and $1,900. Last month, it was between $15,000 to $20,000 — a 971 percent increase on the highest end.
“You have ocean rates that are 10, 12 times what they were in 2019,” Flexport executive vice president and global head of airfreight Neel Jones Shah added. “You have shipping containers that used to cost $2,000 from let’s say Yantian, China to L.A. that are now $22,000 to $25,000. So, you’ve seen this exponential increase in rates on the ocean and at the same time, you’ve actually seen transit times expand dramatically.”
Productivity dips with outbreaks at ports and worker shortages are, of course, critical parts of the problem. But so is access to equipment. There are only so many ships (and making more takes two to three years), and there are only so many containers because with congestion, containers are spending roughly four to five more days out of commission than they were pre-pandemic, whether it’s because they’re holed up at a distribution center or in a warehouse or otherwise idling.
“What that’s doing to rates is that, as these timelines push out and people are looking further and further into the future and realizing that the things that they’re ordering are going to be delayed, it’s kind of gotten into a bidding war for equipment and that’s driving equipment prices up,” Strang said. “[Companies are] going to be willing to pay higher and higher prices to get their containers loaded until you get to a point where either you run out of time and you have to ship to air, or the price point has gotten to a situation where you’re like, ‘I’m just going to move to air’ — if capacity is even available.”
Airborne
The skies have never been particularly friendly to margins, but the once more luxe mode of getting goods from A to B has become commonplace to many — however costly.
And it’s costly.
At the outset of the pandemic, with grounded passenger flights (which typically carry around 50 percent of global cargo in the belly of the plane) and the rush to get PPE in at the time, the supply chain crush began its course.
“With the loss of all these passengers flying, all of a sudden so much capacity got taken out of the market — obviously that had a dramatic impact on both rates and transit times,” Shah said. “I mean, we saw rates go from $3.00 a kilogram, $3.50 a kilogram, let’s just say from Shanghai to L.A. as a representative lane, and it went to $15 per kilogram literally overnight.
More specifically, looking at average air freight rates for Asia to the U.S. West Coast, according to Flexport’s data, 2019 saw costs between $2.50 to $3.50 per kilogram and this year those costs are running between $7 to $10 per kilogram more than double.
For Asia to Europe, pre-COVID-19 rates hovered between the same $2.50 to $3.50 per kilogram for airfreight and the increase is slightly less than double at a current $4 to $6 a kilogram.
“Airports also became heavily congested, so it was sort of this domino effect where we broke all of the norms that the industry had experienced up until that point. In my career we’ve never seen anything like what we saw when COVID-19 hit,” he added. “Now let’s fast forward to today, not a lot has changed. This is sort of the longest running crisis we’ve had in the logistics industry and not much else has changed. Rates have moderated a bit, they’re not at $15, $16 per kilo, they’re closer to $10 per kilo today so they’ve moderated but they’re nowhere back to where we historically have been.”
And frankly, he said, they won’t be.
“Capacity is still down, let’s call it 10 to 15 percent and demand continues to surge,” Shah said. “U.S. consumers have saved over $3 trillion through the pandemic…and people want to spend….Our customers, for the most part, when we survey them have seen an absolute boom in demand and you see the inventory to sales ratio is the lowest it’s been in the history they’ve been measuring that.”
Many retailers, he said, are out of inventory and have been waiting for “this sort of COVID-19 pricing to break,” but the wait may be in vain.
“We’ve been in this situation now for 18 to 20 months and we haven’t seen the situation materially improve,” Shah said earlier this month. “Just in the past week, rates have gone up more than 10 percent. And I anticipate that over the coming weeks, as demand continues to increase because we’re heading into peak season and capacity gets reduced because carriers have canceled a lot of operations, you’re going to see rates continue to go up.”
For one, not much passenger capacity is expected to return, particularly in trade lanes like Asia to the U.S.
“Let’s be honest, I think a lot of maybe your readers, they see TSA numbers are up dramatically, airports are jam-packed and they’re, like, ‘Hey, wait a minute, what’s going on? Why aren’t air freight rates back to normal, the planes are back in the air?’ The planes are back in the air but they’re flying to Mt. Rushmore, they’re flying to Hawaii, they’re flying to Cancun, OK. They’re not going to Shanghai and Hong Kong and Hanoi and Saigon,” Shah said.
Air freight rates currently sit around $10 per kilo, as Shah noted, which he’s calling the “baseline” because “we’re going to be looking at rates in excess of that over the coming weeks and months, so shippers just need to be prepared for that.”
“I anticipate this current situation definitely bleeding over into the first half of 2022,” he said. “The second half is a little bit more interesting because, as the airlines contemplate their schedules for 2022, a lot of them are anticipating returning flights to Asia, but that also depends on quarantines coming down, restrictions being lifted, Asian countries moving more towards a ‘we have to live with COVID-19 strategy’ as opposed to a zero COVID-19 strategy.’”
From the ocean freight perspective, Strang is less optimistic.
“I don’t see rates coming down at least through Chinese New Year, so February of next year,” he said. “I don’t think that the rates are going to come down significantly for 2022 either though.”
Landlocked
While countries work out whether they can or should settle into some type of functioning alongside the virus, more problems are playing out once goods are in land’s reach of their destination — and these show no signs of abating soon, either.
With congestion at ports, it’s taking much longer to unload containers. One customer of freight forwarder Aqualine International Inc. waited a month while their container sat at the Long Beach port, until they handed over an extra $25,000 to terminate the container onsite, pay a trucker to pull it from the terminal, take it to a warehouse for transloading and then putting it into a different truck to get to the destination.
Port congestion is costly all around. Because some terminals have no space to take in extra containers, truckers are stuck holding them until they can get an appointment to return it to whatever alternate location. And because the empty sits on a chassis, that means the already hard-to-come-by equipment is further tied up.
“Before the trucker would pick up the container from the terminal, take it for delivery or they’d pick up the night before and take it for early-morning delivery and then return the empty directly to the terminal the same day. But now, with them having to hold the empty for return appointment, the additional chassis fee is being incurred,” a spokesperson for Aqualine said. “Usually [the process] is two to three days, now it’s like a week.”
That means fashion companies trying to bring goods in — on top of whatever standard costs — can be paying upward of $250 for demurrage fees if the trucker can’t get the goods in the agreed upon time, detention charges around $140 per container per day because the containers aren’t returned on time, plus empty return fees, yard storage fees if the trucker holds their goods for them (which can include pre-pull fees if it’s picked up early and a stopover fee for taking it to the yard), and, of course, a fee for the trucker’s time since waits to collect a single container can run as much as six hours, if not more.
What Becomes of the Broken Margins
Margins, needless to say, aren’t enjoying their finest moment.
Some companies, according to Shah, have foregone focusing on that vision of profit altogether.
“When I talk to some of our high-growth customers, the ones that have been around for a few years but have a really, really interesting line of products and they’re growing like crazy, what I hear from them is: ‘We made the decision to sacrifice margin in the fourth quarter, we’re OK not making money, we want to keep up with our growth trajectory, we want to hit our revenue targets,’” he said. “Shippers that are having to make those sort of tradeoffs.”
What the Sourcing Execs Are Saying
If you ask those further upstream, all of these rising prices are the least of fashion companies’ concerns.
Their primary focus should be on whether they can get their goods at all — and if they can do so without contributing to garment workers dying from the virus.
“It’s not as simple as the labor costs, the factory overhead, the logistics cost inbound and outbound or the material costs,” said Raymond Tan, chief executive officer of Luen Thai Holdings. The Hong Kong-based fashion and lifestyle apparel manufacturer, which has factories across Asia and has had to shutter them on and off amid the pandemic, has itself lost seven workers to the virus, despite its precautions. “Brands have to decide are they going to place the order with factories knowing that the workers will get infected? Now comes the compliance issue.”
Mounting costs and dwindling margins would pale in comparison.
“If I were the sourcing head now, I’m just going to look at which country has a good vaccination percentage and just go place the order there if you want the goods,” he said.
There are three types of current sourcing situations pertaining to COVID-19, according to Tan: those where the sourcing country is going for the zero-COVID-19 goal; those where the sourcing country has accepted coexistence with COVID-19, and those where they can’t afford lockdowns and they also can’t get COVID-19 under control. The third category, he said, which are largely the developing countries, is where the supply chain gets most impacted — and, often, where vaccines are least widespread.
That means on-and-off lockdowns and shutdowns because of the still-spreading virus, more at risk workers, more significant delays and more costly movement from one production facility to the next.
“Just imagine at this moment, Vietnam got locked down, goods start to move to let’s say Cambodia but Cambodia never really had this kind of outbound service because the Cambodian market was never really that big for sourcing in the past. So all of a sudden there’s huge demand for containers but there’s not that many containers in Cambodia. But then the worst thing is, when Cambodia got locked down, the orders were moved to Vietnam. That was April-May and then it got moved back. So all this movement requires logistics service,” Tan explained. “When you talk about the logistics costs, it’s not just about from the normal tier 2 to tier 1, because the material went from the fabric mill to the factory and then from the factory it went to another factory and another country because of the lockdown. And now the material’s gone from the second factory back to the first factory or to the third factory. So you could actually triple the original material logistics costs and time because of those changes.”
Among Luen Thai’s customers, Tan said outbound costs (the portion brands normally pay after buying FOB from a factory) have surged as much as 500 percent. And because of delays, some companies have spent upward of $80 million in air freight this year alone.
“This is a very, very messy situation,” Tan said, noting that it’s far from finished. “Delta is going to have a much, much bigger impact to the supply chain than a lot of people would imagine.”
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