This book is a tool for buying and producing at the lowest cost. The tool is Full Value Cost Analysis (FVCA). As with any tool, you have to read the operating instructions before turning on the power.
The operating instructions for FVCA are very simple. There is only one instruction: Forget everything you ever thought you knew about garment costings. You and I, brought up in the very bowels of the international garment industry, have for years accepted certain unshakeable ‘laws’ of product costs. Dredge them up and throw them up.
Unshakeable Law #1: The lowest cost garments come from places with the lowest wage rates.
There exists no direct correlation between labor rates and manufacturing costs. I realize that to tell you, a professional international garment-sourcing specialist, that cheap labor does not equal cheap garments is like telling the pope that Jesus was not crucified, but pushed in front of an oncoming subway train.
I will return to this mystery later on. For the present, it is enough to say that the unaccounted for money does not wind up in the factory’s pocket. The fact is that for most Third World factories, wage rates are not the most important component of total manufacturing costs.
If you think about it rationally, the conclusion seems almost obvious. Low labor rates do not determine garment cost. If they did, we would all be working in Somalia, North Korea, New Guinea, Cambodia, or any of the other twenty-plus countries where wage rates are six cents an hour or less. Few importers work in the truly low-cost-labor areas simply because the final costs of the products made in these countries are too high.
Unshakeable Law #2: The lowest FOB cost comes from factories with the lowest manufacturing (CMT) costs.
There exists no direct relationship between CMT and FOB costs. I know this is a little hard to swallow. It was for me. Like you, I was taught that the whole purpose of traveling to the ends of the earth to make a five-pocket jeans was to take advantage of cheap manufacturing costs. Yet the figures simply do not support this premise; in fact, sometimes they prove that the entire effort may almost be a waste of time.
Consider this example.
Unshakeable Law #3: The lowest FOB cost results in lowest actual product cost.
There exists no relationship between FOB or landed-duty-paid (LDP) costs and the actual cost of the product. I realize this is difficult to accept. I appear to be saying that costs are not costs. In fact, the real problem is that many—if not most—of the factors that determine costs are not even included in professional buyers’ cost calculations. Yet all importers do use these hidden costs to make their decisions.
Here is just one example of an important cost not included in the cost sheet.
Most garment professionals can work out that in the case of the Sri Lankan factory, direct labor counts for only 10% of CMT. These same professionals know that as in the case of the five-pocket jeans, total CMT in a Third World factory seldom exceeds 30% of the FOB price. That means the total cost of direct labor in these factories is a negligible 3% to 4% of FOB, which in turn works out to 2% of the LDP price or about 0.75% of the retail price.
Yet despite these ratios, I and almost every other garment professional around still looks at direct labor as the prime factor in determining total garment cost. Take, for example, a senior executive for one of the world’s largest manufacturers of active sportswear and footwear in April 1997 commenting on a 10.7% pay rise recently won by their Indonesian factory workers, who stated, “Indonesia could be reaching a point where it is pricing itself out of the market.”
At that time, an Indonesian line worker was paid about $1.80 for a tenhour day. A 10.7% wage increase equals 1.9 cents per hour—adding a cost of a little more than a nickel on each pair of shoes retailing for about $100, or about 0.06% of its retail price. This is an amount so small that it is not even worth including in the costing. Yet the American company spokesperson stated that the problem of rising wages was so serious as to cause the company to consider relocating its production.
Decisions like this are not only illogical, they are insane—especially coming from one of the smartest management teams in the entire industry. A better solution would be to fire the man who made the statement and use his $250,000 salary to pay the wage increase. This way the buyer could increase the direct wages of 4500 workers by 10.7% and still come out saving money.