Keerthi, a garment professional friend from Sri Lanka has asked me to explain just how designer labels can charge $300 for denim jeans, when Wal-mart will sell denim jeans for $15.00. For that matter, how can Wal-Mart sell Levi jeans for $18.00 when Levi sells their cheapest jeans for $48.00?
The difference cannot be in the cost of fabric. Wal-Mart buys the same quality denim — often from the same mills —as Levis Strauss. And, while it is true that designer labels use a finer quality fabric, the difference between Armani fabric quality and Wal-Mart fabric quality is less than $8 per garment.
The difference cannot be factory costs. In today’s market a factory located in any of the big jeans exporting countries — China, Bangladesh, Mexico, Vietnam, and Cambodia — is paid $1.80 (if they are lucky) to cut and sew the jeans. The factories making for Wal-Mart, located in Mexico are paid closer to $1.00 Again, while it is true that Armani and other designer labels are primarily produced in the United States and Europe, the fact remains that their factory making charges will not exceed $15.
Why should the designer label and brand importer receive so much while paying so little to the factory? As far as my friend Keerthi is concerned, the whole thing is more than unfair. It is case of obscene greed.
Unfortunately, this is not the case. It is all about garment industry dysfunctional costing systems where an FOB price of $1 paid to the factory, translates as $8.00 – $11.00 in the store and nobody makes any big money.
The industry operates three levels
1. $300 Jeans: The expensive designer label, such as Armani, Diesel, Hugo Boss etc
2. $48.00 jeans: The major brands, such Levi Strauss, Gap, etc
3. $15 Jeans: The Wal-Mart exception
To understand just what is going on, imagine that you are the owner of Schmidlap Chic — an expensive designer label
As you can see from the costing below, the made in Italy jeans that cost FOB $28 at the factory, retails for $311 at Saks.
|Schmidlap Chic: Designer Label – Made in Italy|
|Export Country Cost||$29.40|
|Clearance and Transport||2.50%||$0.70|
|Delivery Duty Paid||$35.00|
If you were the buyer for Levi Strauss— you would have a similar costing formula but with lower costs. The made in Sri Lanka jeans which costs FOB $6 at the factory would retail for $48.00
|GAP: Brand Importer: Made in Sri Lanka|
|Export Country Cost||$6.30|
|Clearance and Transport||2.50%||$0.15|
|Delivery Duty Paid||$7.70|
We have three players: The factory, plus the two customers: the brand importer and the retailer.
Consider Keerthi and his Sri Lanka factory. The factory is paid $6.00 but very little of that goes to Keerthi. The price of the average jeans is broken down as follows:
60% Fabric Cost
10% Trim Cost (thread, zippers, buttons, packing materials etc.)
30% Factory production
If the product costs $6.00, the factory earns $1.80 on a product with a retail of $48.00 — about 4%. It would seem that the factory is losing out to the customers.
The Italian factory, working for Armani does a bit better. They are paid $15 on a garment that retails for $310, about 5%.
You would think that if you buy for $1 and sell for $10, you would be making a fortune. The truth is very different.
The Brand Importer
Schmidlap Chic buys for $28 and sells for $78.
You must be rolling in money. Your greatest problem in life should be to decide whether to buy a new Bentley or a Rolls Royce. Yet here you are driving a three year old Toyota. Where did all the money go?
Your money bag has two holes
- Pre-production costs of design, sampling and related processes. Whether you are Giorgio Armani or Schmidlap Chic your pre-production costs per style are the same as Levi Strauss, Wrangler or any of other denim giants. The difference is that while Levi Strauss sells literally millions of pieces per style. Your sales are in the thousand. Your pre-production costs per unit can be 100-500 time greater than the denim giants.
- As a wholesaler, much of your gross profit goes back to your retail customer in the form of advertising, mark up guarantees and other add-ons over which you have no control.
At the end of the year, if you can earn 5%-6%, you are doing very well.
The retailer is buying for $11.84 and selling for $48.00. 75% of Gap’s selling price is profit. Surely Gap and Levi Strauss must be raking it in.
Not so. They too have problems. Their biggest problem is markdown. The hangtag might read $48.00 but after sales and discounts they can lose 35%. $16.80 flies out of the window in which case 75% mark up becomes 40%
Gap and Levi Strauss are left with $19.36 to cover is very large and ever-increasing overheads.
The factory earns 4%-5%
The brand importer does slightly better earning 5%-6%
The retailer also earns 5%-6%
At the end of the day, the industry that buys for $1.00 and sells for $10 shows very little for their efforts.
How does Wal-Mart do it
Wal-Mart works differently.
First of all, first of all their brand suppliers work on a lower mark up based on Wal-Marts enormous orders.
Secondly, their largest denim supplier VF Corporation operates the most efficient jeans factories in the world located in Mexico which has duty free access to the U.S.
Finally and most importantly, Wal-Mart works on lower profit margins. While most retailers require 70%-75% mark up, Wal-Mart is content with a 40%-50% mark up.
|Wal-Mart: Made in Mexico|
|Export Country Cost||$5.25|
|Clearance and Transport||2.50%||$0.13|
|Delivery Duty Paid||$5.63|
As a result Wal-Mart competitor’s retail price is over three times the Wal-Mart price
The belief that Wal-Mart succeeds because it underpays suppliers is a myth. If you want to supply Wal-Mart you better be efficient and very large indeed. But the factories who meet these requirements show good and consistent profit.
If their competitors find it difficult to compete with Wal-Mart, the fault is theirs.
Our industry has locked itself into a dysfunctional cost structure where to show even a modest profit, customers must buy for 1 and sell for 10. This may be an effective strategy for drug dealers, but unlike your local cocaine supplier, the consumer can survive quite well without another pair of jeans
The new economic reality is changing the rules of our industry. Those who can accommodate themselves to these changes might survive. Those who cannot will disappear.