Twenty years ago major garment importers and retailers began to move away from independent agents to set up their wholly owned buying offices.
In those early days, every customer required their middle man (agent or buying office) to perform the same work. Every middleman carried out the same work. For the most part the quality of work differed little from one middleman to another.
Everyone carried out the same 5-basic tasks
a To select the supplier factories;
b To allocate orders to those factories;
c To act as a Nexus between the customer and the factory. To ensure that the factory received and understood the customer’s instructions and to communicate the factory problems and requests back to the customer;
d To ensure the factories follow all specifications;
i. In-process inspection
ii. Final inspection
e To alert the customer on a timely basis of existing or impending problems.
If the customer’s annual imports at FOB was in excess of $10 million, the wholly owned buying office made commercial sense. Middleman commissions ranged from 5-10% depending on customer size and other relevant factors. This allowed a total commission of between $500,000 to $1,000,000 — sufficient to pay for a decent size office, and then some. The large customer, which twenty years ago was defined as importing $100+ million at FOB would accrue annual commissions between $5-10 million. This amount could comfortably support a series of regional buying offices and still show profit.
There were real advantages to the wholly owned buying office buying office over the independent agent.
- The buying office worked exclusively for the customer. There was no conflict of interest
- The buying office relationships were directly between the customer and the factory suppliers. The supplier learned to meet the specific needs of the customer, rather than needs of the agent, which were often different.
- The buying office merchandisers were trained to be specialists in the customer’s products, giving them greater understanding of the product and better relationships with the factory
- The buying office provided a special bonus. It was a duty-free and tax free profit center.
Fast forward to 2014, and times have changed. Where once customer requirements for middleman services totaled 5-basic tasks which could be listed on a quarter page, today’s list of services which customers might need and their middlemen must supply can run to 35 pages. Where once middleman personnel consisted mostly of merchandisers and QC inspectors, today that same middleman requires a host of highly educated and highly paid professionals including engineers, QA specialists, finance specialists, logistic specialists. etc.; and that list grows longer each year. For 2014 we can add, chemists, labor relation specialists, specialists in foreign trade, and in-house legal counsel.
Just as the range of services rose, so too did customers’ FOB import volume. Retail and brand importer growth and consolidation has created a class of large customers that import anywhere from $1-4 billion at FOB, allowing their buying office annual commissions to range from $50 million to $400 million. $100-$200 million annual tax-free profit looks very good on the balance sheet, even for the largest garment companies.
All of this gives rise to a serious question: What is a fair commission?
Assume for a moment that you import FOB $1 billion per year, and require only the basic 5 service. Assume you approached a highly qualified major independent agent and offered him all your business at 5% —$50 million per year. He would jump at the opportunity. Major independent agents already have branch offices in most if not all the major garment exporting countries. What more does he need?
- 500 additional local staff @ $5000 = $2.5 million
- 50 additional foreign staff @ $100,000 = $5 million
- Branch office expansion $2.5 million
- Additional travel and other overheads $10 million
No matter how you add up the numbers, the agent cannot spend more than $20-25 million for your account. Half the total commission is money for jam.
When it comes to the 5-basic services, the middleman’s task today has become much simpler. Not only are his people better trained, the factories are better organized and far more competent. We are no longer living in the 1980s or 1990s, when suppliers with some few exceptions were incompetent. Just as competition and consolidation has driven out importers and retailers who could not compete, the same competition and consolidation has wiped out the factories that were unable to make the grade. In this more professional industry, both the middleman and the factory know what basic services are required and have the capability to ensure these basic demands are met. Today, selecting an incompetent factory simply because of low CM is conclusive evidence of middleman incompetence.
For a medium or large customer looking for the 5-basic services, 5-7.5% is a reasonable commission. (Mom-&-pop importers may have to pay up to 15%.)
The Impending Crisis
For years buying offices have arbitrarily charged their customer-owners 10% commission for providing the 5-basic services, accruing substantial amounts of tax-free profit in Hong Kong and other offshore tax havens. While we in the garment industry may not be in the same league with the Googles, Apples, Microsofts and Starbuck who have managed to sock away multi-billion dollar hoards, many of our larger players are doing quite well in the minor league, stashing away $100-$200 million annually.
Times have changed and the U.S. Government wants to take back their money. Again, we are not talking about the Google’s billions. However, giving Uncle Sam even $100 million can be a problem for any company, particularly when multiplied by 5 years.
We move from problem to crisis when the importer has failed to make provision for this possible loss. How many in our industry can survive an unexpected a half-billion dollar loss.
In the past, the U.S. government Internal Revenue Service has had a poor record recovering monies derived from improper transfer pricing. I have been involved directly in a number of transfer pricing cases, and in truth government has never faired well.
However, the IRS is becoming smarter.
- The IRS is becoming more pro-active
- The IRS has consolidated garment industry related transfer pricing cases to a single location;
- The IRS is no longer relying on accountants and Economists for their experts. They are now recruiting garment industry specialists;
We in the industry have become lazy, sloppy and dumb.
- We assume because that because to date the IRS has yet to win a major case, they never will;
- Too many buying offices have become incompetent shells whose main purpose is to be a receptacle for tax free money;
- Time on the side of he IRS. The industry has to win every case; the IRS has to win just one.
The first time a major importer/retailer is required to pay the IRS $500 million, a very large portion of customers will fold their buying-office-tents and slink off into the sunset.
The Now and Future Buying Office
The shells that still live in the past providing only the 5-basic services while charging exorbitant 10% commissions may well disappear; however, there are new-model buying offices that will continue successfully while charging a reasonable and quite defensible 15%-33% commission.
The world of 20 years ago when every customer required the same services; every middleman provided the same services; and every middleman was equally competent is disappearing.
The quarter page list of 5-basic services has been replaced with the 35-page menu of services. In this new paradigm commission will be governed by 3 parameter
- What does the customer require?
- What can the middleman provide?
- How well does the middleman perform?
For example, the industry is shifting pre-production (product development) from their home base to their Asian supplier base. Product development involves 12 separate steps from Fabric Sourcing to R&D and innovation.
For example, Markdown is by far the greatest factor determining garment cost. The industry now recognizes that markdowns can be substantially reduced provided customer and supplier work in partnership. In this regard the role of the middleman is crucial. Reduced markdown involves 20 separate steps from fabric sourcing to sustainability.
In either case, not every customer will want to shift every step. However, three points are clear:
1. The middleman is responsible to ensure that they have the facilities to carry out the work required by the customer with an acceptable level of performance. Whether the middleman carries out the necessary steps in-house or out-sources the work to the supplying factory is irrelevant: the middleman is 100% responsible
2. The middleman is entitled to far payment for this additional work
3. Because this work is not part of the FOB price — fabric, trim and CM — payment must be in the form of higher commission.
Added services = equals increased costs = higher commission
However, there is another factor, which in the final analysis may be the primary determinant of fair commission.
20 years ago, when everybody did the same 5-basic step job and everybody performed their work equally well, we could assume that all thing being equal, the middleman commission should be the same for all. In 2014 with its 35-page menu of services it is unreasonable to assume that everybody performs equally well.
The problem is to quantify the level of performance.
We pay the better lawyer more money because the better lawyer wins more cases, just as the better doctor saves more lives, the better investment banker provides a greater return on capital, and the better football quarterback provides more touchdowns.
It is all about delivery — something that we in the garment industry accept as the ultimate truth.
In this case delivery equals cost reduction.
We moved product development from New York to Asia. How much money did we save per unit?
Our markdown previously averaged 35% now averages 12%, How much money did we save per unit?
I suggest that if markdowns can be reduced from 35% to 12%, the middleman commission should equal 25% of the net savings after all costs.
- The customer’s new profit, after middleman commission would rise by 50%.
- The middleman commission would be 33%.
A fair deal all around.
This is the new middleman paradigm, where for some a commission of 10% is exorbitant but for others 33% very reasonable.
 See Birnbaum’s Global Guide to Agents and Buying Office, Fashiondex (New York 2014)
 Two years ago IRS approached me to act as their garment industry expert