pricing out a low-end shirt: investment implications

A while ago, I wrote about pricing out a polo shirt that retailed for $150 then ($175 now).

Today’s post goes to the other end of the fashion spectrum:  pricing out a “fast fashion” shirt that might sell at H&M or Zara for, say, $15.  The source of my information about Bangladesh is an op ed column, “The Economics of a $6.75 Shirt,” by Rubana Huq, who owns a garment business there.

Just for reference, the factory gate cost of the KP MacLane  luxury polo is:

–materials           $10.35

–manufacturing          $11.05

= $21.40.

These figures are unusually high for a shirt, mostly because of the small initial lots involved.  The unit price could easily be below $15 now, depending on how successful KP MacLane has been in its sales efforts.

in comparison, costs in Bangladesh…

…for an order of 400,000 fast fashion shirts:

materials      $5.75

–cotton cloth           $4.75

–labels, other          $1.00

manufacturing     $.875

–wages          $.38

–finishing          $.15

–utilities, factory rent          $.11

–overhead          $.11

–debt service (for manufacturing equipment)          $.125

= $6.625

The selling price at the factory door is $6.75.  Therefore, the per garment profit is $.125.  The total order earns the manufacturer, before paying himself (or, in this case, herself), $50,000.  In the example Ms. Huq gives in her op ed column, this order represents about five months business for the factory.

what I find interesting

Although the KP MacLane polo and the fast fashion t-shirt sell for wildly different prices at retail, the material costs aren’t that different.

The markup over production cost is 718% for KPM, 140% for the tee.  As I mentioned in my earlier post, a Hermès polo sells for $455, or about 2.6x the price of the KPM one.  Hermès’ production costs are probably lower than KPM’s, so the markup is likely higher than 1800%.   In both cases the buyer is clearly paying primarily for the branding, not the garment.

The operating model for classic luxury goods is far different from that of fast fashion.  The former sells far fewer items-most of which have very long shelf lives–at huge markups.  The latter sells huge numbers of items with short shelf lives at low markups.

The two styles demand different skills.  Fast fashion, in particular, has little room for error in design or sourcing/pricing from manufacturers.

the Bangladesh situation

First of all, we have to remember that the data Ms. Huq present come from a manufacturer in Bangladesh, hardly a disinterested party.  Certainly she will want to put her best foot forward.  Still, I’ve found the situation she describes to be typical of the garment industry over the decades, whether located in New York City, Japan, Thailand, China or Bangladesh.

Bangladesh employs 4 million garment workers, the vast majority of them women, who are the chief breadwinners in households totaling 20 million.  They earn US$70 – $80 a month, which is far more than an unskilled laborer could expect in any alternative employment in Bangladesh.  Although their families are barely surviving, the greatest fear of these workers is doubtless that the garment industry will shift away from Bangladesh to other low labor-cost countries, like Vietnam, leaving them unemployed.

The garment manufacturer in Bangladesh may make $100,000 a year if everything runs smoothly.  But that could be considerably less if he’s inefficient or if he encounters production delays that, say, require him to pay for shipment by air.  So one can certainly understand–not condone, just understandthe temptation an unscrupulous owner may feel to lower rent by turning a blind eye to safety violations.   It’s not clear how much leeway fast fashion has to alter its operating model by raising prices, either (look what happened to JCP).

In theory at least,  consumer pressure on international retailers for a keener eye to worker safety when sourcing garments may solve that issue–although the same problems seem to recur decade after decade and in country after country.

The more difficult issue to reconcile are the ideas that income of $70 a month is a good situation to be in, which in Bangladesh it is, and that well-intentioned efforts to improve it may make the workers’ lot considerably worse.

capital spending, robots and “reshoring” of manufacturing to advanced economies

Blogging for the New York Times, Nobel laureate Paul Krugman recently referred to a Times article on the possible return to the US of manufacturing once outsourced (or “offshored”) to Asia.  In “Rise of the Robots,” Mr. Krugman suggests that much (all?) “reshored” manufacturing will be highly capital-intensive.  Factories will be run by robots, with only a few, highly educated, highly paid human supervisors finding being employed.  Therefore, he concludes, reshoring isn’t the job creation panacea some might think.

I have several comments:

1.  This is not new news.

For over two decades, tech businesses like semiconductor manufacturing have been very highly automated.  Component assembly is increasingly so.  In  the semiconductor case, only a few process engineers watch over $3 billion installations that may generate billions in annual operating profit.  Units of output are tiny and weigh next to nothing, so transport costs aren’t that important.  As a result, tax incentives for building and the rate of tax on corporate profit are the two main determinants of where a plant will be located.

One reason there aren’t more fabs in the US is that income tax rates here are relatively high.

2.  At least some of the current reshoring is either in response to political pressure or to creating a more favorable corporate image in the media.  AAPL, an example cited by the Times, has pledged to invest $100 million to make Mac computers in the US.

Sounds good, doesn’t it?

But $100 million is less than 2% of the company’s annual capital spending budget.  So it’s just a drop in the bucket.  If we pluck a number out of the air and say the investment will generate $1 billion in annual sales, which I think would be an awful lot, that wouldn’t amount to even 1% of the $160 billion or so in sales that AAPL will ring up this year.  Plunk! (=the sound of a drop hitting the bucket)

3.  Stuff that’s very heavy, spoils easily or that faces strong protective barriers against imports, normally must be produced in the same country where it’s sold.

4.  For a brief time I owned shares of Osaka-based manufacturer Sanyo Electric in my portfolios.  I bought it despite its collection of ugly business lines because at the time it was by far the dominant global maker of cellphone batteries.  That business was growing like a weed.  It alone was, in my view, worth far more than the entire market capitalization of the company’s stock.

Because Japan was a high labor cost country, Sanyo had created a highly automated operation.  For each 20,000 units of annual battery production, it had installed machines worth $1 million, which were  watched over by six employees making $50,000 a year each (these are not the real numbers, but that’s not important  for my point).

Business was great–until Chinese competitor BYD emerged.  If the name sounds familiar, it became famous years later when Warren Buffett “discovered” it.  BYD didn’t have the highly educated workers available to it that Sanyo did.  So it couldn’t use the highly automated machinery that its Japanese rival employed.  Instead, it bought simpler, locally made machines that were manned by a larger number of less skilled workers.  To produce equivalent output to Sanyo’s, it installed $500,000 worth of its simpler machines, run by 20 people being paid $7,500 a year each (again not the real numbers–like the real Sanyo figures, those are in notes which remained the property of my employer when I left) .


The really stunning thing about this example is that:

–BYD made its batteries with both less input of capital cost and less input of labor than Sanyo.  In the textbooks that’s not supposed to happen.  You’re supposed to have to choose between capital-intensive or labor-intensive production methods.  And you’re supposed to be able to compete using either approach, depending on your local labor cost structure.  Not here, though.

A little arithmetic–

Assume that we write the cost of the machinery off in equal installments over ten years.  Then Sanyo’s costs are raw materials + electricity + water, etc. + $100,000 in depreciation + $300,000 in salary.  That’s $20 for each battery + materials…, maybe $25 for each in total.

For BYD, the figures are raw materials etc. + $50,000 +150,000.  That’s $10 + materials… for each battery.  That’s maybe $14 in total.

True, the BYD batteries were probably only 90% as good as the Sanyo ones.  But they cost only a little more than half as much to make.

Lots of medium-tech stuff is like these batteries.  Note, too, that the Chinese salary I quote is less than half the minimum wage in the US.  So the Chinese business model won’t fly here.

5.  As the NYT pointed out in a follow-up, wages in eastern China have more than doubled since I owned Sanyo Electric–meaning that, all other factors being equal, BYD’s labor cost advantage has almost completely eroded.  I presume, but don’t know, that, if so, BYD has shifted production into western China, where wages are still low.

If this business follows the pattern of other industries I’ve followed, like the textiles, at some point the battery industry will shift out of China in search of lower costs.  Machinery will be shipped to another low labor-cost country, India?  Bangladesh?, where production will be resumed.  In fact, BYD may enjoy considerable local tax breaks for doing so.

But wherever the machinery ends up, it’s almost certainly not going to end up in the US.  That would just recreate the company’s situation of too expensive low-skilled labor.  Also, its plants may not be particularly welcome in a country where the firm has no political clout.  More than that, it could be that being Chinese-owned would make it a target of adverse political action.

My take:

This is a big issue, one without a clear solution.  Contrary to Mr. Krugman’s suggestion, I don’t think we’re seeing a reprise of the 19th century, when holders of large amounts of capital had a gigantic (unfair?) edge over people born into families of modest means.  Rather, the 21st century reality is that the market price of unskilled labor in an increasingly global world is under $10,000 a year.

A country can try to protect politically powerful but non-competitive industries, as Mr. Obama has recently done with tires, but that leads to disaster–enriching a small group of political favorites at the expense of everyone else (see my posts).

If all the good manufacturing jobs are robot-driven, then not all highly educated workers will find jobs there. That’s also not a great surprise, since the manufacturing sector in the US has been shrinking for decades.

But, of course, poorly educated workers will be excluded from manufacturing employment entirely.

In the service sector, where all the job growth has been in the US, the field seems to belong to highly educated, computer-savvy entrepreneurs.  Again, the poorly educated need not apply.

I don’t think that in the US a good education is a sufficient condition of personal economic prosperity, but it is a necessary one.

G-7 intervention to stop the yen’s rise: will it work?

Please take my survey.  Thanks to everyone who has done so already.  If you haven’t yet, I’d appreciate it if you’d do so.  It’s brief, anonymous and will help me focus future posts.

PSI reader survey.

Will G-7 intervention work?

Yesterday, the G-7 group of major industrial countries announced plans for coordinated intervention in the foreign exchange markets in order to halt the rise of the yen against the currencies of other developed nations.  In the wake of last week’s earthquake and tsunamis, the yen had risen by about 5% against the dollar.  Will the G-7 be successful?

The short answer is “…most likely, no.”

How so?

The main reason is that the major international commercial banks, who are the main forces in the global currency markets, are far larger and have greater financial resources than national governments do.  That might not have been true twenty-five or thirty years ago, but it is today.  Even the G-7 nations acting together don’t have the financial firepower to oppose a concerted move by the banks.  In the past, it hasn’t helped either that governments have typically tried to defend currency values that were politically attractive but economically unsound.

Japan the most skillful government player

I’ve been watching the currency markets as a global investor for over twenty-five years.  Over that time, the country that, to my mind, has the best record in influencing the direction of its currency is the Japan.  Understanding it can’t oppose the banks directly, it has waited until a wave of speculation has almost exhausted itself and then applied enough pressure to send the yen in the opposite direction.

Japan’s present stance is a curious one, though.  The current administration in Tokyo, the Democratic Party of Japan, came into office with the intention of reversing the long-standing (and very outdated) policy of the Liberal Democratic Party of always aiming to weaken the yen in order to help the prospects of export-oriented industries.  Nevertheless, when the original DPJ finance minister tried to enforce the new policy, he was replaced with someone more willing to cater to the Keidanren.  The new minister immediately began selling the yen in what I saw as simply a wasteful attempt to establish his pro-industry bona fides.  That was Naoto Kan, who is now the prime minister.  Who knows what he’ll do now.

A second curious aspect of the situation today is that there’s no good reason for the yen to be a strong currency.  The country’s workforce is shrinking.  The government is ineffective and heavily in debt.  The budget is in deficit.  And the country hasn’t shown any real growth in over twenty years.  Japan’s most “positive” feature  vs. the euro or the dollar is that it’s a known quantity and has less near-term potential for negative economic developments than the EU or the US.

Why has the yen been rising, then?  After the Kobe earthquake in 1995, Japan repatriated large amounts of money invested abroad.  Insurance companies needed funds to pay claims.  Parties–individual or corporate–who had no third-party insurance needed money to rebuild.  this activity drove the yen up by about 20% against the dollar in the months following the earthquake.  It’s probably too soon for this to be happening again.  The yen probably started to rise early this week as speculators began to bet the same thing would happen again.

Interestingly, the yen gave back almost all its gains as soon as the G-7 announced its plans and Tokyo was seen selling the yen aggressively in the currency markets.  To me, this suggests that the big players in the market haven’t decided what to do yet.  In the end, though, it will be the banks, not the G-7, that decide whether the yen strengthens or not.

investment implications

What’s the significance of a rise in the yen for investors?

An appreciating currency has two effects:

–it slows economic growth in local currency terms, and

–it reorients what economic energy there is–away from export-oriented industries, and toward domestic-oriented firms and importers.

If you were investing in Japan and thought the yen would rise, you would overweight domestic firms and underweight exporters and other companies with large foreign-currency exposure.  But the most sensible thing for most people to do, as I suggested a couple of days ago, is just to stay away.  (I own two social networking stocks in Japan, DeNA and its smaller competitor, Gree.  For now, I’m keeping them both.  These are youth-culture special situation stocks that are growing very fast, so I think they’ll be relatively unaffected by problems in the overall economy.  But I wouldn’t advise anyone to follow my lead.)

Comparative Advantage: an early pro-trade argument

Absolute advantage and comparative advantage

The common-sense notion of when trade between countries should occur is this:

if I make something you want more cheaply than you can, you should buy it from me rather than make it yourself; and if you make something more cheaply than I can, again it makes sense to trade.  This is called absolute advantage.

David Ricardo is credited with advancing our understanding of when trade makes sense in his 1817 book, On the Principles of Political Economy and Taxation, which promotes the idea of comparative advantage.

Comparative advantage, in its simplest sense, says that even if you’re a high-cost producer of everything, you’ll very probably be better off if you concentrate on making for export the stuff you’re least bad at, and trading it.  This is a counter-intuitive result.

a (bare-bones) example

Let’s say there are two countries, A and B, and that they make two products, wine and cheese.  Each country has 30,000 units of resources.

Country A needs 100 units to make wine and 300 to make cheese.  Country B needs 200 units to make wine and 400 to make cheese.

At one extreme, country A can make 300 wine and 0 cheese; at the other it can make 100 cheese and 0 wine.  Assuming no benefits/losses from scale differences, it can substitute wine for cheese at the rate of two to one.  Put another way, production possibilities are described by the line, wine = 300 -3(cheese).

Country A can make 150 wine instead of 300 and put the resources into cheese-making–yielding cheese output of 50.  It can choose any point along the line for actual production, but will always have the tradeoff of gaining 2 wine by making 1 cheese fewer, and gaining 1 cheese at the expense of 3 wine fewer.

Similarly, Country B can devote all its resources to winemaking and have output of 150, or all its efforts to cheesemaking, with output of 75.  Or it can make anything in the middle, with a tradeoff of 2 to one.  Its production possibilities are described by the line, wine = 200 – 2 (cheese).

Where does this get us?

The important thing to notice is the wine/cheese tradeoff in each country.  In country A, the cost of 1 extra cheese is 3 wine.  In country B, the cost of 1 extra cheese is 2 wine.

So, both sides would be better off if Country A would trade its wine for Country B’s cheese at a ratio of 2.5 to one.

Ricardo’s insight was that all that’s needed for profitable trade between countries is a differing internal tradeoff, or opportunity cost, or comparative advantage in the production of tradable goods between the two nations.

Lots of caveats in this simple world:  Factors of production must be completely mobile between industries in a given country, but not mobile at all between countries.  Employment should be full.  The market must set prices.


More than just some trade, assume the two countries began to specialize their production according to where their comparative advantage lay–wine for Country A and cheese for Country B.  Let’s go crazy and assume that Country A produces only wine and Country B produces only cheese and they trade with each other for the other product.

Country A makes 300 wine.  Country B makes 75 cheese.  A trades 100 wine for 40 cheese.

Country A now has 200 wine and 40 cheese.  B has 100 wine and 35 cheese.

Could either country have achieved this outcome by itself?  No!

To make 200 wine, A would need 20,000 in resources; to make 40 cheese it would require 12,000.  The total exceeds available resources by 2000, which is Country A’s gain from trade.

To make 100 wine, B would need 20,000 resources; for 35 cheese, it would need 14,000.  Again, this is more than the total available internally.

Neither country has the production capability to achieve this outcome without trade.

Therefore, one would conclude, open yourself to trade and specialize in the things you do best, even if your best is not as good as someone else’s efforts in the same area.  Trade will lift your living standards anyway.

What’s wrong with this picture–if anything?

1.  There are the “usual” kind of observations that point out the simplifications made in trying to illustrate the point.  For example, employment isn’t always full, so relative prices may change if one country has a glut of labor.  Great vintners may make poor cheese makers, and vice versa.   Production equipment may not shift frictionlessly from one industry to another.  Climate may be conducive to some products but not others.  These are not necessarily such a big deal.

2.  Mobility of the factors of production is a much bigger issue today than two centuries ago.  Yes, every country has identified strategic industries–typical cases would be telecommunication or transport–where local ownership is mandated by law.  But otherwise, most nations actively woo foreigners to set up shop locally, especially in areas where they think technology transfer is possible.  Global-oriented firms who believe they have a technological or business-practice advantage also seek to make maximum use of their edge by expanding abroad.  The internet makes this much easier.

3.  The world is changing a lot faster today that it has been in the past.  Putting a lot of your eggs in a single basket requires an enormous level of confidence in a country’s ability to find specializations that won’t quickly become obsolete.

4.  Developing nations consider the short-term rewards of specialization at what they do best at the moment as a trap that will make it much more difficult to advance technologically.  Some might say the entire idea of comparative advantage is a ploy by colonial powers among industrialized nations to keep their technological edge and effectively force developing nations to remain colonies.

They can point to instances of “lucky” countries like Argentina or, until relatively recently, Australia, which have enormous natural resource endowments but have been economically weak  because they’ve focused on farming or mining and have never developed higher value-added industrial or scientific skills.

Is the idea still useful?

Developing nations have gone on to adopt the currency-peg, technology transfer model perfected by Japan after WWII for dealing with developed countries whose markets they are targeting.  So the Ricardo model has been resoundingly rejected there.

On the other hand, two countries at roughly the same level of development still use the idea in their dealings with one another.  But even in this relatively safe arena, emerging countries like China are beginning to raise questions its viability.