Understanding Common Sourcing & Production Issues
In the market today, it is quite common for both manufacturers and retailers to source production. It is a great challenge to learn to source successfully, and especially when sourcing internationally, knowledge of the politics, climate, trade regulations, business culture, overseas shipping, and international finance are absolutely essential.
Sourcing comes with a price; sometimes a hefty one. Sourcing firms need to consider their financial options, and they also need to determine whether production will be sourced internationally or domestically. And probably one of the biggest and most made-aware-of social concerns of production is fair and equal treatment of workers.
To understand the financial options for production sourcing, there is a need to understand the types of firms in the apparel industry who would need to source production. Manufacturers are firms that engage in product development and also own their own production plants. Retailers are firms that are a different type of manufacturer in that their plants are vertically integrated and they engage in private-label product development, and they own their own retail stores. Any firm that supplies services such as sewing, cutting, or finishing are often referred to as contractors, subcontractors, jobbers (sometimes), and vendors. There are several types of financial relationships that exist between firms in the industry.
Options for manufacturers and retailers include:
Cut-make-trim, or CMT (purchase materials and have work done by contractors).
Full package program or FPP (contractors source materials and produce finished goods).
Half package program or HPP (purchase or provide materials and have development and production done by contractors).
Shared production (do part of production and contract the rest [807/9802])
Wholesale (purchase goods from manufacturer).
Own manufacturing capacity.
Option 1 (CMT: cut-make-trim)
Is a common option utilized by both manufacturers and retailers. The manufacturer usually supplies the patterns and provides sewing operators, thread, and machines which are then used by the contractors to make the garments.
Option 2 (FPP: full package program)
Means that the sourcer only develops styles and specifications. The contractor then develops the patterns based off of the styles and specifications, sources all materials, makes the samples, and produces and ships the samples for approval to the sourcer. This puts a lot more financial responsibility on the contractor because they not only have to buy all materials and make the products, all of the operations need to be overseen in producing the styles. FPP contractors are quite popular in Asia, and more and more FPP contractors are popping up instead of CMT contractors.
Option 3 (HPP: half package program)
Is similar to FPP, only the sourcer provides the fabric for production. Then the contractor does all of the product development and production of styles.
Option 4 (shared production: 807/9802)
Means that garments are designed, developed, and cut domestically by either manufacturers or retailers and then garment parts are exported and assembled in a foreign country (usually found in the Caribbean Basin) by a contractor. Garment production costs are reduced by 10 to 20% because when the assembled garments are imported, a tariff is assessed only on value added, and since the added value is mostly labor, and the labor rates are usually a fraction of US rates, the tariff to be paid ends up being very low.
What makes 807 (9802) operations unique is that, first, the operating locations are usually in close proximity to the United States, and therefore turnaround time is often less compared to turnaround time in Asia. It also is easier to keep track of and supervise production and quality control. However there is a catch to this type of production: the fabric used must be domestically produced.
Option 5 (wholesale purchase)
Is the typical and most common relationship between manufacturers and retailers; retailers buy finished goods from manufacturers at wholesale prices.
Option 6 (licensing)
Is a commonly used option by big designer names such as Ralph Lauren and Calvin Klein. This involves giving the rights to use the trademarks and/or technology so products can be economically produced and efficiently marketed. Licensing does have some downfalls however, such as the licensee becoming a competitor of the licenser. Licensing can and usually does result in substantial revenues for the licenser and produces savings for the licensee. The licensee does not have to invest hundreds of thousands, if not millions, of dollars in developing brand recognition and loyalty with consumers and the licenser is paid for the use of the trademark and/or technological process.
Option 7 (own production capacity)
Is also a common option chosen by retailers and manufacturers. For retailers, they are vertically integrated because they need to provide both manufacturing and retailing functions. American Apparel is the perfect example of this, and so far, they remain in a small group of vertically integrated US apparel firms. Manufacturers who chose option 7 perform all the functions that are necessary and required to be a manufacturer. These functions include production, merchandising, and marketing.
Banks are also not to be overlooked when in the process of sourcing production. In this particular industry (apparel), it is quite common for banks to issue a letter of credit (LC) which is used as a method of payment by the sourcer that is given to the contractor, only in an international sourcing operation. Defined for the apparel industry, a letter of credit outlines whatever the purchase arrangement is and the agreements between the two parties. Usually two banks are involved (sourcer’s and contractor’s), and the contractor can use the sourcer’s LC to secure whatever funds necessary from the local bank in order to operate the business. An LC can be considered as an extension of the purchase order (PO) and it therefore becomes the primary document for the terms of purchase.
For the apparel industry, the LC clearly spells out the details of the purchase, including delivery dates, colors, sizes, products, quality criteria, purchase terms, any documents needed for entry into the United States, etc. If the contractor can fulfill all of the terms of the LC and can present the necessary paperwork to the bank, the LC is then paid. If, however, for whatever reasons the LC is not satisfied, the order can be cancelled immediately, or the shipment will occur with problems. And, lastly, both parties must absolutely meet and agree to any and all actions that directly or indirectly impact the LC and/or payment to the bank.
This has become a major issue in recent years, especially within the US apparel industry. Labor exploitation and human rights issues are probably the most important and controversial issues that apparel firms have to deal with. Bad publicity has struck many firms in the apparel industry and have caused damaging repercussions against these firms. In light of these issues, many firms have developed practices that help to guard against this type of treatment and/or behavior. The first thing that should happen is for the person in charge of sourcing to write a code of ethics or a code of conduct for the company to follow. These should strongly state and define the firm’s expectations on human rights issues. It should state and address how the sourcer will handle business, such as working conditions, wages, minimum working age, health and safety standards in plants, etc. And if doing business internationally, this should be translated into the language of the contractor to be used, and the contractor too must sign it in agreement.
The next step, and probably the most difficult, is monitoring the agreement between the firm and the contractor, or what is often referred to as compliance. Getting the contractor to comply fully to the code of ethics/conduct is quite difficult and is a big issue for anyone sourcing production either domestically or internationally, especially internationally because there is usually a body of water that separates the two.
Issues that firms need to guard against are things such as child labor, violation of basic human rights, and substandard working conditions. It makes absolutely no sense to have a code of conduct if there is to be no compliance with it. It is difficult in general to keep track of compliance, but it is even more so when there is a third party involved, which could put you even further out of the loop of what’s going on.
A third party could be a subcontractor or a buying agent, and because of third parties such as the ones mentioned, the sourcer may not only have no knowledge of where and under what conditions the products are being produced, but the sourcer may also not have any control over the situation. However, there are solutions to these sorts of problems. There are several auditing companies that can monitor the compliance with the contractors, whether the auditors are external or internal. Worldwide Responsible Apparel Production is a widely used auditing system for plant certification that relates to safety practices and human rights.
In the global market, social responsibility is an extremely important, necessary, however time-consuming and expensive, element of sourcing production. It is a step that should not be looked over, for it can have damaging results.