At first glance, Pacific Brands’ half-year profit announcement was disastrous — a loss, in fact, of $166 million. But the news was even worse: the results showed, more importantly, the company’s highly contentious move to manufacture offshore, which the company said would increase profits by reducing the cost of production, has not delivered.
Pacific Brands claims its offshore restructure has led to savings which will total over $150 million in this financial year alone. But cutting production costs has not lead to better margins.
Looking below the line in the accounts, there is no doubt the Cost Of Goods Sold (COGS) has dropped since moving manufacturing offshore, but once extra freight costs are added in the gross profit margin is 39% now compared to 32% 12 months ago. Still an improvement, but it ignores that on average in the first half of FY10/11 the dollar traded at US$0.95, compared to US$0.85 in the previous corresponding period. If you adjust the COGS to reflect the added purchasing power of the Australian dollar (Pacific Brands already produced over 80% of its products offshore), the previous trading period’s gross profit margin would have been 38.2%.
This assessment doesn’t take into account hedging and the fact that some of the previously locally manufactured product wouldn’t have enjoyed the full benefits of an increase in exchange rates (as some inputs and labour wouldn’t have benefited). But it shows moving offshore has produced little benefit. Why, and will the numbers on offshore production ever stack up?
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Let’s go back to February 2009, when Sue Morphet, CEO of Pacific Brands, first made the announcement the company would close 10 profitable local factories and, as a result, make some 2050 employees redundant. The banks were not driving the company’s decision to end local manufacturing of its clothing, she declared. But on the day of the restructure announcement, company stock fell 37%, putting an equity value of $110 million on the company, compared with its $740 million debt. Its market value some 18 months earlier in June 2007 had been $1.9 billion.
This dramatic change in leveraging meant the banks were nervously looking at their investment and would certainly have applied pressure to the Pacific Brands board.
The debt position was entirely of the board’s making. Following the 2004 refloat of the company, the board went on a spending spree in an attempt to increase revenue, purchasing the Globe International street wear business, the Sheridan and Perri bedding companies and the Yakka workwear brand among others. Some $250 million of the $740 million which Pacific Brands owed was money borrowed for the Yakka acquisition in 2007. At the time, the clothing industry gasped at how much Pacific Brands had paid — they may now be feeling somewhat vindicated, but still saddened by the problems this debt-funded purchase has caused.
Six weeks before the public announcement that Pacific Brands would be closing its Australian mills, I spoke to Viki Stirling, Pacific Brands’ Hosiery Group marketing manager, who told me the company had recently invested in new knitting machines, dyeing equipment, packaging equipment and water treatment facilities in order to cope with demand for its product. She explained the company produced 70% of its hosiery locally at its Coolaroo factory (one of the profitable mills closed, resulting in the loss of 298 jobs) and at that time the group was considering moving more production back onshore.
Bonds’ Wentworthville factory also installed six new machines around that time. This was the plant that received a $2 million revamp in 2005 to gear it for small manufacturing runs and quick turnaround. The Wentworthville staff had been trained to become multi-skilled and the facility offered small batch quantities, anything from 500 to 50,000 garments.
So why hasn’t shifting production increased profits, as promised by Morphet?
Well, as Richard Abela, Bonds’ head of manufacturing and supply chain, explained not long after the Wentworthville factory had undergone its revamp, it was “a given” that merchandise produced at the local factory would be more expensive than China, but he stressed profits from offshore manufacture could be easily eaten up by supply chain problems such as inadequate quality, overestimating quantities needed and warehouse space for inventory. From reports I have heard, this has been the case with a number of quality control issues causing headaches upon garments arriving at the Port of Botany.
Secondly, wages in China’s garment manufacturing provinces have increased by over 100% (Wenzhou 112%, Quanzhou 129%, Putian and Suzhou 129%, Huizhou 103%, and Dongguan 104% to name a few) in the past six years. Finally, add to this additional freight costs and suddenly the margins seem to have eroded.
Pacific Brands shifted the bulk of its production offshore long ago, and much cheaper labour prices of course led to cheaper garments. But the remaining factories and mills that were shut just over 12 months ago were either running stock replenishment services (where quick selling items could be manufactured and sold at full ticket price) or a low labour, high technology product like the women’s hosiery mill.
Sales have been soft for Pacific Brands in the first half of FY10/11, but the next six months are likely to prove even tougher for the company, with an extremely challenging retail scene and record cotton prices to hit costs hard. The share price has reflected this, dropping over 30% since the latest profit announcement, a slide that is looking more and more difficult to address. This slide is one that cannot be addressed, or seen to be addressed by the sacking of Australian manufacturing workers.
*James Boston is the editor of a number of trade magazines, including Australasian Textiles and Fashion (ATF)