How COVID-19 revealed a skewed power equation of the fashion value chain – Economic Times

By Sandeep Raghuwanshi

COVID-19 has completely frozen the supply chain for the textile and garment industry across the world. This industry is as global as it gets and the impact on the industry is obviously very high.

This business disruption has brought the main fault lines of the apparel industry in a stark view which needs to be addressed both in the short term and long term.

Not everyone shared equal pain
All parties in the apparel value chain got affected by the disruption caused by COVID-19. However, not all parties were equally positioned to navigate the sudden disruption from this global crisis.

With consumer outlets being shut, fashion brands and retailers have taken an enormous hit to their bottom line and cash reserves. The retailers responded by canceling almost all orders of manufacturing factories including the ones under process. A study by Center for Global Workers’ Rights for Bangladesh revealed that when the orders were canceled, 72.1% of buyers refused to pay for raw materials (fabric, etc.) already purchased by the supplier, and 91.3% of buyers refused to pay for the cut-make-trim cost (production cost) of the supplier. Not very dissimilar results were reported for a study done for India. Not only that these factories were left stranded, but the impact was also much more extreme because they have far less access to capital too.

But the worst hit were the factory workers, of which almost 85% are women, who typically earn below living wages and do not accumulate any savings. Millions of these workers were furloughed and terminated without compensation, which puts their ability to put food on the table and cover any health expenses in serious jeopardy.

Squeeze and punishment
The reason for the skewed outcome is that over a period of time the power equation between buyers and suppliers has become more and more imbalanced. McKinsey Global Fashion index reveals that during the 10 year period between 2008 to 2017, top-20 fashion companies cornered on average 88% of entire industry profits. While the buyers were increasingly getting consolidated, a dispersion of suppliers was happening from changing global trade rules which resulted in an increased power imbalance.

This imbalance has resulted in two sourcing trends in apparel global supply chains. First is ‘price squeeze’ in which buyers constantly seek to lower the price paid to the manufacturers. Second is ‘lead time squeeze’ in which buyers demand supplier factories to produce goods in increasingly shorter periods of time.

But beyond the twin squeezes, the buyers also punish suppliers for any delay. During the beginning of the COVID-19 crisis, there was a sudden shortage of raw materials when parts of China went into lockdown. A study revealed that more than 50% of buyers penalized the suppliers for delays in their shipments. For the remaining, almost all of them were unable to have their buyers readjust pricing to accommodate the higher raw material prices.

No safety net on payment terms
Primark, which last year posted operating profits of USD 1.07 billion, canceled all of its orders with its suppliers. As per press reports, this included “orders already in production at factories”. Many buyers evoked the force majeure clause in their contracts to justify the breaking of their binding obligation to pay for orders in production.

This is ironic since according to Article 7.1.1 of the Vienna Convention for International Commercial Contracts, force majeure claims should apply to the party with the most relevant contractual obligation, which in this case would be the factories producing items, not the buyers that have agreed to pay for them.

But how did the industry arrive at such a payment mechanism? A few years back most payment terms were agreed on Letters of Credit (LCs), which essentially is a guarantee from a bank that the seller will receive payment due from the buyer upon presenting certain documents as proof that production has completed to the buyer’s required standards. However it added a layer of bureaucracy and as relationships between buyer and seller developed, a prevalent system emerged of Sales Contracts (SC) based on Purchase Order (PO) issued by a buyer. Based on SC, the manufacturer would raise its own LC to procure necessary raw materials to complete the order. The SC terms typically provide for legal recourse in case of non-payment.

Flaw in this payment system was exposed by the crisis as buyers delayed payments and even canceled orders citing extraordinary circumstances. The manufacturers were left without any bank guarantee even for partially completed orders.

So what next?
All stakeholders of the industry need to work towards the evolution of a more egalitarian payment structure. Like in many other industries, manufacturers should be covered for their expenses as per the stage of the order execution. The buyers should compensate the manufacturers for the purchase of necessary raw materials with the balance payment being guaranteed by contracts or LCs.

Since cost is a critical criteria for any conversation, especially in the fashion industry value chain, technology can be deployed to arrive at cost-effective solutions. Modern cost-effective systems could be deployed to monitor the execution, and trust in data could be established by blockchain, which could then be linked with the stage-wise payment mechanism.

There will be multiple solutions that will be explored, but one thing is certain: any viable payment system has to recognize that such an imbalance of current equation is untenable and it is grossly unfair to expect apparel manufacturers to bear the entire financial burden of such disruptions.

Sandeep Raghuwanshi, CEO and Founder, ESG Robo.

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