Post-Pandemic Sourcing: Amid Ongoing Uncertainties, Prepare for Opportunities

For nearly two years, the COVID-19 Pandemic has shaken our world from the level of individual livelihoods to macro-economics. Global sourcing and supply chains for fashion and other industries have been similarly disrupted, to the extent there can be no return to the “old normal”.

Coming on top of geopolitical tensions, the pandemic has laid bare for all time the risks of relying on cost-optimized, single-route, single-source, just-in-time lean global supply chains. With COVID-19 continuing to ravage lives and economies across the world, it is too soon to forecast the pandemic’s lasting effects on global trade. But it is never too soon to start thinking of opportunities likely to emerge as the pandemic subsides, as eventually it shall with a combination of vaccines, treatments, and natural immunity.

What kinds of opportunities lie over the post-pandemic horizon? How should businesses position and prepare themselves? How best can they identify and mitigate ongoing risks and uncertainty in a post-pandemic world?

Fung Business Intelligence undertakes research and fact-based analysis to help businesses and governments address such questions and adjust their strategies accordingly. Our latest edition of Country Sourcing Report examines recent developments in 16 of the world’s largest textile and apparel producing countries as a basis for identifying and understanding key factors likely to shape fashion sourcing over the next 12 to 18 months.

Below, we highlight these under six headings. Country specific observations can be found in the body of the report.

1. COVID-19 Pandemic Reaction and Response

According to the World Health Organization, as of 14 October 2021 there have been 239 million confirmed cases of COVID-19, including 4.9 million deaths, globally. The most affected apparel-supplying countries, in terms of number of confirmed COVID-19 cases, were India (34 million), Turkey (7.5 million), and Indonesia (4.2 million).

Despite vaccination campaigns, many countries have experienced higher infection numbers this year because of the more contagious Delta variant. Travel bans and sudden lockdowns at country, regional or city level are still occurring in many parts of the world. But consumer demand has not disappeared, especially for daily necessities such as clothing. Helped by an accelerated adoption of e-commerce, pent-up consumer demand has in fact contributed to an improved export performance by many sourcing countries so far this year, compared with last.

Confidence that the world will somehow find a way to “live with COVID”, has trickled down to the commercial level. Fashion suppliers, brands, and retailers have become more optimistic about the near future, and many have already begun to plan for post-pandemic global economic recovery.

That being said, a resurgence of COVID-19 infections in South and Southeast Asia since April this year has caused major disruptions to factories and supply chains in those regions. This has driven additional order volumes to China, where the Government’s “zero-tolerance” strategy has been highly successful in keeping COVID at bay. Many foreign brands and retailers have shifted orders to China or, in some cases, back to China because of its reliability for producing and shipping goods despite the pandemic. One outcome is that the case for adopting a “‘China plus” supply chain model – namely, producing in China plus one or more other regions – has never been more convincing. This is likely to remain so even as China’s government tackles power shortages currently hampering industry in many parts of the country. We see this as a short-term problem that can speedily be addressed through a combination of policy changes and practical measures to increase domestic coal output and power generation.

2. Transpacific Geopolitics

High tariffs on China-US trade continue to be the “new normal”. Broader tensions (such as the escalating technology war) between the two countries are also likely to continue indefinitely as it is clear the overriding issue between China and the US is not trade but geopolitical rivalry.

Relations between the two countries have not improved with the Biden administration. For example, import tariffs imposed on Chinse goods by former president Donald Trump during his administration’s trade war remain in place. At this stage, the US is likely only to reinstate a tariff exclusion process allowing US companies to seek exemption from certain tariffs on Chinese products, as most such exclusions expired at the end of last year. Other points of tension include the blacklisting of Chinese companies by the US, to ban them from doing business there or from buying certain US technologies and services. Given the size of the rift between the two countries, no real progress is expected any time soon, although it is encouraging that both countries are making greater efforts to conduct serious talks.

As noted earlier, China’s trade volume has received a pandemic-related boost from orders redirected from production countries that are experiencing supply chain disruptions. In the medium to long term, however, as the pandemic eases, the ongoing China–US trade conflict will once again spur some multinationals to move part or all of their production to other countries to avoid high tariffs and minimize geopolitical risks. This is also true for Chinese firms exporting to the US market. Some Asian and Central American countries could therefore continue to benefit from the China-US trade war and see further increases in their apparel and footwear exports to the US.

3. Possibilities for a New Multilateral Trading System and FTAs

The World Trade Organization (WTO) was designed primarily to establish and maintain a rules-based system for international trade, to facilitate trade-liberalization and to settle trade disputes. But with the increasing complexity of global trade in the digital era and with intensifying trade frictions involving key WTO members, the WTO has struggled in recent years to deliver on its mission. Since the Doha Round of negotiations effectively ended in 2015 – after 14 years of mostly fruitless discussions – bilateral or plurilateral negotiations between subsets of WTO members have been seen as a more pragmatic way to achieve freer trade. In present circumstances, regional and bilateral free trade agreements (FTAs) are now seen as the building blocks of a revitalized multilateral system.

The renegotiated US-Mexico-Canada Trade Agreement (USMCA) entered into force on 1 July 2020. In November last year, 15 Asia-Pacific countries – China, Japan, South Korea, Australia, New Zealand and the 10 member countries of the Association of Southeast Asian Nations (ASEAN) – signed the Regional Comprehensive Economic Partnership (RCEP) which, when fully ratified, will form the world’s largest free trade region in terms of GDP, population, and trade value. RCEP is expected to promote intra-regional integration between ASEAN and China, increasing their trade flows in intermediate goods, and deepening connections between their supply chains. Over the longer term, as RCEP economies interact with those of USMCA in NorthAmerica and the EU in Europe, the effect will be to create a new global trade network from which it may be possible to reconstruct a new multilateral trading system.

In the more immediate term, trade protectionism and rising supply chain costs are prompting countries to keep looking for opportunities to develop FTAs and preferential trade arrangements (PTAs) as ways to improve market access and save on import duties, which would clearly bring benefits to the fashion sourcing industry.

In Europe, the UK’s access to the EU’s Single Market and Customs Union ended on 1 January this year, making it necessary for the UK to engineer post-Brexit trade deals with other countries and regional organizations. By the end of September, trade deals and agreements-in-principle were completed with 67 non-EU countries and the EU.

Earlier this year, the UK applied to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), a trade agreement among Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam. It is also still in negotiations with the US for a free trade agreement. Other developments of note in 2021 include: the UK’s Developing Countries Trading Scheme (DCTS) which will be effective in 2022, replacing the EU’s Generalized Scheme of Preferences (GSP) f or exporters sending goods to the UK market; the Indonesia-Singapore bilateral investment treaty (BIT) that came into force on 9 March; the conclusion of negotiations and signing of the Cambodia-Korea Free Trade Agreement (CKFTA) in February and in October, respectively; the ratification of the Cambodia-China Free Trade Agreement by the Cambodian government, and the Comprehensive Economic Partnership Agreement (IE-CEPA) between Indonesia and the European Free Trade Association (EFTA) that was approved by the Indonesian government in April. Finally, both China and the Philippines have applied this year to join the CPTPP.

4. Sourcing Costs and their Effects on Apparel Production

Even in the age of automation, the apparel and textile industry, particularly garment manufacturing, remains heavily dependent on having human hands along the production line. Fast fashion brands in particular still search constantly for low-wage production bases to remain competitive and profitable in what is typically a low margin business. Pandemic-related factory shutdowns have placed downward pressure on average wages for garment workers. However, with a view to supporting low-paid workers through the COVID-19 crisis, many countries with minimum wage adjustment mechanisms have still gone ahead with planned increases in the first half of 2020, according to the Global Wage Report 2020/21 by the International Labor Organization (ILO). This year, 11 out of 24 garmentproducing countries monitored by Fung Business Intelligence have increased minimum wages (Cambodia, China, El Salvador, Indonesia, Jordan, Lesotho, Mauritius, Mexico, Pakistan, Sri Lanka, and Turkey).

Also this year, exporters of apparel, textiles and other consumer goods have experienced unprecedented operational hurdles because of surging freight rates and frequent shipping delays. These are mainly due to soaring demand for imported goods in developed economies, driven largely by e-commerce during the pandemic; and by a global shortage of available containers, made worse by an imbalance of container distribution between different markets; and temporary closures of some ports due to outbreaks of COVID-19. As an illustration, the China Containerized Freight Index, which reflects freight rates paid by shippers for containers leaving from China, surged from 834.24 on 15 May 2020 to an all-time high of 3,235.26 on 24 September this year. Exporters in Southeast Asian countries have also been suffering from this year’s high shipping costs. Meanwhile, in September the American Apparel and Footwear Association requested relief from Section 301 import tariffs, citing the impact of unprecedented disruptions to shipping on US companies and employment.

The accident last March when a massive ship became wedged across the Suez Canal, stopping 30% of the world’s container traffic, exposed the vulnerability of today’s supply chains to sudden, unexpected incidents. For the apparel industry, especially, it has tested the resilience of “lean manufacturing” practices. The current global apparel supply chain model, which is designed around optimizing both cost and efficiency, is now being challenged. For better risk mitigation, companies need to think more about how much extra stock to hold in reserve, in what form, and where along the value chain. Of course, like any inventory, “safety stock”, carries with it the risk of obsolescence and also ties up cash. However, savings achieved through lean manufacturing must be weighed against the high potential costs of a supply chain disruption. These costs include lost revenues and the higher prices that must be paid for materials suddenly in short supply.

5. Domestic Development Policies of Sourcing Countries

Sourcing costs aside, access to skilled talent, along with a competitive supplier ecosystem, infrastructure preparedness, logistics efficiency and a friendly business environment are among factors that increasingly influence sourcing or production relocation decisions by fashion companies. In turn, these factors are largely affected by a country’s long-term domestic development policies.

Sourcing countries continue to respond keenly to investors’ requirements so as to keep their business environment competitive, capture more foreign investment dollars and bring greater prosperity to their peoples. Recent examples include the Philippine government’s launch of the Philippine Good Regulatory Principles (PGRP) to serve as guidelines for regulators in making effective policies and improving administrative efficiency. Cambodia is actively improving its infrastructure with initiatives such as The Project for Improving the Logistics System of Cambodia, and the Phnom Penh Logistics Complex Project, to enhance the efficiency of freight traffic there. Pakistan has accelerated the construction of power facilities to solve its longstanding power shortage problem. India’s prime minister announced in August that the country will launch a 100-trillion-rupee (US$1.35 trillion) national infrastructure plan with an additional goal to help generate jobs and expand the use of cleaner fuels to achieve the country’s climate goals.

While digitalization initiatives continue to penetrate deeper into the upper and lower streams of the garment value chain, initiatives in the mid-stream – encompassing actual production, application of technology and environmental compliance – are gaining traction, too. For example, a new facility opened in Phnom Penh by a Hong Kong-based garment company, became the first building in Cambodia to earn gold certification under the US Green Building Council’s LEED v4 Building and Construction rating system – a significant “win” for the country in terms of sustainability. In Turkey, the garment industry is focused on investing in Industry 4.0 across the manufacturing process as the COVID-19 pandemic speeds up widespread adoption of both digitalization and e-commerce.

6. Rapidly Changing Consumer Demand

The global retail environment continues to evolve at an unprecedented pace. Consumer tastes are changing rapidly. New consumer expectations are popping up every day. These, together with exponential advances in technology accessible to the masses, have revolutionized the way retailers operate their businesses and engage with customers. Retailers are adopting various strategies ranging from applying new retail technologies, improving omnichannel capabilities, and offering customized products, to establishing automated production lines, renovating stores, and creating new customer experiences.

The main consequence for supply chains is that they must be much faster, more agile, and more transparent to meet the needs of today’s digital, mobile consumer. This is not just about automation, but also about understanding new technologies such as artificial intelligence and machine learning, big data analytics and block chains; to rethink the entire value chain, while making it more responsive, accurate, and agile.

In recent years, retailers’ needs for shorter turnaround times have drawn attention to possibilities for nearshoring and onshoring, despite the fact such strategies inevitably come at a higher cost. Besides improved speed to market and greater certainty over compliance, nearshoring and onshoring have the potential to enable retailers to achieve greater customization or perhaps go further by offering consumers on-demand manufacturing. With their proximity to the US market and access to duty preferences, sourcing countries in the Western Hemisphere, including Mexico, Honduras, and Nicaragua, are likely to be indispensable nearshoring sourcing bases for US retailers. Meanwhile, onshoring, with the help of automated production, will largely focus on customized and time-sensitive fashion products.

Conclusions

The ongoing COVID-19 pandemic has wreaked havoc on the world economy, but it has also presented the apparel industry with an opportunity to pause, reflect, and rethink its future. Businesses will need to review their sourcing and supply chain strategies in order to better manage risk and leverage competitive production capabilities and trade advantages across sourcing countries.

The pandemic plus ongoing tensions between China and the US have accelerated global discussions over onshoring/reshoring production. One highly possible scenario in a post-pandemic world is that production of essential goods, such as medical supplies, personal protection equipment (PPE), or food, will be reshored permanently, allowing greater national oversight. There are signs this is already happening. At the same time, production of many non-essential items is likely to become even more globalized, to take advantage of the various efficiencies and the capabilities of different production countries. This will help to offset and balance the higher cost of reshoring products that are deemed essential.

Businesses will need to find the right mix of trading countries/economies that enable them not only to leverage preferential trade treatment for exports, but also to optimize sourcing/logistics costs. They will need, too, to seek the best combination of business-friendly environments and production capabilities.

As FTAs and PTAs proliferate, different agreements will offer different advantages to businesses in terms of market access and tariff reduction, all of which will help to increase trade flows. Long-term domestic development policies will have a further bearing on the stability and attractiveness of individual production bases. Vigilance over the direction and details of domestic policies will enable companies to forecast labour and material costs more accurately and better inform their decisions on foreign direct investment and where to locate (or relocate) factories.

With COVID-19 uncertainties likely to continue for the foreseeable future, the practice of maintaining safety stock will be given equal, if not more, weight than the usual practice of just-in-time replenishment and lean inventories. The added cost of having such a buffer could be offset through nearshoring, allowing shorter lead-times for delivery and a more responsive supply chain. This trend will favour production countries in Central and South America for the US market, and countries such as Turkey for the EU market. Companies focused on serving a demanding new generation of consumers who want products made on an individualized basis, will also benefit from locating their manufacturing base closer to market. A post-pandemic sourcing model developed along these lines will be more resilient and better able to withstand supply chain shocks and sudden market disruptions, as well as more agile in responding to new consumption trends.

In general, Asia will remain a manufacturing powerhouse for fashion products over the long term. It is also noteworthy that China will continue to play an increasingly important role as a textile supplier for apparel-exporting countries in Asia. The sourcing model of “China plus one” or “China plus many” will remain dominant in the short term and possibly for longer. China is also among the world’s fastest growing consumer markets for fashion products. Its latest “Dual Circulation” strategy strives to boost and enlarge domestic consumption and accelerate the formation of an integrated domestic market. The opportunity to source in China for China’s domestic market will only increase the country’s attractions as a global production base.