Scale up or die

How does January 1 change things?
Those who held quota, and I mean throughout Asia not just China, had a guarantee that regardless of whether their performance was good or their quality was acceptable, somebody was going to come to them, so many companies lived off the selling or subcontracting or letting out of their quota and never reinvested in building up scalable, efficient garment manufacturing operations.

Now with the quota coming off, the playing field gets leveled and companies are going to compete on what companies should compete on, simply put: their quality, their price, delivery and service.

How will business change specifically within China?
Within China, the changes will be massive. There has been such a long history of only a handful of state-owned enterprises dominating the apparel industry through their holding of quota. The positive side of that in a sense is that those companies that were barred from the export market in the past had to develop really strong local businesses, and you see a lot of them when you drive around China – Bosiedeng, ShanShan, Younger and others – that you can see as nascent, branded Chinese manufacturing businesses.

They sell domestically, but with quotas being lifted, you'll see those are the guys who know a thing or two about apparel manufacturing and presumably they will be the winners and the losers will be the old state trading companies where the people knew only straight quota sales.

What about textiles?
There are areas right now where the US is not in any way competitive: for example most basic apparel fabrics. They are competitive, however, in home textiles, industrial textiles, wall coverings, upholstery, etc. Not unlike anything else, where you need significant cash, the state is going to dominate. To set up an apparel sewing line, you need thousands of dollars: anyone can do it. But to set up a textile business, you need fairly massive investment. There will be changes, but you have to look at it a little more narrowly. Where there's going to be growth will be in areas where the West doesn't at present have significant competition: industrial textiles, upholstery, carpets, etc. When quotas come off, there will be a lot more investment. I'm not sure [China] will be much more competitive, but there will be a lot more investment.

What do these changes mean so far as M&A activity goes?
We're very active right now.

Because of quotas coming off?
Absolutely, that's why I set up the business at the end of last year. We're a fashion industry and investment banking practice. My partners and I saw what was coming and over the course of a couple of years, we decided it made sense to have a boutique investment advisory business that focused on this business here because we saw heaps of opportunities for consolidation.

Originally we started with a lot of vertical plays, for example, US importers and US brands looking for a home or an acquirer, or strategic partner or investor. Our natural strength, being a Seventh Avenue firm, was relationships and experience with these companies, so we found ourselves representing them in terms of introducing business and investment opportunities to Asian manufacturers and sourcing companies. And we're doing a lot of work in that.

Again, with quotas coming off, everybody needs an edge against the competition. One obvious edge would be to have a brand. Right now most of the people I talk to in Asia would like to have a brand that brought them higher yields than selling purely private label. So they want to have brand design and distribution in the West but the real brass ring would be something that was not only a decent brand in America or Europe, but also something that they could bring into Asia for retail play. So you have seen and will see deals being done along that line. For example, there was the [July] acquisition of a larger stake in Mudd Jeans by [Hong Kong apparel maker] Tack Fat Group. And they stated exactly what I just said: That it's great to have this great brand name, and to be sourcing for this company but also that they want to introduce this company into China. So for [Tack Fat], it's two for one.

Is the impact of quotas coming off fully understood?
No. The biggest question mark is the imposition of safeguards by the United States even though jobs won't be lost there with quotas coming off [or gained with the imposition of safeguards.] So, at least for the next three years, there is going to be a premium placed on having manufacturing flexibility. From my standpoint, the confusion over the next three years will encourage companies to merge and create partnerships even more.

For example, firms in Bangladesh and Sri Lanka who have cost competitive factories and great relationships probably will want to have some ability to place goods in China and firms in China will probably benefit if they're part of groups with production capacity elsewhere. If the US does impose quotas for any reason, they can still work.

For us there will continue to be a lot of opportunities. We think it's critical that companies recognize that the future is going to demand scale. We all know Wal-Mart's numbers: US$250 billion in sales. But if you go back only a dozen years or so in the US, you find that the top 10 retailers controlled only 10% of the market; now they're up to 16-17%. So consolidation in retail has sped up on the US side at least. The second thing that's happened as a result is that there's been tremendous consolidation among the wholesalers. If you look at the size of wholesaling companies, whether it's Liz Claiborne, Ralph [Lauren], VF or whatever else, a large one used to be maybe US$1 billion. Now those companies have merged and they've acquired numerous brands and their scale has gotten just so much larger such that [wholesaling] is not in any way what it was 10 or 15 years ago.

Now shift over to Asia, where you've had all these quotas. Luen Thai, which just had its IPO, is Hong Kong's largest publicly listed exporter of garments and their total sales are US$500 million or US$550 million. In other words, not the same scale at all.

And as business grows, the demands for efficiencies and higher quality servicing from retailers and importers is going to force companies over here to consolidate or die. In the future, you've got to have your systems directly linked with the retailer. If you're going to ship to Wal-Mart, you're going to have to have the systems in place and I don't mean just hardware and software. You're going to have to have the logistical support, which is going to allow you to ship to these companies. It ain't going to be about who's cheapest anymore. It's going to demand scale. If Luen Thai got a US$300 million or US$400 million Wal-Mart order, it would probably feel more comfortable being a US$2 billion or US$3 billion company than having so much of its business tied to one supplier. Scale is now very important, and that means more consolidation.