The well of working capital is drier than it should be. And the volatility of Trump-inflicted tariffs is no boon for the loan-seeking or the lender.
From the factory floor, manufacturers haven’t entirely emerged from pandemic-related strains, and now rising energy and labor costs have made manufacturing pricier, while elevated borrowing costs have made financing to support those spikes pricier. And with logistical disruptions driving delays and increasing costs, working capital is even further tied up.
“It’s becoming more and more challenging as we go on to do business,” said Azfar Hasan, chief executive officer of Matrix Sourcing, a Pakistan-based sourcing solutions company set on finding “out-of-the-box” fixes for the supply chain’s quotidian problems. “Factories are filing claims for financing every other day and banks are pulling out of this sector because it’s considered high risk. If they pull their credits out, that would mean bankruptcies and closures.”
On the retailer’s side, according to a Hackett Group survey released last year, working capital metrics are trending negatively for the first time in a decade thanks to stagnant or declining revenues, rising costs owed to inflation and a quickly climbing amount of moneys owed.
“We’re all suffering with working capital issues,” said Brad Ballentine, chief executive officer of MAS Acme, an apparel-design-to-delivery solutions provider and a subsidiary of MAS Holdings, one of the largest manufacturers of intimate apparel and sportswear.
Several things transpired in recent years to drive working capital needs, and the Covid-prompted acceleration in near shoring was one of them, according to Brian Dowd, senior vice president, Americas for Tradewind, which finances supply chains. Long transit times in the Suez and Panama Canals and other regional conflicts have also lengthened the time it takes containers to get from one point to the next, and no one wants to foot the bill for the delays.
“There’s a big strain back and forth on who, between the seller and the buyer, is going to bridge that gap. So there’s been a lot of need for financing inventory in transit,” Dowd said. “In the past you could probably just wait for 20 days. Now it’s kind of unpredictable, so even if you could wait 20, 30 days—it might even be 45—you didn’t budget for an extra two weeks of not being paid.
“That’s also driving U.S. buyers more toward a DDP [delivered duty paid] purchasing model. So instead of buying FOB, a lot of them are saying, ‘You get it here and then I’ll buy it from you’ because they want to avoid any delays or issues with the customs or vessels,” he continued. “That’s been driving a big need for working capital.”
Things are comparably strained where the clothes get cut. Considering how cash flows run, there are factors within the factory, like capacity realization and funds required to pay up front for raw materials, knowing that long-lead—and often further delayed—payment terms from buyers will mean a reasonable separation from the return on investment. Then there are external factors, like climbing costs of inputs and macroeconomic pressures that could drastically reduce demand and capacity utilization. Apparel manufacturers are facing them all.
“Factories are filing claims for financing every other day and banks are pulling out of this sector because it’s considered high risk.”
—Azfar Hasan, Matrix Sourcing
When it comes to seasonal dips in demand, factories tend to face that by overbooking themselves to ensure they don’t run idle capacity—because running at 30 percent capacity still means paying 100 percent overhead. They’re then giving an artificially elevated capacity to the buyer, as Hasan explained.
“The buyer wants to book that factory, the capacity doesn’t exist, the factory tries to make it happen anyway, so shortcuts are taken, they outsource, they may even subcontract. This goes on quietly in the industry everywhere; that’s because of the nature of the business, but nobody wants to admit that,” he said.
And while tariffs have become a moving target, recalibrating almost daily, if they do come to stay, the manufacturer’s road will get even bumpier to navigate.
“There’s going to be knee-jerk reactions, we’re going to see bookings going down, buyers that used to buy 100 pieces of something may buy 50 now,” Hasan said. “Nobody takes responsibility for that. These are supposedly partnerships but there’s no shared risk, no shared transparency.”
Though talk of this topic has been ongoing for years, buyers still want more and more and are increasingly unwilling to pay for it. And when they do pay for it, they want to push payment terms further and further out.
“Buyers come in and say they want a fluid plant that’s so clean you can drink the water and ‘we will still pay you the same as we did before and if you want our business you will accept,’ but they don’t consider things like, if I don’t have the cash flow to pay my workers on time, I’m not compliant, but if I’m not paid the kind of money that can afford me the wages I need to pay them, how can I be?” Hasan said. “Nobody cares about the costs that have escalated.”
Many buyers have showed equally minimal concern where changing their minds about orders they’ve placed is concerned.
“It’s becoming a habit for buyers to randomly postpone or cancel production,” Hasan said. “There’s nobody there to challenge them, there are no voices, none of the vendors have the balls to speak up because they know they’re going to be singled out.
“This is a bad precedent set by China. The government there has been great at promoting their industry and offering credit risk insurance, so they say, ‘go ahead, any customer that comes in, go ahead and take the order, you have insurance if they don’t pay you. So other countries are compelled to accept orders and when some of those orders don’t come through or the customer says they don’t like the quality, there’s no umbrella that can save them,” he continued. “Cash flow all gets affected. This has led to a lot of factory closures, a lot of missteps by factories…That’s the state of the industry right now. People have stopped caring what it costs to produce a product.”
When it comes to inventory—also known as cash you can’t use—it’s a leading one among the the supply chain’s challenges. Having an excess of it, as many companies do, means increased holding costs and often significant discounting, which is another hit to cash flow. In its three-month report ended in February, H&M reported inventory levels up 11 percent year-over-year thanks to higher purchasing costs and extended transport times due to the situation in the Red Sea. At the end of January, Urban Outfitters reported inventory up 12.9 percent, or $70.9 million. It said it was to “support increased sales and planned early receipts.”
“Inefficient use of working capital comes from buyers and suppliers not sitting down and talking about how to make the business better,” Ballentine said. “Even the brands that are profitable are still suffering…but we have the solution to help the retailers and the brands reduce their working capital. Rather than being a transactional conversation [with their manufacturers], it should be a collaborative conversation because there are upstream levers that we know how to pull to solve for that working capital problem.”
The fix is about both dollars and sense: If downstream players won’t come to terms with the critical need for truly collaborative relations with their upstream partners, it will cost profit as well as strain speed to market, innovation and progress where sustainability is concerned—all prices an already plagued apparel industry can’t afford to pay.
Citing “Under the Banyan Tree,” a recent report written by John Thorbeck, chairman of Chainge Capital, and published by the International Trade Centre and the International Apparel Federation, which outlines a model for shared risk and reward, tapping process and data innovation to yield economic value, Ballentine said, “Supply flexibility is the ultimate tool to reduce working capital and improve full price sell through.”
A manufacturer can positively impact the amount of working capital required to run a business by pulling upstream levers like postponement of raw materials, postponement or reservation of capacities, joint business planning, there are “many, many things they can do,” according to Ballentine.
“We have solutions to reduce working capital via supply flexibility but it might require that we charge more upfront costs in order to save them downstream expenses. And the downstream expenses that we’re seeing as the biggest are stock outs, markdowns and expedited transportation…the solve for those three is upstream postponement levers. Period,” he said. “And the only way to get to those is to sit at the table and make a plan, even if it means the direct cost goes up a little bit.”
It might be a hard pill to swallow for those fearing or facing tariffs that had soared as high as 145 percent in China’s case before dropping to 30 percent, but Ballentine said that’s all the more reason for buyers to engage their suppliers in workable ways to save in the longer run.
Manufacturers, in some cases, have been able to demonstrate that through as little as a 2 percent increase in direct cost, channeling supply flexibility, they’ve been able to influence as much as a 10 percent increase in gross margin.
“Inefficient use of working capital comes from buyers and suppliers not sitting down and talking about how to make the business better.”
—Brad Ballentine, MAS Acme
It’s a good trade off for those willing to get past the initial pill.
For Hasan, getting to this type of partnership between buyers and suppliers is about a much greater level of transparency—and trust—on both sides. “There’s a lot of mistrust on both sides and it starts from the bargaining table,” he said. “The buyer is saying, ‘these guys are not telling the truth about their costs,’ and the factory thinks the buyer is not telling the truth about their margins.”
The kind of transparency that could change this relationship and, ultimately, improve the state of working capital, will mean factories, for example, sharing their balance sheets with buyers, Hasan said. “Let them show the losses they are incurring and the pain they are suffering financially from what they are undergoing. It’s not just about handing over orders and having buyers say ‘this is what we’re paying’ and accepting that.”
Retailers, in accordance, will need to share their point-of-sale data. It appears to be working for companies like Gym Shark and New Balance, which have combined factories’ ERP with POS data and can see things like the cost of idle inventory, Hasan explained.
“Both parties know each others’ margins and can say, ‘let’s split the margins, let’s split the profit and loss,” he said. “Maybe some of the new players may shift how they do things, those with revolutionary thought processes…there’s no supply chain that exists right now that’s open to that kind of transparency.”
Ballentine sees hope, however, as some brands are at least beginning to be open to it.
“There has been a group of brands as of late that have been offering point of sale data to a select group of manufacturers so that they can work on it together,” he said. “[They’re] saying, ‘please take a look at this, please help me figure out what we can do to do better business.’”
But for those who aren’t on board or willing to embrace flexibility of thought to improve flexibility of supply chain, the working capital situation will not improve.
“Until we see more fundamental changes, it’s going to be crippling,” Ballentine said. “It’s just untenable.”
