The Leather Pipeline - 03.05.16
03/05/2016
It’s difficult to say what is really the trigger, but it seems the financial world is preparing for something new.
The oil price continues to rise, the US dollar continues to fall and stock markets ended the period with quite substantial losses. Many people have said it is the old saying of ‘sell in May and go away’ now happening at the end of April. At the same time gold reached a one-year record high. In aggregation one has to accept that investors are not too positive about the summer and prefer to play safe with their money. Indeed with the upcoming presidential elections in the United States, the uncertainty about the real status of the Chinese economy, the unresolved conflicts in the Middle East and the Ukraine, the problems in Brazil and questions over the expansion of the global economy, it may be better to be a bit cautious rather than courageous at the moment.
A number of respected pundits consider the present rise in oil prices to be a short-term flurry triggered by financial investors not knowing anywhere better to put their money at the moment.
The balance between supply and demand and the rising offer from various producing countries has not changed and so it would need very little to trigger another decline in prices.
That something is changing one could also see from the results of Apple this week. Sales of the iPhone dropped for the first time in years. Although this can happen to any product it is another example that markets saturate and when there is no new added value it becomes difficult to attract the consumer. The smart phone killed the mobile phone, Apple and Google killed Nokia and Blackberry. Whoever controls the apps controls the market, more features are added, but not more added value and when everybody is served and a smartphones is only a smartphone, it becomes difficult. This is a problem in many sectors. One industry that seems to be in a similar situation is automotive. Models change, but in the end there is little added value in a traditional car; a new car is ‘nice to have’ more than anything else.
Industry 4.0, artificial intelligence, 3D printing are the trigger for the next industrial and social revolution and one can smell that things are very quickly on their way. Self-driving cars and individual mobility are examples that everyone notices already, but there are many others on their way which are not being quoted or noticed in public yet.
For the entire global supply chain, for jobs and production locations as well as well as for many products, things will change fundamentally in the next five or 10 years and this applies to the leather pipeline too. Traditional manufacturing may survive as a niche, but everything else is on the table for discussion.
Market Intelligence
Two weeks ago we were mainly dealing mainly with changes in the industrial supply chain. Manufacturing and product development were in focus.
It might be time now the deal again with the general basics of the commercial raw material trade. The leather price is still mainly calculated on basis of the raw material cost, which today is still around 50% of the finished product price. The raw material price becomes even more important when the credit for splits is low and no longer subsidises the price for grain leathers. The raw material price for bovine hides has become a playground for strategies and less a dynamic reflection of product values and balances. What has happened?
For hundreds of years the pricing process for hides and skins happened behind the doors of trading companies. They were efficient in analysing the markets and the international ones were very efficient in monitoring global supply and demand. They controlled a lot of finance and had a very sensitive radar for structural changes: shifts in production, global supply changes, individual or regional financial issues, currency and political changes and so on. Managing this successfully was the basis of their commercial success.
As we all know the dominance of the trade has been broken and only a handful of mainly small companies with little influence have survived. In several other raw material commodities we saw similar trends, while in others the dominance of the trading companies has increased. In the hide, skin and leather pipeline the main reason for companies’ failure was that the trade never entered supply and production on one side, but also never really invested in manufacturing on the other. While supply wasn’t really an option – why buy a slaughterhouse when you are only interested in one by-product that reflects just 5%-15 % of the entire product value – manufacturing would have been an option, but it never happened. The trade lost the chance to create relations, strategic alliances or manufacturing units to add value. In addition they were suffering from a lack of respect for their function and image. They were seen as the ones making a profit on the shoulders of others. This was mainly the opinion of the suppliers, namely the beef industry. By the end of the last century their time was over, to the great pleasure of the buyers. However, there was a sudden extra-time for the trade. However, this time on the other side of the world with the rise of the Chinese industry. There were different names and players, but a similar set-up and this gave trading another chance. Traders tend to take excessive risks and they also overestimated their position versus the supplier, building financial and market risk by taking excessive positions but also limiting trust with suppliers by not sharing strategies with them. So, another round of selection happened first outside China and more recently inside that market. The key players in the industry had already built up relationships and were neither impressed or disappointed with the development.
Sellers thought that this would erase speculation, unjustified margins and profits, tighter and better customer-supplier relations and more efficient and faithful supply chain management. Buyers thought it would lead to lower prices, guaranteeing them better and consistent quality and give them direct influence on prices. Well, this is what both sides were hoping for, but is not what really happened.
It is important to understand this to understand what is happening as a market consequence now. With an active trade, which is in competition, you have plenty of sources and positions. If you want to defend your position successfully, correct decisions are essential. Your results are based on 100% of the material value. Correct anticipation is essential and quick reactions as well. This means pricing and adjustments are generally taken more quickly and more visibly too, because there are more players and more sources.
Over the years the situation has become different. Supply tries to dictate the price. Pricing has become a strategy and is proactive today, because the industry as a seller has only one side to watch. If you have no reference, all your focus is on selling and pricing and this is how you organise your tools. The main tools are volume and how you create and justify the prices you want your customers to pay. When a customer has only a limited choice of offers and trading dynamics don’t apply he is lacking any reference except his internal calculation to see if the price is adequate in terms of the market. What he gets is only the price as the value consideration of his supplier who has only one intention: to obtain the highest value for his by-product. Totally normal.
In the US, which is still the benchmark we have for suppliers and controls something like 75% of supply, there are various reports which have an influence because everybody wants a reference of some kind. So, everyone is benchmarking on the published prices and other global sellers are setting their prices accordingly. The biggest problem is that the reports are almost 100% furnished by sellers.
This way of price setting is not very flexible nor does it take sudden changes on the demand and material side into consideration. We saw an example of what this can mean in the second quarter of last year when the market all of a sudden fell out of bed because the market reality and the supplier policies had drifted too far apart. Instead of sliding, we saw the market collapse, as many still remember well.
This year the situation is a bit different. While 12 months ago all hides were too expensive and had no correlation with leather demand, it is different this year. Many hides are being sold and productions are being cleared. Tanners will always find raw material too expensive, but for many of the premium automotive leathers, aircraft, high-quality bags and shoes and premium furniture demand is steady and prices for the end products are being paid. Demand here is strong enough to absorb suitable raw material. With the price of a premium car, a high-end bag, an aeroplane or a designer sofa nobody should complain about the price of leather or the associated raw material price, nor should there be any discussions about leather being substituted.
However, for commodity leather the situation is different and the fundamentals are clear. Declining demand because of macro-economic factors, overcapacity in production and substitution of material have sent leather production further down than raw material supply. Normally one would answer with a price reduction to stimulate demand and to ease the decline in demand before it accelerates. However, this time the opposite has happened. Asking prices and bid prices for the medium and low-end hides are, in many origins, really far apart and stocks are piling up. Small volume sales are not sufficient to justify the asking prices and so the vicious circle continues. ‘Think positive’ may be an appropriate tool in personal psychology, but ‘be realistic’ might be more suitable in leather business.
The split market is in a pretty strange situation. Good-quality suede continues to be the best performer and we see good volumes moving through the supply chain. For the rest, however, the situation has become gloomy again with reports from China that lime splits have become a problem once more, with slow sales and falling prices and all this at a time when leather production is not running at high levels.
The skins market remains in the doldrums and more origins are beginning to report that skins are simply being disposed of. It seems that there is no recovery in demand for lamb and sheepskin leather. Again, we have the niches and specialities, but fundamentally not all the skins gained during slaughter can be sold for leather production, even though prices cannot go any lower.
We expect a round of replenishment towards the end of this month at the latest. Despite the above analysis, leather production is not zero. Chinese tanners in general have been absent from the market for quite some time, but they have to replenish, even at lower levels. The problem is just one of sellers and buyers reaching agreement in terms of prices. The difference of opinion today is up to $10 per piece, which is a long way apart.
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