The Leather Pipeline - 17.04.18
17/04/2018
International conflicts might have been taken too easily by the general public but they are slowly becoming more important. The war of words is slowly becoming a war of arms again and the military strike of the US, UK and France against Syria was another step towards that.
It is now evident that all the sideshows seen for years now mean a rising risk of a showdown between the superpowers. Once upon a time it was called ‘the Cold War’ and in that conflict, positions were clearly defined; it was generally a stand-off between two systems. Today the situation is so much more complex and the world is far away from a two-superpower order. It is increasingly difficult to value and analyse the risk potential of the various regional problems.
Syria is once again dominating the headlines, but the conflict between Russia and the West is deepening. The Ukraine, the unclear situation around the poisoning of retired spy Sergei Skripal and his daughter in the UK, the position of Turkey in the region and the position of the third superpower, China, create plenty of situations that threaten peace and global stability.
In the background, Italy is struggling to find a new, stable government, Hungarians have confirmed a populist and nationalist as their country’s leader, the big changes in France have begun to stutter with Mr Macron facing strong resistance with strikes against the changes and restructuring of the French economy. Then there are new sanctions on Russian oligarchs, the Brexit consequences, the risk of an escalating trade war between China and the US despite conciliatory messages from both sides. This is a shortened list and flipping through the news ones can find lots more examples. The world has certainly become significantly more unstable than it has been for a long time in the period after World War II.
The financial markets continue to be quite unmoved. Yes, stock markets saw some setbacks and declines, but recoveries have followed and, considering the political situation, plus indications of a rise in interest rates in the US, one has to be impressed by the stability of the markets. The new sanctions on Russian individuals have triggered a sharp decline in the value of the ruble and substantial corrections on the Moscow stock market.
The currency trend of the US dollar versus the euro is interesting too. Every move in either direction is quickly stopped and the range of $1.2250-$1.2350 remains rock solid.
Another interesting and not much noticed topic is the rising oil price. Although supply remains abundant and the supply-demand ratio hasn’t changed much, investors are buying oil and the price has now slowly moved back to the levels of $70 per barrel. This is explained by the political tensions on one side, but also by a strong outlook for the global economy. A bit strange.
While the political situation could be used as an explanation, a conflict would become a burden for the economy in general and work against oil consumption. So, it looks all the more like a speculation, but with the positive side-effect that oil exporting countries are increasing their revenues.
Market Intelligence
The leather pipeline remains pretty unaffected by the global political tensions so far. They have not had any influence on leather demand or raw material supply. There was a time when global tensions were reflected quickly in the commodity and raw material markets, but one does not see anything like that now.
When we started to publish the Leather Pipeline, more than 15 years ago, we stressed that our aim is not to discuss the week-to-week changes and prices or market blips, but to study trends and to provide our readers with ideas, theories and information, in combination with suggestions to enable them to make decisions for their own businesses. The leather business used to be a dynamic and creative one. Units were reasonably small and along the pipeline there were a lot of specialists and individuals who developed their own articles and found enough finished-product manufacturers and retailers to bring them to the attention of the consumer.
Globalisation, economies of scale and the domination of a small number of big players have turned the leather industry into a kind of monoculture. We still find leather in various different sectors that are not directly connected, but in general the fundamental situation is the same everywhere. It is all about increasing productivity, lowering cost and squeezing the pipeline for more margin. That’s the logic of the market, but it is not the idea or spirit of an industry that has to deal with an extremely wide range of raw material types and qualities.
There used to be a wide range of production. Almost everyone was a specialist, using a special type of raw material to make individual finished products. Over the years, and with the rise of bigger players at the end of the pipeline, it has become more and more a cost- and price-driven industry.
Take automotive leather as an example. Automotive leather has to be uniform and has to meet global technical specs that have to cover industrial standards and market conditions from Alaska to the Sahara desert. One model, one spec, one quality, one (world) market. Easy to produce, easy to manage and, in the simple logic of industrial management, also cheaper (it would be interesting to discuss if that is really true). However, in the world of global companies and managers without too much individual knowledge about complicated products and materials, the decision is simple. Make it big, keep it simple. That is what industrial managers understand; that’s their world. There is no difference in managing metal engine parts, body components, bumpers or seats made from leather.
If we look at automotive leather today, car manufacturers still talk a lot about it, but if you ask consumers if they recognise the difference between cheap and expensive leather, most just shrug their shoulders. They might see a difference in interior design, but the touch, feel and smell of the material seems no different – and how could it? If you follow the technical specs and the expectations of the industry, there is not much room for variation and you have to take all the different hides and squeeze them into the same frame to make them all look and perform the same. This means all effort is on turning difference into uniformity, on turning a million hides that are different into one type of leather, no matter who made it or where.
In the shoe market the conditions are the same, but the consequences are different. Since brands and retailers no longer distinguish between materials and there is no price difference between a leather or non-leather shoe, leather is just one material of many and has to perform, mainly in terms of cost. Consumers are trained not to bother about material, but about brand and social media image. Since all finished products have to look the same, one does need to be too smart to understand how difficult it gets for leather to compete.
We strongly believe in trends and cycles. From an industrial production standpoint and from the logic of economics, we might still be at the beginning of the trend. This would consequently mean that the use of leather will continue to shrink and more and more raw hides will go unused. You would only need to bother about leather for luxury products.
We have been attacked for our scepticism and our predictions that commodity production could face tough times in future. Many may still remember that it’s only three or four years ago that the beef industry came to the opposite conclusion. More people in the world with more income will mean more demand for leather; this was the justification for rising hide prices. Every warning that leather prices have a limit in mass production, every doubt, every alternative idea and the danger posed to leather by alternative materials was just swept away. Anyone who had a different view was labelled as trouble-maker.
This still leaves us with the question of where we are in the long-term cycle. The truth is that there is no indication of any change for the better, except in the luxury segment. Even in automotive business is stable, but nothing more. The market for vehicles in many parts of the world is beginning to show some fatigue.
We need a recovery in the shoe industry. Plans and designs, as well as material decisions, have been made already for the next seasons. From what we can see, there is no indication that any of the volume producers has put a return to leather on its agenda.
We still consider leather to be a valued product if it’s brought in the right way to the consumer’s attention. The luxury segment is a very good example. People like leather and they will buy it when it is presented in the right way. All the questions raised in the Western world about the consumption of beef and the use of leather can be ignored when we actually see the global situation. Beef consumption is still on the rise and that means that more or at least the same numbers of hides and skins will be available in the coming years. Anyone who eats beef can have no objection to using leather products. The big noise several campaign groups are making in the media might impress some people in Europe, but in the global community the impact of these messages is small. That means that consumers will not reject leather shoes if they are fashionable. This is however dictated by the brands. They will only be interested in promoting leather again if they can make good margins.
We believe that around 2019 we will start to have a couple of positives on our side. Casual and athletic footwear made from mesh has become so interchangeable that it would be no surprise to see a price war. Look how many of the so-called premium brands can be bought today at discount prices in discount stores. Actually there is no difference between brand A and brand B, the shoes all come from the same machines and even lookalike products can be bought at prices that are ridiculously cheap. The day might not be too far away when brands with a certain image requirement will have to go for something ‘new’ and different again and leather could fit the bill perfectly.
Next is the price factor. The oil price has been continuously rising and we are at double the level we saw two years ago. Long-term supply contracts and hedging will begin to lose their effect now. Alternative materials will become more expensive. This means the price advantage of alternative materials will begin to fade and the gap will close.
One argument against leather is on the manufacturing side. It’s more complicated to make leather and quality control, cutting and sewing require much more expertise than with manmade materials. However, if you manage to catch the attention of consumers, if you are willing to discuss sustainability and the advantage leather shoes offer and if you can turn this into higher prices there is absolutely no reason why we should not expect a solid return of leather consumption in shoe manufacturing. This is what we are going to monitor as our main interest in the analysis of the leather pipeline at the moment. We might draw attention also to the fact that what applies to shoes can apply to other sectors of the leather business too.
The strong performer remains the luxury industry. All the top French brand names report excellent results from the leather divisions and speak only about expansion of manufacturing and growth. We all know that the supply of raw material in this segment is limited. If all the brands have the intention of expanding and growing, they will have to look at other raw material supplies. This is another argument that is positive for the leather industry in general.
The split market continues to be in the doldrums. Specialties do well but commodities do not. The problems are getting more intense, with decisions from China to consider certain split products as waste and not letting them into the country any more. In China itself we understand from our regular sources that lime splits are beginning to pile up again. Also in Europe, the flow in the split market is not as regular as it should be when we consider that we are at the beginning of the second quarter.
The skin market is pretty interesting. Because it is critical to have skins for nappa leather production, the demand for quality skins continues to rise. We tend to believe that the high prices for calf skins and the general shortage of calves is beginning to have a positive effect on quality sheepskin. In addition, good quality wool-on skins continue to perform positively. Overall, the situation in the skin market is gradually improving and the supply-demand situation is becoming more balanced.
For the coming weeks we can’t be more positive. The leather production cycle is now entering the slow season. There are still very big stocks of low-grade material around the globe and the pipeline for mass production remains congested. The question is how strong is the cash position of the big players and how much patience do they have to see this critical period out. It is more difficult when nobody knows how long it will take. Anyway, the leather business is never zero and the most important factor today is to present successful products to customers and to serve them well.
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