The Leather Pipeline - 07.01.14
07/01/2014
The year 2013 is history and most publications are trying to review the year just gone and give an outlook and prognosis for the coming one. We guess that most of our readers will have had enough of that and so we will not add more of the same. Just a few notes may be made.
In the past two weeks, unrest in Thailand and Turkey and the rise overnight of interest rates in China may have been the most important topics in a generally quiet holiday season. The situation in Thailand and Turkey has put the currencies of emerging markets back into focus. Currencies played an important role in the leather pipeline in 2013. Not only have the currencies of many emerging and producing countries (Indonesia, India, Pakistan and Turkey, for example) lost value, but the same has happened in some of the main raw material exporting countries (including Australia, Brazil and South Africa). In the past three months, the value of various currencies dropped by between 5% and 10% against the US dollar and even more against the euro.
Apart from the political unrest in Thailand and Turkey and the sensitive situation in Brazil in the build-up to the World Cup in June and July, there are concerns about the outlook for many of the tiger economies. Social tensions are rising because the rapid growth in some of the these economies is not affecting everyone to the same extent, whereas rising prices for the basics such as food, energy and housing do. One of the main concerns, apart from poverty of people in the street, is education.
For investors, any kind of unrest and uncertainty are the biggest enemies, so they are pulling out as quickly as possible and exchange rates and stock markets are declining.
In China overnight rates jumped sharply in the days before Christmas. There was a lot of concern about the stability of banks due to bad loans many of the small and medium-size institutions still have on their books. Overnight rates for lending between the banks rose by up to almost 9% until the government helped with small money injections to safeguard the financial system. That was what many investors were expecting anyway so the overnight rates fell back to levels around 6%. The confidence of many investors in the Chinese government seems still to be almost endless, but there are also voices that are seriously concerned about the situation of the financial markets there. The government seems to be aware of the problems and the main concern is still the grey capital market which is so difficult to control, even in such a powerful and centralised economy.
We found it interesting to see gold and silver remain under serious pressure. The argument for the sharp rise in precious metals, which has been used to explain rapid price gains before, are still valid: they offer protection against inflation and are save havens for investment in difficult times. On the other hand, metals are not yielding at all and the indication that the Federal Reserve in the US may have started the process of ‘tapering’ (reducing quantitative easing) is making investment into ‘non-yielding’ assets less attractive.
Oil prices are still holding well. The market prices seem to be following producers’ intentions. Every decline in price is answered by concerns about supply to justify rebounds. The physical situation of the oil market does not explain the present levels.
The euro continues its strong performance, mainly due to the strong outlook for the German economy and indications of a modest recovery in the debt-shaken EU countries. However, this seems to be still rather uncertain and hard facts will have to confirm this in the first quarter.
Market Intelligence
During the holiday season there is little activity in the leather pipeline. Most people in the western world take a pretty long break and even if they visit their offices there is more administrative work waiting for them than commercial activities.
Looking back at the year 2013, one has to admit that it was a pretty special one. The crisis in Europe still has a number of countries in its tight grip, but the recovery after the crisis of 2008 continued and rising wealth around the globe led people, on average, to buy more. For many products such as cars, there was not only increasing demand in emerging markets, but also in markets like the US, which had been in the doldrums for a long time and was in need of renewal. In Europe the situation is still a bit different and car sales are lagging behind the global trend. However, people are pretty optimistic and as current cars get older, more people will have to think about buying new ones.
Car manufacturers are actively developing new models and despite all the discussions about the change in mobility, the standard car fuelled by petrol or diesel will still dominate the roads for some years to come. Interiors are becoming more important too, because people want to distinguish their vehicles by making them more comfortable or more luxurious. Then there is the question of the extra profit a leather interior can offer to the manufacturer. With more cars being produced and leather still a preferred material for car interiors, leather consumption in automotive is growing and from what we can see, this trend is going to continue in 2014.
Most of the discussion in the past year has been about prices and profitability in this sector. Packers and auto makers have taken the benefits while productions in between have had a more complicated time. In many cases raw material prices have reached record levels and for many manufacturers prices have become a great challenge, not only for profitability, but also for their financial resources. This has become about the survival of the fittest, and this is going to be clearer than ever in 2014.
Apart from the growth in the automotive industry, the accessory business was also a strong performer in recent seasons. Here too the material plays a special role and leather can still express itself as being a natural, prestigious component that combines very nicely with the image of brands and their attempts to be something special. Finished product brands have increased their activities to expand vertically and to secure supplies of premium-quality leather; they have bought more tanneries to get closer to those supplies. If we are not mistaken, we are going to see a similar trend in the automotive supply chain too, although here the different steps of production might make direct contacts and negotiations a bit more difficult. However we would not be surprised if the automotive industry is going to try also to increase its influence on the raw material supply chain in the years to come.
These trends still leave a lot of unresolved questions. The finished product industries and brands have very clear opinions and demands with regard to their material quality. They are used to buying from their suppliers exactly what they want and have left suppliers with the problem of dealing with and getting some sort of return from selections and materials that do not meet these clients’ exacting standards. In the luxury sector, brands that have become tanners themselves were not ready for this problem. The automotive industry is complicated, as far as its technical specs are concerned, but from a selection standpoint it can handle different selections at their various quality and price levels much more easily.
The industry will be capable of handling the problem, but it’s going to be a great challenge and companies will have to understand that they must invest in the necessary management and know-how. They are strong enough to do that, but it might take a little more time than many people think today.
In the other fields the situation regarding leather is much more complicated. Standard shoes which are still the bread-and-butter business for the leather industry are much more price-sensitive and the pipeline was not ready for the price rises we saw in 2013. In the first place the tanning industry had to deal with the problem of margins while sitting on long-term, seasonal contracts for leather that had to be supplied at fixed prices. With a quick hike in raw material prices in the first quarter, and only a moderate decline in the third quarter of 2013, the vast majority of tanning businesses were not able to reach an acceptable level of profitability over the course of the year. Shoe companies became aware that a competitor (the automotive sector) was coming from a very strong and financially powerful position to snap up leather supplies, so they set about looking for cheaper alternatives if they felt their finished product price level at retail would not allow them to pay more for leather.
This has sent split prices soaring and leather alternatives and substitutes are becoming much more evident on the shelves of the shops. However, also in shoes leather is still a valuable item. You can substitute linings, you can reduce the content of leather, you can promote ankle boots instead of knee high ones, but in the end the consumer still prefers leather to any artificial product. Maybe we have to be a little bit more precise: this applies to the 30+ generation rather than to younger consumers, who are much more casual about quality and durability. For brands and retailers it is still very important to mention leather as a material, if the price allows, since it makes the sale easier and the consumer happier. However, where price dictates, decisions have to be taken.
Finally we also have to have a look at the leather upholstery market. This might be the easiest sector to substitute leather in. Yes, leather is special and it might even be prestigious, but it is just a ‘can’ and not a ‘must’ material. In furniture for the home it is a question of whether you like it or not, and possibly only still an issue of image in a few of the emerging markets. In transportation it is a bit different, because the durability and the maintenance of leather is certainly superior to textiles and in the long term PU cannot compete with leather at all. Airlines are very price sensitive, but in the end they can pay better prices for the material than the standard private consumer can these days.
From the above we can easily see that the main challenge in the industry is the shift between the sectors rather than anything else. What began in 2013 will, from our point of view, continue and progress more rapidly in 2014. Taking the tanneries in Northern Italy as an example one can see how many of them have shifted from their traditional manufacturing of standard upholstery leather to handbag leather because they believe this might offer a better future than sticking to what they have done for the past decades.
Apart from these sectors we also have to recognise that size matters too. The medium and smaller production units for shoes and upholstery are dying because they have become too small to supply the giants that dominate the retail business today. Those who have not managed to survive in a niche are running into a wall. They are too big to succeed as a niche supplier and too small to succeed as major players. This is going to lead to the demise of many. This trend may already be well under way in Europe, although it will take a bit more time in Asia; it is hard to see how it can be stopped. Possibilities may open up for some, with the help of online marketing, to build a successful business by being special and offering something for the minority who do not want just to buy what everybody else buys. However, let us be realistic: the market-share for these businesses is not particularly large, although it may be worth a try. There are still plenty of opportunities for those are flexible enough, smart enough and willing to think differently, even in a difficult business environment. The most difficult challenge is to tie up the links between manufacturing, logistics and retail flexibility and still be efficient enough to generate a critical mass of production and sales to make your efforts pay.
We begin the New Year still with a pretty high raw material price-level, which means a difficult start to 2014 for the tanning industry. However, not all raw materials are very expensive. You can still find a number of raw materials that are extremely attractive price-wise. If you take ordinary lamb and sheepskins, goats or exotic raw materials, they are by no means expensive and they could even be considered cheap these days on a long-term price chart. There is plenty that can be done with raw material of this kind if you are not dominated by the rules, budgets and technical specs of global marketing organisations. With their lead-times in production, logistics and sales, there is very little interest in raw materials that are much more seasonal or whose availability does not reach the right critical mass.
For the others however, if they are quick and flexible and have sufficient retail potential to bring product to market quickly, consumer prices and profitability are not such a massive problem as many people may think today. We still see plenty of opportunities for modern businesses who have a good, reliable network in the industry and it might be a good idea to start to think and do things ahead of competitors.
The start to the new year might be a bit slow. For standard business, it seems that the industry is reasonably well covered and most managers will now be looking to see how things develop in the real world after people start working for real with the budgets for 2014 that were made at the end of September last year. The positive outlook in the automotive industry is, from our vantage point, the only thing that is a reliable basis for business in the first half of 2014. Although price negotiations are tough and we hear that many of the new contracts are not yet signed, there is no way the production lines can be stopped just because leather is not going to be supplied. So, one way or another the conflict will be solved.
For other markets we are not as confident. Even the luxury segment is not as optimistic and almost all brands are discussing the possibility of a little slow down in growth, although, overall, hardly any of them are considering that their success stories will not continue in 2014. With the recent turmoil in many countries and uncertainty about China, we are not willing to bet 100% on this market. We hear from many sources that in particular in Asia a lot of luxury products have been delivered to shops and many new shops have been opened that need to be furnished, but many of the shop owners and the franchise companies are not happy with sales and turnover. Real sales are lagging well behind the projections. What is a bit difficult to judge because of missing data is if online sales are compensating for the missing ones in stores. This might be something to be monitored in the months to come. However, we agree that production lines will be busy, which will keep demand reasonably steady in the short term. In addition there are also companies that are sitting on the fence with regard to the leather business. Some non-leather brands have reached the limit with their core products and are now looking for growth in add-ons or new marketing options with other articles.
To close this first issue of 2014 we have to say that we would be optimistic about the leather pipeline and about the vast majority of companies involved if only leather could become accepted with all its natural defects. We have no idea if the ‘vintage’ trend will persist and our friends in the fashion industry are no better informed, but it could prove interesting if it does continue. In previous years it was all flawless, natural, ‘defect-free’. What fantastic opportunities it would offer manufacturers and designers if the naturalness and beauty of leather could break through in 2014. Some trade veterans might remember that we had this once already in the early 1970s when upholstery leather had to be full of insect bites and brand-marks to prove it had an outdoor story and ‘flair of the prairie’ qualities. Good luck. Happy New Year.
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