Macroeconomics

On the subject of the war in Ukraine, there is little progress to report. Both sides have had enough time to fortify their positions, which means that gains in terrain can only be achieved at great sacrifice and very slowly. It remains deeply frustrating what is being done to ordinary people just because political leaders want to erect a monument. The biggest problem remains that there is a host of other potentates who would do the same.

On the financial markets, everything continues to revolve around the question of how interest rates will develop in the coming months. The next few weeks will show how the European Central Bank and the US Federal Reserve intend to behave. The financial markets as a whole are betting that the national banks will realise that inflation has passed its peak and that further significant interest rate hikes would possibly do more harm than good.

The current level of interest rates is still relatively low overall, whereas further rate hikes would tend to cause greater turmoil in the financial markets. The main driver of inflation is not so much the price of products anymore, but rather the problem of labour shortages and the capital hunger of many countries, so that governments themselves are now responsible for many price increases.

Apart from that, the development in different countries is quite contradictory. In Japan, where inflation has not been a big issue for a long time, the core inflation rate is now rising. In the UK and the other European countries, inflation is falling. In Russia, interest rate hikes have been announced because the fall of the rouble has now become a burden on import prices.

The stock markets are betting on a pause in the interest rate hikes or only smaller further steps. The first quarterly figures published in the last few weeks showed that the large, globally operating companies came through the second quarter more successfully than feared and that corporate profits for the current year may therefore not come under as much pressure as was feared.

The US dollar, on the other hand, continues to reflect the expectation of stabilising  interest rates in the US and therefore fell significantly in value over the last two weeks. However, a slight recovery at the end of last week did not make up for losses of between 3% and 4%. The current weakness of the US dollar does not really seem justified when one considers the difficulties that Europe, for example, is facing at the moment.

The price of gold remains below the magic mark of $2,000. Oil has been able to recover on the back of recurring fears of cuts in production and supply; the price is hovering around the $80 mark per barrel. 

Leather Pipeline

As every year, the period from mid-July onwards in 2023 is the phase when the northern hemisphere goes on holiday. While in the last few years the pandemic determined the situation, this year the war in Ukraine and the resulting economic consequences are the determining factors for the holiday period. What is often covered up during the other production periods then becomes clear and decisive again during the phase of interrupted production.

Many things in the post-pandemic period have not developed as well as many expected. The old normal is not the new normal. In addition to geopolitical tensions that influence many business decisions, there are many other dominant issues. Climate change, which is also clearly noticeable in many regions this year, dominates the headlines just as much as the resulting consequences and political decisions. One example is the massive political pressure towards battery-powered vehicles, without the corresponding amounts of renewable energy being available for the power supply. What is supposed to benefit the climate may, in the sum of all parameters, be detrimental for a period of time.

For the leather pipeline, the aggressive fight in Europe against meat consumption is a factor, but ever-more stringent laws and regulations regarding the use of chemical substances in tanning are also causing difficulties for Europe as a location for large-scale leather production. All this is exacerbated by labour shortages and uncertainty about energy supply and costs. It makes investment decisions in this part of the world extremely difficult; any investment made today may take five or even ten years to provide a return. With so many uncertainties, it is difficult for any entrepreneur to invest in the leather industry in Europe.

If the worsened competitive conditions for leather production in Europe were to result in a shrinking of production capacity, this would, without a doubt, also have an influence on the structure of the industry between slaughterhouse and tannery. A large part of the supply chain in Europe is based on secured deliveries of fresh, chilled hides to tanneries. If sufficient capacity is no longer made available for this, for whatever reason, then the share of traditional salting would have to increase significantly again. There is a possibility that today’s suppliers would switch to a higher proportion of semi-finished goods, as in other countries. The problem that the full-scale leather factories have would not go away if they switched to a larger share of contract labour and semi-finished products.

Talking to many European stakeholders, one has to admit that they honestly consider this scenario not only unlikely, but far-fetched. Of course, the fact that there is an overcapacity in the leather industry in Europe anyway, and even after a certain contraction there would still be sufficient capacity, speaks in favour of this thesis. This is certainly not wrong in terms of numbers, but transport routes, time and transport costs also play an important role. In addition, there is of course the indication that slaughter will also decrease significantly over the next five or ten years in Europe and thus the total supply will also decrease. However, this will not solve the fundamental problem of total costs, and in those sectors where sufficient processing capacities are lacking, the competitive disadvantage on the international markets would hardly be compensated. Whatever happens, it seems more than likely that, at least in Europe, we are facing relatively extensive changes in the chain from slaughterhouse to tannery to finished product manufacturer. This may be a process that will take several years, but it is certainly not a mistake to raise this question and its possible consequences today, whatever conclusions one may come to.

The leather industry has lived through such changes and production relocations in the past; they have been nothing out of the ordinary over the past decades. This time, though, it may have seemed that more time would need to pass before drastic relocations occurred again. Time will tell whether Europe can become more attractive again as a production location. 

In the media this period is called ‘the summer slump’ and sometimes even ‘the silly season’ because it is usually filled with entertaining banalities owing to a lack of really interesting and significant events. Perhaps this also applies to the leather pipeline. What else can be reported from the leather industry at this stage?

The cattle hide markets continue to struggle to provide a reliable reflection of the supply and demand situation. This seems to be exceptionally difficult. There is no end to the discussions about availability, stocks and the structure of demand.

Many observers of the markets are of the opinion that one large, common market is a thing of the past and that many fragmented and small sub-markets have emerged in its place. These are partly larger units controlled mainly by the large meat producers and on the other hand many small units resulting from specialised niche production. The two can hardly be synchronised; there is little or very little dependency between them. 

There is much to be said for the thesis that the large uniform commodity market no longer exists in its old form. Whereas in the past the price of raw materials and the creativity of leather manufacturers ensured that differences in price, quality and value were always balanced out relatively quickly, this hardly ever happens nowadays. The specifications of the leather processors, inflexible, industrial production and quantity specifications are the main obstacles that make quick adjustment processes impossible, for leather articles and for the valuations of the various raw materials.

At the moment, there is still much to suggest that significant stocks have built up along the supply chain in the leather industry. No one who owns large stocks can have any interest in the value of these stocks falling or being called into question. As a result, price cuts are being handled very cautiously everywhere. The meat industry in particular does not see any point at the moment in lowering prices further in order to stimulate sales, which obviously does not work anyway. That is why in many regions they are using quantity control. It is better to sell 70% at reasonable prices than 100% at unprofitable prices. Only time will tell how this strategy turns out in the end.

We  find the Birkenstock story very interesting. There has been intense discussion in financial circles about whether Birkenstock will go public and be listed on Wall Street. A price tag for the possible IPO has already been thought up and it is around $6 billion. That would be quite a handsome return for the investors who bought Birkenstock a few years ago. Those are the finances, but for us the real story is that there are products made of leather that are so unique that they are discussed in such terms.

It’s footwear, but Birkenstocks tend to be something for the ages. Most users wear them for many years, which they can do because of the quality of the leather, among other things. The longer they are worn, the more they become the image of their owners. Anyone who sees Birkenstocks that have been worn on their owner’s feet for years knows what this means. They are unique because, like a fingerprint, they represent the foot, the way of walking and individuality. That is their value to a great extent. They hardly ever wear out and everyone has a hard time parting with them when the day comes to replace them. They have become a real part of you.

That is the difference between a long use and a short consumption. Other manufacturers of products with leather should really take this as an example because the value of the product can ultimately be reflected in the value of the company that produces it.

It also shows that in addition to the image of a luxury brand, there is also an image of use. Land Rover, Jeep or denim jeans are classic products intended for endless use and many other products derive their uniqueness from use and durability. They are symbols of this and if one material is a suitable reflection of this, it is leather.

The news from the German automotive industry is that, with the exception of Porsche, all the big premium brands are reporting significant production declines measured against 2019. Although the sales figures for the first six months were significantly higher than the previous year’s overall, they were far below the figures for 2019. What is much worse here, however, is that the good figures for the first half of the year were because of backlogs in the production of volume models. All the major premium brands, and these are the ones that still use leather to a greater extent, are seeing major declines in their sales. Automotive leather demand in Europe, long supported by the preferred production of profitable luxury models during the computer chip shortage, may have to contend with significant declines after the summer holidays. European premium brands are trying hard, but when it comes to competing in electric mobility, they simply do not have the same success they have been used to for decades.

Thus, there is much to think about during the holidays. There is without question still great potential for leather as a material, but in our estimation it will not be a simple extrapolation of the past that will meet the challenges. If we do not succeed in transporting the special features and uniqueness of leather in terms of its function, durability and, of course, sustainability into consumers’ minds, we will continue to face difficult times for our sector.

There is not much to report in the split market. The collagen and gelatine sectors are certainly the ones generating the most interest and influence in the split sector at the moment. In the meantime, the finished products of the new capacities for collagen and gelatine that have emerged for some time are coming to market with force. The prices for finished products are falling and the structures in this sector are also changing permanently. As long as cattle hides cannot be completely absorbed by the leather industry at reasonable prices, the production of collagen and gelatine remains one of the possible alternatives. The shortage of collagen raw materials as a by-product of leather production may apply regionally, but it does not exist globally under the given circumstances. However, this also means that one has to think about location and production issues and there may be deep and lasting changes in this sector as well.

Sheepskin leather is increasingly becoming a niche and marginal. Additional demand, which in the past led to the use of sheepskin and goatskin when cattle hides were too expensive or in short supply has not existed for a long time. Gloves and clothing, the formerly dominant sectors, have also long since ceased to be volume consumers of leather from small skins.

The war in Ukraine is putting additional pressure on the business; double-face jackets used to be popular in colder regions for making winter jackets. At the moment, the entire business is only taking place in the high-end niches.

For the next four weeks, the world of leather will remain in summer slumber. Only producers in Asia will be busy preparing for the production-heavy second half of the year. However, the big decisions about fashion and volume of orders will hardly be made in the next four weeks there either. This leaves time to think further about the future of leather production in the coming years.

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