Macroeconomics

Although the normal range of financial information has been evident in the last two weeks, the world of finance is waiting for the outcome of presidential election in the United States before taking any real action.

The weakness of the US dollar is without doubt a result of the impending election, however, even talking to those in the financial community offered no enlightenment as to why the dollar has lost so much of its volume value. Once the trading range of 1.24 against the euro was broken, it seemed that speculators were quite happy to consider the prospect of record lows. In the end the decline stopped just below the 1.29 mark and we will just have to wait and see what happens after the election on Tuesday. One thing is definitely clear, the financial community has not still decided how victory by either candidate will affect the currency. The fundamental problem of the double deficit remains the same, and with the focus turned on the war in Iraq and the fight against terrorism, financial and economic issues have been pushed into the background.

Looking at the facts over the last two weeks, we have seen a weak dollar and an easing in oil prices at the end of the period. US economic growth declined to 3.7% - which is still very good - but fell short of analysts’ expectations.

Consumer prices around the globe stayed within acceptable ranges - around the 2% mark - but we still have to consider that the results of the sharp rise in energy costs have not really reached consumer prices yet.

The economic outlook in the western world remains uncertain and only moderate growth is predicted.

The bank of China increased interest rates again with the lending rate and the deposit rate increasing by a quarter of a per cent. The government is still trying to keep inflation and the expansion of the economy under control, but if this move is to slow things down, it needs to do so in the coming weeks.

As already mentioned above, we believe everything depends on the outcome of the presidential election in the United States. It seems that a lot of investment and consumer decisions have been postponed until after the elections, therefore, more transparency can be expected after Tuesday. One is, however, well advised to pay particular interest to currency and interest decisions.

Market intelligence

The general focus of interest was on the trade meeting in Bologna and on the results of the main upholstery fair in the United States. Let's however start with the general trading activity in the past two weeks.

As already mentioned in our previous report, trading activity in bovine material is picking up. We don't think that this is really a large upturn yet, but rather just a normal development around this time of the year. We witnessed a very quiet September and the first weeks of October did not deliver the volume of trade one expects for the time of the year. Consequently, there was a simple backlog of purchasing activity and many tanners had to refill their pipelines to make sure that the drums kept turning.

Some interest was also related to upholstery finished leather orders and might have been the initial results of trips to the United States to sell leather or leather furniture. Superficially many were reporting that the fair in Highpoint, North Carolina did not deliver good results for the tanning and furniture industry.  There were general complaints about falling leather prices and it is true that the major problem in the leather furniture industry today is the ongoing fall in prices over the past almost two years.

Leather - at least in furniture leather - runs the risk of becoming defunct as a product. The continuous attempt to reduce prices has led to lower qualities being used, so much so that a mixture of grain leather, split leather and even plastic has been introduced. The big retailers have taken no action to protect the quality and the image of the product in their fight for market share and profits in recent years, consequently suppliers were put under pressure by demands for low prices and the buyers looked towards increasing production capacity - in particular in China. Miracles do not however happen in this world and the combination of high raw material prices and manufacturing costs could only be achieved by lowering the quality of the product.

We have already seen such developments in the past and we believe the last time a similar situation occurred was in the late nineties after the financial crisis in Asia and Russia. A natural product such as leather requires a certain image to be appreciated by the consumer, if this image is destroyed and it becomes just a material like any other, it loses its appeal, as the consumer still has certain expectations when buying something made of leather. As already mentioned, this is nothing new and it is quite useless to complain about the situation as very little can be done to change it. Having said this, such a situation, which is extremely difficult for the industry at the moment, not only creates risks, but also a lot of chances. Opportunities exist for those who are strong enough to focus on accepting the relationship between quality and price, as we all know that this cannot be the solution for all tanners or manufacturers.

We cannot prevent the industry from the changes we are facing nor can we save many of the tanners which are now threatened in many parts of the world.

We will stay for a moment longer with the furniture industry that we have dealt with in previous editions of the market intelligence. The uncontrolled expansion of the capacity of furniture leather tanners in China has created the situation we face today. What we were predicting a year ago is a reality today. Many of the tanneries built in China had only one vision and this was to produce cheaper leather. Being cheaper was definitely welcomed by global consumers, but you still need a customer base and a clear understanding about the customer’s needs. We think that this understanding was definitely lacking in China. Many of the tanneries had neither a marketing and sales strategy, nor a strong and trustful relationship with the buyers.  And this has led to many misunderstandings.

The buyers looking for low prices had no sales strategy themselves. Product development in many Chinese tanneries, which have just started, did not and do not really exist. Most of the products are developed by chemical suppliers and reflect nothing more than a very simple and exchangeable standard quality. It is, therefore, not very difficult to predict the result of this. When the product on offer is the same everywhere, the only selling point becomes the price. As it became so easy for buyers to reduce price levels, logically the quality also had to follow suit and fall. Many Chinese tanners are quite happy to do this, because their belief is that a gain of the market share will destroy competitors and the business will gain a stranglehold on the market.

This may work with computers, electronics, components, and other standard industrial products, but it most definitely does not work with a product such as leather. Many seem to forget that leather - at least in furniture – has no particular qualification as a product as such. Consequently, it has to deliver either an image or additional attributes to entice the consumer to choose it over fabric or other materials.

As a result, those who rate leather as merely a product are losing business and starting to fail. They are simply beaten by other - even cheaper - materials and they lose any argument as to why their products should be bought. Years ago we were already talking about integrated manufacturing supply chains and many did not understand that this is not only a question of optimising cost and price, but also a means to ensure that you have the necessary understanding about quality, marketing and vision to reach your client. Price is definitely not enough, although if you listen to some it seems the opposite is true.

Bologna

The fair in Bologna is mainly a meeting point for those who are interested in seeing or displaying products in the shoe and bag leather industry. Many consider it more, but we think this is a mistake.

It is true that some furniture tanners have displays, and raw material suppliers are not just looking for shoe and bag leather tanners, but also for other options. Technicians from all kinds of tanneries come to see the machinery and it is also seen as a general meeting place for exchanging opinions and ideas. However, on the whole, it is a fair which shows new trends, qualities, colours and fashion for shoes, bags and leather goods.

If this is a generally accepted concept, then the fair fulfilled expectations. As usual many visitors came for just one day and on Tuesday and Thursday the aisles and stands were very empty. Some exhibitors were happy, because some of their clients arrived on the Tuesday and so they had enough time to present their products and to do business intensively. For others where most of the visitors came on Wednesday it was the usual nightmare. Stress and a lack of time for individual visitors turned it into the usual chaos of the middle day. Several people commented that it is quite impolite of visitors to just rush in for a day and then expect that the exhibitors to have enough time to take care of them in an acceptable way. The excuses on offer for this were that they also had to go to the machinery fair and also that their time is very limited.

To justify the expense of the exhibitors and to gain the results such a fair is supposed to deliver, a better use of the available three days would be appreciated and would also reward the exhibitors’ effort and expense. For visitors it would also mean more that there was time to stroll around and to see more than just the fixed itinerary prepared before the show.

As far as the results of the show are concerned, in our opinion it just confirmed what we said two weeks ago. The trend for better and higher quality leathers is pretty obvious. Tanneries producing high-quality, elegant leather and which have done their homework and tied up with successful brand names were enjoying very good traffic on the stands and quite a few were even willing to admit that they had had very good results. This was reiterated when talking to the raw material suppliers of superior quality raw material, who were quite happy with the response they got from their clients. The situation in the medium-low end was a bit different. Just like in low quality furniture leather, simple products found it very difficult to attract customers.

One good thing is that despite the general problems of the tanning industry in the traditional centres such as Tuscany - and this particular leather sector - there's still plenty of room for creativity. The problem for many is that this creativity cannot always be turned into the necessary production volumes one needs.

Looking for more good news, there were more rumours that a number of shoe and leather goods manufacturers are pulling at least part of their business back from China. Speaking to some of them they all complained about quality, inflexibility and - last but not least - the large additional expenses doing business in China had created. In short it can be said that mainly medium and smaller size retailers see a number of disadvantages.

The winner in this development seems - in particular - to be India where people believe there is not only very acceptable production costs, but also a good level of quality and a certain feel for the product. If the Indian market can deliver the flexibility needed to be seen in the coming years, it will come down to the bottom line. Other markets will find their role in this change. Eastern bloc countries, Portugal, Italy, and Spain are arousing more interest after the dreadful past two years. Let's hope that this is not just a one-off and that the trade does really materialise, that price is not everything and one has to analyse carefully what the needs really are to build a successful relationship.

There is also a lot of talk in and about the automotive industry. Since the beginning of the summer production volumes of European automotive leather manufacturers have been declining constantly. The recovery that people were hoping and waiting for has not happened and many of the well-known manufacturers in Europe have suffered significant cuts in orders and production. The strikes at Opel and the unresolved labour dispute at Volkswagen have made the problem in Germany very clear and reflect the mood across the industry. General car sales are not meeting budgets and since the budgets and forecasts are the basic level for production forecasts - also in the leather industry - any reductions and set backs are reflected strongly in production numbers. It is still not quite clear what the next six to 12 months will hold, on the one hand some new models are going to hit the roads, but on the other hand it seems that more and more consumers are refraining from buying new and, in particular, expensive cars. With the current overcapacity we are also seeing in the car industry, one has to be ready and prepared for surprises in this market sector. One thing is clear for the moment: Only the luxury sector can maintain leather prices as in the rest of the market a price war has broken out that is going to force changes in the structure of automotive leather manufacturing in the coming years. Taking a quick look at other markets, lamb and sheep skin suppliers in Europe took a beating due to the ongoing shipping difficulties with finished product to Russia. Turkey and China are not meeting production expectations for garment and in particular for double face. Both markets have had to slow down shipments and orders for raw material; to make matters worse a lot of containers carrying raw materials got stuck in Turkish ports. As a consequence prices for lambskins fell by up to 40% and new buyers have still not been found for a number of containers as the original ones either do not have the finance, the wish or the will to honour their contracts. China’s not a great help at the moment because the news coming from there is not much better. Consequently, any optimism the trade had about the season has completely vanished – many are thinking about the problems the market faced after the Russian financial crisis in 1998.

The split market did not offer too much pleasure either. The trend of the session towards more grain leather and the reduction in the automotive industry all reflect lower demand for splits. Prices are continuing to be eroded and only reduced soaking has prevented the market from any major correction.  We believe that the situation will remain for sometime and how much this is going to weigh on prices remains to be seen.

The outlook for the coming weeks is quite difficult. It seems that not only in Europe, but also in the United States, the slaughter is going to increase. While in Europe the end of the subsidy policy will increase the kill for a short time, it seems that US beef can now slowly but surely begin to be exported into various markets again. As a result, in the next three to four months supply is going to be adequate on the whole. This should lead to an increase in demand at this time of the year, but there a still quite a few obstacles for leather sales. Those market segments which are performing quite well are the smaller ones, and they cannot absorb the additional quantities - neither in terms of quality nor from volume. As to whether production is going to return to a higher speed that can only be seen after the presidential election in United States. Raw material prices these days are no longer prohibitive. Basically, within a smaller range of variation they are adequate for an acceptable price. Tanners are still fighting with higher energy and chemical costs.  As a result, we also have to expect moderate pressure on prices in the coming weeks, while market players outside the dollar region have to watch currency developments and work any changes into their own outlook.

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