Macroeconomics

Global research institutes and economics institutions are predicting a good future for the global economy for 2005. The ECB (European Central Bank), the OECD (Organisation for Economic Co-operation and Development), and the World Bank all see positive global growth for the year to come and some are even going so far as to say that they see the period as one of the strongest and most sustained since World War II.

Well, so far as we are concerned our cautious view expressed in the last edition of Market Intelligence is a long way away from the general point of view. Maybe it just depends on which perspective you look at it from and whether statistics can really measure what people consider to be a good or bad personal situation.

While the emerging markets are enjoying very healthy growth and creating more wealth for more people, the mature economies are fighting to maintain their positions. The only statistical exception is the US economy, but only time will tell if economic growth can actually be built on consumer spending and massive imbalances alone.

In our view, the key to the future of 2005 is to maintain global political stability, which is having an increasing influence. The situation in Iraq seems to have become the never-ending-story that many predicted and remains a threat to political stability. The election and the positions taken by the Russians and the West also show that tension between the East and the West is still around, and the big blocs are still fighting for their share and position in the global order.

Fortunately, economic interests are still in the foreground and massive political conflict is not foreseen. However, the political involvement of the Russian government in business matters should not be underestimated and sensitive issues could quickly turn into political tension.

Apart from these general issues, currency issues remained the focus of attention. The Europeans and Japanese have not taken any appropriate measures to stem the decline of the US dollar and the ECB has lost a lot of credibility as it failed to take any action despite having made statements sayng that it would. Consequently, it was easy for US officials and the international currency dealers to get what they wanted, which was: one - a weaker US dollar to try to reduce the deficit, and two - to have a free licence to print money to sell the US dollar short. Although endless ‘experts’ are trying to figure out the correct value of currencies and to justify their view of the trend, nobody is able to determine when a currency is under- or over-valued. However, for European industries the sharp fluctuations at the moment are a tremendous burden on many - including the leather industry.

Finally, statistics released in the last week proved that the US economy is still growing at a faster pace – despite a weaker than expected job market – than its counterparts in Japan and Europe. With the problems of the currency market (see above) the outlook for Japan and Europe is not looking any better.

Market intelligence

The last two weeks, which we are looking at this time, were again quite limited as far as general activity was concerned. Most of the tanning businesses seem to have already closed the books for the year 2004 and are busy either preparing for the end of the fiscal year, or are looking forward to the Christmas holidays. Raw material suppliers don’t enjoy this situation as they lose the feel of the market more and more due to a lack of activity.

Prices continued to trade within a very narrow band with a generally softer trend and many are finding it hard to figure out if the present level is a realistic one or just a consequence of the reduced activity.

Finding an answer to this question is even more important because many businesses need to prepare their budgets for the year 2005.

Let us try to figure out where we stand as of today. The general consensus of opinion in the trade, at least in open discussions, remains one that business is bad.  However, nobody is really specifying what that means these days and as usual a generalised statement never really covers the situation.

The statement that business is bad is mainly related to the problems of the upholstery tanning industry and this is as a result of the excess production capacity amassed over recent years. The sharp increase, in particular in the production of leather, was based on expectations that the market growth in Asia would be much higher and that the cost advantage would make competitors close their facilities in other parts of the world much faster.

As much as the general assumption might have been correct, such a process never develops in a smooth way. This is what we are seeing today. Additionally, the market growth for leather furniture and automotive interiors has not been as positive as many expected. This has led to the classical spiral of excess supply and falling prices that gives market players the impression that business is poor, because margins are deteriorating or even turning into losses. This is not a unique problem to the leather industry. As much as the results of individual companies can be hit, the question is whether the general statement that ‘business is bad’ is the correct one.

We believe not. These structural developments belong to long term changes an industry has to go through. There is always a need for adjustments, corrections and, last but not least, there are always victims. For those involved in the industry, it requires a fair analysis of their position and potential, and requires clear decisions for the future and sometimes adjustments in strategy. The bigger problem in the leather industry in this respect is that production, demand and raw material cycles are different and less stable than in other standard industries. It must be re-iterared that leather for upholstery is not a product which is needed as such, and generally you cannot obtain stable market projections as in other industries which are much more predictable despite suffering similar problems.

Not only does the industry have to deal with these types of problems, we have other temporary ones as well. The currency situation for European tanners (the production costs of which are based on euros, such as labour, effluent treatment, etc.) has increased by more than 20% in the last year due to the currency factor. As a consequence, large tanning companies have continued to consider relocating - at least beamhouse production -  and to reassess their production and distribution set-up. An example of this is may be large South American groups using Asian locations as a beamhouse and distribution hub to save production costs and serve their clients more speedily and with selected materials.

In continental Europe the slaughter industry is now undergoing the concentration process which was already long overdue. This will change the supply chain of raw materials which requires adjustments, not only in the hide processing industry, but tanners will also have to look at whether this could eventually change their procurement set-up. These are only a few examples of influences other than the simple but important question of overcapacity and dwindling margins.

For many, all of these topics may mean very little and many will argue that they are neither related nor will they have any influence on their daily problems, but one can rest assured that nobody will remain untouched by the developments and the influences of this globalisation. A large part of this process has already occurred in the shoe industry, and the upholstery industry is now about to make changes as well.

It may seem that there are only losers in this game. Not quite. Those who have built factories in recent years - gambling on cheaper production costs - are going to flourish whilst all other business will or have already failed. Production that is not based on demand, quality and understanding of the market and customer needs faces a bleak future and is always the first one to be eliminated when the market potential is insufficient. The same applies to the well-established companies that were and are not willing to see the changes in the markets. If you were not willing to show that you wanted to take up the price battle and wanted to try to win by flexibility, service, reliability, creativity and market-oriented quality, or by being a niche player, then it might already be too late. For those who have not yet changed, the leather market has converted into a 90+% mass market and a 10% niche and luxury market. Not fit for the market means: Out! The cosy times of a fragmented, small- and medium-sized global leather family are long since over.

Yes, very simplistic and many of our readers will now say that they don’t need to read this to know what’s what. That may be true, but then it is worrying as to why it is still happening and although ‘pundits’ were convinced that the Chinese invasion would erase almost all other leather production, this hasn’t happened either. In all similarities to other businesses the leather pipeline still has some specialities remaining (see above)  which have to be considered as well.

We have now defined the losers, but who could the winners be? Most of it is self-explanatory from the comments above. The small family of rich people in this world is getting richer and gaining few, but nonetheless more, members. The Middle East, Asia and the Eastern bloc has produced a lot more ‘noveaux riche’ in recent years, whilst in the Western world the rich are still gaining wealth. M&As, bonuses, stock options and simple winners from raw material hypes and wars are disposing of massive wealth and income which they will spend until the next global economic crisis. No leather product is so expensive that it could be disqualified by the price tag. Compared to the cost of a football team, a luxury villa, jewellery or a prestige car,  leather products are take-away items and as long as you attract the buyer by style, fashion, image and quality there are plenty of market opportunities to sell top price products. This market, at present, has a fair chance of growing even further if the suppliers can develop enough attractive products and ideas to serve this special species of buyers - until the next crash.

For the others, with generally restricted budgets, price will remain the main, but not single force. The conviction that price was the only factor led to the flood to China which seemed to be guaranteed as the cheapest production place. For a monocultured and uniform mass production this might even be true but not all leather products qualify for this. We see two developments which have given the industry a shot in the arm.

The sharp and constant decline in price (and quality) has not stimulated demand as with other products (electronics). Quite the reverse, as demand for low price, low quality products made from leather has declined because the reason (image) to buy leather is rapidly fading, leading to a reduction in orders and sales.

China is not a cheap place for everyone to produce. When volumes are not big enough to justify an integrated production chain and to support the necessary investment and infrastructure it becomes a double loss situation. Much higher costs in total, reduced flexibility and sometimes pipeline inventories which are too big for the sales potential lead to write-offs and excessive amounts of capital being tied up.

So, only the few, really big players are successful and report healthy results. The others have to reconsider what they do and find a new structure which suits the business size and improves flexibility to respond to market needs, quality and, of course, cost. This is done with the result that the production and purchasing decisions are no longer based on price alone, which is reflected today in a return of production to other markets (India, Italy, Thailand, Vietnam, Turkey, Pakistan, the Eastern bloc and others). In addition many are restructuring their production chain by dividing and optimising production steps at different locations to find a fair compromise between production costs, efficiency and flexibility to respond to customer needs. For the moment it is definitely a strong option as long as transportation costs, efficiency and availability are not restrictive.

So far as the discussion about the question of whether business is bad or not we will intensify our efforts to monitor the changes in the industry as we feel that this could be the key factor to the next development in the market.

The split market was as quiet as it had been before, but our assumption that reduced supply could become a more determining factor is starting to become more important. This is not so much for leather production as yet, but gelatine/collagen and pet food producers using splits are already seeing supply shrinking. Since their price levels are basically below the level for leather use it is not yet affecting the market, but if the trend of reduced demand from the leather industry and rising demand from other destinations continues, we could see support for split prices in the first quarter 2005 due to this situation. However, for the moment splits as hides could be called, at best, weak but steady.

The lamb and sheepskin market continued the trading pattern of the preceding weeks – a strong demand for cheap products. Everything which is offering a raw material price below $1 per square foot and is suitable for average quality nappas saw enough demand to clear. Double face lambs are still suffering from the past and the lost season, but buyers from China and Turkey are sniffing around and many in the trade believe that the market collapse is behind us and prices are on safe ground now. Many also believe that business for lambs will be better in the first quarter due to bigger sizes, better wool return, a change in fashion and higher demand. We will remain a little less optimistic until the results of the January fairs have been collected and a clearer picture of the Russian leather garment market and trade conditions can be gathered.

For the coming weeks we expect nothing special. Most of the world is preparing for the seasonal break and many are also having to prepare for the end of the fiscal year. This is going to dominate the market decisions, at least in Europe. Some want stocks for tax reasons, others don’t want stocks for the same reason or because their financial controllers told them that stocks on the balance sheet are not looked upon positively in the financial community anymore. Asia will also be busy deciding how much raw material still has to be shipped to arrive before the shut down for the Lunar New Year holidays.

So, trading activity will be limited to strategic decisions of this kind. There is a fair chance that around the year end business could increase again because many need to consider their needs for the the first quarter. European tanners seem to be covered until the end of January, but are still operating on a very short inventory. Asian tanners as already mentioned are still suffering from an overbought situation deriving from large purchases made in the summer in expectation of strong production in the last quarter (upholstery). We know that the order and production situation was far below expectations and so stocks lasted longer than expected. However, in the next 4-8 weeks production and buying decisions have to be taken and it is hard to believe that it will not be less than in the last quarter. With the hide supply from Europe falling and the southern hemisphere taking a break, only the hide supply from the USA could be a burdening factor. Despite all of the negative reports and attempts to write the market down, prices are holding much better than many expected and we continue to believe that many markets today are offering price levels which in historical terms are not on the high side (except the US where prices are in no man’s land) and assuming that Chinese demand has fallen and put in order in the past months, there is a good chance of returning to normal demand levels in the first quarter 2005.

We wish all our readers a very Merry Christmas with a few days to relax and enjoy away from the trouble of business!

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