Hidden costs - only surface deep?

Citation

Jones, R.M. (2003), "Hidden costs - only surface deep?", Journal of Fashion Marketing and Management, Vol. 7 No. 1. https://doi.org/10.1108/jfmm.2003.28407aaa.001

Hidden costs - only surface deep?

As the rush of UK clothing manufacturers offshore gathers pace the old chestnut of "hidden costs" has frequently been invoked to imply that this is all a terrible mistake which will eventually be seen to have been based upon ignorance of the real costs of producing offshore. These "hidden costs" are allegedly costs that are implicit in the decision to move production from the UK to locations that have low labour costs but which decision makers fail to take into account because they are less obvious than the gains in labour costs to be enjoyed in developing countries. They include such items as the cost of extra staff required to monitor offshore production but which are allocated to general overheads; extra freight and insurance costs; quota costs; the costs of late delivery and costs associated with a less flexible production system with slower response times than are typically achieved with domestic production.

I have always found it hard to believe that so many decision makers in so many countries over so long a period of time have never eventually noticed that they've got things so badly wrong! Other explanations might be that the "hidden costs" are not in fact all that deeply hidden or that there is some sort of risk assessment going on – that the decision makers know that the probability of obtaining low labour costs is 1 while the probability of something going wrong, while not zero, is far less than 1. There may also be another factor. A recent report by the European Commission's Internal Market Scoreboard (Evans-Pritchard and Sparrow, 2001) suggested that there may be hidden costs to conducting business in the UK. These would include, for example, excessive red tape; high and rising social costs; high legislative costs; high recruitment costs; high turnover and absenteeism costs; and uncertainty over the future of the provision of export credit guarantees relative to other countries (Litterick, 2002). There may also be "hidden" benefits of moving production to low cost areas. These might include the opposites of the above list plus strong government support for what is seen in those countries as a strategically important sector of the economy.

Therefore, while it is clearly correct to argue that location of production should not depend totally upon a naive comparison of labour costs it is less obvious that a rigorous comparison of all costs could be relied upon to come out in the UK's favour. In the face of the evidence of the decline in employment in the UK clothing industry – down from almost 190,000 in 1990 to 95,000 in 2001 – it would seem to me that reality has to be faced – the jobs are not going to come back. This is not to argue that the industry will entirely disappear from the UK – no one is suggesting that offshore production will entirely replace domestic production in all segments of the industry. There will be many areas in which domestic production will continue to have an advantage, e.g. quick response and small order markets; specialised products which are less labour intensive in their operations; products with a relatively higher scientific content such as performance garments and technical textiles and so on. However, for the mainstream garment, which involves a lot of sewing, non-UK production will become the norm rather than the exception and because, in the clothing industry, the ratio of operatives (usually sewing machinists) to total employment is abnormally high in comparison with the average for the manufacturing sector as a whole the impact of this move is particularly dramatic in terms of total employment. In a recent survey of successful manufacturers carried out by staff at MMU it was noticeable that one of the common features of this successful group was a high and/or rising commitment to offshore production or sourcing.

Two other facts need to be taken into account: first, there are a number of non-UK locations with very low costs that are really quite near geographically to the UK so that the logistics problems are far less severe than those associated with suppliers in the Far East – North Africa and Eastern Europe are good examples. Second, the very rapid collapse in employment experienced in the UK in the very recent past (a fall of 9,000 between May and November 2001), for example, has to be seen in the context of a period of sterling weakness against the American dollar which would have had some protective effect on the relative competitiveness of UK production. The impact of currency fluctuations is complex and variable depending on which currencies are involved. It is true that the pound has been strong against the Euro (Jones, 2001) but it has been relatively weak against the dollar – and a lot of trade in the sector is dollar related. Therefore, if the pound is weak against the dollar this makes UK exports into dollar zones cheaper and UK imports from dollar zones expensive. If, for example, UK based companies have started to outsource in areas where transactions are conducted in dollars then such business becomes less attractive as the pound falls and, by implication, UK sourcing is made more attractive. In addition if international cost comparisons are normally made in dollar terms – which they are – then increases in local cost terms from, say, £4 to £5, which are translated into dollars when the pound is falling from £1: $2 to £1: $1.5, would show up as a fall in costs from $8 to $7.5 per hour.

In fact the pound experienced a very slight gain against the dollar between Spring 1996 and Autumn 1998 but thereafter and especially between Summer 1998 and Spring 2001 the pound fell 14 per cent against the dollar. The rate fell from 60p=$1 to 70p=$1 or from $1.67=£1 to $1.43=£1. The precise impact of these changes on cost comparisons can be traced in data supplied by Werner International. Figures are available up to 2000 for textiles but only up to 1998 for clothing. In Table I the trend in costs between 1990 and 2000 in the textile sector is shown. It can be seen that the UK rate (in dollar terms) actually fell between 1998 and 2000, which was, as we have seen, a period of pound weakness although it also covered the introduction of the national minimum wage in the UK. If a comparison is made of the relationship between the UK rate and an average of eight low cost producers it can be seen that the UK rate as a multiple of the average moved from 12.4 in 1990 to 10.0 in 2000. A falling ratio indicates that the UK's competitive position in terms of wage rates has improved. It may be significant that the ratio deteriorated between 1996 and 2000 when the sharp fall in employment recorded above started to gather pace.

Table II shows the position in clothing between 1990 and 1996: the ratio again deteriorated dramatically, which would be consistent with a period of rapid job loss. Sadly the equally dramatic improvement in the ratio 1996 to 1998 does not seem to have mitigated the collapse in employment. Unfortunately there is no evidence after 1998, but a comparison of the relationship between movements in textiles and clothing for earlier periods suggests that in most countries these were quite similar, so it may be safe to assume that movements in clothing after 1998 would have been similar to those in textiles in which case the clothing sector would have benefited from a roughly 6 per cent fall in dollar denoted costs despite a rise in local rates. Things could have been even worse than they have been, therefore, but the downward trend has been quite bad enough as has been made clear above. It is difficult to be optimistic, which brings us back to the issue of "hidden costs". I can see no prospect of the alleged gap between real and imaginary costs reversing the current trend. In a recent MMU survey related to the introduction of the national minimum wage (Hayes and Jones, 2002) virtually all the 20 companies contacted agreed that a forecast employment of 80,000 in 2005 was optimistic. The sorts of comments emerging about the future of the industry in the UK were as follows:

I think this rise will finish the industry. A lot of my competitors have gone out of business or have stopped manufacturing in the UK and I can see this company having to do the same very soon. We are beginning to look at deals which involve going into partnership with another company that manufactures overseas.I think this rise will be the death of the industry in the UK … and be the last blow forcing us out of manufacturing in the UK.This rise has simply confirmed what I felt all along … I think the effect will be to decimate the industry at an even faster rate than was the case previously.I think the days of clothing manufacture in the UK are over.I could see this coming some time ago and frankly I cannot see any future in UK garment manufacture … within two or three years we foresee that our only operation in the UK will be restricted to design and certain quick response lines.

It was very noticeable in the survey which started in 1997, that even those companies that had initially argued that they could survive and remain competitive by investing in new technology or re-organising work methods had lost confidence in their ability to compete – for example, one said that while there:

… was a time when these (low cost) countries could not compete with us on quality because they could not afford the technology. However due to the volume of business they are doing … they cannot only undercut us on wages but they are also beginning to compete with us on quality as well… I think there will be a future for some time in the niche markets such as designer led fashion. Within a few years only luxury items such as cashmere knitwear will be manufactured in the UK. I can forsee a day when the manufacture of anything in the UK will become a sort of cottage industry … But there will never be a mass market again for clothes produced in the UK because the consumer demands fashionable clothes at ever lower prices.

To recognise the reality of the situation is not to be disloyal to the industry. It seems to me to be futile to try to "talk up" something which is so unlikely to happen. Garment manufacture will survive in the UK in a variety of forms: short runs; quick response; niche and luxury markets; areas such as workwear where import penetration is very low; technical garments and sectors of the industry which are relatively more capital intensive. There will also be, as Professor Horrocks (2001) recently argued in this journal, a strong future for various branches of the textile industry. There will also be a good future for British clothing manufacturers who conduct much of their operations outside the UK – but the most important point is that these companies will require in their staff quite different skills from the traditional company which had large amounts of production in the UK and that is why I believe we are not doing ourselves any favours by looking for reasons to argue that this change is not going to continue especially when one recognises, as has been made clear in International Monetary Fund statistics (McRae, 2002), that the cost of international communications has fallen by some 30 per cent over the last 50 years and the cost of ocean freight and air transport by almost 40 per cent and 30 per cent respectively. A recent report, referred to above, compiled at MMU for the CAPITB Trust (2002) into the practices of the most successful UK based clothing manufacturers found that offshore sourcing was one of the dominant themes in the evolution of these successful companies. This will be the subject of an extended editorial in the next edition of the journal.

Richard M. JonesManchester Metropolitan University, Old Hall Lane, Manchester, UK

ReferencesCAPITB Trust (2002), Skills for Success – A Report on the Impact of Market Changes on the Skill Base of the UK Clothing Industry, CAPITB Trust NTO/MMU, Leeds.Evans-Pritchard, A. and Sparrow, A. (2001), "Britain leads Europe in red tape stakes", Daily Telegraph, 20 November, p. 38.Hayes, S.G. and Jones, R.M. (2002), "Minimum wage legislation and the UK clothing industry", Performance and Reward Conference Proceedings, 11 April, MMU Business School, Manchester.Horrocks, R. (2001), "The UK textile sector: has the time come for real national strategies?", Journal of Fashion Marketing and Management, Vol. 5 No. 4, pp. 269-74.Jones, R.M. (2001), "Too many oeufs in one basket?", Journal of Fashion Marketing and Management, Vol. 5 No. 2, pp. 93-9.Litterick, D. (2002), "Jobs at risk under export plans", Daily Telegraph, 7 May, p. 26.McRae, H. (2002), "Economic view", The Independent on Sunday, 15 May, p. 10.