Procurement

Balancing China Sourcing and the Changing Asia Landscape

Tracey Azzopardi Head of Workwear and Shanghai Operations Pacific Brands (Asia)

Tracey Azzopardi

Contents

1

Introduction to Pacific Brands and Pacific Brands Asia

2

China Sourcing Today

3

The Changing Asian Landscape

3

How Pacific Brands balances the sourcing mix

Tracey Azzopardi 1

Pacific Brands houses some of Australia’s best-loved apparel, workwear, lifestyle and licensed labels

UNDERWEAR & HOSIERY

WORKWEAR

FOOTWEAR, OUTERWEAR & SPORT

HOMEWARES

2

Today, we manage…

A broad portfolio… Product 500K ‘in system’ 230K styles 40% seasonal

…with global reach… Distribution Through 11 DCs With 156K sqm footprint Top 10 countries

…globally sourced…

…to a diverse customer mix…

Sourcing

Customers

Across 7 countries With 180 suppliers And 300+ niche suppliers

20 major wholesale customers 200+ B2B customers 50K independents 180 retail stores 11 online sites

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Pacific Brands Asia is our sourcing arm in Asia Pacific Brands Asia: 3 offices

Pacific Brands has had a presence in Asia for over 30 years Today, we source 75% of product from China

PBA Shanghai

Almost all of that is via Pacific Brands Asia (PBA), the Asian sourcing & supply chain operation of Pacific Brands Group A staff of ~270 staff oversee ~118 suppliers1 PBA Hong Kong PBA Dongguan

25% 26 countries

1)

Source: FY12 Spend Managed by PBA, Apex Pro

75% CHINA

As well as the full services of a sourcing office, PBA handles a range of value-added services, from graphic design, to end-to-end product design and development, to strategic sourcing solutions Categories include Underwear, Bras, Socks, Hosiery, Workwear, Footwear, Outerwear, and Accessories PBA is a strategic resource, providing a competitive advantage.

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PBA provides a range of Core and Value-Added services Standard Services

Expanded Services

Social Compliance

Strategic Sourcing Strategy & Planning Support

Quality

Should-Cost Engineering

Pick & Pack Warehouse

PBA

Apex Pro – System Maintenance Fit / Pattern Making

Product Development

Post-Order Merchandising

Supply Chain Optimisation & Logistics

Pre-Order Merchandising

Supply Planning

R&D Technical

Garment Design Sourcing Execution

Colour

Graphic Design

HR/Admin/Finance

In House Freight Forwarding

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We are committed to sourcing ethically and this has significant influence on our supply chain mix Pacific Brands is committed to ensuring we meet our social compliance responsibilities. We have continued our program of auditing our supply chain for adherence to ethical practices spanning labour rights, safety, quality & the environment. We have a strong dedication to social compliance; however we recognise the difficulties in dealing with a large & complex supply chain. We have made a commitment to overtime developing social compliance within our supplier base. We are to date the only Australian business to be a full member of the global organisation the Ethical Trading Initiative Other members include: Burberry, Gap, Marks & Spencer & Tesco

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Contents

1

Introduction to Pacific Brands and Pacific Brands Asia

2

China Sourcing Today

3

The Changing Asian Landscape

3

How Pacific Brands balances the sourcing mix

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China has been considered the world’s factory for much of the past four decades Two-way trade average annual growth (in nominal US dollar terms) of China’s foreign trade

Economic “reform era” Trade doubles

China overtakes Japan as world’s second biggest economy

China is 16th in world trade rankings

1975

Death of Mao New economic Zedong Creation of SEZs policies drive sharp acceleration in trade Reversal of Maoist economic development strategies – “opening up” begins

Labour-intensive light Heavy industry and industries like apparel high technology account for 49% of total takes over industrial output

Foreign trade is now 20% of GDP

2008-2009 Economic Stimulus Plan Growth begins to slow

Tracey AzzopardiForeign trade is now 20% of GDP

8

But macro-economic factors are changing in China, with major implications for companies sourcing there How are wages changing?

Will inconsistency in fabric and quality continue to increase?

Will raw materials continue to be unstable?

Are exports still a major focus?

What will happen to the exchange rate?

Will MOQs continue to rise?

What industries are important to the government?

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Macro-economic changes are largely to the detriment of apparel and textile sourcing Challenges

Published articles in the Asian press (SCMP)

Economy and Currency Government support for apparel industry waning Inflation a concern Strong pressure to appreciate currency Labour rates and shortages Minimum wages in 2012 increased by 20% on average Workers strikes/protests are getting more common Rapidly aging population Balance of power shifting Industry consolidation means currently suppliers choose their customers Preference for retailers and domestic business (Wholesalers less attractive) Rising Raw Material Prices China Cotton fibre price up 78% since ’09 (Recent drop of 37% from Mar’11 bubble) Synthetics at all time highs in early ’11

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The changes fall into three key categories we will focus on in more detail I: Trends in cotton and polyester prices

II: Wage increases

III: Trends in exchange rates

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I: Recent raw materials trends in China have had significant impact on costs Cotton 40,500 38,500 36,500

250

34,500 32,500 30,500 n 28,500 o t/ B 26,500 M 24,500 R 22,500 20,500

200

Cotlook market closed from 23 Jun '10 - 31 Jul '10 150

18,500 16,500

100

14,500 12,500

Cotlook market closed from 10 Jun '11 - 31 Jul '11

10,500 8,500

50 9 -0 n aJ

9 9 -0 -0 b ar Fe M

9 -0 r p A

9 -0 ya M

9 -0 n Ju

9 0 lu J

9 -0 g u A

9 -0 p Se

9 0 t-c O

9 -0 v o N

9 -0 c e D

China: CC 328 Index (RMB/ton)

0 -1 n aJ

0 0 -1 -1 b ar Fe M

0 -1 r p A

0 -1 ya M

0 -1 n Ju

0 1 lu J

0 -1 g u A

0 -1 p Se

0 1 t-c O

0 -1 v o N

Global: Cotlook A FE (RMB/ton)

0 -1 c e D

1 -1 n aJ

1 1 -1 -1 b ar Fe M

1 -1 r p A

1 -1 ya M

1 -1 n Ju

1 1 lu J

1 -1 g u A

1 -1 p Se

1 1 t-c O

1 -1 v o N

1 -1 c e D

2 -1 n aJ

2 2 -1 -1 b ar Fe M

b /lt n ce S U

50% of global cotton supply is from China China cotton fibre prices have increased ~78% in the last 4 years, though they have fallen ~37% from their peak in Mar ’11) China fibre prices are being driven by a government imposed price floor (19,800 RMB/t until 31 Mar 2012, 20,400 RMB/t from 1 Sept 2012). This has been implemented to encourage farmers to continue planting Cotton The Government holds more than a year’s supply of cotton in reserves

Global: Cotlook A FE Index (US cent/lb)

Polyester Polyester is currently trading at 164USc/kg (7/5) Polyester staple fibre market was under pressure and directionless amid lacklustre market fundamentals during the first few months of CY 2013 The market presented a soft outlook and prices remained stable due to moderate demand from the downstream buyers in the Chinese domestic market Fibre2Fashion (30/4)

Tracey Azzopardi Note on future prices calculation: Future Cotlook and CC328 prices are calculated from a baseline price (the index price at the most recent futures contract expiry date), adjusted by the % change in the futures market (compared to the commodity’s price at expiry of the most recently expired futures contract) 12

II: Wage increases have been constant and significant, and are here to stay Labour Province

Type of region

Wage Increase Annual, FY11-FY12

Guangdong

Traditional; niche

20%

Shandong

Frontier region

23%

Fujian

Frontier region

22%

Zhejiang

Established

19%

Jiangsu

Established

19%

Shanghai

Traditional; niche

14%

There are 34 provinces/municipalities in China: 132% have already announced minimum wage hikes since the beginning of 2013 (averaging ~16%) - The average increase has been about 16% 125 provinces (74% ) adjusted their minimum wages in 2012. The average was 20.2% 1Source:

The Chinese Government plans minimum wage increases of at least 13% in 2011-2015: - There are signs that China is moving into a period of flux in which urban employers need to offer wage increases which are higher than CPI/inflation, to attract rural, unskilled labourers to factories - This is because increasingly the younger generation are opting for education and/or urban, white-collar careers, instead of factory work As this happens, the Government moves towards its goal of becoming a more sophisticated market, focussed on higher domestic consumption and less unskilled manual labour But simultaneously, wage pressure will become greater until rural areas match urban areas; during which time employers across the more established manufacturing provinces will struggle in a labour-short market to attract the calibre of worker required, at sustainable salary levels

http://www.china.org.cn/business/2013-04/15/content_28542521.htm

Overheads During FY12, the China CPI increased 5.5% Growth fluctuated during the first quarter of CY 2013, largely due to the food component of the index Non-food component growth was more stable and looks set to continue as such this year China CPI Clothing yoy growth %, National Bureau of Statistics, PRC

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III: The appreciation of the yuan is a further consideration for sourcing in China

Currency / Exchange Rate The yuan continues to appreciate against the dollar with no sign of significant slowdown or decrease ahead With its stimulus plan in mind to increase domestic consumption, the Chinese Government continues to cite year-on-year gains of 3-5%1 Since the start of 2013, the yuan has risen 0.4% against the USD - Record highs have been exceeded several times already this year Since Jan 2011, the RMB has appreciated against the USD by ~ 4.02% to 6.3364 RMB/USD Expected values in 2012 are around 6.1 RMB/USD, a further 3% appreciation from December 2011

1Source:

Forbes.com, May 2013

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The resulting shift to less established, inland regions carries some risks in the short-term Classification of Sourcing Provinces Beijing Hebei Tianjin

Inner Mongolia Shanxi

Shandong Jiangsu Henan

Shaanxi

Shanghai Anhui

Hubei

Zhejiang

Chongqing Jiangxi Guizhou

Hunan

Fujian Taiwan

Guangxi

Guangdong Hong Kong

Traditional Region

Established Region

Emerging Region

Frontier Region

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All of which begs the question…

Is China the place to be going forward?

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Contents

1

Introduction to Pacific Brands and Pacific Brands Asia

2

China Sourcing Today

3

The Changing Asian Landscape

3

How Pacific Brands balances the sourcing mix

Tracey Azzopardi 17

Meanwhile, strong competition is emerging from China’s Asian neighbours Relative Advantages of Sourcing Regions – Product to be sold in Australia and New Zealand China South Asia (Indian Sub-Cont’) India, Pakistan, Sri Lanka, Bangladesh Low cost, and typically lower than China More suited to low complexity products Duty advantages into Australia Often more developed set-ups and infrastructure as they are ‘nextgeneration’ factories

Able to make ‘everything’ Integrated supply-chain and established infrastructure Relatively low cost, but increasing rapidly Strong existing partnerships

Pacific Rim Fiji, etc. Price competitive and able to service for very low MOQs

South-East Asia Indonesia, Cambodia, Vietnam, Thailand Low cost, and typically lower than China Various category specialisations, dependent on the country Duty advantages into Australia Often more developed set-ups and infrastructure in ‘next-generation’ factories , e.g. PTB LEAN

Australia Fast turn-around for fashion styles Flexibility for low-volume styles High Potential Regions

Potential Specialist Regions

Sources: Trade publications, Desktop research, ClothesSource Guide to the World’s Apparel Trade Regulations Note: Relative advantages change for sales into North America, Europe and other regions. This is primarily a result of proximity, lead-time and variations in import duties

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Within the Asian region there are a range of countries able to service aspects of typical apparel requirements Relative minimum wage Index

Country

1 1

Specialist Categories

Aust. Duty (Treaty)

Aust. Lead Time

Footwear

Duty Free (ASEAN)

27-28

Limited capacity

Footwear, Towels

Duty Free (ASEAN)

17-20

Political instability

Socks, Wovens, Suiting

Duty Free (ASEAN)

23

Textiles less developed and labour lower skilled than China

LOW

High volume basics

Duty Free (ASEAN)

20

Limited infrastructure Underdeveloped textile industry

Philippines

HIGH

Sporting Goods Bra

Duty Free (ASEAN)

15

6

Laos

LOW

Hand-woven, Silk textile

Duty Free (LDC)

28+, via Vietnam

Unskilled labour Child labour

7

Bangladesh

LOW

Knitted garments, Woven garments

Duty Free (LDC)

19

Unskilled labour Poor infrastructure Annual flooding

8

China

HIGH

All products

5% (GSP)

16-21, longer inland

Rapid wage inflation Aging workforce Unskilled labour (inland)

9

Sri Lanka

Various of woven and knitted garment

5% (GSP)

26

Political instability Annual flooding

LOW

Cotton knitted garment

10%

27-28

Rising labour costs and strikes

MEDIUM

Cotton based product / Bedspreads / Quilts

10%

22

Political instability

1

Vietnam

MEDIUM

2

Thailand

HIGH

3

Indonesia

MED-TOHIGH

4

Cambodia

5

8 7

1 0

9

6

4 1

5

2 3

10

India

11

Pakistan

1Minimum

Major Risks

MED-TOLOW

wages calculated as a relative index to Dongguan at 100 & categorised

Tracey Azzopardi 1Minimum

wages calculated as a relative index to Dongguan (100)

19 19

Industry insight for Bangladesh, Indonesia, and Cambodia Insight

Bangladesh

Indonesia

Cambodia

Country Profile

Population: Garment Workforce: Avg. Worker Age: Garment % Exports:

158m 3.5-3.6m 25 88%

Population: Garment Workforce: Avg. Worker Age: Garment % Exports:

245m 0.8-0.9m 28 7%

Population: Garment Workforce: Avg. Worker Age: Garment % Exports:

15m 0.4-0.5m 22 60%

Strengths

Duty free export to AU, NZ Labour Surplus Government support

Duty free export to AU, NZ from 2015 Stable Inflation & Currency Skilled & Stable Workforce Well planned factories High level of social compliance

Government support Duty free export status to AU, NZ Competitive pricing for basics Plentiful young labour Close to Chinese infrastructure

Weaknesses

Lower labour skill than China Lower productivity than China Product performance & consistency Political Instability Poor Infrastructure compared to China Large minimum order quantities Longer lead-time than China

Textile industry is less developed than China Alternative countries are available with lower labour rates Lower labour productivity in comparison to China

Labour unions are plentiful Strikes quite common Underdeveloped Textile Industry Underdeveloped supply chain requires manufacturers to import raw material and thereby resulting in longer lead times High electricity costs Shipping time might be longer

Key Categories

Basic Knits, Men’s Shirts, T-Shirts, High Vol Multipack UW, Denim

High quality woven, Sportswear, Denim, Socks, High quality sports Footwear

Denim, Light Knits, T-shirts, polo shirts, basics, footwear

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Deep dive into Bangladesh Bangladesh Population Garment Industry Workforce % Contribution to US import / valued in US$ Strengths

Risks/Weakness

Limitations

158 Million

Median Worker Age

25 Years

3.5 Million-3.6 Million

Garment Industry Contribution to GDP%

18%

5.5% / 4.0 Billion

Minimum Wage

USD 36 Per Month

Duty free export status to Australia, NZ Labor Surplus Strong in Knits Government support for Apparel & Textile Industry Unskilled labor in comparison to China Lower productivity in comparison to China Product Performance Consistency Political Instability Poor Infrastructure in comparison to China Large minimum order quantities Longer lead-time than China producers Basic styles and colours would be required to meet Bangladesh minimum orders Minimum order quantities for each style and colour limit Bangladesh production to only high volume basics

MOQ per style

3,000-5,000pcs Per Color

Opportunities

Basic Knits, Men’s Shirts, T-Shirts, Supermarket Multipack UW, Denim

Categories sourced by other Australian companies in Bangladesh

Denim & Polos Underwear singlets

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Indonesia’s recent free trade agreement with Australia gives Indonesia a ~10% COGS advantage over China

Australia and the Indonesia entered into a free-trade agreement via ASEAN in 2009; this was enacted by Indonesian parliament in January 2012 Prior to the agreement, Indonesian apparel imports were subject to a 10% import duty. This duty no longer applies, effectively reducing the landed cost of Indonesian apparel imports by 10%

Australian Minister for Trade, Mr Simon Crean, with his ASEAN and New Zealand counterparts, signing AANZFTA on 27 February 2009 in Hua Hin (Cha-am) Thailand

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Deep dive into Cambodia Cambodia Population Garment Industry Workforce % of US imported / valued in US$

Strengths

Risks/Weakness

MOQ per style Opportunities

15 Million 400,000-500,000 3% / 2.2 Billion

Median Worker Age Garment Industry Contribution to GDP%

22 Years

Minimum Wage

USD 64 Per Month

15%

Government support for foreign investment through series of incentives Duty free export status to Australia, NZ, Korea, Japan and China under ASEAN free trade agreements Competitive pricing for large volume basics Plentiful young labor Proximity to China Labor unions are plentiful Strikes are quite common Underdeveloped Textile Industry Underdeveloped supply chain means raw materials often imported from China. This offsets potential cost savings with transport & admin costs (but in the long term, local mills will appear and cost benefits will increase) High electricity costs Shipping time might be longer (up to 7 days) Shipping and logistics support services is expected to be poorer than that in China/HK 8,000-12,000 Pcs Denim, Light Knits, T-shirts, polo shirts, basics, footwear

Categories sourced by other Australian companies in Cambodia

Knitwear Tees

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Whilst non-China sourcing may yield price advantages, challenges and risks should be appropriately managed

Long lead times

Long transport lead time due to lack of good highway networks Raw materials often need to be imported Shipping time is generally longer in comparison to China

Balance the shift of work from China to low-cost countries – send achievable work to new regions and suppliers Enter new markets by first partnering with current vendors in China who may already be setting up factories in new regions

MOQ

Minimum order quantities are significantly higher than for China suppliers

Where possible, shift basic, high-volume items

Social Compliance

Child labour, safety and workers rights issues may be more persistent in lower-cost countries than in China

Strictly adhere to vendor assessment and onboarding procedures Focus on top-tier, established vendors in new source countries to minimise SC risk

Workforce skills limited to certain categories

Specific category opportunities by countries Different to China where it is said “anything and everything” can be manufactured

Restrict sourcing of such categories only to those countries with demonstrated skills and abilities in producing bulk orders of the product

Ability to handle product complexity

The level of ability of suppliers to manage complex products can vary in comparison to China

Focus on basic categories Focus on simple products first with less complicated design requirements

Seasonal volume fluctuation

China suppliers can struggle to cope with indent demand cycles even now, reducing volumes there could be problematic for consistency in production and pricing

A difficult area for many companies: balance of suppliers is key Ensure avoidance of monopoly supply risk by category for both basics and indent

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Contents

1

Introduction to Pacific Brands

2

China Sourcing Today

3

The Changing Asian Landscape

3

How Pacific Brands balances the sourcing mix

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Pacific Brands handles the balance with two key areas of strategic focus CHINA CHINA SOURCING SOURCING STRATEGY STRATEGY

26

Pacific Brands has increased non-China sourcing in recent years, and continues to look for opportunities Bangladesh Pakistan Fiji Italy India

Remaining 19 countries

Optimising our sourcing mix requires us to balance Cost,Stability and Flexibility

Ind on es ia

We are continually researching new areas and analysing them to balance our mix CHINA 75%

We have increasing targets to expand our non-China sourcing

Source: PB CY12 FOB Spend

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At the same time we have focussed on moving spend towards China’s interior Share of PBA Spend by Region Type TODAY

Measures for effectiveness of China strategies: % reduction of volume going through high cost regions Cost performance to should-cost models We have realised opportunity to move to lower cost regions both in and outside of China Movement is limited by capability and total cost

-

China is ~70% of the Asia export market and growing at 20% pa China will remain the dominant source of apparel for us and many other companies

The majority of value in China will come from deepening relationships with existing suppliers

Traditional Region

Established Region

Emerging Region

Frontier Region

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As we do so, we actively manage our existing China supply base through continuous improvement

SMART

AWARDS

INITIATIVES

Supplier Management and Relationship Programme: Data collection from internal monthly supplier performance reviews Annual Vendor Scorecard Feedback on scorecard to suppliers Better understanding of our needs and requirements Encouragement to improve their standards Strategy sharing benefits both parties

Supplier Recognition Annual supplier awards in several categories Awarded for service, quality, leadtime, etc

Working together on special projects Some of our top suppliers are working with us to reduce their lead times on some of our icon products

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In conclusion…

China may feel stable and reliable in comparison to new sourcing destinations And yes, the delicate balance between costs, compliance and the right sourcing mix must always be carefully maintained But to stand still in this business is to miss out As we grow our business internationally, so must we continue to explore our sourcing opportunities internationally.

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