Thinking Outside the Costs
April 8 2011 by Lisa W. Hershman
Commodities are on the rise. From corn for chips to cotton for socks, companies are warning that higher costs for materials will lower earnings growth this year. On one hand, this is good news; rising costs can be a sign that the economy is improving. Yet they pose a dilemma that requires companies to respond. Many see two basic options: pass the increases on to customers and risk discouraging already fragile consumer confidence, or tell shareholders profits will be lower this year.
There is a third option. In facing rising costs for the materials they need to manufacture their products, companies have opportunity to adapt. Breaking the “follow the leader” mentality will take a lot of hard and dedicated work, but companies that overcome their fear of change and rethink their approach are already finding great success.
Cost control at the manufacturing level has historically been a primary focus. Cheap materials coupled with low labor costs in Asia have been central to that effort. Being overly focused on one piece of the process leads to sub-optimization. However, rising commodities prices are requiring companies to start focusing on an end goal rather than just manufacturing. The apparel industry is a prime example of the problem and its solution.
Many apparel manufacturers moved production to Asia in the name of lowering costs. They manufacture large quantities of items to avoid costs of machine changeovers, labor utilization and economies of scale. But who says all textiles and labor need to come from Asia?
An innovative approach is focusing on customer and business results, not traditional factors. Zara, one of the world’s largest international fashion companies, does most of its production in Europe, where it is based. It manufactures clothes in relatively small production quantities, especially early in the season. Zara’s manufacturing costs are much higher than its rivals’, but that’s not their primary focus.
While manufacturing costs have a direct impact on profit, so do many other factors, such as material costs and leftover garments at the end of the season. Zara keeps shipping costs down by manufacturing its products in Europe. In addition to other factors, its small quantities allow flexibility during the season to respond to buying trends, and ensure there are few if any leftovers at the end the season to sell at a loss.
As a result, Zara has positioned itself as a major player in the fashion industry and been recognized by competitors as “possibly the most innovative and devastating retailer in the world,” as Louis Vuitton Fashion Director Daniel Piette said.
Redesigning a process may actually involve higher costs in some areas, even the all-important manufacturing costs, in exchange for gains somewhere else. In Zara’s case the company produces much less clothing that has to be heavily discounted or trashed and thus is more profitable than its competitors. While everyone else has relied on cheap manufacturing in Asia and now must decide how to deal with rising material costs, Zara has already redefined its process and realigned its goals.
Zara has accomplished what many companies that manufacture in Asia haven’t: being nimble. This wasn’t an accident. They designed their business model this way and are growing despite ongoing market challenges. If costs are rising, perhaps it’s time to refocus goals and examine new ways to achieve them. It may be as simple as refusing to play “follow the leader” and, as the clichÃ© goes, think outside the box.
The current economic climate presents a number of challenges, but it also provides an opportunity for companies to throw out the old ways of doing business and pursue innovative, meaningful changes to the way work gets done. We are facing an unprecedented confluence of macroeconomic and business factors that are creating a new and unfamiliar business environment. Adapting to this new climate requires deep and fundamental change to how companies do their work.