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Why factories are accepting huge discounts

  • Published at 06:25 pm April 12th, 2020
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Existing practice in the industry has led to manufacturers not having any bargaining power

We are all aware that the global outbreak of Covid-19 has shaken global apparel supply chains. In the wake of the pandemic, orders placed with different manufacturers in Bangladesh worth more than $3 billion have been cancelled or put on hold by brands/retailers/importers.

After going into silence for more than a month, some brands and retailers are now coming back with a proposal of accepting a great percentage of discount on the agreed price of the orders or asking manufacturers to cancel goods. This is a totally unethical purchasing practice, yet some of the manufacturers are forced to accept such discounts.

Here, I want to offer an insider’s view about how this industry works and by what rules, to help people understand the reasons why manufacturers do not have any alternative other than to accept such discounts. Because of various existing rules and practices in the industry, manufacturers don’t have any bargaining or negotiation power and are ultimately forced to accept whatever clients ask them of them, regardless of how unethical.

The reasons are explained below.

No financial outlay from the client

Clients don’t invest any money on the orders they place. Manufacturers need to finance all raw material and bear all operational costs in advance before delivery of the goods. 

Only then is payment received, and this can be deferred. Clients are free to leave the contract at any time without hesitation and they will not be out of pocket. In the current climate, we are seeing buyers ask for discounts of 50% on goods received 21 days ago. This is the situation we are in.

No irrevocable letter of credit

As a way to save bank charges, almost all brands/retailers have stopped working through irrevocable letters of credit which are usually called “Master LC.” Instead, they have started the practice of using sales contracts or purchase orders. 

An irrevocable letter of credit is a financial instrument used by banks to guarantee a buyer’s obligations to a manufacturer. It is irrevocable because the letter of credit cannot be modified unless all parties agree to the modifications.

That means if the manufacturer fulfils the terms & conditions mentioned in the master LC and delivers the goods on time, the bank of the client is bound to pay the money on time. Unlike the master LC, the sales contract or purchase orders has no such legal binding and there is no way to get the money if the client stops the payment at their will.

Complications in legal steps

All manufacturers have to sign a format of contracts, agreement, codes of conduct, etc with the client which is absolutely made and drafted in favour of the client. Manufacturers must sign and agree with their client’s respective agreement as there is no other way to be listed as a supplier of that particular client without accepting it.

Such contracts/agreements make it difficult to take legal actions against any unethical purchasing practice applied by the clients. Moreover, taking legal steps in a foreign country involves lots of expenses and efforts which manufacturers don’t want to go through.

Afraid of future business

Disagreement with a client’s unethical purchasing practices often results in no further order placements from that client. This is a problem as, in the apparel industry, you cannot on-board a new client instantly. 

Overloaded with suppliers and over production capacity, it may take up to a year before a manufacturer can develop a new client, develop products for them, and get new orders. Hence, if a manufacturer lost a client suddenly, a part of their production capacity would likely be empty for an extended period.

The manufacturer is solely responsible for payment

If a client holds payment or declines to deliver the goods or cancels an order, the manufacturer becomes solely responsible in terms of taking the financial liability. The bank then forces the manufacturer to pay for the raw materials, and all operational costs must be paid by the manufacturers. This includes workers who need to be paid their wages by the manufacturer.

If a client stops any payment, banks usually don’t get involved and don’t make any effort to collect the money for the client’s bank; rather, they make the manufacturer totally responsible for the payment.

Bank liability and complications

The apparel manufacturing business runs in Bangladesh very much depending on the local banking industry and their rules. Banks allow the manufacturers to purchase raw materials for a particular order and pay working capital. All this money needs to be paid back by the manufacturer to the bank within a certain time and this is supposed to be fulfilled by getting payment from the client on time.

This is where the issue of discounting is a problem. If a manufacturer doesn’t accept a discounted price, the client will stop the total payment resulting in breaking the financial cycle of the manufacturer with the local bank. If this is not resolved within a specific time, the manufacturer will be declared a defaulter and the total business operations of the manufacturer may come to an end. 

Cashflow and payment of workers’ wages

Paying workers’ wages on time is a major issue in this industry. The industry has huge problems in terms of worker unrest, and lack of payment or delayed payment of workers understandably leads to industrial strife. This is the last thing any manufacturer would want to bring to their factory.

To avoid this, the cashflow of the operation must be constant -- this is the ultimate vital element of an apparel manufacturing factory in Bangladesh. If the delivery of ready goods/orders/payments is stopped by the client, the manufacturer will fall into a lack of cashflow, making him/her unable to pay the wages of workers. 

Overstock/inventory of ready goods

Any apparel manufacturing business runs through a specific product lifecycle time. Every manufacturer has a calculated and limited storage capacity in the factory for ready goods. If the client is not taking goods on time, there will come a situation that the manufacturer will be unable to produce any new goods as their storage capacity will be full and amount of delayed goods will hamper the factory’s compliance levels and working environment.

The show must go on

Last but not the least, a manufacturer usually employs 5,000-10,000 workers at their factory. As thousands of families depend on the income of the employment, a manufacturer always wants to put his/her last drop of effort to save the factory and continue the employment.

 Hence, they often accept discounts with a thought of incurring loss but continuing the factory operation. Clients are aware and they take advantage of this by enforcing unethical purchasing practices. 

To come out from this unethical purchasing practice and unfair situation, partnership and trust between the clients and the manufacturers is vital. The current and existing business norms need a complete overhaul. Brands and retailers/clients need to engage in financial investment in the supply chain.

A new system whereby buyers pay for raw materials at the time of placing orders would be a major step forward. The trade associations of the manufacturers as well as the buyers can play a vital role there. 

These associations can discuss and formulate a set of guidelines which both the buyers and manufacturers have to comply with. The guidelines will include clauses such as no orders without irrevocable LC.

The global apparel industry is a dynamic sector which contributes to the lives and livelihoods of millions of people across the world. As this is an industry that involves supply chains in different countries, it’s time global trade organizations like the WTO brought this industry under its legal purview and there should be provision of seeking legal redress to the WTO if any party of the supply chain is hindered by another.

Last but not least, there should be unity among manufacturers. The tendency of clients “preying on the weak” is commonplace, mainly due to the lack of unity and cooperation between the manufacturers. 

Mostafiz Uddin is the Managing Director of Denim Expert Limited. He is also the Founder and CEO of Bangladesh Denim Expo and Bangladesh Apparel Exchange (BAE). He can be reached at [email protected] This article previously appeared on Apparel Insider and has been reprinted by special permission.

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