Economic Integration

A fully integrated sourcing strategy throughout the supply chain is essential to controlling  gross margins and reducing input costs, according to a study by an international management consulting firm.  

In a review of the 2011 edition of the Global Sourcing Reference from Kurt Salmon, whose specialties include financial services and retail and consumer products, UK-based World Textile Information Network (subscription required)  reported that among the findings is a 25 percent to 40 percent cut in lead times, by incorporating cross-function planning with what was called a “holistic ‘go-to-market’ calendar.”

“In addition to identifying the current and long-term sourcing trends and developments along the complete supply chain, the guide also contains production and logistics costs of the 45 most important sourcing countries for the EU market, so companies can benchmark the competitiveness of their own sourcing,” said the WTiN report to clients, and for the first time, sourcing regions appropriate for the US market have also been included.

Predictably, China recorded a steady increase in production costs during the past five years and showed no less than a 50 percent jump since 2009 (when the previous guide was published) – “by far the largest percentage increase of those regions working with European customers,” WTiN reported. 

“Given its size and capabilities, China will continue to be the major supply region for the foreseeable future. However, its competitors are getting closer. Vietnam, which has profited from the shift of Chinese suppliers and a stronger domestic demand, as well as Turkey, which faces considerably less capacity constraints, are looking to catch up.”

With respect to other sourcing trends, WTiN said Kurt Salmon has identified that switching activities, such as technical product specifications and quality control, into sourcing countries results in a better and faster local coordination of development and sourcing decisions. Of the 100 plus UK sourcing managers surveyed, 40 percent said they found it easier to shift these activities into their own buying offices, rather than working with external agents, which was reported by 30 percent.

The report also addressed Corporate Social Responsibility, which has become a more important issue, particularly for retailers and brands.

 Questions:  Has your company already begun to incorporate a more ‘holistic’ approach to sourcing throughout the supply chain?

Which supply chain sectors lend themselves to greater efficiencies when included in the whole?  In what areas are such an approach more difficult?  Why? 

Since the explosive futures market in the spring of 2008 forced a number of well-known, old line cotton trading firms to close their doors, traders have been faced with the challenge of perfecting long-standing methods of hedging price risk and developing new ways to insure their long-term financial health.

Futures and options markets, operated by the Intercontinental Exchange (ICE) in New York, continue to offer a means of mitigating the inherent risk of carrying either long or short positions in raw cotton.  However, the relevance of ICE futures has been questioned by market participants on a number of accounts.  Indeed, the exchange itself has acknowledged perceived short-comings.

Futures and options markets, operated by the Intercontinental Exchange (ICE) in New York, continue to offer a  semi-liquid market for mitigating the inherent risk of carrying either long or short positions in raw cotton.  However,  the volatility that has become inherent in ICE futures has made the financial cost of maintaining adequate credit lines for hedging physical cotton burdensome to the extent that many traditional hedgers simply will not use it.  Furthermore, volatility has increased options prices to such an extent that they are no longer a viable tool for any hedger of physical cotton positions, whether they are a buyer or a seller.  As such, the relevance of ICE futures has been questioned by market participants on a number of accounts.  Indeed, the exchange itself has acknowledged perceived short-comings.

Writing in a Special Feature on managing trading risk, published early last year by Liverpool-based Cotlook Ltd., ICE Futures US president and chief executive officer Tom Farley noted a decades-long shift in US global standing among cotton producing and consuming countries.  Although the US has evolved into a dominant exporter of raw cotton, it no longer holds such preeminent positions in production and consumption.

“These developments - both recent and long-term - have had profound effects on both the Exchange, which operations the Cotton No. 2 futures contract, and the cotton trade, which has traditionally relied on the contract to manage day-to-day commercial business,” he said.

In his paper, Mr. Farley questioned the relevance of a US-origin, US-delivery futures contract in the face of a market in which the bulk of the global crop, as well as annual consumption, take place beyond US borders.  Production in the 2011/12 marketing year, for instance, is initially expected to account for just less than 14 percent of world output, compared with almost 16 percent in 2010/11, while consumption is forecast to remain unchanged at about 3 percent.

Moreover, the base quality specified for delivery against the No. 2 futures contract no longer reflects that which is produced and traded in both domestic and global markets.  Strict Low Middling 1-1/16” became the contract’s base quality in 1968, and although some fiber characteristic additions have been made subsequently, there has been no concerted effort to update it.  Cotlook Ltd., in contrast, introduced its first index in 1966 based on a Strict Middling 1-1/16” quality, but adjusted that to Middling 1-3/32” at the beginning of the 1981/82 season to reflect the change in production and marketing patterns in the intervening 15 years.

Another issue raised by Mr. Farley noted the “emergence alternative pricing and risk management tools such as swaps, (Cotlook) A Index-linked pricing and new futures contracts such as the Zhengzhou Exchange contract” in China.  Despite these new means of trading, he insisted, however, that the ICE futures contract continues to play a key role in hedging price risk in the raw cotton market.

“...discussions with market participants have confirmed that a well-designed and liquid futures contract is still central to an orderly and efficient world cotton market, notwithstanding these other risk management tools.  That said, the futures contract should be as connected as possible to these alternatives, and the Exchange itself could play a role in creating and/or clearing some of these products, if that would better link the futures contract with these alternatives.”

The ICE chief executive noted the complexity of the issues facing the Exchange and the need for market participants to provide their guidance.

“We will look to the cotton trade to help determine what should be done to keep the contract and the Exchange relevant to (its) needs,” Mr. Farley said.

Questions:  How serious are the challenges to the value of the No. 2 futures contract?  

What steps could be taken to help the contract protect its relevance?

Can the alternative tools mentioned stand alone as a means of hedging price risk, or should an effort be made to integrate the use of them with the No. 2 futures contract?