The dollar has been on a tear over the past year. Check out how much it has appreciated against the euro over the past year or so (A Shakeup in Currencies, Wall Street Journal, Mar 19).
There are some obvious implications from this chart. For example, if you spent spring break in Europe, you have an impeccable sense of timing. Also, if you are US-based manufacturer counting on exporting to Europe, you are going to be swimming upstream (see, for example, Strong Dollar Stands in Manufacturing Sector’s Way, WSJ, Mar 15).
But if a strong dollar hurts US firms, it’s gotta be a godsend for European businesses, right? Well,maybe not. How a weak euro impacts European firms is going to depend on the structure of their supply chains. Check out this eye candy from today’s Wall Street Journal (Europe’s Fashion Retailers Under Pressure From Strengthening Dollar, Mar 24).
Note that H&M and Inditex (which you may know best as Zara), despite both being fast fashion plays, follow fairly different sourcing strategies. H&M relies much more heavily on Asia to make its goods while Inditex has the bulk of its manufacturing in Europe. The difficulty for the Swedes in this is that those Asian sourcing contracts are all denominated in dollars.
The Swedish fast-fashion retailer is more exposed than rivals to the dollar’s rise, analysts say, because the majority of its sourcing costs are in dollars while about half its sales are in euros. H&M sources about 80% of its products from the Far East, where suppliers for international brands are largely paid in U.S. dollars, according to data from RBC Capital Markets analyst Richard Chamberlain. …
Zara is more insulated than many of its rivals from the weaker euro because it sources about two-thirds of its products in the eurozone but generates about 50% of sales overseas, said Nomura analyst Fraser Ramzan. He estimates Zara could enjoy a sales bump of about 3.5% this fiscal year due to the stronger dollar, but its gross margin will be dinged by higher costs in the U.S., from which it sources about one-third of its products. Inditex declined to comment.
So despite being European, H&M is unlikely to benefit much from the falling euro and indeed could be looking at a world of hurt while Inditex should enjoy fatter margins (at least in the US). This seems to raise two questions. First, how did these competitors end up with such different supply chains? It seems that part of this can be explained by noting that Europe is not as homogenous as Americans might like to think. The European Union may be one market, but local labor opportunities differ. Said another way, it is cheaper to hire people to sew on the Iberian Peninsula than it is in Scandinavia. Over the years, Inditex has relied on a local production base to rush products from concept to store. That has presumably hurt them some on cost when the euro was strong but speed to market made it worthwhile.
Now, H&M could have produced in southern or eastern Europe to have lower cost than producing in Sweden. But if this limits the speed of getting products to market, then why not go all out and chase the cheapest labor in the world? That is, if the firm is not committed to closely integrating design and manufacturing, then it should find the cheapest acceptable production location. (For what it is worth, there have been reports in the past that H&M’s supply chain is significantly less flexible than other firms. See here.)
The second question is whether H&M could have hedged its exposure to swings in the euro-dollar exchange rate. That was what one of my colleagues immediately asked when I showed him the chart above. It turns out they do, they just don’t do it for very long.
H&M could also feel the impact faster than peers as it has buying and hedging arrangements that are typically shorter than the rest of the industry. Last summer the company locked in a purchasing price for products it sold in the first quarter, Mr. Vinge said. The company’s purchasing costs, which started rising in the second quarter, will increase through the year.
Note that this is consistent with chasing the lowest production costs. If they are content to be in China today but Thailand tomorrow, the exposure they face may evolve more quickly than other firms.