Death By A Thousand Paper Cuts

One of our key Macro TAIL (3 years or less) themes for Retail is the disintermediation of the West as it relates to its importance to global retail and sourcing. China unexpectedly handed us further validation for this game-changing theme.

‘Game changing’ theme? Don’t you think you’re being a little dramatic, McGough?   Hardly. Consider the facts. Here’s what we already knew…

  1. The consumer durable/non-durable brands and retailers in the US have come off of a 30-year cycle of scaling manufacturing out of the US, and into Asia, and to a lesser extent, Latin America. That’s hardly news to anyone. But an important consideration is that this offshoring/outsourcing was largely done with the US Dollar as the payment standard to foreign factories. With the US$ as the world’s reserve currency, this was the safest bet for all. But factories are beginning to accept payment in currencies that are not US$. That’s bad, really bad for companies that are not sophisticated enough to proactively manage this margin volatility – especially with the time lag between when an order is placed, and when the product ultimately arrives on a shelf for sale.
  2. Then, on January 1, we saw the implementation of AFTA, Asia’s equivalent of NAFTA where 4% import duties were eliminated between 16 nations to spur local consumption as a more profitable alternative than export to Western markets.
  3. Then yesterday, China pulled a surprise move and granted its first full factoring license to a London-based company called China Export Finance. Wy is this notable? Because it eliminates a step in the factoring process. Ordinarily, a Chinese factor working with a seller would have to collaborate with its counterpart in the West working for the buyer. Through China Export, the necessity for a Western Counterpart is mitigated. This would free up the Chinese vendor to sell its receivables to the trade finance firm, which would then make an advance payment to the vendor against the approval of a Western buyer. The buyer would then make payment directly to China Export when due.  Is this lone instance cause for alarm? No. But imagine if there were a thousand such licenses. Why can’t there be?

Our point here has not changed. In fact it is growing stronger as all this new evidence comes to the forefront. There are many different dynamics impacting the global supply chain. Any of these viewed in isolation is probably benign enough to slip right past the goalie without anyone noticing. But add ‘em all up and it definitely smells to me that generational shift we’ve seen in the manufacturing power base is at the end of its rope. The balance of power is swinging away from the West.

This is one of those themes that is probably irrelevant to near-term results. In fact, management teams won’t be talking about it, because I’d argue that over 90% of them don’t even know about it. This is something that will unfold over 1-2 years, and it will be clear who ‘gets it’ and who does not.

The longer-term winners are those that either have size, clout, pricing power AND a Macro process. NKE, UA, WMT, BBBY, RL, HBI an Li&Fung.

Losers will be those with no Macro process that are cruising by now on unsustainable margins due to lack of investment in content. JNY, DG, FDO, M, JCP, WRC, TRLG, and GIL.

Brian McGough