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The Cotton Crunch Tears Through the Fabric of Retail

Tuesday, 30 Nov 2010 | 1:39 PM ET

The Grinch may not have stolen the Black Friday momentum, but the coal in the retailer's stocking next year could the high price of cotton. "The fabric of our lives" is going to be more expensive come Spring and the prices you are seeing now will soon be a memory.

While the floods in Pakistan are being blamed as one of the reasons for the run up in the fluffy fiber, its good ole demand from China that's one of the driving forces.

"We are seeing strong demand from China," says Jason Roose, Vice President and commodities analyst a U.S. Commodities, "With the weak dollar they are buying commodities. For the first time in six years, China bought corn. They are getting good value (with cotton and corn). We are temporarily in a bubble."

With less acres of cotton being cultivated and being used instead for soybeans, the cotton crops aren't getting any larger.

So which retailers will be hurt most from this cotton crunch? Dana Telsey, CEO and Chief Research Officer of Telsey Advisory Group, says the impact of rising sourcing costs, including raw materials such as cotton, freight and labor will begin to have an impact most likely in the beginning of the second half of 2011 than the first of the year.

"Companies that have mentioned the upcoming pressures, include Jones, Volcom , and Carters. The magnitude of the increase is still in question and appears to vary; we are hearing everything from 3 percent to 5 percent to as much as 10 percent in terms of what the increases could be; although, there is no exact quantification," Telsey says.

One of best people to talk to when it comes to the overall health of the retail environment are the mall owners and operators. I decided to sit down and speak with Bill Taubman, Chief Operating Officer of Taubman Centers, on the headwinds retailers are facing when it comes to cotton as well as how this holiday shopping season is shaping up.

LL: What are you hearing in terms of the run up in cotton and what it means for the retailers?

Bill Taubman
Getty Images
Bill Taubman

BT: At the moment cotton prices are up 40 percent but it keeps going up and at this point, manufacturers are only quoting day by day. Meaning, you have to lock in that day or the quote is not good for tomorrow because there is such instability in the market. It is now having the impact of rising the price on synthetics because people are now pushing into synthetics as a way of trying to defray the cost increases of cotton.

The weird thing is, the flood in Pakistan clearly had an impact, but no one can connect the dots for you in a transparent way as to what supply was lost and how that was impacting pricing. So therefore, there is suspicion people have that this is a bubble, and it makes them even warier about locking in because they don't know what the pricing is going to be in three or four months because the price just could collapse if it is a manufactured crisis. No question some supply was taken out, but the magnitude in the increase in pricing seems completely out of connection with the amount of cotton that was supposedly lost in Pakistan. On the other hand, it may be increasing demand and that its hit a relatively small decrease in supply and the two rubbing together could cause a little change but we just don't know at it this point.

LL: So what are retailers doing?

BT: They're trying to move factories to cheaper labor. They're trying to address the detailing of the goods to take down some of the costs. Obviously this impacts the lower price goods than the upper price goods—I'm talking about the difference between H&M and Ann Taylor. The value of the fabric as part of the overall price of goods as you go down the price scale to Wal-Mart , excreta, is far higher because there is much less detailing on those goods. So therefore the impact at the low-end is going to be substantially greater than the high end. So people are monitoring this day by day trying to decide what to do. But there is no question the second half of next year there is going to be an increase in price of apparel because of the number of people locking in (on the price of cotton) now. There will be an increase in apparel cost, how much of that is transferred to the customer remains to be seen. And given we've had 20 years of apparel price deflation world-wide because of China and new markets opening up in terms of manufacturing, this is going to be the first delta change in the price curve.

LL: What kind of changes will we see if any from the retailers?

BT: Because it will be uneven in its impact, what its going to do which will be interesting. Its going to modestly narrow the pricing gap between the lower and higher priced goods. The Anthropologies and Ann Taylors are not going to change what they are buying and how they are sewing it. They might take a button off. They might change the engineering of it at the margins but they will not have to change it much. Where as it will be much more dramatic at Wal-Mart and Target .

LL: What kind of impact will this have on inventory if any?

BT: You could shrink inventory, but the retailers have shrunk inventory a lot. So I don't think they are going to want to do that. They are going to want to keep that consistent. Sales have been very good as you know. Sales have been very good particularly because electronics have not been a stand out this year. Meaning electronic sales are probably flat at best because of the deflation in t.v. prices.

The number of units are probably up modestly but the pricing has gone down. So overall, there might even be a decline in electronics at this point in terms of total sales. Not a decline in units, but in total sales. So what you are seeing for the first time really since 2004 or 2005 is you're seeing a more apparel Christmas. Where apparel is doing materially better than electronics. That's a real change which will of course help the mall because outside of Apple we are really apparel focused.

LL: Exactly, look at your outlets. The images of the shoppers in the apparel stores were mind blowing.

BT: Black Friday was absolutely amazing. We were 110 percent capacity in the parking lot at one o'clock in the morning.

LL: Do you think the momentum will continue?

BT: This is always the 64 thousand dollar question. Did we pull sales forward, and therefore December will be quieter, or in fact, is this an indication that Black Friday was a sign of momentum building between pent up, new fashions, household income, or some combination of the above.

My guess is we have not pulled sales forward because when you walk through the mall, of course there were Black Friday Sales, and there were a few stand outs in the mall—Gap was 50 percent off on everything until noon I think. And you had some that were cutting more deeply. But in general, stores were between 20 and 40 (percent off) on select goods and with the occasional thing it was off more and so you did not see an increase in discounting. And for sure, you almost never saw 70 percent off or 50 percent off. You're seeing no increase in my view on promotions. These were all planned promotions. No one has pushed the panic button. Normally you pull sales forward when you have a big increase in promotion because people will go out at that time and buy thinking if they don't, they'll miss out on the promotion. You haven't seen that.

LL: What do you think about the impact of a "Saturday Christmas"?

BT: Some say it is not good because you are losing a weekend of shopping, but I think it is over played. At most it could be a 100 basis points. Because at the end of the day, people have a list of who they are buying for and they are going to buy a certain number of things and if they have to fit it in in a little less time, they will. That might mean they might buy a little less for themselves on a discretionary basis which is why I think there is a modest impact but that's not going to change Christmas right now.

I bet you Black Friday weekend in the mall we were up high single digits. I don't mean my business, I mean the mall business pretty much as a whole. I would say mid to high single digits easily. I think my business, being more upscale is probably better.

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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."

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