When Quotas End, Who Gets The Goodies?

Wholesale apparel prices will plunge, but retailers may not pass on a lot of savings

Falling apparel prices have been a big boon for consumers over the past five years. So on Jan. 1, when decades-old quotas on apparel imports from low-cost manufacturing countries expire, allowing a flood of ever cheaper jeans, T-shirts, and sweaters from China, India, Pakistan, and other countries into the U.S., shoppers can expect to ring up monster savings at the cash register, right?

Well, don't be rushing out to the mall just yet. As retailers prepare for the end of the quotas, they are hotly debating just exactly what the impact will be. And while no one doubts that stores will pay sharply lower prices for imported clothing, it's far from clear that big savings will trickle down to consumers. Instead, most expect retailers to try to hang on to most of the savings to maintain profits and improve margins. "In the absence of quotas, retail prices should come down, but I'm not sure that's going to happen," says Marshal Cohen, chief industry analyst at market researcher NPD Group Inc.

Once quotas are lifted, U.S. retailers and others who bring in garments from abroad are expected to consolidate more of their apparel manufacturing to low-cost, efficient producers. The big winners are likely to be China, India, and Pakistan. Until now, the quota system had made such consolidation impossible because companies could only buy a limited amount from each country. J.C. Penney Inc. (JCP ), for example, currently imports clothes from about 51 countries. But within two to three years, it will concentrate production in just 23 countries, says Peter McGrath, chairman of Penney's purchasing division. Likewise for Liz Claiborne Inc. (LIZ ) Ultimately, it will trim its sourcing in half, to about 20 countries, says Bob Zane, vice-president of manufacturing, sourcing distribution, and logistics.

The upshot: Retailers will get a huge cost break. McGrath, who is also chairman of the National Retail Federation's International Trade Advisory Committee, figures wholesale prices to retailers and other importers will drop by 8% to 18% between 2005 and 2006.

Many are counting on hanging onto as much of those savings as possible. Sluggish sales and aggressive discounting in recent years have eaten into their bottom lines, leaving them little incentive to pass along lower prices. And though quotas are disappearing, rising prices for cotton and oil are pinching retailers. Also, while lower wholesale prices will help retailers bring down costs, the expected flood of cheaper imports will almost certainly spark further deflation in the apparel sector as some try to gain share by passing on the savings. Frank Badillo, chief economist at consultant Retail Forward Inc., says retail apparel prices have fallen at a 2.1% annual rate over the past five years. After quotas are gone, he expects retail prices to drop about 4% a year for the next five years.

`SOMEONE COULD BLINK'

To hold the line, many retailers are planning to maintain current prices while using the cost savings to boost the quality of their apparel. "What you'll probably see is higher-quality product, but at the same price point," Joseph J. "Jay" Fitzsimmons, senior vice-president of finance and treasurer at Wal-Mart Stores Inc. (WMT ), said at a recent retail conference. J.C. Penney execs agree.

But the brutally competitive market won't make it easy for retailers to pocket most of their windfall. If one major player starts to lower prices, all bets are off. "Sooner or later, someone could blink and cut prices. If that happens, everyone else will have to follow," says analyst Daniel D. Barry of Merrill Lynch & Co. (MER ). Concedes Liz Claiborne's Zane: "What we or our retailer does depends upon competition to a large degree."

In the end, apparel analyst Marie Driscoll of Standard & Poor's (MHP ) figures one-third of quota savings will be passed to consumers while retailers and manufacturers will keep another third as profit, with the remaining third reinvested in improving products. Let the countdown to a quota-free environment begin.

By Stephanie Anderson Forest in Dallas, with Nanette Byrnes in New York and bureau reports

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