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Op-Ed | Who Pays for Sustainability?

To fund a more sustainable future, the fashion system must become more productive, embracing a supply chain strategy rooted in shared risk, not lowest cost, argues John S. Thorbeck.
Shoppers carry Zara and H&M bags in London, UK. Getty Images.
Shoppers carry Zara and H&M bags in London, UK. Getty Images.

Sustainability is front and centre in fashion, but there is no consensus on how it will be funded, measured or rewarded. Where will the money come from to unlock the potential of sustainability at meaningful scale? Where are the funds to accelerate innovation, adoption and value creation?

In 2021, fashion is seeking to recover after a year of crisis and yet the industry finds itself on the defensive on its most promising proposition to reach and excite a new generation of customers.

In industry forums on sustainability, references to real economics are casual at best: charge more to consumers; pay more to factories and workers; call out extreme greed and excess profits; divert a percentage of revenue or profit to key causes; reallocate funds from… somewhere!

Sustainability’s journey from CSR to enterprise strategy is near complete. But as a C-level priority, its future pace depends heavily on its case for capital. The business rationale for sustainability is clear because consumers increasingly demand it, but that does not resolve capital scarcity.

The business case for sustainability is clear but that does not resolve capital scarcity.

Put another way, how can a brand finance sustainability, so it becomes 100 percent of its business versus 5 percent?

Here the industry’s “cost-plus” perspective, whereby it adds a markup to the cost of goods to arrive at a selling price, is up against the reality of a low profit, low growth and low-tech sector where profitability is dominated by a handful of firms, many of them at the luxury end of the spectrum.

The challenge becomes: full market acceptance of sustainability is going to require lower costs.

Like quality in automobiles in the 1980s, sustainability is not an add-on for which the vast majority of consumers will pay extra. At the time, dominant American carmakers became vulnerable to Toyota precisely because it offered superior quality, albeit with lesser style, at a lower cost.

Like autos, fashion is a globalised market which punishes competitors severely if they remain at status quo and fail to advance product and process innovation. Toyota and Zara owner Inditex have common origin stories: both were begun by founders without sufficient capital to survive their early years. Each invented a business process to generate internal capital at far less risk: “just in time” manufacturing for Toyota, and design cycles for Zara. One is known for efficiency, the other is known for speed, and yet the genius of both is how they minimise uncertainty and capital across all tiers in their value chains.

In fashion, the enemy is uncertainty around lead times out of sync with what will actually sell in any given season. This is the reason its 60 to 70 percent margins evaporate to low single digits or worse when all is said and done. That dismal profit gap also effectively makes up the sector’s sustainability gap: margins so thin that investment in sustainability would never be meaningful. What will it take to escape this trap?

In a decade of research with Warren H. Hausman at Stanford, we found the answer in what we called “the Zara Gap” or the gap in market value between Inditex and the rest of the industry. The key factor was risk management, not margin or inventory turn.

Indeed, the number one problem in fashion is the cost of markdowns, lost sales and working capital resulting from failure to manage inventory risk other than by price, volume and financial gaming. And yet today the upstream landscape of materials, capacity and production planning is still largely untouched by advanced technologies that could help change the supplier/buyer relationship.

The fashion system must embrace a supply chain strategy rooted in greater productivity and shared risk, not lowest cost, taking a page from the electronics and automobile sectors. Apple provides an example of short order cycles minimising the volume of finished goods the company must hold, lowering total inventory risk. Toyota requires suppliers to manage component inventory.

Fashion must embrace a supply chain strategy rooted in shared risk, not lowest cost.

So, why isn’t change happening in fashion? My sense from direct experience in 2021 is that it finally is.

The global supplier community is organising after a damaging year of broken contracts and trust. Led by the International Apparel Federation and the OECD, ten nations in Asia that normally compete are working together to advocate common purchasing terms and accountabilities. Their new proposition is built on the value of supply flexibility, a major pivot. As advisor to this initiative, I am encouraging buyer relationships based on shared risk and productivity, including mutual investment in sustainability.

New ventures, free from the cultural retrofit required at large brands, are deploying process innovation to minimise inventory, waste, design and working capital requirements. These ventures include Katla, Saint Art and SXD, which are focused on social branding and sustainability impacts from fabric to factory to fashion. In Europe, PlatformE is activating made-to-order for luxury brands. The company enables 3D virtual design to be sold and manufactured on-demand without ever holding finished goods, commanding premium margins while minimising end-to-end partner risk.

The emerging engine to scale these enterprises is data science, which allows them to solve for risk and time over price and volume. This upstream approach to merchandising is what drives forecast accuracy to more than 90 percent and slashes retail’s highest exposures: markdowns, lost sales and working capital. The economics of shared risk work at every tier, benefitting each partner by eliminating excess production and superseding transactional, adversarial negotiations.

Has the new wave begun? I am heartened by these alternative narratives, but also highly aware of an embedded industry culture for lowest cost and buyer-supplier power imbalance. The truth is, fashion underperforms other industries, a track record evident long before the pandemic. Can we adapt process innovation from our outliers and outside industries?

Today, the fashion ecosystem must align consumer and supplier incentives to compete on sustainability. What will create a more sustainable future? Cost, control and profit, at the supplier’s expense? Or risk that is shared to unlock capital for sustainability over inventory? Which will it be?

John Thorbeck is the chairman of value chain advisory firm Chainge Capital LLC.

The views expressed in Op-Ed pieces are those of the author and do not necessarily reflect the views of The Business of Fashion.

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Inside H&M’s $4 Billion Inventory Challenge

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