XVII UITIC Conference, Leon, October 2010
Just a month ago I was fortunate enough to be able to visit EXPO in Shanghai. One large area was dedicated to the future of the city, and a figure was presented that this year some 3.4 billion people, half the total world population lives in cities.
It struck me that today’s urban population of around 3.4 billion was just about exactly the total population of the world when I first came to Leon in the early 1970s, when I was living in El Salvador and working for Don Roberto Palomo at Empresas ADOC.
Some issues like the importance of working out how to get the best out of the large close United States market still remain, but it is remarkable to consider the changes since then. Athletic footwear, the trainer that makes up the huge white footwear market did not really exist. And Korea was just beginning to move agricultural workers off the land to show the world how from nothing it could create an export oriented economy based largely on footwear; a process that was to be emulated throughout Asia in the coming decades.
All of us who work with leather and leather footwear now know that we cannot look at one part of what happens from the farmyard to the shopping mall in isolation. One has to take into account not just what we call the supply chain but the other important organisations that provide chemicals, machinery, and advice. This is really a network and we make better decisions if we consider it is such.
In looking just at the leather part – although the situation is similar for many footwear makers – the main characteristic is that tanning is a predominantly family business that fits into the category of SMEs. Place these between the big retailers like Wal-Mart and Marks and Spencer along with Brands like Nike, Clarks and LVMH on the one hand and the big raw suppliers like Tyson and JBS on the other you can see that tanners are weakened by what we call asymmetric relationships-having to deal with much larger and more powerful customers and supplier. This is a serious issue and you need to consider that Procter and Gamble’s purchase of Gillette had as major part of its strategy a size and brand ownership position that would give Procter and Gamble a more equal strength when dealing with Wal-Mart.
Being squeezed in this way creates low margins. Add in over capacity in the industry as tanneries are built in the new parts of the world without equivalent shedding of capacity in the traditional countries and then consider the huge and increasing environmental issues one wonders who would want to be a tanner at all.
The trends of the last few decades have been quite strong. Footwear used to take up nearly 70% of all leather produced in the world but it dropped to nearer 50% in the middle of the last decade which has just ended. On the other hand automobile upholstery was only about 1% as we moved into the 90s and was nearly 10% by the mid decade with general upholstery for households and aeroplanes also growing.
Go back 30 years and leather was still a necessity in many articles. But new textiles, membranes and insulation materials along with better synthetics mean that there is an alternate for every end use. In the seventies and eighties we used to think that demand for leather would grow beyond supply and the result would be higher leather prices and better margins for tanners. Not any more.
And most significantly in the first quarter of 2008 we began to see some definitive figures showing that less than 50% of the shoes in the world were now being made of leather. It could be argued that this moment had been reached much earlier if you include slip on footwear such as Chappals or thongs which really distort the figures. But by 2008 it was definitive that leather was a minority material.
While some shoe types do clearly still require leather but overall in footwear if leather’s price starts to move upwards to any significant degree the footwear industry would just use less. And this is the trend we have seen in sports gloves like golf where the full leather glove is now a rarity and a combination of leather and synthetic or even full synthetic is much more common on the fairway than just fifteen years ago.
Macro Issues
In looking at the status of the leather industry the tool we employ is what is a called a macro-environmental analysis which is just a term for the examination of the big issues under the headings of Political, Economic, Social, Technical, Environmental and Legal and interrogating how these are likely to impact on our business and that of our suppliers and customers.
All of these issues affect us but the big social issue which is most important to leather is demographics and I would like to focus on this for a moment. I have already said that when I first came to Mexico the world population was 3.5 billion and when quite a few of us here today were born the world was only about 2.5 billion people. At that time established long term trends were quite steady. As the population grew the need for meat and dairy products grew so the cattle population which supplies 65% of our leather also grew and the ratio of leather per capita in the world stayed amazingly constant. But when the population began to pass 6 billion and then get up to 7 billion things began to change. The human population continues to grow, but the land area of the planet of the planet stays the same.
Three areas are important:
- Land use
- Water use
- Non renewable resources
Considering land use we first identified that China wanted to reserve land for the cultivation of crops for human consumption and that it was worried about illegal urbanisation and the relentless building of golf courses. Land in many countries was being rented out to South Korean, Indian, Saudi Arabian, and European countries to cultivate crops for food security and for profit all taking grazing land out of commission. There are negatives and positives here as some think this will lead to better husbandry and a higher kill with better quality especially in Africa. New Zealand has just reacted by stopping a Chinese purchase of some 20 dairy farms. And then we had seen many reports that deforestation in the Amazon was becoming closely linked to the rapidly growing Brazilian cattle herds. Of course our report was written in 2007 before the publication of the Greenpeace document entitled The Slaughter of the Amazon but it was clear even then that cattle population will at some stage in the next decade have to adjust to the realities of a small planet with a lot of people on it. Cattle in terms of protein production are inefficient users of land, and if grain fed they are inefficient users of resources in terms of oil and energy. I do not think we can say that this is just a PR issue for leather. The Amazon Biome currently supplies 8m hides. My own view is that the leather industry will have to try and build its long term future on pasture fed cattle throughout the world and live with the size of industry that leaves us, whatever it is, but there is a lot science to be examined here before we can come to final conclusions.
The second issue related to land is landfill. In many parts of the world we have run out of holes in the ground to put our waste and where we still have space we have problems of seepage into the ground water and of methane production. It is clear that the pressure on landfill will get even more severe for the tanning industry and that at the same time the issue is quite enormous for footwear and leather products. We will need to start looking at products from the moment of design with regard to length of life and final disposal which implies much closer cooperation between the tanner and the users of leather.
For most of the latter part of the 20th century the environmental business of tanners was about compliance. CATNAP we call it – currently available technology narrowly avoiding prosecution. While most tanners are very responsible sadly there are a minority who had effluent treatment plants but found them too costly to run and others who built wet blue operations with no secondary and very limited primary treatment. So what we have seen in the last ten years is community action from China to Pakistan even Ethiopia where ordinary people have found the means to let it be known that they need and expect clean water. And governments who mostly have good solid legislation in place – it is the enforcement which varies – have started to react. This extends now beyond toxins and chrome six problems into soluble salts getting into the ground water and aquifers making them unsuitable for drinking. Common salt used in preservation and pickling has become the industry’s biggest problem.
And the last of these demographic points that we need to consider is non renewable resources. Mostly we think about the subject of peak oil but be aware that chromium left at its current consumption has a lifespan in decades from known reserves and that while we choose vegetable tannins today mostly from renewable resources if we return to vegetable as we had it in the 19th century tanners did massive damage to forests and mangrove swamps around the world not least here in Middle America, and Dr German at Reutlingen made it clear earlier this year that there just are not enough trees in the world to make that significantly more vegetable tanned leather.
When you look at these issues and wonder on timing and how soon they will need to be addressed I ask you to think of the quote form Toffler that “the future arrives faster than you expect and in the wrong order”. Our customers and many consumers are aware of these matters and quite well educated about them. Our trade organisations are in no way structured to meet them with good science. And the continued defence that we are bi-product users and refuse collectors does not pass muster in a world of instant communications and skilled well financed pressure groups. Taking hides and filling them with chrome to be left in landfill in the form of chrome shavings and trimmings along with putting large quantities of salty waters into our aquifers does not constitute good citizenship. There are of course solutions to these issues but the leather industry will have to adopt them in a more serious way.
The Last Decade – a game with two halves
Looking more closely at the last decade it split into two parts. In the first the industry grew steadily on the basis of the trends of the 90s. Great success for automobile, strong demand for well made luxury items with the USA and the EU still leading demand while China and other developing countries lead increasing demand for meat and dairy products. Although a lot of poultry and pig meat began to feed into this growing demand.
Production continued to move to Asia and with it came a levelling or reduction in prices in the stores of consumers in the US and the EU which kept them buying. What did surprise everyone was the acceleration in the move of manufacturing to China. China added major penetration into the world casual leather shoe market to its previous domination of the sports shoe market. And its domestic market – demonstrated by its inland smaller towns like Chengdu and Xian – also began to take off. And in some of the bigger organisations – and China’s dominance of shoe factories with 10000 workers plus is immense – they linked to tanneries to get big reductions in delivery times and other efficiencies. This coincided with a period when the Brazilian currency became very expensive and many major corporations who had sourced, for example, sports shoes from China and ladies leather footwear from Brazil decided to simplify matters and source everything from China. We reached a point about mid decade when we thought China might take it all.
We have always known that making a jacket of leather or a pair of shoes is much more labour intensive than tanning so were not surprised at the continued move to Asia of the leather using sector with tanning sticking more closely to the origins of the hides and skins. An exception was Italy’s tanning industry doing exceptionally well to stay in the top three in volume output in the world albeit it involved the processing of large amounts of semi processed material. China took nearly two thirds of the world’s footwear manufacture but even with its huge production of pigskin only about 30% of world leather manufacture. We saw two phenomena with leather manufacture location which are still playing out now. One is that leather will be made where the hides are and the other is that it will be made where the end users are. If the raw suppliers are well set up in terms of waste management as many are the logic of location balanced their way, but it does mean end users can lose flexibility and speed. Now we move leather about in pickle, wet blue and crust so there are many options in this dynamic. With US and Brazilian hide producers investing in tanning – and it is not yet clear whether this is a defensive move or a deliberate strategy – we are currently seeing the biggest change since the foundation of the United States Leather Company out of some 200 US plants in 1893 and the subsequent move into tanning by the packing industry in retaliation. This dynamic of location is evolving here in the Americas.
As this scenario developed in mid decade China made some major decisions.
- It was not going to accept tannery pollution as an inevitable consequence of industrial development.
- It wanted to move away from low added value items such as footwear and leather garments to higher value products such as computers, cars and planes
These decisions gave rise to some quite determined legal moves and changes in industry support. China’s industry is very strong. It has well developed networks, high levels of labour efficiency, strong customer orientation, good infrastructure and logistics and benefits from scale that beat the world hands down. So I am not saying that China can or will be replaced. But I do say that the speed of growth in the leather sector will slow and that the focus will be much more on the internal market. Any one of you who has visited some of the smaller tier two and tier three cities will have seen the fabulous new shopping malls going up with outstanding shoe stores and departmental stores with entire floors dedicated to footwear. To reach 80% of the Chinese middle class in 2005 you needed stores in 60 Chinese cities.
What this has certainly done has been to change the approaches elsewhere in the world where countries had come to accept the crumbs that might come from China plus one buying policy where a second country was kept on line for emergencies. We have already seen strong growth in places like Indonesia – where clients who had left returned – Bangladesh, India, Vietnam and even in Ethiopia, which is the new blueprint for sub Saharan Africa. Each country with a leather industry began to re-examine its strategy in the light of what we can call a new optimism. Significant changes continue to develop.
8/14. What a difference a day makes
During 2008 we began to sense a slow down. It came first in housing when in some countries such as the US and UK it became clear that money had been lent for purchasing over valued houses without scrutiny as to whether the buyer could afford the repayments. The upholstery sector began to slow as housing sales plummeted. But the big moment was the 14th September which was the day Lehman went bankrupt. In general until that moment tanners had thought they might escape with a relatively shallow recession but by January every sector was hurting and the automobile sector had come to a total stop, not helped by the supply chain managers they used who had not bothered to understand the fundamentals of industrial life. In other sectors orders were cancelled, reduced or renegotiated. Minus 30% became the new normal for the industry and for the first time that many of us can ever remember in some parts of the world hides were actually thrown away.
Looking forward from 2010
So what does this tell us about the future? Only so much as in most instances the outcomes are still working themselves out. But we have some very distinct clues.
- The automobile manufacturing industry has not changed as much as we expected as governments have chosen to hang on to production. The focus of growth has moved to China and India where prestige cars have been selling very well. Indeed premium autos have seen quite a resurgence this year. Yet overall it looks like smaller cars are going to be much more important. How far down the range can leather be offered as standard becomes the question. Leather is in about 20% of automobiles currently and it is a guess where this will end up. The BMW Mini is now 50% leather and in China the VW range has leather standard right down to the Jetta.
- Throughout 2010 prices for tanners and leather products have been tough as raw material has risen while raising prices at retail is not option for many. The consumer has changed habits in many countries. Russians bought less milk, Brazilians travelled less and in the USA we are seeing a new frugality which plays into what some are calling a new abnormal in terms of how people use their disposable income. The middle ground has become a tougher area as consumers shop for value, but they are interested also in buying the authentic the core products they want. This might be the correct running show, or a premium handbag, but it also shows in certain segments where the $3 latte is still a required purchase and queues form to buy $500 iPads. Have the right product and the consumer will buy. The underlying issue is that in many countries you have two groups of consumers who we have lost. Those families who lost 20 to 30% of their household wealth as they got hit by the perfect storm of property price collapse, equity downturn and damage to their pension funds. And the second group is the unemployed – 10% in the USA and 20% or more in places like Spain.
- But is has been astonishing how well premium quality leather goods have done this year. For the consumer these are a mix of a small indulgence and a long term investment as a good quality handbag can last for ten or twenty years. In China luxury consumption is more complex and almost a requirement if your disposable income rises if you are to hold the respect of your neighbours and family.
- While footwear has been hit this has been less dramatic than was expected and footwear overall is best described as flat, but of course there have been regional impacts such as the reduction in remittances from the USA which has slowed domestic retail. Suggestions coming recently from China indicate that by 2015 Chinese consumers will double their per capita consumption of footwear from 1.5 pairs per annum to 3 pairs per annum. That is a growth of 2 billion pairs per a year. Even for China with its billions of pairs of production that is formidable task. No other country in the world gets much past a billion. So they question for you is where will these 2 billion pairs come from and what are the implications for China’s continued dominance of over the rest of the world?
- Since the recession it is clear that countries with emerging leather industries will start to look at new destinations. Globalisation has stopped being Americanisation. The BRIC countries to which we have to add Indonesia without doubt and possibly the Gulf region including the Maghreb start to become the new focus for growing consumption. Taking the restructuring of the leather industry we have already mentioned we see a new trend developing which we call Time Zone Manufacturing which roughly splits the world into three zones. So we expect to see more production in Africa and Eastern Europe for sales in the EU, in middle and South America for the whole of the America and in Asia expanding Chinese production increasingly being for the domestic market, and in India for the Indian domestic market. This implies that we will see some new sourcing plans, supply chains and Foreign Direct Investment.
- Allied to this TZM Time Zone Manufacturing we see innovation starting to change. You may remember Clayton Christianson’s book the Innovator’s Dilemma and his talk of disruptive innovation. Often this moves against our standard trend of adding more features and benefits to products to actually making them simpler, allowing them to do one or two things well rather than over-engineering them. This is sometimes called reverse innovation, but I prefer to match the times with the other term being used – frugal innovation. Most of this new thinking is coming from the developing parts of the world but we are seeing the introduction of some old footwear machinery into the US where they will be reconfigured with new thinking.
- Consolidation in the industry will continue. In general we will see fewer larger units in the tanning industry and more tanneries with a mixed shareholding rather than pure family ownership. Product complexities, investment risks related to new plant and machinery, environmental costs and the need to deal strongly with strong customers and suppliers militate against the smaller business. We will see more vertical integration and more experimentation with business structures. The boutique tannery will become better defined.
- Environmental issues in their largest sense will play a very big role in the future concerns, costs and developments of tanneries. Pressures have moved from getting round legislation to meeting the demands of consumers reflected via retailers, brands and governments. Some points are becoming clear
- The concept of tanneries only utilising 50% of inputs cannot survive even in the medium term. Via reduction, reuse and recycle this needs to be changed. The industry needs to start measuring these things and be transparent about the changes.
- Associated with this we expect much more activity in the bio-base concept of making leather. The idea of replacing difficult inorganic chemicals with enzymes and smarter materials looks to have a lot of long term potential to help with our waste
- This sort of research appears to be moving from the chemical companies to the research institutes and the tanneries as the chemical companies are investing heavily in compliance such as REACH at a time of reduced margins compared to the 1990s. New relationships and funding routes are likely to be established to facilitate this.
- A re-examine of old methods and research into new methods of dealing with tannery solid waste is required in order to for example extract chromium from shavings and trimmings and to fuel etc from fleshings. New economics are increasingly coming to work on the cost of waste and the financial benefits of re-use or clever use of waste. Research has proven the value of “lost”. There are a number of technologies that we know of or have seen in places like Argentina which can be replicated and developed commercially.
- Tanneries and end users such as bag and footwear makers will start to work more closely together to consider design implications and end of life of a product. It is increasingly recognised that 90% of the matters related to the end of life are decided during the design stage. Designers will demand to be better briefed about all aspects of the materials they will be using
- The message here is one of “quality leather”. Our recent research at Northampton indicates that consumers still have an inborn understanding of the qualities of leather in terms of touch, feel and sometimes smell which constitute value for money and quality. Attempts that have been made to sell lower grade products have confused the consumer and damaged the brand image of leather. Furniture has been one area which has created a lot of this problem. The market penetration of leather – which is a complicated figure we will now have to start measuring – will depend on all tanners keeping quality up as far as possible and building quality characteristics into even lower grade raw material.
- And finally it does appear that the reputation of our science of leather is being damaged by claims that any leather that has not been chrome tanned is “green”: touched only by natural materials and the like. Our top scientists all tell us that at the moment in terms of the whole life cycle chromium remains probably the best tannage for the environment. It is for short term market gain that very many “greenwash” claims are being made and long term they will confuse and damage the industry. They need to be challenged.
At the moment a new concept for promoting leather under the current banner LeatherNaturally! is starting to get discussed in the industry with the intention of promoting and explaining quality leather and making these challenges against false or confusing claims.