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Failure of proper costing dragging RMG industry down

The economy of Bangladesh solely depends on the garments sectors. During 2018-19 the garments export of our country is amount $34.13 billion sharing 84% out of total country export $40.53 billion. Bangladesh started doing the readymade garments (RMG) business almost 40 years ago. Gradually the growth of garments export of our country has increased remarkably.

Failure-proper-costing in-BD-RMG

Bangladesh is called the second-largest apparel supplier as a single country in the global apparel market. But it seems that Bangladesh would lose its position ‘the second-largest apparel supplier’ to Vietnam soon. However, Bangladesh started its journey in the apparel sector prior to Vietnam and the industry expects continuous growth in the global market. But calendar year 2019, the Bangladesh apparel sector achieved only a 0.44% export growth whereas Vietnam achieved 7.30% growth.

In addition, recently our readymade garments sector has been facing several challenges for the last few years. Production cost goes up, but the price of products declines. In Bangladesh, the minimum workers’ wages have already been increased by 51% in December 2018 as the living standard and economy of Bangladesh are growing steadily.

challenges-BD-RMG

Similarly, the utility rate has been increased by approximately 41%. These are finally increasing production cost, which seems unbearable for many small and medium type factories as the product price is not increasing aligned with increasing production cost.

A current report showed that around 39% of Bangladeshi RMG exporters accept prices less than their production costs for the sake of business. Some 33% think they will face the risk of shutdown and 29% will face difficulties in wage payment to workers.

Why does RMG exporter accept prices less than their production costs?

Product pricing seems to be a major challenge. Without a fair price, exporters cannot cover the operational cost having a minimum profit margin. Bangladesh started doing the RMG business almost 40 years ago. At growing stage of the garments industry in our country, apparel’s price was industry favorable having a satisfactory profit margin.

But day to day cost structure of our economy has been increased, price is becoming more competitive, the profit margin is being decreased drastically depriving the RMG sector earning optimum cash inflow. Due to a fair price and profit margin in early-stage, management and marketing people were not aware of costing but recent situations make them bound to think about cost structure and product costing.

Usually, business people of our garments and textile industry only focus on the top line (known as total export of RMG product) of the RMG sector rather than bottom line (total profit margin made by RMG product). The bottom line starts to decline due to low product prices and increasing product costs. For the last few years business people are concentrating on costing of products to achieve the target profit margin through proper pricing.

Problems occurred when buyers recently introduced open costing approach for price fixation. Another target of buyers behind the open costing is to achieve purchase gain and find out the cheapest product from Bangladeshi RMG manufacturers. The purchase gain strategy is not an ethical approach for sustainable supply chain and profit earning drivers as well.

Costing-RMG-analysis

In the open costing approach, buyers find a significant costing gap between ‘A’ category and ‘B’ category factories in our country. There may have several reasons i.e.

1) Individual cost structure

2) Costing procedure

3) Utilization of plant capacity

4) Lack of knowledge to understand the open costing format

5) proper timeline not given by buyer

6) lack of readiness to meet the requirement of buyers

‘A’ category manufacturer bargains for fair price whereas ‘B’ category manufacturer bargains for lower price targeting their unused capacity utilization. So, they dump the garments price below cost in order to catch the order hoping that price may rise up in the future. Finally, the product is becoming a loss product and its life cycle is shortened earlier in Bangladesh market.

In a competitive market strategy when the price falls, it will never rise up. Salary and utility costs have been increased significantly. In some cases, concern persons involved in pricing do not know how much increase wages and utility amounts will be added to the price and negotiated with buyers for reasonable additional making charge (CM).

Bangladesh is a very promising country in textiles and garments sectors. The awareness of cost control and target-oriented initiatives taken by individual factory management, industry expert people, garments and textiles associations, the government will be the turning point to overcome the challenges.

Industry management fails to bargain with buyers due to a lack of knowledge and calculation procedure on spot.

The manufacturers are facing problems to get the orders as per their expectations promised by buyers. Without optimal capacity utilization, the cost per unit will not be a market competitive. The alignment of target order and capacity is a vital considerable factor for fair costing and pricing.

Cost structure

Every company has its own cost structure having cost element like material cost, salary and wages, utility cost, depreciation of assets, spare part and repair maintenance, other manufacturing overhead, administrative and selling expenses, finance cost, etc. incurred in different cost centers which are responsible for making the cost-effective for the company.

This is high time for the owners of all cost centers to identify the cost drivers which are factors to make the cost downward or upward.

Without proper costing we cannot bring money in our pocket from others. The basis of the pricing of a product is costing. So, if reasonable costs are not included in product costing due to lack of knowledge or improper way of costing methods, the company will face loss with this same amount not recovered by customers.

The economic definition of cost is “Resource utilization value which will bring benefits of the company through revenue generation. So where “cost” is incurred, the benefit is expected. It is highly recommended today to make a cost-benefit analysis in every steps of activity. But the main problem is there that cost can be calculated easily but benefit calculation is difficult because it comes over the periods.

Considering the industrial activity, the three major objectives of costing are focused in RMG:

Costing for price fixation

Costing of a product should be done by standard costing procedure. There must be SOP for costing. By following the SOP, costing fault can be reduced in a maximum range. Costing of a product is done by CPU (cost per unit) and every CPU has a basic formula.

Total cost (Financial issue)/ Total output of production (Technical issue) = cost per unit

In Bangladesh, a few renowned RMG factories do the costing involving both the financial experts and technical experts. A combination of Techno-finance knowledge is required to make perfect costing. But most of industry technical people and financial people are not working as a team. Finance people work their own way and technical people work their own way. They are not on one platform.

Costing-price-fixation

Technical people have financial knowledge gap and finance people have a technical knowledge gap as well. In our garments industry, most of the company, the technical (marketing people) negotiates the price with the buyer. As technical people are not aligned with finance people, they are not aware of actual costing or cost structure of the company which are recorded by finance people.

The finance department is the hub of all cost elements of all cost centers.  So without making a team of technical and finance people, it’s impossible to calculate cost of a product accurately and effectively.

There is a need for training on finance for non-finance people and training on technical issues for finance people. A combination of techno finance knowledge will make the price bargain with buyers. Due to lack of combination, it is seen that Buyers are ready to pay $2.50 for a product but a sudden call from a merchandiser comes for $2.20, even buyers know it is tough for a manufacturer to produce the product within $2.20 because buyers are concern about standard costing for their product.

High fashion brands consider quality issues ready to give a standard price but medium fashion brands offer manufacture less pricing in order to purchase gain. Most order quantity comes from medium fashion brands and they have many suppliers and sources for their product.

When they take the low price as a benchmark, buyers push the low price in other factories.  For the fear of plant underutilization, other factories are accepting the order. Ultimately the product becomes a loss product in the Bangladesh market and the product life cycle is shortening drastically in our country as well.

Some buyers or buying houses recently introduced open costing approach. Buyers should have a costing team having technical and finance people but every time it is seen that only technical people are dealing with open costing from the buyers’ side.

Their query and format for open costing is not up to the standard of company cost structure and accounting standard procedure. Lack of understanding, manufacturing of our company is providing misleading information and buyer are setting products offer prices based on this.

So, buyers should seriously think about this. If apparel products are becoming dead in the Bangladesh market due to wrong costing and pricing, buyers and buying house will unfairly lose their business and source similarly. Buying houses have a costing team having technical person and finance people to make the open costing procedure smooth and acceptable for garments manufacturer.

Actual cost

In Bangladesh, every marketing people and management who negotiated the price with buyers must know the actual costing of their own factory. Actual cost shows the actual output, wastage, actual cost structure. Every company should compare the standard cost and actual cost frequently and identify for continuous improvement through process innovation.

Vietnam hires professionals from China whose manufacturing efficiency is high and they are now depending on automation reducing the excess cost and lead time compared to Bangladesh.

per-hour-productivity-rate-RMG-labor
Figure: The graph is showing different countries’ per hour productivity rate of labor.

From the principal of CPU (cost per unit) to optimize the cost, Bangladesh has to work on efficiency. Higher efficiency will result in more production that will absorb the fixed cost resulting in lower CPU. Salaries and wages are increased in Bangladesh RMG sector but per hour productivity of Bangladeshi labor is low from other countries.

The table is showing different countries’ rate of per hour productivity of labor Source: Dhaka Chamber of Commerce and Industry (DCCI) revealed the statistics, quoting the Asian Productivity Organization (APO) Database 2018.

Reducing the actual cost would be hard by depending on the labor-intensive force. It is high time Bangladesh should go for the automation and work on efficiency.

There is a need for a strong MI system (Management Information represents the process to apply to the data and convert it into real) which will contain both financial and technical data. A strong MI system can solve the difference between the financial and technical departments. Bangladesh still follows the manual process to data collection and use so risk data manipulation is high. Without proper data collection and data use owners can’t be aware of the current situation.

Many companies include costs that are not related to the main business. Some stakeholders use company assets for a personal issue or in their other business units. The cost associated with these assets are included in costing but only operation cost should be included in costing. Otherwise, it has a huge impact on actual costing by increasing the total cost which will decrease the actual profit margin.

Decision making

Many companies make the investment after costing but costing should be done before investing. The cost incurred in a product in several stages like 1) Investment stage 2) Operational stage 3) Upcoming future consequence. Every company should exercise the pre-investment analysis to make its product-market competitive. Cost-benefit analysis is the core tool to take any decisions.

There is another psychological factor that the word “cost” has a negative impression on people’s minds. With this negative thought, people cannot work in a positive way. In true sense, the cost is a positive work which brings benefit to the company. The decision should be drawn based on where the Benefit is higher than cost.

Proper future market analysis is a drawback of our garments industry. Sometimes buyer deals with numbers of manufacturers simultaneously for capacity building and future order placement targeting cheaper product and diversified source of the supply chain.

Based on their promise factory builds huge capacity. Finally, industries do not get the expected order from buyers, factories become underutilized. In this situation, they are bound for low pricing for the utilization of the plant. So, when the management of a factory go for expansion or a new plant, the market forecast promised by buyers should be analyzed very carefully.

Bangladesh’s professional’s training and education system are aware of this costing issue. Government and professional training institutes must have to be engaged with industrial resource persons to add or change the training or education system, according to real industrial demand.

Still, Bangladesh is a very promising country in textiles and garments sectors. The awareness of cost control and target-oriented initiatives taken by individual factory management, industry expert people, garments and textiles associations, the government will be the turning point to overcome the challenges.

(The article has been made with the help of a leading company’s official.)

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