83081 Policy Note September 2013 TRADE DEVELOPMENT Improving trade competitiveness: Cambodian footwear exports Significance Cambodia’s capacity for footwear production has expanded significantly in the past five years, with 20 new factories opening. This was after a period of five years of no investment. Some of the new factories are derivatives of earlier investments, but there are also new, large specialized factories. All factories producing footwear have some level of foreign ownership. To understand the footwear value chain, one must differentiate between vendor and contract factories. One unique aspect of the footwear industry’s growth is that the value of each unit of output has been growing at the same time as the volume of the exports has increased. This growth in unit value implies that the footwear industry is climbing the value chain in sophistication and quality faster than other export sectors. The World Bank published a Transport and Trade Facilitation Assessment (TTFA) report in 2013, designed as a snapshot of a country’s trading environment, viewed from the perspective of four key industries, including the footwear industry. The report dissects the inputs and outputs of the sector by analyzing how the inputs arrive at the processing plant and are then exported. Each step of the value chain is examined for logistical issues. The analysis and recommendations are designed to provide an overview of logistics issues that affect the private sector, and to assist the Government in implementing its footwear export policy. Background Trade and Markets Over the past decade the value of Cambodian footwear Growth of the industry reflects a shift in production from exports have tripled (Figure 1). The increase in value was due neighboring countries to take advantage of low production to an increase in volume but more importantly to an increase costs and Cambodia’s duty-free access to the EU under the in the unit value, which doubled over the same period. Everything-But-Arms (EBA) initiative. Business Model Figure 1: Cambodia’s Leather Footwear Exports Source: UN-Comtrade, 2012 The responsibility for managing the footwear supply chains rests with the shoe factories. However, their roles in structuring 20 120 the inbound and outbound supply chains vary. The two 18 16 100 prevailing business models are vendor factories and contract 14 manufacturers. Vendor factories are locally incorporated 80 Thousand tons 12 production units of foreign corporations. They are directly US$ million 10 60 managed by their overseas headquarters, which allocate 8 40 orders to factories according to capability, cost structure, 6 4 and capacity. 20 2 0 0 The contract manufacturers have stand-alone factories 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 that produce finished goods according to specifications Quantity Value provided by the buyers. They compete for production contracts and procure most of the inputs. In addition to these factories, there are domestic firms that provide complementary services including dying, trimming and supplying locally produced packaging material. 1 Policy Note Trade Development Supply Chain Issues Foreign Domestic Supplies Suppliers Suppliers Most of the leather and other raw materials used to produce footwear are sourced from within the region but very little Foreign is produced in Cambodia. For vendor factories, sourcing HQ of inputs is arranged by the parent company, which takes advantage of its size to obtain favorable treatment. In most Vendor Contract cases, the parent company has long-standing relationships Factory Manufacturer with its suppliers and many are from the same country as the parent, e.g. China, Thailand, Taiwan, and Vietnam. The parent often purchases the inputs on FOB terms and Foreign Nominated arranges for their delivery to the factory. HQ Forwarder Figure 2: Cambodian Footwear Export Destinations by % of Value Source: General Department of Customs and Excise, 2011 Asia Foreign 1.14 Buyers Africa 0.77 Oceania 20.27 0.60 North America 50.41 10.96 South America Supply Chain Performance Central America All of the factories surveyed were vendor factories. Middle East Their supply chains are relatively simple. There are few 2.56 intermediaries other than the foreign owners and forwarders 3.74 EU.27 0.56 nominated by the buyers, as shown in Figure 3. The leather Rest EU and fabric used for production is imported primarily from China, Taiwan and South Korea. The factories purchase The contract manufacturers are at a disadvantage in sourcing leather direct from tanneries although they frequently have inputs because of their size. Their suppliers are usually problems with quality. Fabric is ordered from suppliers smaller and the prices are higher. Most inputs are purchased nominated by the buyers. The suppliers usually arrange C&F with shipments arranged by the supplier. the shipments. These are on an FOB basis with weekly shipments in containers. Buyers and Distributors Vendor factories sell their products to brand manufacturers, Most inputs are imported duty-free with a value per wholesalers and retail chains. The contract manufacturers container ranging from US$15,000 to US$55,000. The sell primarily to wholesalers and buying agents. The larger trade documents that present the greatest problem are factories market their services directly, while smaller import permits and technical certificates, which normally manufacturers often rely on the Footwear Order Center of require 3-5 days to obtain. Cambodia (FOCC) to identify buyers and, in some cases, to manage product quality. Footwear exports are usually Nearly all the exports are shipped by sea in containers that shipped on FOB/FCA terms with the factory responsible are loaded at the factory. Principal destinations are Japan for delivering the goods to the loading port or the warehouse and the EU. of the buyer’s nominated forwarder. Financing for investment and working capital is the Concentration responsibility of the headquarters. The principal financial Six of the shoe factories in Cambodia are large vendor risks are those associated with fluctuations in demand, factories that employ on average about 6,000 workers. They prices and exchange rates. have a relatively high productivity due to investment in modern equipment. The remaining factories are smaller, employing The principal trade corridors used for exporting the footwear an average of 1,500 employees. These are estimated to link the factories with the loading ports. The firms located produce between 2,000 and 3,000 pairs per day or about in Manhattan SEZ near the Vietnamese border use Cai 500 pairs per employee per year. Total production in Mep, while those located in or around Phnom Penh Cambodia comes to about 50 million pairs of shoes per year usually use Sihanoukville. 2 Policy Note Trade Development The strategy for the contract manufacturers would focus Opportunities and Constraints on incentives for increasing the span of control. This would include greater involvement in sourcing inputs, and Growth of the Cambodian footwear sector has been marketing their production capacity to buyers interested dependent on foreign investments. Opportunities to increase in small to medium orders of high-value footwear. the average value per pair are limited because larger vendor factories are managed overseas and contract manufacturers lack the scale to develop and promote their own designs. Cambodia’s duty-free access to the EU has attracted Implementation foreign investors from South Korea, Vietnam and other Specific activities to support these strategies might include: countries that do not enjoy preferential treatment. However, this advantage is fading as Cambodia’s competitors have  eveloping enclaves to encourage both foreign invest- • d joined the WTO (China in 2001 and Vietnam in 2007) and ment in factories and domestic production of inputs; the EU has reduced its tariffs on footwear. • improving training for both management and semi-skilled labor; and, Cambodia, like its competitors, faces wage pressures as the footwear sector is having difficulties in recruiting skilled • increasing the availability of finance to support the craftsmen and qualified supervisors. growth and evolution of the contract manufacturers. The enclaves would be in the form of special purpose Objectives and Strategies zones. One would be for leather processing and include the necessary water treatment facilities and other environmental Footwear exports account for less than 2 percent of GDP safeguards. This would be used to expand tannery capacity and this share has changed little over the past decade. and develop leather dyeing and finishing activities in order to Nevertheless, it generates significant employment and has increase the supply and improve the quality of local leather. the potential to grow rapidly in the future. The principal This would produce a significant increase in value addition, benefit to the economy from this expansion is the generation since leather accounts for a significant portion of the cost of employment for the urban population. At the same time, its of footwear with leather uppers. Since there would continue growth will be challenged by rising wages and competition to be significant competition from low-cost suppliers in from its neighbors. In order to sustain its growth, it will have China and Vietnam suppliers, this enclave would focus on to increase both the average value and value addition of the providing a reliable supply of higher-value leather. its footwear. This can be accomplished by improving the quality of production and the proportion of local inputs. Another enclave would support a cluster for shoe factories, Unlike garments, competition is less affected by order suppliers of inputs and providers of services. It would cycle. At the same time, there are greater opportunities encourage local production of inputs including lasts, soles, for local design and procurement since there is less diversity lining and packaging; provide bonded storage for generic in fashion and in materials. inputs; and create opportunities for joint procurement of inputs and logistics services. The access to local inputs Any strategy for achieving growth must differentiate between and services would be of immediate benefit to the contract vendor factories and contract manufacturers, since the manufacturers. Over time, it is expected that the vendor activities of the former are controlled offshore whereas the factories would also increase local procurement. latter are more responsive to local market conditions. With These enclaves would allow for a reduction in order cycles. the current structure of the industry, overseas managers At present, the typical order cycle up to the point of export make the decisions regarding markets and product value is 1.5-3 months with imported inputs accounting for about for half of the exports. For the other half, decisions are half of this cycle. By introducing local production and made locally but the factories are smaller and have limited bonded storage for generic inputs, the order cycle could capacity to move up the value chain. be reduced by 2-4 weeks. The strategy for the vendor factories would focus on The challenge in developing both enclaves is to provide creating an attractive environment for FDI. In the short sufficient value for potential locators. In order to do this, there run, the challenge will be to improve productivity and quality would have to be substantial private sector involvement of output of the factories, so that their owners will allocate in both the planning and management of these enclaves. to them the production of higher value products. In the medium term, the challenge is to create an environment that will attract companies that produce higher value footwear. 3 Policy Note Trade Development Activities related to training require collaboration between The target audience for the training would be the contract the industry and government, to provide training in areas manufacturers, since the vendor factories already have that individual companies lack the capacity or resources to their own training programs. However, if the training is provide. The selection of the curriculum would be done successful, it is expected that the vendor factories would jointly; the private sector would take the lead in recruitment of also make use of it in training their employees. instructors; and the Government would provide support for the operation of a common training facility. The assignment Improvements in trade finance are required so that the of responsibility for specific areas would be assigned based contract manufacturers can expand their activity, and on interest, for example: extend their involvement in the inbound supply chain to include procurement of inputs and participation in the  private sector effort to provide management training in • a design process. lean manufacturing and quality control;  public sector effort to train managers in the evolving • a In addition to these activities, the development of an physical, social and environment standards of importing efficient corridor connecting to the new container terminals countries; and, downriver from Ho Chi Minh Port would reduce the order • a  public-private effort to teach new workers the skills of cycle and lower freight rates for both imported inputs and shoe making. exported products. Recommendations 1. Encourage the increased use of locally sourced inputs, as well as greater value addition in Cambodia. 2. Develop footwear industry clusters to increase volume, have access to a larger pool of labor, and obtain the benefits from economies of scale from co-location, through public-private partnerships. 3. Develop the trade and transport corridor to Cai Mep in Vietnam, which has a higher frequency of vessel calls to key source markets for inputs, and to markets for exports. 4. Increase the availability of finance, for contract manufacturers in particular, so they can increase quality and capacity. The World Bank Office For further information, Funding for the Trade Related please contact: Assistance Cambodia Multi-Donor No. 113 Norodom Blvd. Phnom Penh - Cambodia Trust Fund from the EU, DANIDA and Tel: (855 23) 861 300 Julian Clarke UNIDO is gratefully acknowledged Fax: (855 23) 861 301/302 Senior Trade Specialist Visit our website: (jclarke1@worldbank.org) http://www.worldbank.org/cambodia Vannara Sok This note reflects the views of the authors and not Operations Officer necessarily those of the World Bank and the donors. (vsok@worldbank.org)