Wednesday, October 7, 2015

What does American Apparel’s bankruptcy mean for responsible business?

This week’s announcement of American Apparel’s bankruptcy and subsequent filing for Chapter 11 protection could spell the end of a unique experiment in responsible business.

Although it has been a fixture along with global retailers such as Zara, Gap, and H&M on high streets across the world for the past decade or so, American Apparel is unlike virtually all of its counterparts in the apparel industry when it comes to responsible business. While other global clothing companies outsource their production to suppliers in emerging economies, American Apparel has steadfastly stuck to a made-in-America philosophy, promising that its clothes are ‘sweatshop free’.

According to the company, the average American Apparel stitcher earns more than $2,000 month, along with a range of employee benefits including subsidized health insurance, an on-site medical clinic, subsidized public transport, and English classes. By contrast, according to the ILO, garment workers in key Asian export countries Vietnam and Cambodia earn around $80 monthly while the minimum monthly wage for garment workers in Bangladesh is a rock bottom $39.

Given that American Apparel’s competitors therefore enjoy such drastically lower labour costs by sourcing from overseas, it may come as little surprise to many that the company is facing major financial difficulties. How could it even have hoped to compete with the likes of its fast fashion rivals Zara and H&M when its cost profile is so unfavourable? Isn’t it simply inevitable that it would eventually go bankrupt?

The answer to that question is not as obvious as it may seem.

The company itself has often acknowledged that its approach is, as it says on their website, “not the easy road to travel”. Nonetheless, it claims that its vertically integrated business model offers efficiencies because everything is completed in-house, and furthermore it enables better quality control and provides for a faster response to the rapid changes in the fashion industry. According to the company, its approach is not only more ethical, but more financially responsible too.

There is some truth to these claims, but even so, it is hard to square them with the huge differences in production costs enjoyed by their rivals. There is little doubt that American Apparel’s ethical stance has, and continues to, put it at a major cost disadvantage in an increasingly price conscious category.

Of course, higher labor costs are not in themselves necessarily such a problem, providing either that the company can enjoy cost advantages elsewhere, or that its customers are willing to pay for a premium for the additional value they bring. Again, American Apparel can make something of a case here. It spends considerably less on marketing than many of its competitors by producing advertising in-house and adopting a highly controversial, sexualized approach that garners much greater attention than is warranted by its ad spend. Also its core customer base of hip teens and 20-somethings do typically applaud its sweatshop free position, at least in so far as they have heard about it - the company has generally eschewed an explicit ethical positioning in favour of a “sex sells” approach to marketing. The problem is that however much some of their customers might support a made-in-the-USA philosophy, there is little evidence to date that a sufficiently large slice of the mass market fast fashion category is willing to pay the extra $5 or so that a t-shirt produced in the US costs just to assuage their consciences.

Despite the numbers not quite seeming to add up, until just a few years ago, American Apparel did seem to make it all work. Throughout the 2000s it was seen as offering something unique in a crowded and quite bland retail space – a combination of the edgy aesthetic, clever marketing, and a seeming alignment of values with its core customer base helped inspire a cultish devotion that quickly took off. By the mid 2000s the company was expanding rapidly across the world, transforming from a predominantly manufacturing-based company to a global retail giant almost overnight. It was a lauded US success story.

And despite the cost issues with its made-in-the-USA approach, it was not labor costs that ultimately brought on American Apparel’s downfall - but they have played a role in preventing it getting back on its feet.

So if not labor costs, what did cause the crash? Although it was clearly a combination of factors, the fact that its rapid international expansion coincided with the 2008 financial crisis probably changed the course of the company more than anything else. With markets shrinking, the company quickly found itself mired in unsustainable debt, with a major cash flow problem. A run-in with the immigration authorities in 2009 then led to severe staff shortages and supply hold-ups, while a hike in global cotton prices subsequently drastically cut into the firm’s profitability. Compounding the problem, its competitors responded to the new market realities by stripping out costs and forcing down prices. This left American Apparel with a shrinking customer base ready to pay for its now seemingly overpriced basics.

At this point, it’s ethical sourcing strategy probably did hold it back from cutting costs as ruthlessly as its competitors. A retrenchment of its retail operations, several attempts to refinance its debt, and some last minute angel investors held off bankruptcy until now, but with the company unable to turn a profit since 2009, it has simply not been enough. Even the ousting of controversial founder and CEO Dov Charney last year did little to engineer a turnaround in fortunes. This week’s announcement seems to be merely the next chapter in the ongoing battle to resuscitate a severely sick patient.

So what does the rise and fall of American Apparel mean for responsible business? The bottom line is that the company’s strategy just about worked while times were good and the economy was strong - and probably even added to its distinctive appeal. But in more difficult circumstances the challenging economics of domestic production reduced the company’s ability to compete effectively in the marketplace. With better timing, deeper pockets, or just a little more luck, catastrophe probably could have been avoided, but even then American Apparel showed some alarming financial mismanagement and some clear unwillingness to adapt its formula despite shifting marketplace dynamics. As the company says, “Manufacturing in America requires risk taking and long-term investment,” but as with many aspects of responsible business, it takes great skill and foresight to maintain the alignment of ethics and profits over time.

Photo copyright Emily Burnett. Reproduced under Creative Commons Licence