Rising cotton prices may not be sustainable

Disclaimer/Note: Please take serious note of the fact the views expressed here are merely speculative and based on the observations and understanding of the authors of this blog post, and should not be taken otherwise. Strictly, this should not be taken as an investment advice for people holding futures or options in cotton commodity trading. Textilestock.in will is not in the business of proving investment advice on trading of any financial instrument, and hence will not be liable for any implication whatsoever for actions following the views expressed in this blog post.)

The Economic Times, on 9th Feb, published the article “Cotton farmers smile amid global, local demand and price pick up”. Here are our views on how cotton prices will fair in the short to medium term on the commodity exchanges. We predict that in the short to medium term future, the cotton prices will fall due to various reasons.

The above mentioned article states that China is India’s biggest customer for cotton and China is also the largest garment exporter to USA. There is a growing demand for cotton from China, which is a direct result of the increase in demand of textile products in the US due to economic recovery from recession. As per our understanding, this is true and is surely a major reason for rise in cotton prices since the demand of cotton from Chinese exporters have risen.

We believe that the demand of textile products in the USA has recovered but this recovery might be unsustainable. A clue to this might be found in the February edition of The Economist in the article on America’s budget. In fact, this sudden surge in demand of textile products may be a result of long refrain from purchases of clothing and general textiles on part of the US consumer due to economic recession. Once this wave of sudden demand is over after the consumer has stocked their requirements, the spending on clothing and textiles will significantly reduce. Thus the demand for cotton will reduce and its price will fall.

Other factor which will contribute to falling cotton prices in future will be the fact that this year’s agricultural output of cotton fiber is expected to be good. This will indeed increase the supply for better quality raw cotton from India in the international as well as domestic market and that will pull the cotton prices down.

Once the demand for textile products falls, many companies will have to deal with inflated inventories. If your company happens to be dealing with such as issue, don’t forget to list you products on www.textilestock.in.

Innovation and moving up the value chain

Earlier, in this series of articles, we mentioned that we will be addressing the issue of reducing the adverse effect of macroeconomic factors such as rise of domestic inflation and currency appreciation against the dollar on diminishing profits. We addressed some remedies to counter strengthening rupee and rising domestic inflation in by suggesting some short to medium term plans.

Now let us take a close look at some of the long term strategic options. Before I start, I would like to quote Peter Drucker, the famous marketing guru, who said “Business has only two basic functions – innovation and marketing”. Although marketing have significantly evolved in the post-Drucker time, and technologies especially those relating to the World Wide Web are redefining the boundaries and scope of modern day marketing, the statement surely holds power.

As we pointed out in earlier articles, macroeconomic factors such as domestic inflation and currency appreciation become survival threatening concerns if businesses compete on price. This may be specifically true for Indian businesses since as compared to China, Indian manufacturing is certainly not the cheapest. Inflation and currency fluctuations are routine phenomenon in capitalistic and democratic economies such as India. The point here is that smart businesses should learn to build long term strategic safe guards so that every time currency appreciates or inflation rises, profits don’t have to take a beating.

In other words, if the core competency of a business is price, then any fluctuation that affects price, affects profits.

This is not to suggest that competing on price is a crime. But to successfully do so, companies need robust, well established and operationally efficient supply chains. Building such supply chains, such as one owned by world biggest retailer, Wal-Mart has a learning curve and needs economies of scale. But in today’s world, to achieve such a feat, companies need to be in a commanding position which is thoroughly challenging.

What is the Solution? Reduce dependency of business on price and command significant margins to insulate the bottom lines from frequently changing macroeconomic factors. Here is where, we think Drucker’s advise will come in Handy.

To put this view in perspective, we will look at “Innovation” from the point of view of establishing sustainable competitive advantage. Further, we will take up marketing in the context of redefining your target audience.

For smaller set ups, there may be innovative ways of achieving sustainable competitive advantage and command a reasonable premium on their products. Innovation doesn’t limit itself to creating new products, but also includes new ways of managing business. Some of the ways we know in the context of Indian textile manufacturing are:

1) Design expertise
2) Customer intimacy
3) Higher quality standards
4) Supply chain stability

Competing on other factor such as design expertise, customer intimacy, higher quality standards, and supply chain stability is far more challenging than competing on price and essentially involves top management since these are strategic and long term.

In our next article, we will address each of these strategic options and how they can help businesses command a premium. Watch out for this space for insights into managing textile manufacturing business in India.