Subscribe to Inc. magazine
STRATEGY

Case Study: A Quota on Profit

Lafayette 148 had high hopes for its new Chinese factory. Then it encountered an unforeseen problem: trade restrictions.
Advertisement

Deirdre Quinn could not have survived a career in the fashion business without a strong sense of optimism. But by the summer of 2004, even she had to admit that the future seemed dark. Her company, Lafayette 148, had a warehouse full of fine women's apparel in China and a host of retailers eager to stock it. But neither Quinn nor her business partner, Shun Yen Siu, knew how they would actually get the merchandise from China to the U.S.

The problem was export quotas. Anyone manufacturing overseas needs to pay close attention to the details of U.S. trade deals. And that's especially true in the fashion business, because the U.S. government sets strict limits on foreign-made apparel. Once those quotas are established, manufacturers must obtain the rights to export certain amounts of certain items to the U.S. Acquiring those rights is critical because a manufacturer's products cannot leave China without them.

Because demand for export rights often exceeds supply, a secondary market has emerged in which brokers obtain unused export rights and sell them to manufacturers that need them. The challenge for exporters is to get the right quota at the right price. By July 2004, it was painfully clear that Lafayette 148 did not have enough quota on hand. And prices were rising fast.

Quinn and Siu had opened their Chinese factory two years earlier, and with some reluctance. They were proud of Lafayette's "Made in New York" label and had worked hard to offer retailers including Saks Fifth Avenue high quality and quick turnaround times. But even as revenue grew to $28 million in 2001, the company was losing money because of high production costs. When demand plummeted in the wake of September 11, it became clear that to survive, Lafayette would have to move production overseas. Siu headed to his hometown of Shantou and several months later had a 20,000-square-foot facility capable of producing apparel at a fraction of what it cost in New York.

In 2003, the first full year the factory was on line, trade restrictions were not an issue; at that point the company made only about 60% of its merchandise overseas. Revenue hit $39 million, and thanks to the lower manufacturing costs, Lafayette broke even. For 2004, Quinn and Siu decided to boost Chinese production to 95%, a move that would put Lafayette back into the black--but first Quinn and Siu had to devise a quota rights plan. Based on prices over the past year, they estimated an average cost of $20 per garment, for a total cost of several hundred thousand dollars. Because the company didn't have the cash to buy quota rights in advance, Quinn and Siu decided instead to buy them as new orders came in--essentially betting that prices would remain steady.

But quota prices did not remain steady. In fact, thanks to unexpectedly robust demand for apparel, quota prices surged to more than double Lafayette's original estimate by June and seemed certain to climb even more. Without sufficient quota in hand, Lafayette 148 would be unable to ship its orders to retailers. Lafayette's quota plan was suddenly obsolete--as were its hopes of turning a profit in 2004.

The Decision

Every morning when Quinn arrived at her office at 148 Lafayette Street, an assistant brought her a report with the latest, eye-popping quota prices. Siu, meanwhile, would wake up in China at 3 a.m. to call his partner. Both of them checked with their network of friends in the industry, many of whom were also scrambling. And prices kept going up, hitting $60 per garment in August--triple the cost of actually producing the clothing.

Loath to pay the soaring prices on the open market, Siu and Quinn considered delaying shipments on certain garments--such as wool jackets, the most heavily restricted item--until the current quota treaty between the U.S. and China expired on December 31. But Siu and Quinn knew that many women purchased Lafayette 148's clothing as complete ensembles. Delaying shipment of one item could wreak havoc on the company's careful planning for 2004 and potentially damage sales of the remaining items.

It was soon apparent that they had no choice. They paid the sky-high prices, nearly triple their original budget. They tried to soften the blow by not manufacturing any garments that hadn't already been sold. But the high quota prices cut the year's net income in half. There was some upside: The decision ended up forcing positive changes in the way Lafayette 148 does business. Garments are now cut to order, which has reduced the amount of inventory the company carries by almost 50%.

The trade relationship between the U.S. and China remains volatile, but it hasn't posed much of a problem lately for Lafayette, mostly because restrictions on wool jackets have been lifted. The partners say they'll deal with future quota issues as they arise. For now, they're scrambling to keep up with demand for new items, such as leather and knitwear, and Quinn's old sense of optimism is back. "It's exciting watching the company finally become healthy," she says.

The Experts Weigh In

Get some help

Small entrepreneurial businesses like Lafayette are often so busy managing on a day-to-day basis, it's hard to work on a major transition like moving to China, and even harder to plan a season or two ahead. They may want to hire another person who has some expertise on quota rights. That would provide a way to deal with quota issues as well as create more efficient shipping.

Jim Rice
Retail analyst Susquehanna
Financial Group
New York City

It's not over

Depending on the product, Lafayette is likely to get hit with quota problems again. The U.S. government has reimposed limits on exports of a range of specific clothing items manufactured in China for this year and at least another year or two. It may make sense for the company to admit it went too far in trying to establish its own production facility. Control from a distance is difficult even for a large corporation.

Thomas Pugel
Professor of global business
NYU

Control the costs

Owning a factory, and I've gone through this, is not something you want to do. Contracting makes more sense because when you contract, there are no surprises related to quota. You contract in U.S. dollars for a certain price at a certain date. If you're going to import, you need to take all the variables out of it. Lafayette needs to make certain of all of its costs early in the process.

Bud Konheim
CEO
Nicole Miller
New York City

What do you think about Lafayette's decision? Sound off at casestudy@inc.com.




Register on Inc.com today to get full access to:
All articles  |  Magazine archives | Livestream events | Comments
EMAIL
PASSWORD
EMAIL
FIRST NAME
LAST NAME
EMAIL
PASSWORD

Or sign up using: