It’s always been the case that supplying big-box stores like Target and Walmart has carried big risks for small businesses. But these days, it's even more taxing.
China’s devalued yuan has added a new wrinkle to the typically one-sided deals that small suppliers often agree to. Such deals, which can promise huge sales that can push a lucky few manufacturers into the big leagues, usually ask small businesses to take on all the risk by investing heavily in creating and holding inventory. In exchange, payments can be large, but they often come late. For some companies, waiting many months down the line is commonplace.
Now it turns out that Walmart, the world’s biggest retailer, has asked for price concessions from its worldwide network of 10,000 suppliers, asking the ones that manufacture in China to cut prices between 2 percent and 6 percent, to reflect the devaluation of the Chinese currency, Reuters reports. In August, China rattled world markets when it decreased the value of its currency by 3 percent. (Walmart did not respond to a request for comment.)
In sum, Walmart is seeking a discount from its small business suppliers, financial experts speculate, to help pay for the worker wage increases it put into place in the last year. The company in now in the process of lifting its minimum wage to $9 an hour, and it will make additional investments in employee training, which are expected to cost the company $1 billion in 2015. It also needs to shore up its balance sheet, as its share price has dropped about 30 percent in the last year to about $63 currently.
Such a move can wreak havoc on any number of Walmart's small manufactures with operations in China, particularly as most haven’t seen their own suppliers cut prices. What’s more, such companies tend to operate on extremely tight margins, and a price cut isn’t feasible for a variety of reasons. In a worst-case scenario, it can force a company out of business by asking owners to take on debt to produce their products.
And in the race to the bottom to satisfy such retailers' everyday low prices, it simply amplifies an already bad situation that forces more suppliers to move more jobs overseas, to areas that can offer the cheapest labor possible.
“To do business with a company like Walmart, vendors are really pushed to the maximum of what they can do,” says Bruce Bachenheimer, a clinical professor of management at Pace University in New York.
That’s certainly the case for Walmart supplier Royce, which provides the Bentonville, Arkansas retailer with luxury items including cuff links, belts and small leather goods. The company, which is based in Secaucus, New Jersey, has 26 employees and $6 million in annual revenue.
“Having retailers like Walmart push back on prices in order to sustain their ‘everyday low price’ guarantee, takes a toll on us so grand that it's simply not sustainable beyond a few fiscal quarters,” says William Bauer, managing director of Royce, a family-owned business started by Bauer’s grandfather in the 1970s. To seek price advantages, the company began manufacturing the majority of its products in China in the 1980s.
Walmart did not ask for a specific percentage decrease, Bauer says, but has nonetheless said it needs a concession to maintain its own low prices. And that’s a problem for Royce, because the company’s manufacturing partner has not passed along the cost benefit of the falling yuan. That’s because Royce’s manufacturing arrangement is denominated in dollars, Bauer says.
Such demands are a big deal for any small company hoping to supply the big leagues, says turn-around expert Nat Wasserstein, founder and managing director of Lindenwood Associates, in Upper Nyack, New York. Yet 80 percent of the distressed companies he’s helped restructure in the past 20 years have gotten into trouble by trying to meet the demands of big box stores, he says.
So if you’re one of the tens of thousands of suppliers that any of the big box stores use, here are three things you need to consider right now.
1. Consider a currency hedging strategy.
It makes sense, if you’re manufacturing overseas and paying for things using local money, to get a handle on costs by protecting against currency swings. One way to do that is by purchasing a currency contract, known as a hedge, that allows you to exchange dollars into the local currency, but at a fixed price and at a predetermined time in the future.
You benefit if the value of the local currency goes up, but not necessarily when it drops in value. With the strong greenback in recent months, you’re likely to feel some pain. But here’s an additional thing to be wary of, Bachenheimer says: If the currency you’ve hedged decreases in value, and the retailer you supply also asks for a price concession, you’ll take a double hit to your bottom line.
2. Create more flexibility in your overseas production.
While that’s not as easy at it sounds, you could explore adding in other countries that peg their currency to the dollar. That includes many Caribbean nations, suh as Barbados, Antigua, and Belize, Bachenheimer says. Inc. 5000 company Lollicup, uses three regions to manufacture its paper plates and cups, including China, Taiwan, and the U.S. Like Bauer, Alan Yu, the company’s chief executive and founder, says Chinese suppliers have not passed along the price advantage to them. The company can, however, ramp up production in its Chino, California facility if costs continue to rise in China, Yu says.
Similarly, Bauer says he’s trying to make more of his leather goods in the U.S., by contracting with Amish artisans in Lancaster, Pennsylvania, who specialize in leatherwork.
“Similar quality can be attained without worrying about currency volatility and shipping costs,” Bauer says.
3. Establish your contracts in the local currency.
While that may take some negotiating expertise, paying in the local currency can help shield you against some of the negative effects of currency devaluation. And it’s a particularly good idea if you plan to sell your product into that market, especially with the strong dollar. On the downside, you assume the risk if that currency suddenly spikes upward.