Eratat and other listed Apparel Players like Lilanz, Zuoan, and Xiniya all have adopted the “
Asset light distribution model” aka “
wholesale model”. The main advantage of this business model is – it is
Highly Scalable. The model has allowed Apparel Players to build or have access to a large retail network throughout China without significant initial capital outlays and with less resource allocation. However, there exist other risks in this model.
Let’s take a closer look at this business model
Characteristics of “Asset light distributor model” aka “wholesale model”
- Apparel Players (AP) like Eratat/Lilanz/Zuoan/Xiniya are responsible for design/product development/brand management/marketing
- Apparel Players outsource the manufacturing of its apparel products to third party contract manufacturers.
- AP sells its apparel products to its Distributors, who in turn distribute these products to end consumers through their self-managed retail outlets or through retail outlets owned and operated by third party retail operators / sub-distributors. All third party retail operators/sub-distributors are appointed by the Distributors.
- The Distributors are responsible for managing local networks of retail outlets which include specialty shops and shop-in-shops.
- AP does not own or operate any of these outlets (hence Asset light – highly scalable model), with the exception of flagship stores.
- AP does not enter into any contractual relationship with any third party retail outlet operators/sub-distributors appointed by its Distributors.
- All of the retail outlets operated by distributors and third party retail operators / sub-distributors are required to operate under the AP’s brands and are required to sell AP’s products exclusively
- Although AP does not have a direct contractual relationship with third party retail operators / sub-distributors, distributors are required to ensure that third party retail operators / sub-distributors comply with terms and conditions of the distributor agreements
- Distributors place advance purchase orders at AP's biannual sales fairs/trade shows. (some AP have 3 trade shows per year)
- AP normally offers a credit period of 90 to 120 days to Distributors. Some have been extending credit terms to its distributors for up to 150days.
- AP does not hold any material collateral from its Distributors for granting credit terms..
- If sales increase, the amount of accounts receivable to AP from its distributors may increase
- Distributors are normally responsible for absorbing unsold inventory
- AP have been awarding “incentives” in one form or another to their distributors – seems like a market practice.
Risks to Apparel Players with “Asset light distribution model” :
- Heavy reliance on distributors: Apparel Players rely too heavily on Distributors (customers) to drive sales and growth. There is no assurance that AP will be able to decrease its dependence on these major customers over time. The failure to renew distributorship agreements with the major distributors or a breach of such distributorship agreements by them may materially and adversely affect AP’s operations.
- If any of AP ’s Distributors fails to adhere to its contractual obligation to distribute its products on an exclusive basis, its brand image and sales could be materially adversely affected.
- AP is expose to high credit risks of not getting paid by Distributors – especially if and when the underlying businesses are not profitable or in distress – maximum exposure is amount of trade receivable
AP’s Distributors and incentives given:
Lilanz/Lilang (HKEx)
http://www.lilanz.com/lilang/en_about.html
Number of distributors = 64
Number of sub-distributors = 1,472
Total number of retail outlets = 3,327
Number of retail outlet operated by distributors = 1,069
Number of retail outlet operated by sub-distributors = 2,158
Number of flagship stores/Self-operated stores = ？
From AR of Lilanz
Quote:
“Advertising and promotional expenses and
renovation subsidies amounted to RMB254.4 million for the year” – AR2012 of Lilanz
“Included in the selling and distribution expenses were advertising and promotional expenses and
renovation subsidies totaling RMB221.5 million” – AR2011
“Included in selling and distribution expenses were advertising and promotional expenses and
renovation subsidies totaling RMB181.2 million for the year” – AR2010
Unquote:
Xiniya (NYSE)
http://www.xiniya.com/
Number of distributors = 29
Number of sub-distributor = 1,378
Total number of retail outlets = 1,710
Number of retail outlet operated by distributors = 118
Number of retail outlet operated by sub-distributors = 1,590
Number of flagship stores/self-operated stores = 2
From AR2012 of Xiniya
Quote:
“In the years ended December 31, 2010, 2011 and 2012, we provided
rebates to our distributors in an aggregate amount of RMB34.1 million, RMB51.5 million and RMB67.6 million, respectively”.
Unquote.
Zuoan (NYSE)
http://zuoancn.investorroom.com/
Number of distributors = 16
Number of sub-distributors = 325
Total number of retail outlets = 1,329
Number of retail outlet operated by distributors = 180
Number of retail outlet operated by sub-distributors = 1,142
Number of flagship stores/self-operated stores = 7
From AR2012 of Zuoan
Quote:
We rely on a small number of distributors for the sale of our products.
We sell a vast majority of our products in China through our distributors, who in turn sell our products to consumers through retail stores directly operated by them or by their sub-distributors............................................................
Our dependence on distributors increases their bargaining power with us and the need for us to maintain good relationships with them. To the extent that any distributor ceases to cooperate with us for any reason and we are not able to find a suitable replacement in a timely manner, we may lose significant business. To the extent that our large distributors significantly reduce their purchases from us due to the deterioration of their financial position or other reasons, our sales would be materially and adversely affected. In addition, we may have to offer volume-based discounts or more favorable credit terms to our distributors in the future, which may lower our operating profit. As we rely to a large extent on our distributors for the sale of our products, our future growth will also depend on the performance of our distributors and their ability to expand their business and sales networks. In addition, any consolidation, restructuring, reorganization or other ownership change in our distributors may have a material adverse effect on our sales. We generally enter into agreements with our distributors for a term of three years.
There is no assurance that we will be able to renew our distribution agreements or renew such agreements on terms that are favorable to us. In addition, there is no assurance that one or more of our major distributors will not breach their distribution agreements or fail to comply with their obligations thereunder. In such event or events, our results of operations may be materially and adversely affected.
We are exposed to the credit risks of our distributors.
We generally provide credit terms of up to 90 days to our distributors. However, since the third quarter of 2012, we extended credit terms to up to 120 days for certain of our distributors who experienced difficulties in collecting from their sub-distributors due to the economic downturn since the second half of 2012 in China. As of December 31, 2012, we have not experienced any significant difficulty in collections or made any provision for bad or doubtful debts. However,
our sales going forward may rely more heavily on credit, and we may be unable to collect these accounts receivable in full or at all. Failure by our distributors to pay us in a timely manner or at all could have a material adverse effect on our financial condition and results of operations
Brand Promotion Allowance . Prior to 2010, as an incentive to promote our brand in order to facilitate the expansion of our sales network and enhance sales,
distributors were entitled to a brand promotion allowance equal to 3% of the total purchase orders from us. Such allowance was terminated beginning in 2010 as we adopted a strategy to increase our spending on centralized nationwide marketing activities while continuing to encourage our distributors to pursue their own marketing initiatives in line with our guidelines. Since the fourth quarter of 2011, as a result of warmer winter, we provided discretionary brand promotion allowance equal to 3% of the total purchase orders from us to our distributors for their marketing efforts to clear inventories for the 2011 winter collection.
Since the third quarter of 2012, we provided higher discretionary brand promotion allowance equal to 6% of the total purchase orders from us to our distributors in light of the declined spending power caused by the economic downturn in China since the second half of 2012 . In the future we will determine whether such brand promotion allowance is needed based on market conditions and may enter into agreements on such brand promotion allowance
Unquote
Eratat:
Number of distributors = 12
Number of sub-distributor = Not disclosed ?
Total number of retail outlets = Not disclosed ?
Number of retail outlet operated by distributors = Not disclosed?
Number of retail outlet operated by sub-distributors = Not disclosed ?
Number of flagship stores/self-operated stores = 0 (coming soon in Shanghai)
2010 (29 distributors), no bad debt, no inventory obsolescence
2011 (12 distributors), no bad debt, no inventory obsolescence,
provided sales incentive of RMB 51.7 million to Distributors
2012 (12 distributors), no bad debt, no inventory obsolescence,
provided renovation subsidy of RMB 41.7 million to Distributor
Comments:
1) Lilanz has been providing “
renovation subsidies” to its distributors.
2) Xiniya has been giving “
rebates” to its distributors.
3) Zuoan has been giving “
brand promotion allowances” to its distributors.
4) Eratat has been giving
“renovation subsidies”, “sales incentives” and
“longer credit terms” to its distributors.
5) Be it allowances, rebates, renovation subsidies, or extending longer credit terms etc –
these are all incentives in one form or another which these listed Apparel Players (with asset light distribution model”) have been “awarding” to their distributors, for "whatever reasons" - seems like it is a market practice in this business model. Is this justifiable ? One has to make his/her own judgement !
6) Distributors seem to have stronger bargaining powers than AP in this “asset light distribution model” relationship – mainly due to the fact that AP are relying too heavily on Distributors for driving sales and growth. Afterall, it is much easier for a distributor/sub-distributor/retailer to "switch brand" than for a AP to "switch Distributor"
7) Beside exposure to high credit risks, AP are subject to higher business risks, as Apparel Players (brand owners) have weaker control (indirect) over the sub-distributors/third party retail operators. The greater the proportion of retail outlets owned by sub-distributors/third party retail operators, the greater the risks. Lilanz seems to have the highest proportion of retail outlets owned by its direct distributors, at around 32%. Hence, less risky.
8) For the sportswear sector, in recent years, this highly scalable “asset light distribution model” has resulted in channels overstocking / inventory problems – due to over expansion of retail outlets in excess of demand. Hence, certain investors may now take a more cautious view on apparel companies operating on similar business model - by demanding higher risk premium for exposure to such increased business risks. As reported by AT Kearney : "
Unless lessons of recent past are absorbed, history is likely to repeat itself"
(not vested)
Research, research and research - Please do your own due diligence (DYODD) before you invest - Any reliance on my analysis is SOLELY at your own risk.
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