How Retailers Are Managing Disruption by China’s Shein, Temu

July 10, 2024

The following is based on a panel discussion among our retail analysts at the Harding Loevner 2024 Investor Forum.

The three most important considerations for companies in the retail industry are product, price, and place. This is because a retailer generally differentiates itself through what it sells, how much it charges, or how convenient it is for customers to shop there. Therefore, when new rivals enter the industry, they tend to target perceived shortcomings in one or more of these areas.

The clearest example of how these dynamics can play out has been the rise of e-commerce over the past two decades. Websites such as Amazon.com were able to take market share from store-based retailers by providing shoppers a greater assortment, price transparency and savings, and the ability to shop from their homes.

Now, a new class of online retailers is finding room to further disrupt the 3Ps of retail by offering deep discounts on trendy apparel and other impulse purchases. They include Shein, a company that is aiming to go public soon, Temu, a subsidiary of China’s PDD Holdings, as well as TikTok Shop, a shopping feature that was added to the namesake social-media app owned by China’s ByteDance. (While Shein has moved its headquarters to Singapore, its operations are also primarily in China.) All three cross-border operators are bringing specific competitive advantages to large retail markets such as the US and Brazil.

Perhaps because consumers in the US and elsewhere are accustomed to seeing “made in China” tags on their clothing, there is a misconception that China was always the domain of fast fashion—cheap, rapidly produced apparel that mimics catwalk trends. Traditionally, though, production and shipping lead times were longer in China, making it a more suitable supplier for brands such as Nike than retailers trying to quickly recreate viral looks. Leading fast-fashion retailers such as Inditex, the Spanish parent of Zara, and the British e-ecommerce site ASOS source only about 30% to 40% of their merchandise from China and often turn to countries such as Spain, Portugal, Morocco, and Turkey for styles requiring a quicker turnaround.

Shein and Temu, however, mostly rely on Chinese suppliers, and they’re able to offer low prices in part because of the method they use to get their products from those suppliers to shoppers. By shipping individual orders directly to customers, they avoid US import duties, which are waived if a shipment’s value is less than US$800. US lawmakers have called this an unfair advantage over American retailers, many of which do pay import duties to bring in inventory made overseas. Duties, particularly in countries with high duties, can be a meaningful component of costs, although their avoidance isn’t the only reason Shein and Temu can offer low prices. Another is the efficiency of their supply chains and logistics operations.

But while these relative newcomers have been popular with some consumers, there doesn’t appear to be much risk to high-quality retail companies. One reason is that the retail market pie is so large, which means the rivalry dynamics are such that many different strategies can succeed at the same time. For example, even after getting off to a gangbuster start in the US, Temu’s gross merchandise value represents just 1% of the US e-commerce market, putting it significantly behind Amazon at 38% and even Walmart at 6%. Its customer retention rate is also lower, suggesting that some shoppers may be drawn to the novelty of scoring a deal but aren’t becoming repeat customers. The Sensor Tower data below shows the proportion of Apple iPhone users who open the Temu app at least once a month after downloading and how that compares to other retail apps; the large drop-off in Temu visitors is true among Android users as well:

Source: Sensor Tower

To offer such low prices, Shein and Temu also can’t provide the speedy shipping that American shoppers have come to expect from companies with robust local distribution infrastructure, such as Amazon and Walmart. Instead, the packages can take a week or longer to arrive from China. This is one reason that the risk to sales of large, easily accessible US discounters such as Amazon and Walmart, which has over 4,600 stores in the US—more than one for every US county—appears to be low.

Where Shein has somewhat differentiated itself is in its use of artificial intelligence (AI), which helps it quickly respond to fashion trends and accelerate production of items that are expected to be in high demand. It’s a strategy that other retailers with high financial resources can replicate. AI may prove particularly advantageous for online marketplaces because of the tremendous amount of data that is captured by a company’s relationship with a large mix of buyers, sellers, and goods. So far, though, most of what the retail industry has done with AI doesn’t appear to be game-changing. In fact, there are cautionary tales in which brands have put too much emphasis on technology and the product suffered as a result. For example, Adidas said in 2019 that it over-invested in digital advertising and focused too much on the number of shoppers clicking its ads rather than its overall brand perception.

The category of retailers that would seem to be most at risk from competition from Shein and Temu are dollar stores given the similarities in product selection and prices. But even dollar stores have some differentiating characteristics. For example, many sell items that the Chinese apps don’t, such as consumables. They also offer convenience for shoppers in need of an item quickly and the ability to inspect a product in person rather than scrolling through a long list of options. So far, new online challengers haven’t had a material impact on the dollar-store industry.

Overall, high-quality specialist companies have continued to grow despite the success of new challengers such as Shein and Temu. It’s because of their differing strategies around product, price, and place that the barriers to entry in retail are higher than most might assume. However, it is possible that market-share gains by Shein and Temu will shake the stock-price sentiment for even some high-quality retailers, which may produce more attractive valuations and potential buying opportunities.

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Over the Barrel: The Complex Task of Decarbonizing the World

June 12, 2024

Fossil fuels are the lifeblood of modern society, used for everything from heating homes to powering cars and planes to generating the electricity that keeps the internet running. Crude oil, natural gas, and coal currently meet about 80% of our energy needs globally, but 75% of carbon dioxide emissions come from finding and burning these fossil fuels. There is a consensus about transitioning away from those sources of energy, given how much they contribute to climate change, but there is not a consensus on how much our reliance upon them can be cut or what will replace them. There does not appear to be one clear replacement and there will likely be multiple pathways to decarbonizing the global economy. To understand our energy future, it is helpful to have a perspective on past efforts to develop new energy sources. In this excerpt from the 2024 Harding Loevner Investor Forum, our analysts offer some perspective on the history of energy transition.

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What If Fashion Were Taxed Like Cigarettes?

By Maria Lernerman, CFA, Analyst and Portfolio Manager | May 22, 2024

The fast-fashion industry produces a lot of waste but has largely avoided any consequences for its impact on the environment. That is starting to change.

The lower house of France’s Parliament passed a bill in February that would impose a “sin tax” of up to 10 euros or 50% of the selling price on fast-fashion clothing, a severe penalty given that many of these products cost less than €10. The bill would also ban advertising and demands that companies in the industry disclose the environmental impact of their businesses. The bill was approved unanimously and moved to the upper house of Parliament. If it becomes law, it will make France one of the first countries to impose this type of penalty on fast-fashion companies.

Fast fashion has become a roughly US$120 billion industry and is projected to grow to US$185 billion by 2027. Shein, H&M, Temu, Zara, and others have built worldwide businesses by creating cheap clothing in bulk as quickly as possible to respond to changing fashion trends, especially for a growing global middle class with more disposable income. The crux of the problem is that fast fashion tends to encourage what many consider an excessive amount of consumption. Traditional clothing companies might release new lines four times a year; fast-fashion companies do so weekly or even daily. The clothes are designed to be relatively cheap and worn for a short period of time before being discarded, sometimes after only seven or eight wears. Consumers are then expected to buy the next hot thing. The result? People are buying more clothes, an estimated 60% more, but keeping them only half as long as they would a more durable, higher-quality piece of clothing.

Those dynamics exacerbate the environmental impacts of an industry that is inherently polluting to begin with. Conventional textile mills generate about one-fifth of the world’s industrial water pollution. About 20-35% of all the microplastics in the world’s oceans come from microfibers shed by clothes as they are washed. The industry also produces veritable mountains of unsold clothing, which get burned or thrown into landfills strewn around the Global South. (Shein, for one, has argued that its business model better matches supply with demand and produces less unsold clothing).

The photograph above was taken by Maria Lernerman, who came across the Shein-labeled piece of plastic while on vacation.

Businesses with a high-volume, low-price model, such as Shein and Temu, would be the most vulnerable to a tax like the one France is contemplating, given higher prices would test consumer demand. The effects would also depend on how the French regulation ends up defining “fast fashion.” It may cover only the “fastest” companies, such as Shein and Temu, or it could include older, more established players like Zara and H&M. An advertising ban would severely limit companies’ ability to grow, and the tax would cut into both growth and profits. While it would be a competitive benefit for “slower” fashion companies, placing severe costs and restrictions on even part of the industry could cement the image of fashion as “sinful,” making it easier for other governments to levy taxes or fees on all players over time. Lastly, a bill such as this could be politically divisive, opposed by consumers who are already facing economic strains.

On one level, France’s bill is aimed directly at the environmental impact of fast-fashion companies, but there is another motive behind the bill. This bill would give a competitive advantage to France’s domestic fashion and retail industry and protect it from upstarts. But lawmakers in other jurisdictions are also looking at the industry. The EU’s European Commission has been working for four years on regulations for the industry that should enter into force by 2030. In the US, state lawmakers in New York and California have introduced bills that address the fast-fashion industry’s environmental effects. And in 2022, Massachusetts banned textiles being thrown out in the garbage, mandating they be recycled.

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What P&G’s Pricing Decisions Tell Us About Inflation

By Sergei Pliutsinksi, Analyst | June 07, 2023

Inflation has been the relentless economic theme of the last two years. Even with interest rates higher than before the pandemic, global supply chains no longer paralyzed by virus-related bottlenecks, and the World Health Organization declaring an end to the COVID-19 emergency, prices for goods and services in many parts of the world continue to climb.

As the world’s largest consumer-goods company, Procter & Gamble provides insight into what’s driving the pricing decisions at big brands.

In the first three months of 2023, P&G raised prices a whopping 10% year over year, following a series of large price hikes implemented throughout 2022:

Best known for brands such as Cascade, Gillette, Pampers, and Tide, P&G sells items typically found in the bathroom cabinet or under the kitchen sink. They aren’t the sort of hot items consumers blithely splurge on—but they are necessities. Despite P&G’s brands being among the most expensive in their categories, customers are loyal partly because the premium price and name recognition suggest they can expect consistent quality. Family and home care are areas “where the consumer doesn’t want to risk failure,” Andre Schulten, P&G’s chief financial officer, said during an April earnings call. “You don’t want to wash your clothes twice, and you certainly don’t want to deal with a diaper failure.”

With the latest round of price increases, P&G sold just 3% fewer items during the quarter (with the company’s decision to scale back operations in Russia responsible for one percentage point of this decline). This tells us that P&G may be losing some customers to sticker shock, but most are still coughing up the extra money. In fact, shoppers were entirely undeterred in the US, where the company’s sales volumes were up.

P&G is starting to see pushback in Europe, where the problem of stubbornly high inflation is worse due to the conflict in Ukraine and resulting energy crisis. P&G’s private-label rivals, which sell cheaper alternatives to brand-name goods, have been slow to raise prices in those markets as European consumers opt for the more affordable choice. This contrasts with the US, where consumers aren’t trading down and market share for private-label brands remains stable at about 16%, according to P&G. Rather than cut prices in Europe, though, P&G is spending on product and packaging enhancements as well as marketing to boost its brand prestige. For example, it’s promoting Ariel and Tide laundry detergents for use in cold water for consumers wanting to reduce their environmental impact or energy costs.

One reason P&G continues to raise prices for consumers is that the company is feeling the pinch of inflation, too. While higher prices benefited its gross profit margin last quarter by 470 basis points, much of that was offset by higher input expenses. Even as freight and transportation costs have come down, certain commodities and materials, such as ammonia and caustic soda, have gotten more expensive as P&G’s suppliers look to cover their own increased labor costs. Meanwhile, as the company reinvests in its brands to entice shoppers through means other than competitive prices, its operating margin widened by just 40 basis points, an improvement nonetheless.

Inflation isn’t in the rearview mirror, even if it is starting to ease. The companies with the greatest pricing power are taking advantage while they still can.

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Out of Our Minds

How Retailers Are Managing Disruption by China’s Shein, Temu

Source: Sensor Tower

Over the Barrel: The Complex Task of Decarbonizing the World

What If Fashion Were Taxed Like Cigarettes?

The photograph above was taken by Maria Lernerman, who came across the Shein-labeled piece of plastic while on vacation.

What P&G’s Pricing Decisions Tell Us About Inflation

Disclosures

Out of Our Minds

Source: Sensor Tower

Over the Barrel: The Complex Task of Decarbonizing the World

What If Fashion Were Taxed Like Cigarettes?

The photograph above was taken by Maria Lernerman, who came across the Shein-labeled piece of plastic while on vacation.

What P&G’s Pricing Decisions Tell Us About Inflation

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Disclosures