FOCUS: Sogo Shosha in fashion: Japanese trading companies adapt to changing fashion market

The big Japanese trading companies are key conduits in domestic apparel and fashion distribution. They supply yarn, buttons and other parts, clothing, accessories and footwear to most of the high street retailers, while also acting as distributors for hundreds of overseas brands. Their role is changing, however, as more foreign brands operate directly in Japan and more of the bigger Japanese retailers source direct from overseas. Not to be outdone, trading firms are diversifying OEM services to support the next generation of fast growing retailers, buying retailers themselves, signing yet more up and coming brands from overseas, while also buying outright those they don’t want to lose, and investing in e-commerce at home and across Asia. Their influence looks set to strengthen not weaken.

CHARTS

Who owns Who in Japanese Fashion Distribution and Retailing

Trading Company Deals in Fashion 2012-2015

SOGO SHOSHA: Big in fashion

Japanese trading companies (Sogo Shosha or Shosha) have long been an important part of distribution in Japan, especially in fashion and apparel, first as sources of textiles, then apparel production, and later master licensees and importers of Western brands. Their influence has been much greater than appearances would suggest. These massive conglomerates control many major Japanese retailers and brands through supply contracts and above all financing of inventory, binding customers to them in ways that are particularly Japanese in their complexity and breadth (see Chart 1).

Today the business of the Shosha is changing. The widespread shift by many big fashion labels to direct distribution means distributing brands is a riskier bet than two decades ago simply because an overseas brand is much more likely not to renew a contract and go it alone than in the past. This risk is even greater given the much larger initial capital investment required these days to make a brand a success – building costly stand alone stores is now a prerequisite for success for many brands, especially at the luxury end of the market.

At the same time, supplying apparel and accessories product to retailers and brands in Japan is also becoming more challenging. China’s rise, along with new shifts in production far beyond China, alongside more direct sourcing and private brand development by retailers themselves, are all major shifts that the Shosha are having to adjust to.

As a result, all the leading Shosha are looking for new business models while adapting others. Unlike in decades past when they would copy each other, today the pressures on the bottom line mean that all are coming up with very distinct strategies that fit their individual strengths alone, with much less crossover than before.

The four biggest Shosha in fashion distribution are Itochu Shoji, Mitsui Bussan, Mitsubishi Shoji and Sumitomo Shoji. There are others such as Marubeni, Sojitz and Toyota Tsusho that also have interests in this sector, as well as specialist trading firms like Yagi and Yagi Tsusho. The recent activities of four largest in fashion are listed in Chart 2.

Locking in brand distribution

The position of Shosha within apparel supply chains has changed over the past 30 years. In the 1970s and 1980s it was all about licensing brands. Leading overseas brands were signed up, and then loyal and compliant subsidiaries and affiliates were handed dozens of sub-licences for small parts of the total pie. Shosha themselves handled brand relations, paying royalties and taking a cut at each stage.

This simple, highly profitable business model waned in the late 1990s as overseas brands built greater understanding of the market and cut out middlemen. For most Shosha this meant a partial retreat from the fashion business.

Except for Itochu. As the leading fashion distributor, Itochu has created a new role for itself. Forced to relinquish control of the likes of Dunhill, Giorgio Armani and others, it has since acquired rights to a myriad range of smaller brands, succeeding with some and discarding others. This model is akin to that of a record company talent spotting new artists.

It has also broadened its reach, selling itself to Western brands as their man in Asia, now proffering license and distribution contracts not just for Japan but Asian-wide, and where it can, beyond – recent signings include Bear USA, Penfield, Skins, and for Outdoor Products it also has rights to Middle-Eastern countries.

This new approach has served Itochu well and while it is hard to get a precise lock on Itochu’s sprawling brand business, estimates suggest it now manages some 180 brands – and keeps adding more, both directly through Itochu Textile and through subsidiaries like Coronet and Joix, but also through affiliates like Look and, more recently, Toray Diplomode. Its high profile means it is always on the list of potential partners when brands consider entering the Japanese market or when seeking to review existing arrangements.

Given how important the business is to Itochu, it now seeks to lock in its most lucrative and strategically important brand assets. The sight of so many brands cancelling licenses and setting up direct distribution made Itochu realise it would need to find a way to avoid the risk of its biggest brands waving goodbye in the future.

The solution was to commit. As it has done with Paul Smith and Le Sportsac, this meant buying large stakes in the parent businesses, stakes that effectively act as a poison pill to keep the brands in-house at all costs. In the case of Paul Smith, for example, Itochu owns 40% of the UK business but has so many other ties to it through supply contracts, Asian distribution, not to mention the dependence of Paul Smith on Japanese sales, that its influence is much greater than the sum of its equity.

Mitsui followed the same strategy when it rushed over to the US in 2012 to snap up its long-standing licensee Paul Stuart, which was in danger of being sold to private equity interests following the death of the head of the family owned business. Like Itochu, Mitsui had already seen formerly licensed brands like Valentino take over controlling stakes in their Japanese business and was about to lose its biggest, Burberry. Holding on to Paul Stuart was seen as pivotal to keeping a stake in the fashion distribution business, even if it did mean getting involved in the ‘messy and stressful’ business of managing overseas executives.

As well as equity purchases, Shosha are now using tighter contracts to try and lock in brands for longer periods, arguing that to make the significant capital investments required in today’s retail-led market, they need security of tenure, all the more so when distributing across Asia.

Buying brands and going global

Itochu itself has since discovered that owning global brands is not only strategically necessary to protect its Japanese and, increasingly, Asia-wide licensing and distribution rights, but it is actually good value both monetarily and for its ability to trade at the top table in global fashion markets.

Le Sportsac is a case in point. It is increasingly regarded inside Itochu as the base for the Shosha’s new role as a global brand distributor with Asia as its power base. Le Sportsac is already distributed in 35 countries through 1,200 stores, providing the trading firm with an infrastructure for other brands too – Itochu itself has offices in all major countries, making it that much easier to set up in new markets.

This is, as always, a long game but once Itochu feels it has mastered the art of global brand distribution and put all the infrastructure in place, it will likely start seeking equity stakes in other brands it holds the Japanese/Asian rights to and become a global distributor of a multitude of fashion brands – again a model not dissimilar to the big music businesses.

Mitsui too claims an interest in buying into more brands following its acquisition of Paul Stuart, although mutterings about the purchase of an Italian brand late last year have yet to become reality.

Smaller firms are also purchasing brands. Yagi Tsusho is now the owner of Mackintosh and J&M Davidson, both UK brands, and is expected to acquire others in the next two years. Yagi & Co (no relation) acquired down jacket brand Tatras late last year.

But while most Shosha talk up the potential of global brand ownership, execution is another matter. Apart from Itochu, arguably no other Shosha has the reach, connections or knowledge to create true scale.

At home, both Itochu and Mitsui have also slowly moved closer to the end consumer, buying directly into Japanese brands and retail interests. Itochu saved Edwin from ignominy following its financial scandal, and has also bought into retailers like Java Holdings and Leilian. Mitsui owns Hanae Mori, and Toyota Tsusho recently acquired Fukusuke and Biscaye Group. Given the lack of long-term growth in Japan, most Shosha regard further investment in retailing and e-commerce as key to sustaining their own longer term growth, as well as improving profitability by capturing more margin.

Suppliers to everyone

Along with specialist textile traders like Toyoshima, the Shosha have been the conduits to China production for Japanese fashion brands and retailers for two decades. While once a lucrative business, the almost doubling in Chinese wages in the last five years has meant a squeeze on margins for such intermediaries – although apparel retail prices have risen in the last two years, the consumption tax hike has made more substantial increases impolitic.

Chinese production has also become somewhat erratic due to the low appetite for risk among factory owners as the cost of labour rises; they have held back hiring in the face of these higher wages, fearful of being left with major overhead and no orders, thus resulting in longer lead times as they scrabble to find workers once orders do come in.

At the same time, the quest for additional and ever cheaper production centres has provided an expanding role for the Shosha in identifying reliable sources in countries like Bangladesh, Cambodia, Vietnam and Myanmar, and then managing these more complicated supply chains. While most Shosha used to see about 10% of production outside China, today most have increased non-China sourcing to around 30-40%. Mitsubishi Shoji Fashion expects to see non-China sourcing exceed 50% this year.

The Shosha, especially Mitsubishi Shoji Fashion, Itochu and Sumitomo have the contacts, supply base, and local offices that make them a useful partner for apparel firms and retailers. This also makes sense from a product planning point of view given that each country, and even each region, has its own particular expertise and different types of fabric production, so while spreading production across different countries is more complicated, it means access to more skill sets and fabrics as well as lower prices. This helps in diversifying merchandise ranges and creating more differentiation, important in a market that has suffered from an excess of copycat product.

Of course, more complicated supply chains also enhance the value of the role played by the Shosha. They take on the hassles of production planning, coordination between yarn, parts and apparel factories across countries, quality checks and shipping. They have also invested directly in ownership or part ownership of factories, thereby providing a stability of supply, quality and trust that local competitors can rarely match.

Shosha also hold another key carrot: money. They fund production, offering generous payment terms, making it possible for fast expanding retailers to manage cash flow with ease. For any ambitious retailer or brand, tying with a Shosha may lead to dependency, as the likes of Adastria have found, but it’s a compelling package.

The profitability and other benefits of non-Chinese production is precisely why Itochu Shoji acquired UK manufacturing business Bramhope in 2012. At the time of the purchase, Bramhope had sales of around ¥14.5 billion and is one of the leading suppliers to Marks & Spencer. The deal gave Itochu Shoji unprecedented access to the UK retailer, but Bramhope’s directly owned factories in countries like India, Sri Lanka, Bangladesh and Cambodia allowed Itochu to leapfrog competitors in non-China sourcing – another example of its ability to use its international reach to its advantage.

Selling to Asia

Asia is not only a source of manufacturing, its burgeoning middle classes are also a rapidly growing market for branded product. Led by Itochu, as mentioned above, the Shosha now seek Asia-wide rights to brands that they sign up for Japan. The growing affluence of not just China but Vietnam, Malaysia, India, and Bangladesh is regarded as a major source of potential growth for the Shosha given the declining population at home.

In purely macro terms, the 600 million populations of the leading six South East Asian countries are less appealing than the 1.3 billion in the one market of China, but for Japanese trading firms, they offer two distinct advantages beyond an appetite for Japanese pop culture and fashion: low political risk and virgin territory. While everyone has piled into China, the Shosha have an advantage in these other markets given their already extensive contacts and joint ventures in apparel production. At the same time, Japanese businesses can operate with a level of freedom from fear of future political conflict in these countries – something that will remain impossible in China for the foreseeable future.

It is for this reason that Shosha investment in Vietnam, Malaysia, Indonesia, Thailand, Singapore and Cambodia has been so extensive in recent years, and also why retail partners like Aeon and the department stores have been supported in their expansion in the same countries, providing the retail channels through which the Shosha can distribute the brands in their portfolios.

Concretely this means establishing a distribution base from which to reach these markets. In January 2014, Itochu acquired a stake in Hong Kong firm ASF which distributes brands like Anteprima and is feeding recently signed brands like Outdoor Products through it. Sumitomo Shoji too is using its Jupiter TV Shopping business as the base for Asian expansion, tying with Saha Group and Central in Thailand to create a joint venture called Shop Global as a hub for expansion in Thailand, Indonesia and other nearby markets. It also acquired a stake in Singapore-based AWCG (see Chart 2).

Still powerful players in fashion long into the future

As the recent deals shown in Chart 2 make clear, the Shosha remain a significant force in all aspects of apparel and fashion distribution in Japan, and increasingly in Asia and beyond. Their role may be changing, and most major brands may now be distributed directly here, but their influence is as strong as it ever was. They remain major brand distributors and there are hardly any local fashion retailers that do not have significant dependence on the Shosha for supply.

While the biggest retailers now source more product directly and even have their own factories overseas, the Shosha simply move on, supporting the next generation of fast growing retailers, aiding their growth through slick supply, risk free inventory and the kind of generous financial terms that can make their western counterparts weep with envy. It is this level of support that has made the rapid growth of many retailers like Fast Retailing, Point, Urban Research, United Arrows and others possible.

At the same time, the Shosha are now keener than ever to grab a slice of the retail market themselves, both through acquisitions as well as beefing up brand retailing. In this regard, e-commerce is perceived as a gift from the gods; it means direct sales to consumers without the need to build expensive networks of stores. Given that most of the Shosha already have interests in e-commerce and direct marketing, it is no surprise that the online market is where much of their investment is going, both at home and abroad.