83075 Policy Note September 2013 TRADE DEVELOPMENT Improving trade competitiveness: Cambodian garment exports Significance Garments are Cambodia’s largest export and constitute the bulk of its manufacturing sector. More people are employed in the garment sector than any other industrial sector in Cambodia and, as a result, Cambodia’s rapid growth in attracting garment factories has led to rapid progress in the alleviation of poverty. Although the industry has been successful in linking Cambodia to regional production networks stretching from Taiwan to Indonesia, the type of cut-make-trim activities carried out in Cambodia typically add little value to exports, implying that Cambodia could increase its share of this industry by adopting more sophistication into garment processing. Cambodia’s challenge is to solidify its industrial expansion by encouraging sophisticated forms of garment manufacturing and to use the garment sector as a means of attracting diversified industries outside the garment sector to establish manufacturing activities in the country. The World Bank published a Transport and Trade Facilitation Assessment (TTFA) report in 2013, designed as a snapshot of a country’s trading environment, viewed from the perspective of four key industries, including the garments industry. The report dissects the inputs and outputs of the sector by analyzing how the inputs arrive at the processing plant and are then exported. Each step of the value chain is examined for logistical issues. The analysis and recommendations are designed to provide an overview of logistics issues that affect the private sector, and to assist the Government in implementing its garments policy. Background Export growth has been achieved through an increase in foreign investment, which led in turn to rapid growth in Cambodia’s export-led growth strategy has paid off in the number of factories and associated employment. terms of GDP growth, employment and poverty reduction, The majority of garment factories in Cambodia are owned with garments accounting for some 80 percent of export by investors from Taiwan, China, and Hong Kong. The revenues. The industry has tripled its share in the global average level of employment per factory is about 1,100 market place over that period, but it still faces constraints employees, while the larger firms employ between 6,000 in its ability to lead Cambodia’s growth up the value chain, and 9,000. The social welfare benefits thus rest in the or towards more sophisticated export product diversity. hands of foreign investors. This poses questions on the benefits and limitations of the current industry structure. Trade and Markets Figure 1: Cambodian Garment Exports Source: GMAC, 2011 The potential instability of Cambodia’s reliance on foreign 80% 3.5 investment in the garment industry was illustrated in the 75% 3.0 financial crisis of 2008. The contraction brought a halt to new investments. The fast pace of recovery since 2010, Share of Exports Value US$ billions 70% 2.5 65% 2.0 however, has allowed exports to return to pre-crisis levels, although employment, the number of factories and the 60% 1.5 management structure have remained relatively unchanged. 55% 1.0 Recently, there has been renewed interest from foreign 50% 0.5 investors in relocating garment factories to Cambodia 45% 0.0 and a number of proposals for investment are awaiting 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 government approval. 1 Policy Note Trade Development Cambodia serves a relatively small number of markets are generally small operations. The basic nature of this work with a limited number of products. The principal export and the claustrophobic management structure, in which destination is North America followed by the EU. ASEAN all decisions for the factories are made offshore, contribute accounts for less than 1 percent of garment exports, most little to Cambodia’s ability to move up the value chain. of which is rag trade sent to Singapore, presumably for re-export. The concentration on markets in the US and EU Vendor factories have the advantage of scale through their has been encouraged by preferential access agreements, relation with the parent company, which provides access to such as the EU’s Everything-But-Arms (EBA) initiative. finance, regional suppliers and global markets. This gives them a distinct advantage over the smaller, locally-owned Figure 2: Cambodian Garment Export Destinations 2010 Source: factories, which produce only for the domestic market and GMAC, 2011 sub-contract to larger producers. This may be a reason why locally-owned factories comprise just 6 percent of the 7% garment manufacturing sector. 2% US Supply Chain Canada 28% The TTFA approach looks at the upstream and downstream EU-27 supply chain. To that end, the supplier and buyer relationships Japan 55% are seen as crucial factors in analysing the garment sector. Other 8% Supply Chain Performance Despite continued growth, the apparel industry in Cambodia faces a number of challenges. The immediate concerns are Business Models the rising cost of production due to increasing wages and the high cost of energy. While the value of exports is The type of factory ownership may have an impact on expected to grow in the short term as more factories are Cambodia’s ability to move up the garment value chain, as established, this industry may become increasingly vulnerable the current structure limits growth in knowledge spillovers unless changes in the structure and management of factories from foreign experts into the broader economy. Most of take place. At the present time, most factories have minimal the foreign-owned firms are vendor factories. Their parent investments in fixed assets and can easily relocate if companies operate as Original Equipment Manufacturers operating costs are no longer competitive. The main challenge (OEM), sourcing the inputs used by their factories and, in is to solidify the foreign investment in this sector, perhaps some cases, as Original Design Manufacturers (ODM) by fostering the span of control of local factories. providing the designs for the goods produced in their factories. Therefore, the factories located in Cambodia In the medium term, the industry needs to move away from tend to be tightly controlled by offshore owners, with very basic apparel, because of strong competition from larger little room for local initiative or entrepreneurship. exporters, such as Vietnam, Bangladesh, China and India, that can offer economies of scale. If it is to compete for The parent company distributes orders among factories the production of higher-value goods, the industry needs that it owns across several countries, including Cambodia, to become more efficient, primarily by improving the according to their available capacity, unit production costs, performance of its inbound and outbound supply chains. and required skill level. It then arranges delivery of the inputs to the factory according to the buyers’ requests. The factory The major challenge for the factories is to retain skilled has little ability to attract orders or identify markets into labor and secure adequate energy supplies. Logistics is which it could expand. not considered a major problem, although the high cost for land transport and difficulties with submission of various Most of the contract manufacturers are foreign-owned shipping documents and with clearing the cargoes are but operate as independent enterprises providing Cut, among the concerns mentioned by factory managers. Make, Trim (CMT) / Assembly services. Some take orders from buyers who provide the designs and specify the Customs declarations can be submitted electronically for inputs; others operate as OEMs, assuming responsibility imports but hardcopies must be submitted together for sourcing inputs and preparing samples for approval with supporting documents, which is seen as inefficient. by the buyer. A few factories operate as ODMs, but these A Report of Finding from the PSI is required for imports 2 Policy Note Trade Development worth more than US$4,000. Clearance may be delayed if customs officials are unavailable for processing. An import Implementation license may be required for specific commodities. Cambodia may benefit from a strategic vision for the The application for import permits should take only one industry. Priority should be given to developing a vision of day but, in practice, can require three to four days. Finally, how to achieve the growth objectives mentioned above. This the level of inspection remains high. requires a coordinated effort involving the Government and private sector. It also requires an assessment of the market For exports, the major source of delay is associated with opportunities. Most of the management decisions are made the issue of the certificate of origin (CO), which can only outside Cambodia, with the result that the domestic industry be issued after shipment and can require 5-10 days. This lacks a consensus on the need for diversifying its products delays the transfer of documents to the buyer and payments and markets, increasing the quality of its products and/or to the exporter adding value within Cambodia. There are a variety of markets for higher-value garments International Competitiveness that Cambodia might consider, such as fashion basics, small brands and speciality garments. Each has slightly different The recent upward pressure on wages of Cambodian requirement in terms of supply chain performance. While workers is creating a problem for Cambodia’s garment individual firms will continue to choose their markets, there manufacturers, who compete primarily on price. There is is an advantage to selecting a target market for the garment greater competition from China, which has reasserted industry, especially for the contract manufacturers. This itself in the low end of the market. Also, opportunities for would allow for a coordinated effort in developing the reducing the order cycle are limited, since about 70 percent logistics and other capabilities that will provide a competitive of the order cycle is taken up by delivery of inputs and advantage for that target market. international shipping of exports. Most of the markets for higher-value garments will require For Cambodian manufacturers to provide more value- a reduction in the order cycle times of up to 4 months. addition, however, access to credit for garment factories Efforts to reduce the order cycle to 2-3 months would that have been incorporated locally or that wish to evolve require a tightening of the inbound supply chain, primarily to become ODMs may need to be facilitated. For the through improvements in the trade corridor linking Phnom same reason there is less concern about foreign exchange Penh with the international container terminals near Ho risk, in addition to the fact that there are few restrictions Chi Minh. Current efforts to finalize the transit agreement on foreign currency transactions in Cambodia. with Vietnam and to introduce simplified procedures for the movement of goods in transit should ensure reliable connections to scheduled container shipping services. Objectives and Strategies For Asian trade the savings in the transit time to Asian The objective for the industry is to sustain growth in the value sources of fabric and to customers in Japan, South Korea of exports and thereby continue its contribution to economic and Taiwan should be 1-2 weeks, while for the European growth. The strategy for accomplishing this objective must trade it would be 2-3 weeks. have separate components for vendor factories and contract manufacturers. Additional savings in transit time can be achieved through improvements in trade facilitation that are needed to reduce For vendor factories, logistics need to be improved to reduce the clearance times for both imported fabrics and exported time and cost for the inbound and outbound supply chains, garments. These would build on the current Customs and to address shortages of labor and power. It is also Reform and Modernization program, but target the border important to facilitate foreign investments that will produce crossing at Bavet and the Phnom Penh port, and focus higher-value garments, and open new markets, while also on the other border agencies, especially CamControl. providing access to credit for local manufacturers. In addition to developing a single window for processing For contract manufacturers, the improvements in logistics documents, greater use of risk management can reduce should be complemented with improvements in the supply the amount of physical inspections, expedited testing chains. There is also need for technical and financial support procedures, less direct interaction between shippers and for the transition from CMT/Assembly operations to OEMs, regulators and better control on hours of operations. so as to compete effectively with vendor factories. 3 Policy Note Trade Development Another opportunity for reducing the order cycle is without restrictions on location or the activities they can improving the management of the inbound supply chains. pursue. To be successful, any new clusters should be This applies primarily to contract manufacturers since designed jointly by the Government and GMAC and offer the vendor factories already have tight control over their the same advantage. supply of inputs. Local contract manufacturers rely on retained earnings In order to create an environment that is attractive to foreign for working capital and limit their investments in new investors, Cambodia needs to develop garment clusters equipment. However, if they are to improve their control that can accommodate bonded factories, offer reliable over the supply chains and produce higher-value goods utilities and logistics services, provide access to a large with more costly inputs, then it is necessary to create labor pool and attract supporting industries. An extensive financial instruments specifically for this sector. network of special economic zones exists, but only three have had any success and these have a random collection of enterprises. Even with the development of clusters and better access to capital, the contract manufacturers need to develop Currently, most garment manufacturers prefer to operate knowledge-based competencies, and training activities in outside of the zone near Phnom Penh or in Kandal Province the areas of sourcing fabrics, supply chain management, because they have the same ability to import fabric under lean retailing, managing financial risk and human resource temporary admission and set up bonded storage but development need to be expanded in both scope and scale. Recommendations Encourage contract manufacturers in particular to engage in collective ordering of inputs in order to benefit from 1.  economies of scale and reduce costs. Incentivize garment manufacturers to move up the value chain from production of basic apparel, which is increasingly 2.  crowded, to producing niche higher value items. Improve the performance of the trade corridors to ports in Vietnam which have more frequent vessels calls with 3.  direct shipping that would significantly reduce sailing times and so order cycle times. Develop garment clusters that offer reliable utilities and logistics services, access to a large pool of labor, credit and 4.  support services, in order to attract more FDI. 5. Streamline and expedite the issuance of certificates of origin, and reduce renewal costs. The World Bank Office For further information, Funding for the Trade Related please contact: Assistance Cambodia Multi-Donor No. 113 Norodom Blvd. Phnom Penh - Cambodia Trust Fund from the EU, DANIDA and Tel: (855 23) 861 300 Julian Clarke UNIDO is gratefully acknowledged Fax: (855 23) 861 301/302 Senior Trade Specialist Visit our website: (jclarke1@worldbank.org) http://www.worldbank.org/cambodia Vannara Sok This note reflects the views of the authors and not Operations Officer necessarily those of the World Bank and the donors. (vsok@worldbank.org)