Beyond guesstimation: negotiating fair and transparent FOB prices

FOB - free on board - is the technical term for the moment when goods are loaded onto a ship or a plane for delivery to a buyer. It is also the point at which ownership transfers from the manufacturer to the brand or retailer who bought them. Over the last two decades this innocuous trade term has become an epithet uttered with increasing distaste and venom by manufacturers, and the further down the supply chain you go, the greater the distaste. Why?

The FOB price is “agreed” between the buyer and the manufacturer before the latter orders materials and sets workers and machines to work. That makes sense. No brand or retailer is going to say “Make me 50,000 t-shirts and tell me how much they cost”. No, that would be an invitation to inefficiency and cost overruns. So how do they do it?

The scientific way would be for one of them to cost every unit of material, energy, water, labor etc that goes into manufacturing the t-shirts, but that is a complex and time consuming costing exercise and worse, the other party would not trust the numbers. Many players in the apparel game do not even have the skills set to come up with such a detailed costing and it would be extremely difficult for the buyer to do it since they do not know enough about the local costs the manufacturer will incur.

So, simple solution - the buyer takes a guess. Well not a complete guess. The buyer talks to other people in the business, tries to get a feel for local conditions and then tries to figure out what the market will bear. That is proposed to the manufacturer, or sometimes imposed on the manufacturer, and after a little haggling the production cycle gets underway.

The problem is that there are so many manufactures competing for the business of relatively few brands and retailers that the haggling takes place on very unequal terms and covers not only the FOB price but the delivery date. Since the manufacturer has not calculated exactly how many minutes it will take each worker to perform the separate activities that go into making the t-shirt, multiplied by 50,000, he/she really does not know what a realistic delivery date would be. But the brand or retailer knows when they need the t-shirts on the shelf so they set the date and that's it.

Manufacturers tell me that both the FOB price and the shipping date regularly turn out to be totally unrealistic, either because they were guesses or because things did not work out as planned and delays crept into the production cycle. Maybe materials were delivered late, maybe the manufacturer couldn’t hire enough extra workers in time, maybe the monsoon rains were heavier than usual and the factory flooded, maybe warring political parties called tit-for-tat stay-aways. And maybe the manufacturer just did not organize production well enough.

Whatever the cause of the delay, the shipment must be made on time or the manufacturer faces heavy financial penalties and may not get future orders. So manufacturers will work their facilities day and night if need be to make the shipment date. Since the FOB price has already been set, they cannot afford to pay the overtime premiums for all the extra hours worked so workers get cheated. All because the FOB price and delivery date were based on guesswork.

Some manufacturers do know how to do accurate costing and production scheduling and thanks to years of experience they know how to factor in the unforeseen problems that may provoke delays. The problem is that the buyer does not want to hear about them. Instead, the buyer unilaterally presents a take-it-or-leave it number and refuses to explain how they arrived at it. Some well established manufacturers refuse to accept such “negotiations” because they know the buyer's number is unrealistic and that the process will end badly, but such manufacturers are rare. Most are too uncertain about the future to refuse an order and risk offending a buyer. 

So how could this systemic flaw be addressed? Responsible buyers need to engage with manufacturers on the costing and scheduling to make sure that it is complete and realistic. For example, does the labor cost include all the wages and benefits and overtime premiums for all the days workers are likely to work? Once the buyer has tested the assumptions and calculations of the manufacturer they can agree on a price and delivery date that everyone can live with and that will not necessitate wage and hour violations just to finish on time. Sure, this will take a little more time and effort on the part of both buyer and manufacturer and maybe a little training for one or both of them but in the end it will produce a more efficient, and more ethical, supply chain.

 Auret van Heerden is a colleague of the Center and former president of the Fair Labor Association.