Kwality and Protekt
Andrew Strauss, Chief Marketing Officer at Kwality Knitwear, Inc. (Kwality), explained in September 2006 why his company had decided to explore the introduction of a branded line of insect repellent clothing. “We’ve got to improve gross margins,” he said, “and this looks like the most expedient way to do it.” Kwality’s problem with gross margins was that its private label or unbranded knitwear had no branded recognition among retail customers, which sharply limited the opportunity to differentiate its products. The company’s executives believed this led to substantially lower gross margins than those enjoyed by leading branded product manufacturers—currently 18% versus 30% to 40%. Kwality had recently succeeded in shrinking that gap, but not enough to suit an increasingly growth-hungry board. Kwality had been investigating the launch of a line of insect repellent shirts through a partnership with chemical firm Protekt, Inc. (Protekt). Strauss, along with CEO Robert Ortiz and CFO Sandra Chong, were in the late stages of evaluating a preliminary marketing program and estimating demand for the new line. If their analysis showed that demand for this higher-margin line would be robust enough to surpass break-even, Ortiz wanted to announce the new line at Kwality’s analysts’ conference call in late October.
Kwality Knitwear and Its Markets
Kwality Knitwear, a publicly traded company headquartered in Miami, Florida, was established in 1995 as a manufacturer and distributor of unbranded casual knit apparel (T-shirts, sport shirts, sweatshirts, fleeces, etc.). Some casual knitwear was expensive and carried prestigious fashion labels (e.g., Ralph Lauren, DKNY). Kwality did not operate in this category; it operated in the $24.5 billion category of non-fashion casual knitwear. Kwality reported 2005 revenues of $550 million (see Exhibit 1 for a summary income statement). All of Kwality’s revenues were earned on U.S. sales; CEO Ortiz perceived too much risk in foreign markets. Wholesalers comprised 75%, or $413 million, of Kwality’s revenues. These wholesalers sold, in turn, to screen-print channels—companies that customized t-shirts and other knitwear with logos of everything from rock bands to small businesses to tourist destinations. Kwality had concentrated on this segment of casual knitwear because Ortiz and Chong believed it offered faster growth potential than ordinary retail. Screen-print industry shipments to wholesalers exceeded 80 million dozens1 in 2005, representing roughly $2.5 billion in factory sales (over and above the non-fashion knitwear retail sector). Most industry analysts believed Kwality was the #2 player in this sector, with 16.5% market share. The other 25% of Kwality’s revenues came from knitwear sold through mass retail channels as private label merchandise, which typically carried the name of the retailer or of some in-house “brand” the retailer had invented. Just two retail customers—Wal-Mart and Dollar General— accounted for 57% of revenues in this category. The non-screenprint portion of the non-fashion casual knitwear market had 2005 U.S. revenues of $22 billion. Branded product (e.g., James Brands) accounted for $10 billion, and private-label $12 billion; Kwality, with $137 million, had slightly more than 1% of the private-label sector. Kwality had achieved low production costs through the establishment in 2004 of a state-of-the-art offshore production hub in the Dominican Republic. Combined with the economies of scale from high-volume, low-SKU2 production runs (that is, large runs of a small number of distinct products), Kwality enjoyed a moderate cost advantage over other U.S. producers. Although a number of competitors had migrated many of their production facilities overseas, the higher complexity and SKU count of their production runs—sometimes constrained further by the use of dated legacy equipment—made it difficult for others to replicate Kwality’s model. Still, Kwality...