Reference no: EM13850581

Leatherine Inc.

35-year old Ennio Fellini is the proud CEO of Leatherine Inc., an Italian, family-owned, Naples-based company employing 500 employees and supplying top quality leather to high-end European brands of handbags and shoes.

From a five-men operation set up three-quarter of a century ago, Leatherine has slowly but steadily grown into a low-cost, high profit margin global leather powerhouse that most industry observers rank among the world's top three leather suppliers, not a small feat considering that the field is crowded with more than 30 small, medium and large competitors.

Leatherine produces three types of leather (top-grain, corrected-grain, and split leather) that are then further transformed (through a process called "tanning") to improve their strength, their suppleness/pliability, their resistance to stain and/or their colour-retaining ability. Leatherine's product line is extensive and uses hide from a variety of animals (cows, pigs, goats, etc...) to meet the differing requirements of its many clients who are either seeking various grades of leather or looking for leather made from different animals to cater to the expectations of various cultures (Hindus, for instance, avoid cow-skin made leather and Muslims do not wear pig-skin leather).

Ennio might be rightfully proud of the company founded by his great grandfather but he is also very concerned about the wisdom of perpetuating family business traditions in the face of mounting local, regional and, increasingly, global competitive pressures. Furthermore, as if these competitive pressures were not enough, a multiplicity of somewhat recent developments in the external environment seem to all conjure up against Leatherine's currently dominant market position.

For one, Ennio read about but also personally noticed a growing trend among younger consumers from developed economies towards eating more fruits and vegetables while consuming less or staying completely away from meat. A vegetarian himself, Ennio understood the health benefits of such a diet but that consumer preference shift had indirectly affected the supply of cattle hide, the base material from which most leather was produced. As a result, the cost of hide had shot up and with it, Leatherine's profitability took a nosedive.

To compound the problem, animal-derived product manufacturers such as Leatherine were increasingly facing the wrath of animal rights activists who regularly came out in the media to denounce animal slaughter to satisfy the vanity of the clients of the luxury good industry, Leatherine's main leather buyers.

The collective conscience of the developed societies had also lead to the creation of synthetic leathers such as vegan leather and pleather, two very close substitutes to natural leather that were not only more eco-friendly but that were then perceived to be stronger and more resistant to staining than their natural counterpart. Again, the preference for or acceptance of synthetic or natural leather seems to be generation-dependent: the older consumers prefer natural leather but the younger ones seem to be more willing to buy synthetic leather products.

For a while, Leatherine did consider the option of setting up its own artificial leather facility but Ennio eventually decided against the idea for two main reasons. Firstly, he realised that the market was already dominated by well-established China-based manufacturers. And secondly, the top luxury good brands were still very adamant about natural leather as their designers demanded it, saying that it was much easier to create innovative handbags and shoe designs using natural leather, and also because their marketing research team stressed rather emphatically that the more affluent luxury brand consumers preferred the feel and demanded the assurance of natural leather that they perceived to be far superior to artificial or synthetic leather-based articles.

As if these were issues not challenging enough, Leatherine has also had to abide by European Union legislation aimed at curbing the excesses of major polluters, among which the leather industry that the world's media fingered as one of the main culprits. For that reason, in the last five years, Leatherine had to invest heavily in leather transformation and post-production cleaning processes and equipment to diminish the impact that the company's operations had on the environment, namely the pollution of the air and of the rivers nearby. Needless to say, the recurring anti-pollution expenses had a significant impact on the company's production costs, already inflated by lower cow hide supplies.

While this investment did initially ensure that Leatherine met EU clean environment legislation, it suddenly became insufficient when, six months ago, the European Union strengthened its anti-pollution regulations against, among others, the leather tanning pollutants, giving the latter a 3-year period to comply.

After reading the details of the additional investments that would be needed to ensure the company's compliance with these new regulations, Ennio knew that Leatherine's production costs would further increase, a situation that would force the company to either accept lower profit margins or, if Ennio decided to pass the additional costs to its industrial clients, lose market share to rivals whose production facilities were located outside of the EU.

Speaking of the competition: Leatherine's sales had been steadily going down in the last three years because it was no longer cost-competitive when compared to the other two top leather manufacturers who invested early to modernise their production facilities or relocated them to low-cost countries such as India or North Africa or even outsourced part of or their entire production to China. Furthermore, synthetic leather, a type of leather that is more ecological because it does not involve killing animals for their hide, had made serious strides in the market as its quality, appearance and durability had gradually become more and more indistinguishable from the natural leather.

The declining sales figures were not just attributable to competitive pressures however: the economies of Europe and North America had gone through rather sluggish quarters in the last three years, leading to increasing unemployment rate and depressing leather good sales as end consumers had become more price conscious than during more prosperous years. To not only address its high-cost problem but to also circumvent the EU anti-pollution regulations, Ennio had decided to move all of Leatherine's production facilities abroad.

At this point, he had narrowed down the choice of possible relocation destinations to three countries: Morocco in North Africa, a country well known for its leather manufacturing expertise and low production costs, India which is the one of the world's largest exporter of leather and China, a relatively new entrant in the leather production industry but already the world's lowest-cost production leader.

When it comes to that new location abroad, Ennio's main concerns were as follows:

• to at least match the quality standards that its Naples-based operations have so far reached. This is by far the most important criteria that must absolutely be met, since Leatherine's reputation and market standing have been built on quality and its customers, the top luxury brands, demand no less than the best of the best leather.
• to lower its production cost by at least 50% while maintaining the quality discussed in the previous point; this is necessary to ensure that Leatherine regains the price-quality ratio leadership that it has held for the last decade.
• the new location must not be too strict on pollution controls. On that point, Ennio is willing to accept a location with pollution regulations but he wants to be able to "buy" the right to pollute by either paying an affordable fine, even if it is recurring, or bribe the local officials for them to turn a blind eye. One thing is for sure: if the foreign country's legislation is as unforgiving as the EU laws are on polluting industries, Ennio is not interested in setting up its production facilities over there.

On the first point, Fabio, Leatherine's VP of Operations advised Ennio that Morrocco would top the other two locations, followed by China and then India. On the second point, China was the clear winner, followed by India and then Morrocco and on the third point, India was the more "forgiving" of the three destinations, followed by Morrocco and then China.

Sitting down at his desk and looking out of the window, Ennio knew that the next couple of years would be critical to Leatherine's long-term success. The decision was not easy for a young CEO like Ennio who, in the past, never had to decide on his company's operations relocation options. Although not totally sure that he had considered all possible options or all the criteria for a good relocation, Ennio picked up the phone and called his VP of Operations:

"Fabio? Could you come to my office now? I have made my decision about our offshoring. Let's get this moving."