The World’s Fragile State and What It Means for Fashion

If any questions remained as to how interconnected the global economy has become, 2022 provided clear answers. By the end of the year, few economies were spared from the effects of escalations in everything from inflation to global supply chain meltdowns to heightened geopolitical tensions, all amid a worsening climate crisis that has contributed to unprecedented environmental events, from droughts to floods to heat waves. None of this looks likely to disappear entirely in 2023.

The impact on the global economy is already evident: the strong GDP growth of 6.1 percent recorded in 2021 will likely slip below 3 percent in 2022 and to approximately 2.5 percent in 2023. The uncertainty around these outcomes remains very high, reflecting the ongoing volatility of the global economy.

In the year ahead, business planning across the fashion industry must reflect this new state of fragility. In this environment, scenario and contingency planning becomes even more critical as companies must understand whether the range of potential outcomes will require tactical changes in their operating plans in the next one to two years to mitigate risks and seize hidden opportunities. Business leaders must ask whether this potential range of outcomes changes their view on the fashion industry market segments within which they operate and what their medium- and long-term strategies should be.

Shocks Spill Over into 2023

Several events in 2022 will continue to shape 2023. Russia’s invasion of Ukraine has first and foremost created a humanitarian crisis. It has also severely disrupted global commodity markets, catapulting Europe into a severe energy squeeze and causing many developed and developing economies to struggle with significantly high prices for basic food imports. In Germany, the euro zone’s largest economy, the annual increase of food prices reached close to 15 percent in July and energy costs are expected to triple from 2023, shrinking consumers’ budgets for discretionary goods like fashion.

By contrast, the financial boost from gas and oil exports is evident in countries such as Saudi Arabia, where the economy is expected to grow at its fastest pace in a decade in 2022 with GDP expanding by 7.6 percent, creating opportunities for the fashion industry.

While Covid-19 has mostly faded from news headlines in some countries, it continues to cause a significant health and economic impact in others. Nevertheless, during 2022 most governments rolled back Covid-19 public health restrictions as well as pandemic-related household and business aid packages, from tax and other relief for US households to cash handouts in Japan to loan guarantees in South Africa. China is a notable exception; new Covid-19 variants and outbreaks are being met with strict lockdown periods that continue to raise concerns about the country’s growth trajectory in the short term.

In the US and Europe, the effects of inflation are already apparent in fashion. Prices for apparel for sale online across the US, UK, France, Italy and Spain increased 22 percent between July and October 2022 compared to between March and June 2022. Price hikes are expected to continue into 2023 as brands pass on increased costs to customers. Inflation could impact fashion companies in other ways, including higher costs of borrowing, potentially causing planned investments or growth strategies to be delayed or scaled back.

To help curb inflation, the US Federal Reserve, the European Central Bank and other central banks have been aggressively raising interest rates — after negative or ultra-low levels for several years in many countries — bringing what Jerome Powell, head of the US Federal Reserve, described as further “pain to households and businesses” as part of the “unfortunate costs of reducing inflation.”

Here too, China is an exception; a slowing property market in the country prompted the People’s Bank of China to lower key interest rates in August 2022 after total credit extended to the economy hit record lows in the previous month.

In the US, many economy watchers believe that a recession is increasingly likely in 2023, while the Bank of England warned in September 2022 that Britain’s economy may already be in recession, following forecasts of GDP contraction over two consecutive quarters. In other parts of the world, a different pattern is emerging: According to the World Bank, growth in major East Asian and Pacific economies is projected to be higher and inflation lower than in the rest of the world, due in part to sustained global demand for exports of manufactured goods.

These and other global shifts are impacting currency markets. During the summer months in Europe, the euro fell below parity with the US dollar, its lowest level in 20 years, while in September the British pound hit a record low against the US currency. Meanwhile, the Japanese yen hit its 24-year low against the dollar. Currency headwinds are weighing on global businesses. With the US dollar widely considered to be a premier currency for international trade, many companies around the world are having to adjust their performance outlooks.

To be sure, currency fluctuations are also creating opportunities for international companies operating in the US, or countries with currencies pegged to the dollar, by artificially increasing their revenue when converting back to their home currency.

Consumer Caution

Consumers are facing higher prices on multiple fronts, from groceries to petrol, straining household budgets and impacting consumer confidence. In a summer 2022 McKinsey survey, US consumers reported they were twice as pessimistic about the economy than during the prior two years. In Europe, consumers cited rising prices, the war in Ukraine and extreme weather events as the top reasons weighing down their sentiment, according to another McKinsey survey from the summer, with respondents predicting they would make the biggest cuts in spending on apparel, footwear, and accessories and jewellery. In China, continued Covid outbreaks have dampened consumer spending, as illustrated by the Golden Week holiday in October 2022, when consumer spending was down 26 percent year on year, the lowest level since 2014 and less than half of 2019′s spending.

Many shoppers are becoming more cautious about their discretionary purchases, indicating that the surge in spending on apparel and other segments following the height of the pandemic is reaching an end, if it has not already ended. According to the BoF-McKinsey State of Fashion 2023 Survey, 45 percent of fashion executives expect to update their assortment mix to adapt to lower consumer purchasing power, while 72 percent plan to increase retail prices to help their companies manage the inflationary environment.

Consumer behaviour could turn suddenly, again, from cautious to confident if economic signals brighten. However, brands should remain flexible to respond to a potential, and sudden, release of pent-up shopping demand and uneven patterns emerging across different markets. Brands should also anticipate the fragility of these changes. While high-income households will be most likely to continue shopping in 2023, given their relatively healthier financial foundations, even they may prioritise saving over spending out of caution.

Plan and Pivot

The fashion industry weathered unprecedented challenges in recent years, and 2023 will test its resilience yet again, albeit with some categories entering the year in a stronger position than others. According to McKinsey analysis of publicly listed companies, the luxury segment’s top-line grew 27 percent in the first half of 2022, compared to the same period in 2021, while luxury groups like LVMH and Kering reported double-digit growth for the first nine months of 2022 and have increased their revenue projections. If the impact of inflation follows that of prior slowdowns and predominantly effects lower- and middle-income consumers, industry analysts expect the luxury category to be more resilient than the rest of the fashion market.

Even so, companies’ scenario planning during the year ahead must sufficiently capture the increased levels of uncertainty, with contingency programmes under varying scenarios clearly mapped out. Fashion leaders will need to prepare for a number of economic and political outcomes. Some of fashion’s more challenging scenarios may play out in the developing world, where local conflicts in manufacturing hubs can escalate and impact industry practices. For example, the 2021 coup in Myanmar is among the factors that have left the country highly vulnerable to conflict or collapse, according to annual research from think-tank Fund for Peace.

At the same time, trade wars and sanctions can limit access to raw materials and energy sources while obstructing supply chains. Severe floods in Pakistan and Brazil as well as extreme temperatures in India in 2022 show how climate disruptions can hinder both raw material production and manufacturing operations that are critical to the fashion industry. Similarly, new Covid-19 restrictions imposed in China that impacted factories and ports in 2022 demonstrated the industry’s reliance on the country as a manufacturing hub.

When considering scenarios for key markets, brands should hone their flexibility, agility and speed to balance the realities of short-term crises with long-term strategic priorities. Key projects, like investments in digitisation advancement and the reduction of environmental impact, should not be abandoned.

The ultimate aim for fashion leaders will be to build resiliency, which will require a renewed focus on profitability. Before the pandemic, the industry experienced a period of high growth, during which many brands focused on their top lines and building market share. Funding was cheap and accessible, boosted by inexpensive debt and eager investors. In the year ahead, investors are expected to be more cautious, showing a high, if not singular, preference for businesses with robust margins. Brands with weaker margins or market positions, such as mid-market brands, will be particularly vulnerable. A focus on the bottom line in this inflationary climate will require difficult trade-offs between, for example, capping salaries or investing in pay rises to retain key employees in a competitive job market.

Growing profitability will entail multiple actions, including learning how to better manage unpredictable consumer patterns while staying ahead of supply and demand pressures. Companies that had wanted to avoid supply chain disruptions ahead of the downturn by placing advanced orders are now facing record inventory levels and will likely need to discount substantially to clear stock. Creating greater flexibility across inventory management systems will help minimise such challenges. For example, technology can help with re-routing supply to low-congestion ports and shipping lanes to reduce the time goods are in transit or by optimising the assortment mix between season-agnostic and seasonal products. Fashion leaders must also monitor capital efficiency with granularity to be able to re-allocate resources as needed.

Having a resilience mindset will be non-negotiable in 2023. For fashion executives, this will require putting contingency planning centre stage and embedding clear accountability for business performance throughout every part of their organisations. By taking an all-hands-on-deck approach, leaders can strengthen their companies’ positions to flourish even amid global volatility and economic uncertainty.

This article first appeared in The State of Fashion 2023, an in-depth report on the global fashion industry, co-published by BoF and McKinsey & Company.