Brunello Cucinelli - A Study of the Cashmere Supply Chain
June 6, 2023
I like to study the building blocks of companies and industries. It's easy to get drawn into a company's products or services without understanding the nuts and bolts that go into making them. Studying supply chains and manufacturing are a great way to improve our understanding of a business, to find potential danger zones, and to deepen conviction.
One area I’ve been studying is cashmere, which is part of a broader exploration of luxury fashion and apparel companies. I've been a consumer of cashmere clothing over the years, but I never appreciated the evolution of the supply chain until now.
Recurve is invested in Brunello Cucinelli, a company whose heritage began with cashmere sweaters and has grown into a global ready-to-wear luxury apparel and accessories brand.
I've read through an assortment of academic research papers and articles on cashmere, I've talked to industry experts on this topic, and I've watched a number of videos which have been very informative. Below I summarize some of my learnings.
Let's start at the top, with the source: goats.
Source: PETA
Goats
Cashmere comes from cashmere goats (the Capra Hircus Laniger) which have two types of hair: a coarse outer coat, and a soft undercoat of wool. The coarse outer coat is present all year, while the soft undercoat thickens and grows as the days get colder. The soft undercoat is harvested by hand using a comb that collects the fine hairs of the inner coat from the fully shorn fleece. The total yield of soft undercoat is small - a single cashmere goat produces only about four ounces of cashmere fiber, meaning one sweater is the product of 4-8 cashmere goats.
Cashmere goats mainly live in the Mongolian steppes and the Gobi desert, where temperatures can drop to -40°C. The colder it gets, the more they grow their soft undercoat. Mongolia and Inner Mongolia (part of China) are the primary areas for goat farming and herding, and are responsible for producing 90% of global cashmere.
Cashmere's widespread popularity has increased demand and supply, but it also has created new environmental challenges for its main production centers. For example, Mongolia's exports of raw cashmere increased about 3x from 2008 to 2018. To accommodate significant cashmere export growth, farmers allowed their goat populations to swell. However, the gradual warming of the climate has reduced the short hair yield per goat, thereby requiring more goats to produce the same volume of cashmere (unfortunately, global warming has impacted Mongolia more than average, with temperatures rising over 2°C since 1940, nearly 3x the global average over the same period). Between lower yields and rapidly increasing demand, the exploding population of cashmere goats has had significant negative impacts on the pasture lands because cashmere goats dig up and eat whole plants, including the roots. Healthy pasture lands become desert. The fragmented nature of the industry, with hundreds of thousands of farmers producing cashmere, makes it difficult to properly manage and optimize the region's natural resources and herds.
The short hair from cashmere goats tends to be around 14 microns thick, can range from 12 to 30 microns depending on the grade. This compares to ultra-rare vicuña at 12 microns and widely available merino wool at 15-25 microns thick. (for reference, a human hair is 100 microns). Cashmere is finer, stronger, lighter and softer than wool, and it is three times more insulating than merino wool.
Turning Cashmere into Clothing and the Investor's Angle
Cashmere is most often exported in raw form to countries that convert it to end products, like sweaters (50% of cashmere is used to make sweaters). Loro Piana is an exclusive fashion brand, but it is also one of the largest and most significant textile companies for high-end fabrics like cashmere, vicuña, wool, and more. Companies like Loro Piana import raw cashmere and spool it into yarns and fabrics that can be used by clothing makers. While there is an active marketplace for these raw materials, Loro Piana, Zegna, Cariaggi, and others expend significant effort to secure supply for their current and future needs. On one extreme, Loro Piana has partnered with Peru and Argentina to secure exclusive vicuña export rights from those countries. Most major luxury clothing makers and/or suppliers have invested locally in their source countries to ensure they get a steady stream of supply at the quality standards their customers expect.
Because they are both thin and short, ultra-fine raw materials like baby cashmere and vicuña are difficult to weave and require engineering capabilities that most mass-market textile companies do not possess. Even armed with the best raw material, they would create worse fabrics without the right technical equipment and knowhow. Only a handful of companies have the ability to consistently source the best raw material and engineer it into the luxury-grade textiles and end products.
There is no doubt that fine fabrics command "luxury" price points due to their superior feel, comfort, and insulating properties. However, learning about the cashmere supply chain (and other fine fabrics) has made me appreciate how much manual labor goes into procuring enough material to make even one garment. For instance, as mentioned above, four to eight cashmere goats are needed to make one sweater, while one sheep's fleece can yield up to three sweaters. It's no wonder why cashmere prices are so much higher than their wool equivalents.
Now, let's run some quick math to understand the profitability. Let's say one sweater requires one pound of cashmere. Cashmere's market price fluctuates in the $150/kg range, plus or minus $30-40, so the one sweater might have a material cost of $68 for one pound. Loro Piana sells the below men's cashmere sweater for $1,700.
Source: Loro Piana
If Loro Piana paid market prices at every step (for cashmere, transportation costs, import duties, design, manufacturing and labor), I would estimate their costs on this sweater are likely below $250, meaning they make an 85% gross margin on the sweater itself. Obviously, luxury apparel is an incredible business. Now, let's turn our attention to Brunello Cucinelli. Below we can see a similar pricing dynamic - a cashmere hoodie costs $2,095. Brunello's product gross margins are in the 80-90% range, consistent with the product-level profitability estimated above for Loro Piana.
Source: Brunello Cucinelli
Most large luxury players vertically integrate into certain key parts of the supply chain which secures supply and saves them money in high-volume parts of their supply chain. In Loro Piana's case, it also gives the broader LVMH group efficient, predictable and exclusive access to some of the world's finest fabrics.
Recently, Cariaggi, an important Italian cashmere and fabric manufacturer, has entered in a transaction whereby Brunello Cucinelli and Chanel will both own 24.5% and the Cariaggi shareholders will retain 51%. This is yet another example of luxury companies expanding their reach into the supply chain to ensure favorable and consistent product supply. Luxury products require exceptional product sourcing, skilled artisanal (and humane) manufacturing, unique design, superior quality, and more. If these companies can't source the best materials that are harvested in the most humane conditions for workers and animals, they will have lost their way with customers well before raw material turns into fabric, and fabric is turned into a product.
Conclusion
Reading on this topic also has improved my understanding of the luxury supply chain, but it also has made me appreciate the industrial impact of global warming on temperature-sensitive industries like cashmere. Mongolia and China are at risk of turning their fertile lands into desert through the overproduction and mismanagement of their goat herds and their land. There are other regions that can pick up some of the production, but these goats are native to the Mongolian steppe and need harsh weather conditions to grow their soft inner coats. This is something for all brands to consider, especially with regard to other options for super-fine fabric alternatives like brushed baby camel hair, super-fine merino wool, and other hair/wool products whose herds do not leave their grazing lands barren.
This exercise also gave me new appreciation for the global challenges facing luxury companies that must plan for their future volume growth needs in potentially scarce raw material markets like cashmere or vicuña. Those that verticalize in important areas have greater ability to manage their long-term supply chains with greater control. It would be problematic and potentially damaging to a brand like Brunello Cucinelli's if it could (1) not produce enough of its high-demand cashmere items, or (2) suffer from uncertain and/or worsening raw material and end product quality.
Fashion brands like Versace offer specific, unique designs that will draw customers seeking certain brand-specific looks. Quiet, no-logo luxury companies like Loro Piana and Brunello Cucinelli must attract customers through a combination of exceptional product quality (materials and craftmanship) and their unique, brand-specific heritage. For Brunello Cucinelli, the brand stands for humanistic capitalism and a commitment to dignity for everything and everyone that touches the brand - from animal herds to farmers, manufacturers, and customers. Working with 80-90% product margins at ultra-luxury price points enables all participants in the supply chain to extract what Brunello would call a "fair margin" for the work they do. Importantly, this also drives a flywheel that allows Brunello to secure more raw materials, more production capacity, and drive more product volume growth as it expands its business globally over time.
Brunello is crossing the €1 billion threshold this year, the same level achieved by Hermes in 2015 in its Ready to Wear and Accessories segment. Hermes is on pace to nearly quadruple its 2015 revenues in this segment in 2023, and if Brunello could achieve a similar outcome, its earnings power will grow substantially from current levels. Brunello is significantly under-represented in China, with only 12% of revenues (roughly €110m) coming from one of the largest luxury markets in the world. There is plenty of open field to grow, but ensuring product quality and brand perception as Brunello enters its next phase of growth will be more important than ever.
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