Global Business Guide Indonesia

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Manufacturing | Indonesia's Footwear Industry – Challenging Opportunities

The footwear industry plays an increasingly important role in Indonesia's manufacturing sector. Producing shoes for many global brands, footwear manufacturers are a vital job creator and an important foreign exchange earner for the country. Competitive labour costs have long convinced global brands to source footwear from Indonesia and have drawn in investment from China, Korea and other countries, but this advantage is in jeopardy today amid steep increases in minimum wages, with rival producer countries such as Vietnam just around the corner, ready to sell on the same ASEAN market. While the depreciation of the rupiah boosted Indonesia's competitiveness in 2013, a supportive exchange rate cannot be counted on in the long run.

Indonesia's Footwear Industry – Challenging Opportunities
Changing lifestyles in Indonesia are expected to generate particularly strong demand growth for athletic footwear, giving manufacturers in this segment an appealing alternative to exports

Changing lifestyles in Indonesia are expected to generate particularly strong demand growth for athletic footwear, giving manufacturers in this segment an appealing alternative to exports. Providing that costs are kept under control, the country has all it takes to secure or even improve its position as one of the leading footwear exporters, much to the benefit of local companies and global investors.

Growing markets all around

Indonesia's footwear market was estimated to be worth 29.3 trillion rupiah in 2012, with household spending on footwear increasing by 47% over the 2007-2012 period (Euromonitor International). Growing domestic demand has seen footwear imports to Indonesia grow, but it is an opportunity first and foremost for local manufacturers. Statistics Indonesia (BPS) subsumes the footwear industry under the category of “textile, leather products and footwear industry”. This industry outpaced overall GDP growth in 2013, increasing at a real (i.e. inflation-corrected) rate of 6.1% to 172.4 trillion rupiah (after rising at a modest rate of 4.3% a year earlier). BPS data also show that small manufacturers of “leather, leather goods and footwear” fared much better than large ones. While large and medium-sized businesses in this segment expanded by merely 4.2% in 2013 (after contracting by 7.0% a year earlier), micro and small businesses saw their output grow by 9.3% in 2013 (up from an 8.9% increase in 2012).

Indonesia is one of the world's leading footwear exporters, shipping abroad $3.86 billion USD worth of goods in 2013 (Indonesian Government data). Leather footwear, which includes athletic shoes, accounts for most of the exports.

Leading Footwear Exporting Countries (exported value in billion USD)

Leading footwear exporting countries (exported value in billion USD)

Source: ITC calculations based on UN Comtrade data reported by Governments

A sporting nation

Emerging economies such as Indonesia and other ASEAN countries are forecast to see particularly strong market growth for athletic shoes over the coming years. A young population, urbanization and rising disposables incomes are the main factors driving demand for sportswear in Indonesia, with a growing number of city dwellers turning to sports and fitness as an escape from office work. Ever more Indonesians embrace sports as a lifestyle choice illustrated by the increased frequency in ‘fun runs’ as well as corporate sponsored marathons taking place on an almost weekly basis in Jakarta with other cities following suit. A ‘running culture’ is also emerging alongside the nation’s traditional sport of badminton and the urban trend of futsal with consumers seeking out specialised, sport specific footwear as well as apparel (See Indonesia’s Textile & Clothing Industry). This is a trend that global brands, and a growing number of local ones, will happily embrace.

The labour headache

The biggest headache for Indonesian footwear makers is the steep increase in minimum wages, which affects a large portion of the total workforce. More than in many other manufacturing industries, margins in the shoemaking business hinge on competitive labour costs. Gaining an edge over rival producers often boils down to offering products of required quality standards at low prices, and the high degree of manual labour involved in the manufacturing process makes wages and benefits a significant cost factor.

Following large protest marches and strikes, annual minimum wages were increased by more than 40% in some provinces in recent years, forcing a number of factories to close and others to relocate. Indonesia's labour cost advantage over China, a pivotal factor for many investors choosing to invest in the country, is gradually waning. The Indonesian Footwear Association (Aprisindo) has warned that numerous manufacturers were moving away from the industrial heartland of Greater Jakarta and West Java to Central or East Java, while others had left or were considering to leave Indonesia altogether. Vietnam is a formidable low-cost competitor, while other ASEAN countries such as Cambodia and Myanmar are also on the radar of investors.

Excessive and oftentimes hard-to-predict wage hikes aside, employment regulations also pose a risk for labour-intensive industries in Indonesia. Law No. 13/2003 on Labour mandates high severance pay and additional rewards for long-serving staff, making lay-offs a costly undertaking. The law also leaves very limited options for firms to outsource (subcontract) work processes to other companies. The World Bank has described Indonesia's employment rules as the most restrictive in East Asia. They are likely one reason for the continued existence of a large informal sector, where many of the protections afforded to formally employed workers have no bearing.

There is widespread consensus that industrial relations tilted in favour of workers from 2011 through 2013. Government representatives appeared to be siding with labour unions in tripartite negotiations on minimum pay, and legislation on outsourcing became more restrictive. Most attributed the pro-labour bias to the large number of gubernatorial elections in 2013 and national elections in 2014. This, so the reasoning goes, gave rise to a pro-worker stance by elected officials and the administrations they control. Following this line of argument, pragmatism should stand a greater chance of trumping populism after 2014, with newly-elected MPs and a new president seated. Whether this will indeed result in more investor-friendly labour rules and less excessive wage hikes remains to be seen.

Government support

Meanwhile, the government has taken some steps to alleviate cost pressure elsewhere in the footwear industry. For example, the Industry Ministry extended financial support to local producers seeking to replace old machinery in a multi-year programme launched in 2007. Much of the equipment currently in use is a decade or two old. The government's roadmap on economic development includes the creation of footwear industry clusters aimed at facilitating vertical and horizontal integration as well as staff training, particularly for the benefit of small and medium-sized businesses. Finally, improving road and rail links should help contain overland transportation costs, while capacity at the country's main export terminal of Tanjung Priok and other seaports is being expanded, albeit at a pace that frustrates manufacturers (See Transport in Indonesia: Roads and Railways).

Raw materials in short supply

The other major challenge facing Indonesia's footwear industry lies in the limited domestic supply of crucial raw materials, notably leather. The importation of animal products to Indonesia is strictly regulated to prevent the transmission of infectious diseases, requiring rigorous checks and frequent delays on incoming shipments. A ban on imports of leather from particular countries was forcing some producers to temporarily close shop. Domestic production was only capable of supplying two million sheets of leather against national demand of five million, while the imports – due to the restrictions – were insufficient to fill the void.

Domestic industries even rely on imported rubber for shoe soles, despite the fact that Indonesia is one of the world's biggest producers of raw rubber (See Overview of the Rubber Sector). Much of that produce is exported abroad for processing, then re-imported for industrial use. Both the shortage of rawhide and rubber should improve eventually, however, if Indonesia can deliver on its promises to massively increase domestic cattle farming as well as leather tanning and boost downstream rubber industries. But it will not happen in a day.

Fancy Footwork

Moving up the value chain is key to maintaining the country’s competitiveness within the footwear sector and overcoming the challenges associated with rising labour costs. Indonesian manufacturers have a proven reputation of working with international, high end brands and meeting specific production requirements in addition to compliance with strict health, safety and labour regulations. As a thriving democracy it offers a less controversial base for multinational footwear brands to set up their production facilities. A more educated workforce have also demonstrated adaptability to new trends as well as creativity in producing their own designs while working with international principals and buyers. This has seen the country becoming a manufacturing base for value added footwear brands such as the production of NATO standard military boots, high end leather footwear and sportswear brands for their latest high performance models.

Strategic location

Indonesia's strategic location in a high-growth region and its proximity to the giant markets of China and India make it the ideal production hub for global footwear brands. Growing exports between East Asia's emerging markets is a mega trend that cannot be ignored. The upcoming ASEAN Economic Community (AEC) will spur trade across the region while also intensifying competition. To be ready, local manufacturers in Indonesia need to rejuvenate their facilities, optimise production processes and distribution channels and – perhaps most of all – create their own designs and brands for global markets. Many should be happy to accept help from experienced industry players. The market spells opportunities for investors in local factories and joint ventures as well as for companies selling machinery or providing training and consulting services.

Global Business Guide Indonesia - 2014

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Indonesia Manufacturing Snapshot

Contribution to GDP: 18% (2015)
Sector Growth: 5.5% (yoy, 2015)
Number Employed in the Sector: 16 million (2016)
Highest Minimum Wage by Province: 3,350,000 IDR/month (DKI Jakarta)
Lowest Minimum Wage by Province: 1,631,245 IDR/month (West Nusa Tenggara)
Main Areas: Automotive, Electronics, Textile & Garment, Footwear, Food & Beverages, Metal Products, Chemicals.
Main Export Markets: USA, Japan, China, Turkey, South Korea, Germany, Singapore, Thailand, Philippines, Saudi Arabia, Malaysia.