For more than a decade clothing prices have been on a downward curve as the growth of value retailers, the strength of the pound and Far East sourcing allowed some stores to sell jeans for just £3.

But those days may be over. Garment prices are looking like they have bottomed out and the price pressure is now set to be upwards.

The strain is being felt not just from one source, but several. The VAT increase to 20% in January 2011, dollar pressures, Chinese labour cost increases and raw material price hikes are all impacting garment prices. The result is fashion retailers must decide whether to swallow price rises, which is likely to affect margins, or pass on the increases to the consumer.

For this autumn, some retailers are pencilling in price rises to consumers of between 4% and 8%.

One fashion retail boss says: “There have been lots of stories about prices going up over the past 18 months - but these are not scare stories now, these are real. The long running era of price deflation will now come to an end.”

Navigating the costs

Investec analyst Katharine Wynne says clothing retailers have experienced deflation since around 1998. Upward pressures that some other sectors faced were navigated by the clothing sector as a result of cheaper sourcing options and value players’ ability to play off costs, price and volume.

Wynne says Next chief executive Simon Wolfson was the first to warn of clothing price increases. In November 2008 Wolfson forecast that the falling pound could lead to a rise in clothing costs of between 7% and 10%. That has not happened yet, but Wynne believes clothing prices generally have gone up about 2% already this year.

Wynne notes that many retailers were able to mitigate the impact over the past year. “This is partly through renegotiations with their suppliers and consolidation of the supply base, and change of sourcing locations,” she says. But she warns: “Having done this trick once it will be hard to repeat.”

One clothing supplier also says there is no more room for negotiations with suppliers so that they assume the burden - many suppliers have already been pushed hard and their costs are climbing too. “We are about to put our prices in for summer 2011,” he says. “Most supplier prices are going up double-digit.”

That is linked to another problem in the fashion supply chain. “There is a scarcity of supply,” the supplier says. “Suppliers are coming out of the market because they can’t make money.”

US retailers, which have been enjoying improving trade, have been increasing orders in China where some factories had closed during the downturn. They have also been moving some sourcing to Sri Lanka, a country more typically used by UK retailers. Additionally, the UK is terminating Sri Lanka’s duty-free status on August 15, meaning the US retailers will have a price advantage.

The supplier worries that soaring prices and the excess of demand over supply in some places will lead to retailers moving to “more questionable” sources. “Either prices go up or they accept less stringent standards,” he says. Some suppliers are considering countries that have less of a proven track record ethically - including, it is said, even Burma.

The main pressure most people are concerned about is the pound, the weakness of which against the dollar could impact fashion retailers more severely than anything else.

“With little agreement around [UK economy] growth targets, sterling remains unpredictable against the dollar and euro” says AlixPartners director Dan Murphy. “Any weakening of the pound puts upward pressure on retail cost prices across the board, which then feeds into higher prices in stores.”

Wynne says that sterling needs to move closer to $1.60 for retailers to be able to be totally relaxed about next spring - last month the rate troughed at $1.43 and has rallied slightly since. However, that looks unlikely and Wynne says that “retailers can’t afford to take too many bets against currency”.

There has also been the news that China will unpeg its currency against the dollar, enabling its value to float more realistically, which may also bring upward pressure. But Wynne warns retailers not to get “overly fixated” with China. “This is expected to bring a gradual headwind but it will not happen overnight,” she says.

This, along with increased demand and labour costs rising, between 10% and 20% dependent on area, will be another factor prompting some retailers to look at other locations to source from.

Helpful trends

Some of the trends of the last year have helped fashion retailers justify small price hikes. Embellishment has been a big trend for the past few seasons but some analysts believe if preferences shift towards simpler fabrics or shapes there will not be a convenient reason to add costs on to product prices and question whether customers will accept increases.

“The consumer is still very price sensitive,” warns Shore Capital analyst Kate Calvert. She also says that scrimping on quality will be dangerous as customers are often buying “fewer items at better quality”.

The buying director of one big high street retailer points out that the meaning of value has changed in the past few years, potentially enabling retailers to increase prices. “The customer is looking for value - it is about what comes with the product such as service and quality,” he says.

Another fashion boss agrees: “The focus has to be on value rather than absolute price. Customers really understand value and want things you can wear more than just a few times.”

He says there are three options for retailers facing price hikes. “Accept you will make a lower profit and stay competitive, reduce quality or put up prices. I think we will see a bit of everything. I think it is a mistake to compromise on quality. It will then be a question of if you are prepared to invest margin to take market share, or edge up prices.”

George at Asda managing director Andrew Moore has an advantage being part of such a powerful global retail business. “We are doing all we can to mitigate as much as we can, including harnessing our partnership with Walmart on global supply deals, reducing the options we buy, taking costs out of the business. We will keep prices as low as possible.”

But he adds: “With the level of price inflation I’m seeing on raw materials, it will be very difficult for any retailer to absorb them completely.”

Raw material price increases include cotton - prices have soared following crop failures - and oil, which is also expected to cost more partly as a result of increased Chinese demand. This may not only affect clothing prices but other categories, including toys, which rely on Far East imports and raw materials such as oil to make their products.

Wynne points out: “Clothing retailers are in some ways better placed than hardware retailers as the fashion supply chain is inherently more flexible.”

There are some other levers that fashion retailers can still pull. Many are trying to tackle rising shipping costs, for example, by trying to get more stock into fewer journeys. Others hope to hold key entry-level price points while changing prices elsewhere in the mix.

And Singer analyst Matthew McEachran says it may be possible, for instance, to move up the prices of non-discretionary clothing such as maternity or childrenswear.

Murphy says that mid-market players can try to justify price rises through better quality credentials and thinks that branded goods - for which higher prices can be demanded - may be on the up. He points to this week’s £300m sale of branded clothing specialist Republic as evidence of that.

Despite some options being open to mid-market retailers, they are still likely to be hit hardest by the impact of rising costs and prices. Value retailers are snapping at their heels and there is likely to be a game of cat and mouse between retailers on price to see who blinks first. Premium retailers are likely to be more insulated.

“In the clothing sector this increases pressure on the mid-market players like Marks & Spencer and Next, as they already look expensive when compared with Primark and the grocers,” says Murphy. “If their cost and margin structures drive retail pricing up even further, they look even less competitive against the value players.”

Numis analyst Andy Wade points out: “Ted Baker changes its ranges each season so it makes it easier for them to put up prices than at M&S, where a customer may have bought the same three-pack of shirts for the past 10 years. It is this customer who will notice a change.”

The buying director sums up the changed pricing landscape after 10 years of deflation. “This is now a macro issue - it used to just be strategic but it is much bigger than that now,” he says.

Often, retailers have battled against just a handful of upward pressures at one time. Now those pressures are coming from many different sources and amid continued uncertainty about the economic climate ahead.

But the sector has proved resilient in the recession and the best retailers will find ways of adapting. The buying director says: “This is such an entrepreneurial sector that people will find ways to adjust costs. Whoever you are you will have to make sure that you continue to think about your customer. Those who have the correct proposition will continue to do well.”