Article 1: Breaking a Taboo, High Fashion Starts Making Goods

Overseas

By ALESSANDRA GALLONI in Cairo, Egypt, CECILIE ROHWEDDER in

London and TERI AGINS in New York
Staff Reporters of THE WALL STREET JOURNAL
September 27, 2005; Page A1

A desert wind blows through the open windows of a factory in Cairo that
harbors one of the biggest secrets in Italian high fashion: Egyptian tailors.

Women in head-scarves stitch shoulder seams, press wrinkles out of silk-

lined pockets and weave Italian fabric through digital sewing machines.
They're making $1,300 men's suits for Valentino, one of the most storied
names in Italian luxury. They learned the craft from videotapes on TV sets
positioned around the factory floor.

For years, European luxury-goods firms manufactured T-shirts and jeans in

Eastern Europe and North Africa, but drew the line at their fanciest
collections, which commanded premium prices precisely because they
were "Made in Italy." Now, pushed by rising labor costs, currency
fluctuations and competition from low-price brands, Valentino and other
firms in Italy and France are breaking one of the strictest taboos in high
fashion: they're starting to produce some of their most exclusive lines in
developing countries.

Celine, a unit of luxury goods giant LVMH Moët Hennessy Louis

Vuitton SA, is manufacturing some handbags in China, including its
denim-and-leather Macadam bags, which sell for $500, according to
people familiar with the matter. Though it still makes its swankiest label in
Italy, Giorgio Armani SpA says it produces 18% of its Armani Collezioni --
which pitches wool trousers for $450 and silk jackets for $1,500 -- in
Eastern Europe.

Even "Made in Italy" stalwarts such as Prada, Gucci and Tod's say they are
tiptoeing into foreign sourcing. Last year, Gucci Group NV began sewing
some sneakers at a factory in Serbia while leather-goods
company Tod's SpA produces a part of its Hogan sneaker line in Hungary
and is considering moving that to China.

"What do you care where I make my shoes?" says Prada Group NV Chief
Executive Patrizio Bertelli. Where local laws permit, Mr. Bertelli says he'd
prefer to insert a "Made by Prada" tag in his products. In addition to
sewing the upper part of some shoes in Slovenia, Prada makes pieces for
some of its handbags in Turkey.

The move out of France and Italy is only just beginning. Fashion
executives say some production won't ever move to low-cost countries
because Italian craftsmanship is still unparalleled. Sophisticated items
made in low volumes -- such as hand-woven leather handbags -- may
always be "Made in Italy," for example. For the rest, the industry thinks it's
only a matter of time.

"It will take another 15 years until luxury brands' main lines are
completely delocalized, but it will happen," said Tonino Perna, chief
executive of IT Holding SpA, which manufactures relatively affordable
collections for labels such as Versace and Dolce & Gabbana. IT Holding
makes about 30% of its clothes and accessories abroad. Executives say
privately that more fashion brands are producing outside of Europe than
the number who care to admit it.

This shift underscores how the developing world's manufacturing talent is

improving to the point where even quintessential luxury products are
starting to move offshore. It's also a sign of the extent to which high-end
products are under pressure from low-cost alternatives.

Companies from sneaker makers to automotive giants have long

outsourced to China and Mexico, but luxury-goods brands have always
touted Italian and French production as essential to the luxury experience.
The "Made in Italy" label, with its centuries-old history of artisanship, has
justified exorbitant prices. If their clothes are stitched at low-cost factories,
how will consumers react? Will luxury brands eventually have to bow to
pressure and lower prices at the expense of their margins?

Many Italian fashion houses fear a backlash if they're seen hastening the
decline of Italy's textile industry. For more than a century, that sector
helped power the Italian economy, the fourth-largest in Europe. As
companies outsourced production, sales of Italian textiles have fallen
more than 10% in the past three years, with 24,000 textile manufacturing
jobs lost last year, according to Italy's textile association. How to stop the
trend, which is contributing to Italy's current economic malaise, is a hotly
debated political issue.

"Our 'Made in Italy' has to be defended with force," Claudio Scajola, Italian
Minister for Productive Activities, said at the Milan fashion shows, which
started this week.

Alaa Arafa, the businessman who owns the Egyptian factory making
Valentino suits, has little sympathy for such complaints. "Yes, some Italian
jobs will be lost, but the writing is already on the wall," he says. "No Italian
girl will sit at the sewing machine anymore, no matter how much you pay
her."

As a result, executives are beginning to change their tune. "We can't be

closed-minded. China will be part of the process for everybody," says
Franco Pene, chairman of Gibo SpA, a high-end Italian manufacturer that
produces clothes for fashion labels Marc Jacobs, Michael Kors and Paul
Smith. Gibo says that for now, it produces only in Italy.

Mystique and Aura

The "Made in Italy" mystique dates back to the early 20th century when
artisans throughout the Italian peninsula began exporting their products
and know-how. Neapolitan shoemaker Salvatore Ferragamo was one of
the first to venture abroad when he hand-stitched shoes for Jean Harlow,
Douglas Fairbanks and other 1920s Hollywood stars. Florentine leather-
goods maker Gucci soon followed suit.
After World War II, Italian craftsmen developed a second expertise. Using
new ways to wash yarn, the key to high-quality knits, Italy soon surpassed
Scotland as the world's best knitwear producer. By the mid-1950s, the
"Made in Italy" label had developed unparalleled snob appeal around the
world. Even French companies such as Louis Vuitton and Chanel
transferred some production to Italy.

The first shift came during the 1990s luxury-goods boom. Some high-end
fashion companies quietly began moving production of secondary,
cheaper lines to Eastern Europe to help meet rising demand. Italian
handbag maker Francesco Biasia, whose purses sell for between $350 and
$500, started shifting production to China and Eastern Europe in the late
1990s. Creative Director Claudio Biasia says the company gambled on
what it saw as shifting tastes. "Younger consumers don't care where a
product is made," he says. "They care about creativity."

In the past two years, new problems intensified this overseas shift. Luxury-
goods companies never fully recovered from the economic slump that hit
their profits beginning in 2001. At the same time, rivals such
as Inditex SA's Zara and Hennes & Mauritz AB's H&M flooded the
market with inexpensive but fashionable copies of catwalk designs,
putting further pressure on the luxury business.

Finally, the increasing strength of the euro is eating into the margins of
luxury-goods companies, which buy raw materials and pay workers in
euros, but sell their products mostly outside the euro zone, in particular in
the U.S. and Japan. Saving on production costs to boost margins has
become an appetizing prospect.

"The euro-dollar relationship has become such that it has made it

necessary for us to look outside this country to find a cost that is more
advantageous," says Prada's Mr. Bertelli.

With this sea change come some ticklish challenges, including managing
logistical headaches. Italian leather-goods Company Furla SpA began
making some wallets and handbags in China in 2002, hoping to cut
production costs in half, says company Chairman Giovanna Furlanetto. But
because Furla needs to get products in stores fast, it's spending more than
it expected moving goods by plane instead of by boat, which is less
expensive but takes longer. As a result, it has cut costs by only 30%.

Fashion trends change so quickly that companies get only one shot to
produce collections for any one season, a problem that makes quality
control a top priority. Gucci says it tried using a factory in China to sew
some of its sneakers but wasn't satisfied with the quality. Others have
gone to extraordinary efforts to maintain quality. When Prada handed
partial production of some shoes to a Slovenian factory last year, it
dispatched the plant's workers to Tuscany for training. Independent New
York fashion house Lafayette 148, which makes knitwear, sent one of the
world's top knitwear experts to China two years ago to teach factory
workers Italian knitting techniques.

Some companies argue that they lose nothing by moving offshore because
they can no longer find skills that were once a core part of Italian
craftsmanship. A talent to sew shoe uppers, for example, hasn't been
passed on to younger generations of Italians.

Even harder than sustaining quality, executives agree, is managing the

perceptions of consumers. Valentino, a unit of fashion and textile
maker Marzotto SpA, rips out the "Made in Egypt" tags in its suits before
shipping them to boutiques in Europe, where companies don't have to
divulge where they make their products. For the U.S. and Japanese
markets, where labeling rules are stricter, Valentino produces suits in
Italy, where it also still makes its priciest items.

In the U.S. and Japan, "perceived quality is more important than real
quality," says Valentino CEO Michele Norsa.

It's a proposition that seems to divide consumers. "If I knew an expensive

piece came from China, I'd have a problem with it," says Robert Ekblom, a
London-based banker. "I'd rather buy something unbranded," he adds.
Daniela Witte, a 38-year-old stay-at-home mother, also from London,
doesn't have such qualms: "If I love the color, the cut and the design, I
don't give a toss about where it's made," she says.

Some luxury brands are hoping to educate consumers. Stitched inside

Celine's Macadam handbags is a brown leather tag telling customers that
the product is designed in Paris and "handcrafted in China with the
greatest attention to quality and detail."

Others have dipped their toes in the water and withdrawn. Silvia Stein
Bocchese, president of Miles SpA, a high-end Italian knitwear maker, says
the company was happy with the crochet sweaters it manufactured in
China for closely held Dolce & Gabbana. But the client asked her to stop
because it wanted a "Made in Italy" label, both sides say. Ms. Bocchese
says "many don't want their brand tied to China" for image reasons.

Stitch Like an Egyptian

Valentino didn't have such preconceptions when, at the end of 2002, it

received a call from Cairo-based A-Arafa Group SAE. Italian textile giant
Marzotto had just acquired the Valentino label and was looking to cut
costs. Valentino already produced some menswear in Eastern Europe. In
2004, the hourly labor cost of a textile worker in Italy was $18.63
compared with 88 cents in Egypt, according to U.S. management
consultant Werner International Inc.

The Egyptian company had recently signed a contract to buy technical

know-how from a menswear producer, based in the northern Italian city of
Vicenza. As part of the contract, A-Arafa received patterns and designs.
The Italian company, Nervesa Uomo SpA, sent several technicians to A-
Arafa's factory in Cairo and allowed 30 Egyptian staffers to spend five
months at its facilities. A-Arafa commissioned an Egyptian television crew
to film every step of the tailoring process from cutting fabric to stitching
buttons. The crew made 140 videotapes.

In 2003, after A-Arafa successfully negotiated a trial run making two dozen
suits, Valentino awarded it a contract. At the beginning of this year, the
factory began making its first batch of Valentino suits. A second load of
12,000 suits -- which will retail at about $1,300 -- are now being shipped
for the 2006 spring/summer season.

Valentino still designs its products in Italy and keeps strict control over the
Egyptian assembly line. It makes some parts of the suit in Italy, such as
the shoulder pad and the breastplate. Valentino executives say they are
pleased with the quality, though they acknowledge that about 3% of suits
have some faults and are sent back. Valentino says it doesn't have a
comparative figure for suits made in Italy.

At the A-Arafa factory, managers hadn't been told that the "Made in
Egypt" labels are pulled off after the suits are shipped to Italy.

"It makes me sad that they take off the tags," said the factory's 39-year-
old product manager, Yaser Husien Nada, when informed of the
procedure. "But I am very happy to be making products for Europeans."

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