ow textile egypt

8/10/2019 OW Textile Egypt

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ORIENTAL WEAVERS

HIGH FINANCIAL PROFITABILITY AND LOW ECONOMIC RETURNS

Preliminary Draft April 2012

BY

Tarek Selim and Yasmine Wissa

The American University in Cairo

ABSTRACT

Egypt has always been considered as one of the Middle East and North Africancountries which functions based on comparative advantage in terms of its naturalresource base and critical geographic location. The textiles industry in Egypt hashistorically shown considerable economic value-added due to an efficient input baseof Egyptian long-staple cotton and supply chain linkages across the industry.However, industry development recently has shown a reverse trend in declining

productivity, over-employment, outdated technologies, and highly fragmented supplychain. The Egyptian rugs sub-industry is not an exception to its parents performance.This paper examines the Egyptian carpets and rugs sub-industry within an industrialdevelopment perspective using historical, competitive, and cost-benefit evaluations.It questions the major pillars upon which the theory of comparative advantage isfounded based on results in economic performance, and adopts the new competitiveadvantage approach of industry competitiveness. Oriental Weavers is taken as a casestudy within the Egyptian carpets and rugs sub-industry and is dissected in terms offinancial profitability and economic value-added using cost-benefit valuation. The

paper concludes with high financial profitability and low economic value-added.It provides a timeline of recommended solutions for industry competitiveness.Policies and regimes should be formulated to establish more technical institutions

related to textiles sector generally and more specifically towards labor productivity inthe carpets and rugs sub-industry. Intra-industry linkages are also examined.Moreover, it is not seen that relaxed government intervention will solve the problemat the present time.


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INTRODUCTION

The Egyptian economy had experienced a noticeable turnaround after the Jan25th revolution towards an aspiring economy of more equity for the masses, lesstolerance of monopolistic practices, and greater shared value of economic

outcomes. However, Egypt ranking in the world competitiveness report hasdeteriorated, ranking has fallen twenty places (out of 142 countries) reaching 94 th

position in 2011. Its best sub-rank is market size (27th) whereas its worst sub-rank isin labor market efficiency (141st). Also, technology and innovation pillars continue toworsen and Egypt might lose its competitive position in many sectors through thecoming years, if no drastic changes take place on the ground.

One of the main sectors that enhances the Egyptian export position around theworld and is considered to be a main pillar in its growth is the textiles sector. It is oneof Egypts most important industrial sectors, accounting for 25 percent of thecountrys total industry and nearly 30 percent of all industrial labor employment.

Cotton and textile fabricates ranked third in Egyptian exports and accounted for 25percent of all Egyptian cumulative exports in 2010 (Coface Egypt, 2010). Betweenthe years 2005-2008 the sector had experienced an average growth of 10 percent dueto the QIZ (Qualified Industrial Zones) Protocol with the United States. It is highlysignificant that Egypts textile garment industry is one of the very few manu facturing

processes which has the complete supply chain within the countrys resources.Although the public sector historically dominated most of the activities of the sector,the private sector is now playing a major role. It is worth mentioning that the Egyptianagreements with EU, U.S. and the QIZ protocol all had shifted the sector to a state ofcontinuing growth. Among the major challenges of the sector is the lack of qualifiedtrained labor on international standards as a result of the lack of R&D and technology

framework. However, Egyptian unskilled labor is very cheap which yield acomparative advantage to the whole sector among its rivals. Yet, achieving acompetitive advantage is the major challenge ahead.

The spinning and weaving sub cluster is one of the emerging clusters in Egypt.Its exports are 10.5 percent of the total exports of the textiles sector. Oriental weavers,in that context, is a main player in the textile market and weaving cluster. It controlsaround 85 percent of the market share, with many subsidiaries in the United States,China and the Arab region. Its operations are seen as cost-effective and hence add upto the comparative advantage of the whole sector, yet with no real R&D andtechnological innovations, it can risk the whole sector losing its potential competitiveadvantage.

This paper is classified into five main parts. First, it analyses the textiles sectorwith its local and international position, the different trends in the industry and themajor players inside it. The cluster diamond is analyzed in details in this section. Thefollowing section highlights the case study for the rugs and carpets sub cluster andOriental Weavers (OW) as the main player in it. The following section focuses onsupply chain linkages that relates industry competitiveness to financial performanceof OW. Finally the paper analyzes financial performance and economic evaluation ofOW. Last, recommendations highlight the main policies that the Egyptian governmentwith its public and private enterprises should undergo in this cluster, with implicationsto nation-wide industrial development.


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CLUSTER ANALYSIS

A.The Egyptian Textil es Sector

Textiles industry is one of the ancient industries that mark the Egyptianeconomy. It was first a domestic and mostly a family industry until the 1500; this wasthe date of the first established factory in the history of the Egyptian textiles industry.Moreover, the geographical distribution of the industry was mainly concentrated atthe Nile valley. Today the textiles industry contains more than 3000 companies, both

private and public enterprises ranging between companies that employ only twolaborers to companies with 20,000 labor of the Egyptian labor force. Before 1973, theEgyptian textiles industry- especially cotton- was a leading and a competitive industryfor the Egyptian economy. While after the open doors polices and especially duringthe 1980 period, textiles started to lag behind. Raw cotton exports- as a share of totalGDP- were around 68 percent in 1980, but it dropped to 25 percent and 15 percent in1990 and 1991 respectively. In 1993 the share of the textiles industry as a whole waslagging behind that of oil, petroleum and tourism with 11 percent only of total

Egyptian exports. In 2001 the industry accounts for 18.9 billion LE to GDP. Itrepresents around 2 percent of the total output and 11 percent of the output of themanufacturing sector. In 2003, the industry's total production reached around 27

percent of the total industrial production in Egypt. Since then the industry is alwaysworking on enhancing its productivity and its competitive position by trying to adoptthe latest technology, it became a major contributor mainly for the local economy andin the international context as well. With respect to the employment Level, Textilesindustry employs around 8 percent of the total industrial workers and 2 percent of thewhole labor force including government and agriculture labor. In terms of exports, theindustry amounts for 13 percent of total exports in 2002. The government has also

planned to increase the annual textile exports by 3 bills in the period 2006-2010.

Although there is a high competition in the international market from US, china,Turkey, India and Israel, the Egyptian economy's share around 35 percent of theworld market. Today the textiles industry is attracting FDI's from the entire world.Total investments (foreign and local) have risen by an average of 9.5 percent per yearover the past four years. More than 40 Turkish textiles firms invested US $ 104million in the sector. Moreover, in 2006 Egypt and China had agreed to ease Chineseinvestments in the Egyptian market.

B.The Cluster Positi oning

1.

Product SpecializationThe main products of the industry with their exported products could be

summarized as follows:

Product Exported sub- products Major companies

Fibers Medical cotton Misr spinning and weaving company

YarnsCotton yarns, rayon yarns andflax yarns

Misr spinning and weaving company

Cotton and blended fabrics Printed and finished Middle Egypt Spinning and Weaving company

Carpets and floor coveringsMachine woven ready- madecarpets, towels and floorcoverings

Oriental weavers

Apparel and tailoring Readymade garments

Al Arafa Investment and its subsidiary Swiss Garments

is Egypt's twenty third largest and fifth fastest growingexporters

Knitted apparel JIL Brand and jackets. KABO (El Nasr clothes and textiles) and Saba Apparel


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0

500

1000

1500

2000

2500

3000

2005 2006 2007 2008

Textiles Export Value

2. Export Trends

From the period of 1989- till 1997 the market for Egyptian textiles haschanged dramatically. At the beginning of this period 1990/91 textiles accounted foraround half of the total exports earning. It amounted for 2,364 million LE in 1992with 1.7 million earned from ready -made garments and Knitted carpets. Then in 1993the exports trends started to decrease, but the government took an adverse action thatit enters non-traditional markets especially its exports to the European Union increase

by 28 percent as shown in figure 1.

In 1994 the General Agreement on Trade and Tariffsreplaced the Multi- Fiber Agreement; under the GATTagreement the quotas facing the Egyptian exports will be

progressively removed. It will be removed as follows 16percent in 1995, 17 percent in 1998, 18 percent in 2002 andfinally the remaining 49 percent by 2005 (with the FTAagreement been in place) (SEAM, 1995). The period 2005-2008 has shaped the textiles industry in a totally differentmanner. An artificial comparative advantage and a managedtrade that shaped the global market after the fully integration

in the WTO and free quotas agreements had been imposed onthe Egyptian market. In addition low-cost suppliers in Asiawill no longer confront a significant barrier to their exports.Egypt has lost the free access to US and EU markets andhence employment in this sector declined22, 185 direct jobs(approximately 0.5 percent of industrial employment), and shipments to drop byUS$203.9 million or about 4 percent of non-oil exports. This represents 19 percent oftextile and apparel exports to these markets for 2002. During 2006/2007 the Egyptiangovernment had entered into the QIZ agreement that spurred growth in the textilessector with the following trend. The total Egyptian exports to the U.S. that was 1,283$million in 2004 acceded 2$ billion in 2005 and continued to climb during 2006. In the

year 2006 to 2007, the industry experienced 10 percent growth. It exports an averageof 305,000 tones of cloth and garments annually; 80 percent to the U.S and 20 percentthe EU and the Arab countries. The apparel industry is one of the dynamic industrialsectors in Egypt.

3. Market Segmentation

The textiles industry is characterized by the existence of both public andprivate enterprises, with the public enterprise dominating the market by 31 largeenterprises and there are 2,300 private sector companies operating in the industry thatincludes also small workshops and informal workers. The public sector accounts for90 percent of cotton spinning, 70 percent of weaving, and around 40 and 30 percents

for both Knitting and finished products respectively.(SEAM, 1998). Today the privatesector controls the markets of readymade goods and Knitted fabrics. Orientalweavers' is the largest machine made rug manufacturer in the world, it is based inEgypt at which it produces a bunch of textile products ranging from towels to allverities of carpets and floor coverings. (Dannies, 2009) Moreover the apparel sectorcomprises some 1,500 private companies clothing and intermediate manufacturers.After the QIZ protocol, the private sector has been expanding rapidly, with 387foreign companies in vesting in the sector according to the General authority ofinvestments.

4. Production Trends in the Textiles Sector

The main governorates that provide textiles in Egypt are mainly Alexandria,Kalioubia, Gharbiya and Cairo. Although the productivity for most of the textiles

products increased during the last decade, the production of cotton by volume, which

Figure 1: Textiles Export


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Yarn

Fabric

Garmenting

Productivity inc. 12 times

Productivity inc. 10 times

Basic garments inc. 15

has sharply declined in recent years, it had fallen again to 260000 ton (from265000ton in 20003/2004). Significant changes in technologies have resulted inincreased productivity and enhanced quality. Increased use of microprocessor basedtechnology for color matching and reduced dyeing cycle times.

Figure 2: Evolution of Textile Production: 1969-2005

C.

The Cluster Diamond

The Textiles industry represents an opportunity for the whole Egyptianeconomy and for itself. It constitutes a major contributor to the nation's exports, as itis ranked the second after food processing for the share of exports by themanufacturing sector. High domestic and international demands for its different

products such as yarn cotton and carpets represent a major opportunity for the wholecountry. Woven apparel represents the largest category of the textiles sector thatassisted Egypt to be the second largest exporter to the MENA region.

1. Opportunities

The most important factors are cheap labor and energy cost that play thegreater role in the country's competitive advantage for that sector. Moreover, thewhole supply chain for the textiles industry is present within the Egyptian economy.The apparel industry as mentioned above is highly developed if compared to the restof the sectors industries. Most of the companies are equipped with the state-of-the-artmachinery. The latest technologies are used in all the phases of production. The totalapparel production output is approximately USD 3 billion of which USD 1.3 billioncomes from the textiles and garment sector. Egypt also offers much greateropportunities for the production of small lines and shorter lead times than that of Indiaand China.

2.

ChallengesThe fact that the whole production process is inside the country as it

constitutes an asset is also a liability, since after the FTA agreement the Egyptianeconomy had become highly exposed to the fluctuations and competitiveness in theinternational market. If any of these stages of production fails to adapt to theinternational manufacturing and trading patterns the whole industry will be under highrisk. (Dannies, 2009) After that market liberalization in 2005, a series of tariffs cutstook over and foreign manufacturers invaded the market. This had affected the factoryowners and local producers competitive position negatively since they are now facedwith high import and port tariffs on the foreign made fabrics. Despite that some ofthem shifted to the low prices fabrics such as acrylic; they still faced to compete with

the low prices and more efficient Chinese products. However the Egyptian exportsstill counts for the counter effect against losing its domestic sales as it has always did.

Spinning and Weavingproduction significantly

transformed to capital

intensive industries.

Garmenting continue

being highly labor-

intensive.


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(Hassan, 2010). One other major challenge that faces the industry is that the quality ofthe textiles produced in the country over the past 30years generally not matched thatreputation, with the exception of apparel industry. Moreover as mentioned by Mrs.Ghada El Shazly the textiles industry is based on the basic items and materials thatneednt capitalization on the state-of-art technology. She added that spinning andweaving in recent years were able to buy new machines and produce fashioned

products. This might be reasoned to the lack of qualified workers that leads to theemployment of some foreign labor particularly from China and India. Although theyare paid in high wages but their productivity and expertise is much better.

Factor conditions Certain major raw materials are used in this sector, they arebasically natural fibers or man- made fibers and synthetic fibers. Among the naturalfibers cotton is the most commonly raw material produced and processed in the wholeindustry followed by the flax for the use of linen and seed oil. All the stages of

production starting buy cotton cultivation to the export of the product itself areprocessed in Egypt. One important factor affecting the competitiveness of the industryin a negative way is that 30-40 percent of the price increase is due to the long timetaken in the collection of cotton. It is directly exported as raw material to US and then

manufactured and returned back with a high price. Moreover, the cost of raw materialand inputs were lower as well. For instance, the water and electricity costs in Egyptwere among the lowest in the world. The Egyptian wage level is among the loweststructure throughout the whole world, it doesn't exceed one dollar per hour. Thereforethe textiles industry is highly characterized by cheap labor and this is considered to beits main competitive advantage, as it is reflected in low prices.

The technological base of the whole sector is very weak. Although thegovernment is working on the enhancement of the technological base for the wholeindustry, the whole sector seems to be more of follower for the international weavingtechnology settings. One exception for the whole industry is Oriental Weavers thatacted more of a trend setter rather than taker for the weaving technology, which hadhelped it to excessively succeed. Local manufacturers have access to financialresources that increased local production. This is most notable in terms of exports ofhigher value-added items such as ready-made articles and clothing, both of whichhave demonstrated expanded growth. The apparel industry in the sector is equippedwith state-of-art machinery. The latest technologies are used in all phases of

production: pattern making, spreading, cutting, sewing, and packaging (Montasser,2009). After 2005 the government had spent excessive amounts of money on theirrigation projects that act as a good base for the agriculture sector infrastructure andspecifically for cotton cultivation. Also the Telecom and transport infrastructure forthe whole country and especially for the industry is progressing during the last period.

The transport problem lies in the quality of the services offered and the maintenanceneeded for the roads and railways. Hence in some locations such as Gharbia and otherareas in southern Egypt are mainly characterized by high transportation costs. Fromthe human capital side the major challenges facing the textile industry in Egypt is thelack of qualified middle and upper management who are related to the industry. Thisconsequently negatively affects productivity, quality, marketing and R&Dcapabilities. In addition, it led to the increase in production costs. In the Coface reportfor 2010 it refers that the textiles industry has several attractive qualities includingexcellent transportation links, and support for workforce training skills.

Context for fi rm strategy and ri valr yThere are limited markets barriers against theEgyptian textile products in its access in the international market. This if Egypt iscompared to China one of the most rivalry competitors in this industry. After the FTA


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agreement and the QIZ protocol the Egyptian textiles industry has been ensured acertain market share in the US markets. Foreign companies perception to the localmarket of garments is perceived as vertically integrated than its competitors in India.For instance foreign investments increased by more than 20 percent of totalinvestment in the sector. Domestic markets' imposes limited barriers to entry for newcompanies except for the carpets and rugs sub-cluster where Oriental Weaversconstitute a semi-monopolist in the market thorough its brand loyalty. Thegovernment increased the export tax rebate for textile products to 12 percent inDecember from 8 percent earlier. Hence this policy might encourage the Chinesecompanies to open in Egypt, taking into account that the cost structures in theEgyptian market are very similar to that in China. In addition to this the drawbacksystem applied, that states that custom duties are paid on the imported materials andconditioned to be re-exported as a final good within one year. This has led that thelocal product is sold at a price higher than the imported one, thus harming the rivalryof the textiles products within. In addition to this, the whole industry seemed to becharacterized by the fact that its small-scale enterprises face weakness in marketingstrategies while its large companies are mainly vertically integrated. Moreover, thegovernment has formulated laws on competition, taxes and custom duties during the

04/05 period, these laws aimed at enhancing competition and enhancing theproduction process domestically. Recently the government had also introduced aroundLE 350 million for three year project that aims at increasing the capacity of localmanufacturers through high access to financial resources. The government had alsofoot the bill for 80 percent of training costs. The ITC has trained around 6000workersin the textiles sector.

Demand conditions In General, textiles industry goods market is not characterized byhigh price elasticity. However, the clothing market might be highly sensitive towards

price changes, since there are many varieties of producers and styles. For the factormarket, slight changes in the prices of raw materials have a very high impact on the

cost of the product and hence on the demand structure. It is worth mentioning that thetextile industry also absorbs some 80 percent of domestic cotton production.According to the Coface (worldwide credit management and rating group), countrieslike Egypt have an organically sustainable demand, which have rushed forward afterthe recent economic recovery of Egypt from the global financial recession and theintroduction of QIZ.

Related and support ing industriesPetrochemicals industry is a main supplier for thepropylene which is a raw material for the textiles production and is enhanced in recentyears. One major threat to the whole industry is the risk of fluctuations in the prices ofraw materials, such as the increase in the price of polypropylene for the rugs

producers. Egypt is becoming a country where more and more car assembling istaking place. This in turn incurs that for the textiles industry there is a potential ofnew markets to be developed. This could be explained through the introduction ofnew facilities and the optimization of other production techniques by the cars industrywould spur growth on textiles (Medibtikan, 2007). After the crisis the market hadexperienced a decline in order from the construction and automotive industries.Consumers will then reduce their spending on all the sectors which will affect themargins of the textiles and its competitiveness. As explained by Ghada el Shazly thevice president and the regional head of the enterprise banking at Credit Agricole Bankthat the trend in the whole market for both car assembly and textiles will move in the

same direction. The textiles sector will also be affected by the prices of plastic andpacking materials. Due to the QIZ protocol the price of packaging materials haddecreased which decrease the cost of production of the Egyptian final products and


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hence enhance its price of exports. Cotton is one of the main feeding industries for thetextile sector. It is characterized by high quality, while Egypt produces only 1.2

percent of the world's cotton; it represents 35 percent of the production of the highquality fabric. The government had also foot the bill for 80 percent of training costs.The ITC has trained around 6000 workers in the textiles sector.

Figure 3: Cluster Diamond Model

Context for

Firm

Factor

Conditions

Demand

Conditions

Related and

Supporting

Industries

Foreign companies perception to thelocal market of garments is perceivedas vertically integrated than itscompetitors in India.

There are limited markets barriersagainst the Egyptian textile productsin its access in the internationalmarket.

small-scale enterprises face weakness

in marketing strategiesthe government has formulated laws

on competition, taxes and custom

duties during the 04/05 period

The cost of raw material andinputs were lower as well. For

instance, the water andelectricity costs in Egypt wereamong the lowest in theworld.

The Egyptian wage level is

among the lowest structure

throughout the whole world,

it doesn't exceed one dollar

per hour.

Also the Telecom and

transport infrastructure for the

whole country and especially

for the industry is progressing

during the last period.

The transport problem lies in

the quality of the services

offered and the maintenance

needed for the roads and

railways.

Textiles industry goods market isnot characterized by high price

elasticityFor the Factor market, slight

changes in the prices of rawmaterials have a very highimpact on the cost of the productand hence on the demandstructure

Organically sustainable demand,which have rushed forward afterthe recent economic recoveryfollowing the reforms of 2004that boosted consumerconfidence and enhanced his

consumption behavior.Therefore his spending increasedacross the board.

Petrochemicals industry as

being main supplier for thepropylene as a raw material forthe textiles production isconsidered to be enhanced andgrowing in recent years.

Egypt is becoming a country

where more and more carassembling is taking place. Thisin turn incurs that for thetextiles industry there is a

potential of new markets to bedeveloped.

Cotton is one of the main

feeding industries for the textilesector. It is characterized byhigh quality, while Egypt

produces only 1.2% of theworld's cotton; it represents35% of the production of thehigh quality varieties. The QIZ

protocol the price of packagingmaterials had decreased whichdecrease the cost of productionof the Egyptian final productsand hence enhance its price ofexports.


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ORIENTAL WEAVERS

A.Sub-sector: Rugs and Carpets Industry

1. Cluster Overview

Oriental weaver rugs history can be traced back at the beginning of humancivilization. Rugs and carpets are considered one of the final product transformationsto the consumer markets. Most of the analysts and buyers dont see of the Egyptian

rugs as being of an oriental type. The reason might be on one side that the Egyptianrugs have never been mentioned in books of Arts and others. On the other side mostof the Egyptian rugs seem to the buyers are merely design copies of the Persian rugsand lacks any creativity. A good quality rugs and carpet is distinguished for its design,quality, pile material and construction and its foundations and thread density. Therugs and carpet industry in Egypt has always been known for its high quality fromevery respect. The true shift for the cluster was in 1950s and due to the importsubstitution policies that had been in place, the Egyptian rugs industry began toflourish again especially in the handmade rugs in and around Cairo. The Egyptian

rugs have always been the dominant in the market. Competitors began to appear at thelate 18thcentury especially the Persian (Sine) Knots that tended to replace the Turkishstyle in carpets. The arrangements of the Egyptian rugs started to take a second role inthe design after the elegant and rich Persian carpet styles. In order to analyze the trendof the industry and the competitiveness of the whole cluster, a quick look on someindicators like its manufacturing processes will be of a value add.

2. Manufacturing Process

The global carpet market for domestic and industrial end use is dominated bythree manufacturing processes;

Woven are normally the highest carpets' values in the market. It is produced on a

loom similar to the woven cloth (that's why some might consider the whole carpet'sindustry as being part of the textiles industry). Predetermined designs are alreadyavailable for this type of cut-pile carpets, from which yarns of different colors areused. Hence increase the capability of the production of complicated patterns andshapes of these carpets.

Tufted are carpets produced with a tufted machine, with either a single colored or anon-colored yarn. Tufted carpets can either be cut pile or loop pile or both. Tuftingmachines are characterized by more production than the weaving ones; it producesmany more meters per hour than the latter style of production. The more advancedtufted machines allow for the production of the basic geometric patterns. This kind ofcarpets is usually at the low or medium end of the market.

Needle feltthese carpets are more durable and advanced than other carpets. They areproduced by electrostatic attraction of individual synthetic fibers. These kinds ofcarpets are normally found in the contract market.

The carpets types vary between the flat weave, hooked and knotted pile

carpets. The flat weave carpets are created either by vertical or horizontal threads. Thehooked rugs are simple type of handmade rugs; it is now generally made as ahandicraft. The Knotted carpet is just a supplementary pile carpet. Hand knotted rugsare most expensive among all. The more knots per square inch the more expensive therug is. The manufacturing process of carpets includes three main materials which arefibers, either natural or synthetic or a blend. The major constraints on the

manufacturing process are mainly the durability, aesthetic character and cost.


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B.Oriental Weavers: The Fi rm

The Oriental Weavers Group is a leading company in the machine-woven rugsand carpets. It is a holding and manufacturing company that has been founded in 1980

by Mr. Mohamed Farid Khamis; an Egyptian industrialist and entrepreneur. It becamea joint stock company in 1986. The company has been traded in the Egyptian

Exchange since 1997. The Shareholding structure is as follows: Khamis family (68percent), Institutions (24 percent) and Retail (8 percent). The company has beenexpanding tremendously, moving from a local company to a leading global one. Itwas the first company to establish a factory in 10th of Ramadan industrial city, withlicense numbered as 1 and the world largest showroom. They now have factories inUSA and China. They also serve customers in more than 110 countries all over theworld. They mainly export to North America, Europe and the Middle East. They alsoenjoy a 25 percent market share in the US. The Egyptian ports have OW as the mainexporter in which they use the largest number of containers in these ports. Locally,they have more than 85 percent market share of the Egyptian market. OW has thelargest capacity in the market, running 24 hours per day, 7 days a week. They work

mainly Business-to-consumers (B2C) where they have 207 showrooms with uniquelocations. They provide a full basket of products. This variety is considered acompetitive edge because they have a wide range of products compared to othercompetitors. Their products include machine-woven, printed and tufted rugs andcarpets, Goblin upholstery, floor coverings and rugs. Oriental Weavers Group asknown today includes Oriental Weavers Carpet Company, Oriental Weavers USA,Oriental Weavers International, Oriental Weavers (Tianjin) Company LTD., MisrAmerican Carpet Mills (MAC) and New MAC, Oriental Weavers Fibers, theEgyptian Fibers Company and New EFCO. Oriental Weavers have some competitorssuch as Carpet City andMoketCenter but they are not main players in the market. Onthe other hand, the competitors in the hand-made carpets and rugs are Al-Kahal andAl-Assiouty (Moneim).

In 2008, when the financial crisis hit the world, Oriental Weavers was able toachieve positive results. They were slightly affected by this crisis, contrary to thenegative effects that many countries experienced. They were able to react, forexample, to the high oil prices through shifting between the productions of certain

products. For instance, according to Mr. Haytham Abd El moneim, Investor RelationsManager in Oriental Weavers, the company has three grades of woven carpets; A, Band C. As the machine can produce different types of products, the production shiftedto products of A and B quality because they require less oil (Product mix flexibility).In addition, to cope with this crisis, they had changes in their international strategy in

which they started to target emerging markets to compensate the slowdown in sales inother targeted companies. In 2008, they announced their financial figures as salesgoing up 12 percent to reach EGP 3,442 million, net profits were EGP 552 millionwith a slight decrease of 2.8 percent from the previous year. However, in 2009, theyannounced that sales were up 3.71 percent to reach a total of EGP 3,551 million. Theirsales in woven segment increased by 6 percent and their tufted segment went down by1 percent because of a 6 percent reduction in Price. Their profits were also up andreached a value of EGP 678 million. The figures show that the company was able toface the global financial crisis in 2008 with some minor negative effects (Report2009). However, things got better in 2009 with a positive impact on the group.Oriental Weavers is planning for new expansions including a plant with a total of 450

million in the free zone area in 10th of Ramadan and another one in china. Thegovernment supports the industry and the company. It provided export subsidies


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which encouraged the company to increase its export activities more. The exportsubsidies increased between 2008 and 2009 by 32 percent.

C. Oriental Weavers' Advantages over Global Competi tors

Verti cal IntegrationThis could be considered one of the competitive advantages ofOriental Weavers. They have a full control over the production process that includes

producing raw materials such as polypropylene, spinning, dyeing yarn, weaving andfinishing. It also is responsible for packaging, delivering and distributing the finished

products domestically and internationally (Report 2008). Through this integration,they control the availability and the cost of raw materials. To support this verticalintegration, the spinning company was established in 1983 to provide the wool fiberwhile EFCO and OWF were founded in 1987 and 1993 respectively to provide the

polypropylene fibers.

Synergies of sister companies Oriental Weavers enjoy good and strong synergieswith its sister companies. The company has backward integration which includes

producing polypropylene, yarn fibers, dying, and spinning (Report 2008). They also

have forward integration in the US, China, England and Egypt.Product Diversif ications mentioned earlier, Oriental Weavers provide wide variety of

products with different quality grades. The price range for the products is vast, in away that suits the different levels of income. The diversified product lines helpedthem in reducing risks and reaching more people locally and globally. R & D in thecompany is very powerful which encourages having more diversified products. Theinnovation cycle is very short in which it only takes two weeks to introduce a new

product. They currently have 120 products. The current business lines are machinewoven and printed rugs and carpets, Axminster, hand tufted rugs, polypropylene and

polyster fiber extrusion, wool dying and spinning, Gobelin upholstery, floor coveringsand rugs, carton and plastic tubes, felt and master batch, terry towels and plastic rolls

for packaging.Global Presence and I nternational Agreements Oriental Weavers serves 110countries. They have a strong presence globally with many distributors in manycountries. The company focuses on exporting with more 45 percent of their salescoming from exports. International agreements, such as the Qualifying IndustrialZones (QIZ) and the Egypt-EU partnership agreement encouraged the company inexpanding globally.

D.Oriental Weavers F ive Forces of Competi tion

Bargain ing Power of SuppliersThe bargaining power of suppliers is low because thecompany has control over most of the raw materials involved in the production

process such as Polypropylene which is produced by Oriental PetrochemicalsCompany (OPC). The company is the sole company producing this material in Egypt.However, Oriental Weavers imports wool from New Zealand because it is known forits high quality. But, the company takes care of the spinning phase. As for themachine suppliers, the company has good relations with them in which the suppliers

provide the company with exclusive rights to some machines. Although the machinescosts a lot as mentioned earlier, the company gets the machines with a percentage ofdiscount because of the long-term relation between the supplier and the buyer.

Bargaining Power of Buyers Buyers in the case of Oriental Weavers includeIndividuals, importers and retailers, world-wide corporate and hospitality chains. Asfor the individuals, the demand is huge because most of the people use carpets and


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rugs. The wide price range in Oriental Weavers allowed them to reach more people inthe different segments. However, importers, retailers, world-wide corporate andhospitality chains have more power than individuals because they have more optionsto buy from on a global level. However, there is almost no threat from buyers in termsof producing the industry's product themselves because of the high costs of

production.

Barr iers to EntryThe barriers to entry are very high and the threat of entry is low

because for any company to enter the market, this requires huge capital. For example,the cost of one machine is around $1.2 Million (Moneim). The new entrant will haveto enter the market on a large scale. Thus, it is very difficult for companies to haveenough capital to establish itself in the market and face the 85 percent market share ofOriental Weavers and its economies of scale. Oriental Weavers enjoy supply-sideeconomies of scale in which they produce large volumes with lower costs per unit

because the fixed costs are divided among more units. This puts pressure on newentrants who need to enter the market on a large scale. In addition, the companycontrols some of the raw materials that are necessary for production of rugs andcarpets such as polypropylene. Other companies would need to buy from them.Another point which increases the barriers for entry is demand-side benefits of scale,

in which many buyers have the willingness to buy from Oriental Weavers because ofthe huge demand from of other buyers towards the company's products. Thus, the

percentage of buyers who might go to a new comer is low.

Threat of Substi tutesThe threat comes from wood, tile and ceramics floorings. Theyare considered the main substitutes but with little effect on Oriental Weavers. Some

people prefer other alternatives other to carpets and rugs for different reasons such ascleanliness or durability. However, those alternatives cannot work in every place andneeds more time to install. People usually need carpets and rugs in their homes incertain rooms such as living room. One thing that might face buyers is the switchingcosts because through buying carpets or rugs, the initial cost would be the cost of it.However, if using wood floorings or ceramics, the initial cost would include also

workers fees and other supplementary costs.

Rivalry among competitors Oriental Weavers has 85 percent market share of theEgyptian market, in carpets and rugs. They have some competitors such as CarpetCity and Moket Center but they are not main players in the market (Moneim). Thecompetitors are few in number as well as in the size of their business. Because someof those competitors does not have the capacity, they had to ask Oriental Weavers tohelp in the manufacturing process; use facilities. On the other hand, the competitors inthe hand-made carpets and rugs are Al-Kahal and Al-Assiouty. Rivalry amongcompetitors in carpets and rugs is not fierce in which Oriental Weavers control themarket (almost a monopoly).

E.Oriental Weavers Value Chain

Support ActivitiesAccording to Michael Porter (2009), they are the activities thatsupport the primary activities which include the following;

Firm Infrastructure Oriental Weavers has a very good infrastructure. Theirmanagement is well cooperated with an organized and well-established vision. Theyhave good corporate governance that works according to the rules and regulations.One of the key points in their corporate governance policy is the communication withthe shareholders with effective shareholder participation.

Human Resource ManagementOriental Weavers have transparent human resourcespolicies and procedures. They have a non-discrimination policy in which all theemployees are being treated equally with not no bias towards any employee. In


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addition, the company provides benefits to its employees in a way that guaranteestheir satisfaction such as subsidized housing and medical insurance. There is alsogood communication between the employers and the employees.

Technology DevelopmentOriental Weavers spend a lot on R&D. They have a veryshort innovation cycle in which it only takes two weeks to come up with a new

product. They are concerned with product as well as process design. They have sixpatents covering technology in the value chain. Recently, they have been using 4

million points-per-square-meter technologies which are considered a breakthrough inthe industry material and market research, R&D

Procurement Resources are acquired for the success of the business and themanufacturing process. Suppliers of wool in New Zealand have good relations withOriental Weavers (Report 2009). They provide the company with discounted prices

because it takes huge volume of these raw materials. In addition, the company hascontracts with machine suppliers in Europe who provide the company with exclusiverights to certain machines. The company tries as much as possible to reduce the costsof purchasing the needed resources in order to decrease its overall costs so as not tohave unreasonable prices for the final products.

Primary Activities They are mainly the activities that are related to the physical

creation of the product itself.

I nbound logistics Warehousing is very crucial part for the manufacturing process.Oriental Weavers owns warehousing facilities that are to where the manufacturing

process takes place. The storage of raw materials such the polypropylene used to beimported so the company had to order amounts that cover 4-6 months (Moneim).However, after producing the polypropylene, the company stored amounts for 1-2months.

OperationsOriental Weavers' operations include all the processes that transform theraw materials into the finished carpets and rugs. The operations include spinning,weaving, knitting, and dying. All the processes are carried out in the company

efficiently. The company has backward integration in which they produce most of itsinputs such as the polypropylene which is used to get fibers. Then, they do thespinning as well as dyeing yarn which is followed by weaving to get the finished

product.

Outbound Logistics They have very sophisticated distribution channels throughdomestic outlets and international facilities. Globally, they have distributions facilitiesin the US, UK, Germany, Canada, Italy and Dubai (Report 2009). These facilitiesenable the company to reach more markets all over the world.

Marketing & Sales The Company has around 207 showrooms that allow them tointeract with the customers and show and market their various products. They have

the largest showroom in the whole world in 10th of Ramadan city. They also havewell designed websites that are easily accessible and they have a website for OrientalWeavers Carpets Company as well as MAC and Oriental Weavers US. This allowsglobal distributors, for example, to locate Oriental Weavers and know more its futuredealings. They participate in local and global exhibitions and fair such as HannoverFloor coverings Fair. They also built partnerships with leading companies such as

National Geographic and Disney.

Af ter Sales ServiceThe after sales service is important to keep good relations with thecustomers which are mainly through their showrooms. Oriental Weavers handlescomplains of customers who might have concerns towards the carpets, showrooms, orother factors that cause dissatisfaction. In addition, the company provides

maintenance and repair services, however they guarantee that most of their productsrequires low maintenance. The quality of the products is high with good durability.


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LINKAGES

The change in policies and overall political situation in Egypt during the pastyears had enhanced FDIs. Today, the political instability mentioned above is expectedto affect the economy in general and more specifically the textiles industry as well asthe company. On the economy level, investments will decrease and governmentexpenditures will increase which will increase the government deficit. On the textiles

front some companies had entered into joint ventures with some foreign investorssuch as Italys Micro Radici, one of Europes leading manufacturers of textiles andfibers. This political instability will then affect that kind of cooperation negatively.Hence its productive and exporting capacity will decrease. The company will haveuncertainty so they will be more cautious in their future and expansion plans and thiswill be proved in the following section of the financial performance.

The economic ties between Egypt and Israel as they signed an agreement withthe US to establish seven Qualifying Industrial Zones (QIZs) in Egypt, will allow anymanufactured goods with at least 11.7 percent Israeli inputs to be exported to US byduty free. Concerning the cluster, this agreement had spurred growth in the textilessector with the following trend. The total Egyptian exports to the U.S. that was 1,283$

million in 2004 acceded 2$ billion in 2005 and continued to climb during2006.According to the company it will increase its exports to the US and expandthrough establishing factories there. Agreements between Egypt and the US createopportunities for Oriental Weavers to reach more customers in the US market.

The huge population in Egypt creates more demand for the company'sproducts. The consumption of the Egyptian consumers to carpets and rugs is high andincreasing which is reflected in the sales of the company in the financial andeconomic evaluation. As population increase the percentage of cheap labor will grow,which will increase the competiveness of the whole industry especially ininternational markets.

Government spending on R&D in Egypt falls far behind the world averages;this is reflected in a poor quality of technical education which is a barrier for thecompany to find qualified labor. Without this qualified labor, the company won't beable to offer the good quality products that create its competitiveness. On the textilesfront, the human capital side is of a major challenge in Egypt since it lacks qualifiedmiddle and upper management who are related to the industry. This consequentlynegatively affects productivity, quality, marketing and R&D capabilities. In addition,it led to the increase in production costs in the economic evaluation section.

ORIENTAL WEAVERS FINANCIAL VS.ECONOMIC PERFORMANCE

In this paper, we examine the Oriental Weavers' economic viability and its impact onthe Egyptian economy both on the cost side and benefits side. To achieve this, afinancial analysis should be conducted first using the Pro-forma income statements,capital requirements to investment, optimum financial structure to calculate therepayment as well as to conduct a financial analysis to scrutinize the financialviability and economic profitability of the project which are the basis of theinvestment decision undertaken by the investor.

1. Income statement

The revenues of Oriental Weavers which are accruing from sales have

increased through the analyzed period 2005-2009.Since the Financial statement is notdetailed we had to estimate the following figures comprised from the revenue of eachyear; (i) utilities (5 %); (ii) salaries and wages (30 %); (iii) raw materials (50 %); and


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(iv) others (15 %) (such as administrative costs, maintenance, and marketingexpenses.)From both revenues and costs we reach the Gross Operating Profit.

Gross Operating Profit (GOP) = RevenuesCosts= 3,264,397,462

In order to obtain a Pro-forma Income Statement, we discount the given percentage oftaxes (10%) from the GOP for each year which is the annual Net Cash Flow.

Table 1: the Pro-forma Income Statement of Oriental Weavers group for the period (2005-2010) in EGP is as follows:

Year 2005 2006 2007 2008 2009 2010(Projection )

Utilities 80,091,215.55 145,996,744.65 153,353,027.45 172,119,354.50 177,531,863.80 223,117,036.46

Wages 480,547,293.30 963,578,514.69 1,021,331,162.82 1,260,946,391.07 1,430,658,277.62 1,977,812,045.00

Raw

Material800,912,155.50 1,459,967,446.50 1,533,530,274.50 1,721,193,545.00 1,775,318,638.00 2,231,170,364.58

Others 240,273,646.65 437,990,233.95 460,059,082.35 516,358,063.50 532,595,591.40 669,351,109.38

GOP 327,937,819.00 405,599,850.00 577,216,848.00 634,474,212.00 619,753,787.00 699,414,946

NCF 295,144,037.1 365,039,865 519,495,163.20 571,026,790.8 557,778,408.3 639,473,451.4

However, for the purposes of calculating the residual, as a step for calculating thePresent Value of the Net Cash Flow, the estimation of GOP for the sixth year wasrequired. We projected it by the average annual percentage change of revenue minusthe average percentage annual change of cost of operation, in order to ignore theoutliers' effect.Further to obtain a Pro-forma Income Statement, we discount the given percentage oftaxes (10%) from the GOP for each year which is the annual Net Cash Flow. The NetCash flow is the value of the annual net income accrues to the project, which is the

basic required value for comparing revenues to costs to check the financial viability ofthe project. Revenues solely aren't sufficient for this comparison, as they must beassociated to costs that were needed to achieve those revenues over the lifetime of the

project.

2. Capital Requirements

Calculating Capital Requirements of a project is a vital step for doing afeasibility study for this project. It also helps by verifying the capital requirement theinvestor to evaluate the projects investment cost. Capital requirement is the total of

the fixed capital and the net working capital. Fixed Capital is the resources required tofinance Fixed Assets (including all pre-opening expenses) and the Net WorkingCapital is the resources required to operate the project totally. The fixed assets are

pre-opening expenses, land, buildings, machinery and equipment, furniture and meansof transportation.

Table 2: Total Fixed Assets for Period (2005-2009)

However, the Working Capital is the capital required to finance the four financialgaps any project encounters during its operations which includes; accounts receivable(sales to receiving cash gap), inventory of final product (production to sales gap),inventory of raw materials (buying raw materials to production gap), and accounts

payable (credit payments).

Year 2005 2006 2007 2008 2009Total

Fixed

Assets

909,920,212 1,475,271,938 1,651,688,281 1,625,254,153 1,608,600,860


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Table 3: Net Working Capital for Period (2005-2009)

3. Optimum Financial Structure

The financial structure is the capital outlay of the project which is the total ofthe investment costs of the project (Investment Cost = Equity + Loan).Afterdetermining the amount of Investment needed for the project, the Optimum FinancialStructure should be determined for the allocation of the required resources to the

project and the income of the project would yield over its lifetime and hence theinvestor decide to invest or not. This Optimum Financial Structure refers to theoptimal ratio between equity and loans used for financing the project, which could be

identified by the following equation; E/I + L/I =1. This implies that by identifying

the amount of one of the two sources of finance, the second is the residual. TheOptimum Financial Structure, for any project is calculated by the followingrelationship between repayment, investment, its return, interest on loans and numberof installments; Repayment = Return on investment x Investment Cost/ 1+InterestCharges x number of installments.

(Repayment for Oriental Weavers = 0.221*1,482,038,848 / 1+0.12*60)

Table 4: Repayment for period (2005-2009)

Year Amount of installments Repayment

2005 39,925,310

39,992,417

2006 39,925,310

2007 39,925,310

2008 39,925,310

2009 39,925,310

Total 199,626,549

A. F inancial Evaluation

1. Weighted Average Cost of Capital

The WACC is the basic measure of financial viability. It is the minimum riskadjusted rate of return required by investors before they decide to invest in a project.The WACC is the discount rate at which the NCF is discounted to the investment

cost. Investment decisions cannot be made without estimating the projects WACCaccurately. The WACC of Oriental Weavers group for all the years = 0.15532 1Therefore, the WACC is calculated as an average of the different financing costs ofthe firm weighted by the proportions of debt and equity in the capitalstructure(WACC= iB(1 - t) L/I + (id + S * ) E/I.

2. Net Present Value (NPV)

The NPV of an investment is the difference between an investment's currentvalue and its cost. Instead of simply adding together each year's cost or benefit, net

present value analysis first converts the value of future costs and benefits to theiractual value today.

1I= Loan +Equity (I, L, and E should be based on market values)

Year 2005 2006 2007 2008 2009

Net

Working

Capital

438,292,906.46 855,011,674.75 853,998,602.33 962,407,384.83 1,002,784,237.46

Net Working Capital = Accounts Receivable + Inventory of Final Product +

Inventory of Raw Materials Accounts Payable


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Table4: The PV of Oriental Weavers group over the analyzed 6 years in EGP

If PV>Investment (I), then the project is financially viable

If PV < I, then the project is not financially viable

After converting each year's future value to a present value, the present value for eachyear is summed to calculate the net present value. Oriental Weavers is financiallyviable since;

NPV > I48,278,850,356.45 >14,901,896,219

3. Internal Rate of Return (IRR)

It measures the performance of an investment as a rate of return (it is thediscount rate at which the NCF could be compared to investment cost). The IRR usesthe same net cash flows as one would use under the NPV method but expresses theend result as a percentage yield. Provided that the IRR is greater than OrientalWeaverscost of capital, then the project is said to be viable from a financial point ofview.

PV > I, NPV> 0, IRR>WACCproject is viable

PV


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The breakeven point for Oriental Weavers is 0.70 or 70%.The higher the BEP thehigher the business risk, and the lower the BEP the lower the risk. This implies that aBEP of 70% is on the very high and thus this project is risky. The company has tosell at minimum 70% to break even and cover its costs.

6. Return on Investment (ROI)

Return on Investment is calculated as net profit before interest and taxationdivided by total assets(ROI =GOP/I).ROI> WACCproject is viable

ROI < WACCproject is not viable

The ROI for Oriental Weavers is 0.22which is positive and greater than the WACC.

ROI > WACC0.22 > 0.155

This indicates that Or iental Weavers is fi nancial ly viable.

7. Social Rate of Equity (SRE) and Social Rate of Investment (SRI)

SRE=Net Cash Flow-Interest/Equity

SRI=Net Cash Flow/Investment

If SRE > SRI, then the project is financially viable.

SRE>SRI

1.09>0.90

Therefore to sum up the fi nancial evaluation for Or iental Weavers;

1)NPV > I

2)NCF > I

3)NPV > 0

4)I RR > WACC

5)SRE > SRI

ORIENTAL WEAVERS IS FINANCIALLY VIABLE

B. Economic Evaluation

Economic evaluation is about the cost benefit analysis of direct and indirect

costs and benefits. It is based on an approximation of economic prices known asshadow prices, which are adjusted to reflect opportunity cost to the society. It isconcerned with cost and revenue to both the investors and the society. Besides themaximization of profit which is the sole objective of the financial analysis, theeconomic analysis considers other macro parameters as criteria for economic

profitability as the value added effect, employment effect and foreign exchange effect.

1. Market Distortions

A main principle in economics is that prices set in perfectly competitivemarkets provide clear signals of the value the economy places on items. An economicdistortion occurs when some market intervention creates a wedge between the value

of resources used in the production of a commodity and the value to consumers ofconsuming it. Price distortions are a key constraint in the economies of mostdeveloping countries and Egypt is no exception. In most cases, domestic prices do not

BE of the base year (2005) = FC

TRVC

BE = Util i ties + Wages

RevenueRaw materi al

BE = 80,091,215.55 + 480,547,293.30

1,601,824.31 - 800,912,155.50

BE = 0.70


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match world prices, do not reflect opportunity cost and lead to the inefficientallocation of resources mainly due to:

Government interferences through taxes or subsidies. Most governments relyon income or consumption taxes to raise their revenue to finance government

expenditures. Heavily taxed projects distort by directing investment tosubsidized projects which emphasize the importance of using a taxation policyto encourage investment in economically viable projects and discourageinvestment in economically unviable projects. The main distortions in theEgyptian economy are reflected by the heavily subsidized energy sector for all

projects even big companies such as Oriental Weavers. Companies may erect entry barriers, thereby creating market power. An

oligopoly is an extreme example of such market power. Firms with marketpower can sell goods at a price exceeding their marginal cost of production,and have a bargaining power in buying their raw materials. Oriental WeaversGroup enjoys a market share of 85 percent which enable the group to practicethis power in the Egyptian market.

The production or consumption of some commodity may have some positiveor negative impact on other parts of the economy not transmitted throughmarket prices. Such impacts are called externalities. In general, an unregulatedeconomy produces too many goods with negative externalities and too fewgoods with positive externalities.

We cannot have wrong prices in a free economy as this leads to investment in the

wrong projects which results in: low productivity, misappropriation of resources andloss of international competitiveness. In order to test price distortions, we convert

prices from commercial/financial prices to economic prices. Since economic prices donot exist, we use an approximation of prices called shadow pricing.

2. Testing for Distortions and Estimating Shadow Prices

Shadow pricing is the estimation of values of goods and services in a way that reflecttheir social opportunity cost. However, most of the prices in developing countries aredistorted due to over-taxation and over-subsidization. These distortions prevail in fourmain markets; (i) commodity market (inputs and outputs), (ii) labor market (mainlyunskilled labor), (iii) capital market; and (iv)foreign exchange market.

Table 5: Oriental Weavers Inputs and Outputs

i. Commodity Market

First, in our project we had to identify all inputs, outputs and factors ofproduction contributing to the production in Oriental Weavers, clarified by thefollowing table;

Second, we identified their domestic market prices(DMP), foreign market prices(FMP) and shadow prices to test for distortion by using the accounting ratio or theeconomic value;

Accounting Ratio = Shadow Price/Market Price Economic Value = Value of Item/ Market Price* Shadow Price

Inputs Outputs

Wool A class woven carpets

Cotton B class woven carpets

polypropylene fibers C class woven carpetsOther raw materials Tufted

Wages and salaries Goblin tapestry

Utilities (water, gas, electricity)


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Table 6: Shadow prices for inputs and outputs

Inputs Shadow Price Outputs Shadow Price

Imported Wool CIF price A class woven carpets FOB price

Local CottonCIF price as it is cheaperabroad

B class woven carpets FOB price

Polypropylene FibersDMP as it is cheaper in thelocal market

C class woven carpets FOB price

Other Raw Materials Tufted FOB price

Utilities (water, gas,electricity)

International market priceas an estimation of cost. Goblin tapestry FOB price

Notes on shadow prices:

All prices are distorted by more than 10 percent except for other raw materials. Electricity's International Market Price (IMP) is used as an estimation of the

cost because electricity is subsidized in Egypt, where its distortion is very highthough its value to production cost is only 5%.

Domestic Market Price (DMP) of wool is estimated by the ratio of itsinternational price to the cotton's international price.

ii. Labor market

The labor market consists of both skilled workers and unskilled workers. In

most countries, skilled labor has no distortions and the wage rate reflects theopportunity cost of worker because surplus of labor is the main source of distortion.However, unskilled labor has a significant distortion as the supply of labor exceedsthe demand. The outcome is that the marginal productivity becomes very low. It isthus important to estimate the shadow wage rate so as to get the optimum cost oflabor.

Shadow Wage Rate = Marginal productivity+ training costs+ additional costs= 145 L.E/ month (given)

Oriental weavers group currently employs 14,000 workers. We assumed that 4,000are skilled labor working in administration and engineering and 10,000are unskilledlabor working in factories. We further assumed that the cost of labor for unskilledworkers is 40 percent of wages and salaries consecutively.The shadow wage rate for unskilled workers at Oriental Weavers for the analyzed

period of 2005- 2009 is 1,450,000.

Table 7: Wages and salaries of Oriental Weavers after adjustments

Year 2005 2006 2007 2008 2009

Wages 289,778,376 527,038,280.7 553,520,898.8 621,079,676.2 640,564,709.7

Thus, the Market Wage Rate (MWR) for Oriental Weavers exceeds the Shadow WageRate (SWR) due to labor law that states a minimum wage rate.

iii. Foreign Exchange Market

The foreign exchange markets in developing countries are highly distorted.They either overvalue their currency (OER > EER) in order to increase cost of exportsand reduce cost of imports and vice versa. The main source of distortion of foreigncurrency is government interference through tariffs and subsidies on exports. TheOfficial Exchange Rate (OER) is given and it is equal to 5.5 which we used it for the

base year (2005).

iv. Capital Market

Capital markets in developing countries are highly distorted with the savingsratio lagging behind the investment ratio. This implies that the demand for the capitalis high and its supply is low leading to a shortage or scarcity of capital. Government

and policy makers in the countries interfere to control the interest rate and this leadsto distortions in the capital market. In order to adjust this distortion, we calculate thesocial discount rate (SDR).


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The Social Discount Rate (SDR) is the discount rate to the society and it reflects thesocial opportunity cost of the capital to be injected in the country.

SDR= iL+ R2

=7+1.25= 9.5%

Explaining Calculations

We divided all revenues and costs by their domestic market prices to have quantitiesproduced of output or of used inputs. Then we multiplied the shadow prices by the

quantities so as to have the costs and revenues at the adjusted prices. Hence wereached both the total economic revenues and total economic costs.

ERR = Total Economic RevenueTotal Economic Cost

Table 8: Economic Rate of Return of Period (2005-2009)

Year 2005 2006 2007 2008 2009

ERR -2266996001 -4327536768 -521764198.3 -5149277116 -5314312855

3. Economic costs and benefits

After we tested for distortion, we divided all revenues and costs by theirdomestic market prices to have quantities produced of outputs or used for inputs.Then we multiplied the shadow prices by the quantities so as to have the costs and

revenues at adjusted prices. Hence we reached both the total economic revenues andtotal economic costs.

Table 9: Total Economic Revenues from outputs for Oriental Weavers

Year 2005 2006 2007 2008 2009

Outputs 1,435,973,018 2,552,662,797 6,697,460,966 2,926,229,571 3,010,656,010

The difference between financial and economic cost and revenue is who will benefitfrom the project. If the benefit goes solely to the investor, then it is purely financial

but if the benefits and costs impact the society then it is economic. These impactscould be negative (cost) or positive (benefit).

Table 10: Total Economic Costs from Inputs for Oriental Weavers

Year 2005 2006 2007 2008 2009

Inputs 3,702,969,019 6,880,199,565 7,219,225,165 8,075,506,687 8,324,968,865

We derived the indirect effects of manufacturing carpets and rugs and quantifiedthem. There are several hazards associated with the manufacture of carpets and rugs.These hazards are indirect negative effects which are a cost to the society. Workers inthe company are routinely exposed to harmful petrochemicals and dyes which areused in the manufacturing processes. The main petrochemical used in OrientalWeavers is polypropylene which poses several hazards to workers such as;

Inhalation: Dust may irritate the respiratory system. Skin contact: Repeated exposure may cause a slight irritation

Contact with the eyes: The dust may cause a slight irritation Absorption by the skin: There is no evidence of systemic effects Effects of overexposure: The inhalation of high concentrations of dust may

irritate the upper respiratory tract and damage lungs by accumulation.High economic cost is attributed to distortionsin all inputs and outputs prices and notonly to the cost of pollution and health. To improve actual damage estimation: wethought of operatinga survey among a sample of factory workers to check the realcost of polypropylene on their health treatment cost and productivity.

2IL: long run international rate at which one can borrow money in the international free market.R: risk factor to repay money borrowed in foreign currency.


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4. Quantifying Indirect Cost and Benefits

There are three methods to quantify indirect (economic) costs and benefits;(i)

quantifying the actual damage and actual benefits, (ii) mitigation cost; andwillingness to pay. Oriental Weavers is aware of these hazards, and is complying withinternational standards in controlling production of polypropylene and managing itswastes. They comply by the hardest international standard to maintain their supplyrelationship with major players. For example, they comply with EU environmentaland occupational health and safety standards as required by IKEA and Marks &Spencer, and comply with the American standards USEPA as required by HomeDepot. Therefore, they maintain a consistent improvement of production processes tominimize the adverse impact of water, air, noise and solid waste emissions to theenvironment. Consistent with this internal policy, Oriental Weavers maintains 1SO9001 (Quality Management System) and ISO 1400I (Environmental ManagementSystem) certification.

The group also provides free medical care for employees and their families ata hospital established by the Chairman in the 10th of Ramadan city. However, there isstill cost paid for health treatment and the decline in productivity due to healthdeterioration. We estimated these costs (after consulting a physician) by quantifying

the actual damage method. We assumed that 10% of workers in factories (10,000) areexposed to polypropylene and its wastes and therefore suffering chest diseases andcomplications. We also estimated that monthly cost for their treatment is 1000 L.E

plus the cost of their absence 3 days monthly.

Damage = 1000 * 1000 +1/7 * 1/10 * Revenue

Table 11: Treatment Cost and Absence Cost of Period (2005-2009)

Year 2005 2006 2007 2008 2009

Estimated

Treatment cost1000000 1000000 1000000 1000000 1000000

Estimated cost of the

absence of 3days/month/worker

22883204.44 41713355.61 43815150.7 49176958.43 50723389.66

5. Economic Profitability

i. Net Benefit (NB)

In order to calculate Present Value of Net Benefit PV(NB), we have tocalculate the NB (NB = sum of all costssum of all benefits) of the project along itslife time of 5 years.

Table 12: Net Benefit for Period (2005-2009)

Year 2005 2006 2007 2008 2009

NB -2290879206 -4370250123 -566579349 -5199454074 -5366036245

ii. The Economic Present Value (PV(NB))

PV (NB)= NBI1+ 1+SDR + NB2/(1+SDR)2+ NB3/(1+SDR)

3++ NB/(1+SDR)

5

NPV (NB) = - 2950448708

Table 13: Economic Present Value (EPV) for Oriental Weavers

Year 2005 2006 2007 2008 2009

PV(NB) -1174809849 -1149309697 -76411180.09 -359599683.7 -190318297.9


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iii. Economic Rate of Return (ERR)

It is the economic return on capital invested in the project to the society. It isthe discount rate we put to bring the EPV equal to investment cost based on shadow

prices.ERR ERR

This project is subsidized or it encounters tax exemption to decrease cost and increase

benefit for the economy. Oriental Weavers receive an export subsidy and they were tax

exempted for 15 years.

SDR>ERR< IRR>WACC

In spite of having Oriental Weavers as a financially viable project, however it is not

economically viable.

6. Deriving Economic Profitability Using Macro-parameters

Although Profit is the key issue in economics, however, it is not the onlyparameter we use in evaluating the project economically. There are other macro-parameters to use for the evaluation of the project from an economic point of view;(i) Value Added Effect, (ii) Employment Effect; and (iii) Foreign Exchange Effect.

i .

Value Added Effect (V.A)It is the most basic criteria to estimate the effect of the project on the

economy. It introduces the payments to factors of production and it measures thedifference between the output value and the input purchased from other industries.The statement also includes the wages and salaries and the social surplus as a residual.

Domestic Value Added(DVA) =Gross Output (GO)Material Inputs (MI)= Wages + interest + Profit= Wages + Social Surplus= 7,753,008,133.16

Since the domestic Value Added might not include the interest paid on money fromabroad; therefore we need to calculate the National Value added.

National Value added (NVA)= DVA - TB (Transferred money from abroad)= 5,357,489,549.16

NVA measures the net contribution of the project to the national economy. It is foundthrough discounting the National Value added at the Social Discount Rate (SDR).PV (NVA) = NVA1/1+SDR+ NVA2+ (1+SDR)

2 + ....= 61,922,764.67

If PV (NVA)> Investment cost: project is economically viableIf PV (NVA)< Investment cost: project is not economically viable

PV (NVA) < PV (I)

61,992,764.67 < 14,901,896,219

Oriental Weavers is not economically viableSocial Surplusincludes the interest and net profit. A positive Social Surplus indicatesthat the project is efficient from the national point of view.

Absolute Efficiency Test (AET)is a screening test for the viability of the project. Apositive AET means that the project is economically viable. A negative AET meansthat the project is not economically viable.AET = PV (NVA)PV (I)

= 61,992,764.67 - 14,901,896,219 = - 14,839,973454The AET for Oriental Weavers is negativewhich implies that the project is noteconomically viable.

Relative Efficiency Test (RET)is a ranking system that enables the investor to analyzeand choose which project to invest in. It reflects the right decision because it dependson the Marginal Productivity.


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RET= PV (NVA)/PV (I) = MPI= 61,992,764.67 / 14,901,896,219= 0.004Since this is very low rate it indicates that it is not an economically viable project asit has a low value add to the economy as a whole.

i i . Employment effect

One other important criteria that would follow the Value added effect (butnever be traded for it) is the employment effect. It refers to the new employment

opportunities created within Oriental Weavers which is measured on the basis of thelabor capital ratio.EE = E/I = LU+ LS/ I= 14,000 / 14,901,896,219= 0.000000939This means that for every 14,901,896,219, Oriental weavers creates14,000 Jobs. Thisis a tremendous contribution to the economy so the cost of one job equals LE1,064,421.16.Our source in the company informed us that they have high barriers tothe entry of new competitors as only one machine costs them more than 1 millionUSD. This could explain the low employment effect relative to the capital investedregardless that the whole group employs about 14,000 workers in absolute terms.

i i i . Foreign Exchange Earnings

This is another criterion to use in measuring economic profitability. It assessesthe effects of the implementation and operation of the project on the foreign exchange

position of the country. Foreign Exchange flows are discounted at the SDR to get thePV (FEE).FEE = PV (NFE)/PV (I)

= 92,243,709.32/14,901,896,219 = 0.01

Since this value is less than 0.2 then the project has a negative impact on foreignexchange and it is not economically viable.

CONCLUSION

Egypts stage of development is between a factor driven and an efficiencydriven country. However the most problematic factors in Egypt that affects productionnegatively are (i) inefficient government bureaucracy; (ii) tax regulations; (iii)inadequately educated workforce; (iv) inflation; and (v) corruption. Although theworld financial crisis took place in 2008, Oriental Weavers was able to achieve

positive results. In 2009 Oriental Weavers sales was EGP 3,551m (3.71% increases),sales in woven segment had a 6% increase, tufted segment had 1% decrease (6%reduction in price) and profits were EGP 678 million. According to the financial

performance analysis, the financial evaluation showed that Oriental Weavers isfinancially viable since; (i) NPV > I, (ii) NCF > I, (iii) NPV > 0, (iv) IRR > WACC;and (v) SRE > SRI. In spite of having Oriental Weavers as a financially viableinvestment based on cost-efficiency and comparative advantage, however it is not

economically viable. Oriental Weavers has IRR>ERR and SDR> ERR. It does notprovide basis for a competitive advantage in the future. It is highly subsidized toachieve cost-advantage, but does not contain the main ingredients of technologyinnovation or strong local supply chain linkages. It encounters tax exemption todecrease cost. Oriental Weavers receives an export subsidy and they were taxexempted for 15 years. As Oriental Weavers controls 85 percent market share, andhaving a very high BEP (70 percent), therefore they have higher financial profitability

but negative value-added economic returns. We can therefore assume that thecompany has an abuse of monopolistic power which allows it to control market pricesin the industry. The company incurs higher social costs than benefits. This means that


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the value is positive to the investor but not to the society at large. Last but not least,the company reaps benefits from the heavy subsidization by the government of theenergy sector and low taxes.

RECOMMENDATIONS

1.

Introduction of new facilities and the optimization of other productiontechniques in the sector are needed.2. The government should gradually stop the heavy subsidization of the energy

sector.3. Disincentives should be administered to deter investors from investing in this

project through higher taxes to lower financial returns to the investor.4. Correcting price distortion will ensure that people are not misguided to invest

in the wrong projects.5. Increase the government spending in Research and development and education

by building qualified research institutions especially in the field of technology.This would give Egypt the opportunity to be an industrialized country and

have more updated machines for example in the field of textiles and cotton tohave a competitive advantage for the country.

6. The government or the private sector should take a serious action in fightingcorruption by forming an institution for anti corruption, new effective lawsand focusing on awareness campaigns that can explain for people the negativeimpact of corruption on the countrys development.

7. Increase the government incentives to exporting companies to encourageexports and manufacturing of goods.

8.

The company should be familiar with the international agreements in order toexpand globally. With more agreements signed between the government andother countries, they should make use of all the benefits that result from those

agreements.9. The country should establish more technical educational institutions related to

the textile industry in order to have more skilled labor that can support theindustry.

10. The government should spend more in resources to improve the skills andtraining and promote a more attractive landscape for foreign companies.

11.

The government should promote offshore investment environment andenhance transparency among the different industries within the sector.


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REFERENCES

Interviews:Mr. Haytham Abdel Moneim, Investors Relations Manager, Oriental WeaversMrs Ghada El Shazly, Credit Agricole Bank

Site Visits:

Oriental Weavers, Sheraton Buildings, Cairo, Egypt

Work Sited:"A Hub for Sustainable Development ." IMC, 2009. Web. 10 May 2010..

Al Alwady, Nadia. United Nations Educational, Scientific and Cultural Organization(2007): Arab Science Expenditures disappointing Forum Hears, October.http://www.unesco.org/science/psd/focus/focus07/arab_science.shtml Brandis Royal, Cotton and the World Economy, Southern economic journal, 1956"CERF 2011 Conference." Coastal & Estuarine Research Federation, 04/14/2010.

Web. 11 May 2010. .Economist Intelligence Unit (2010): Country Report, Egypt, February.Economist Intelligence Unit (2008): Country Profile, Egypt.

Economist Intelligence Unit (2009): Country Forecast, Egypt,July.Economist Intelligence Unit (2010): Country Risk Service, Egypt,February.CI Capital Research (2010):Monitoring Brief, Egypt, April.International Country Risk Guide (2010), Egypt, January.The World Bank Group (2009): Country Brief, Egypt,September.The Global Competitiveness Report (2009-2010), World Economic Forum.Korayem Karima, Research Environment in Egypt, Research for Development in theMiddle East and North Africa.Transparency International, The Global Coalition Against Corruption"Our Oriental Rugs." N.p., 2008. Web. 11 May 2010."Bella Rugs." N.p., 72008. Web. 9 May 2010. .

Baroudi Sami, The Egyptian Agriculture Exports since 1973, Middle East journal,1993.Dan Mageler, Egypt after the Multi fiber Arrangement: Global approach apparel

and textiles supply chain as a route for industrial upgrading., institute for

international economics, 2005"EFG-Hermes offers its clients a complete spectrum of investment services." N.p.,2010. Web. 5 May 2010..Fawzy Samiha, Nada Massoud, The future of the Egyptian textiles and Apparel

under FTA, 2003,www.eces.orgHaddad Amira, Vertical Integration and institutional constraints on firm behavior:

the case of garment industry in Egypt, 2008,www.erf.orgKarima Korayem, Research Environment in Egypt, Research for development in theMiddle East and North AfricaOriental Weavers Annual Report 2008Oriental Weavers Investor Presentation 2009Oriental Weavers Carpets, CI Capital, 2 March 2010.Refaat Amal, Assessing the Impact of the QIZ protocol on Egypts textiles and

clothing industry, eces.org, 2006The Egyptian competitiveness reportTextiles and clothing industry in Egypt, Business Studies and analysis center, 2004

Transparency International, the global coalition againstcorruptionhttp://www.transparency.org/Yang Diao, Textile company weave Nile dreams, www,chinadaily.com, 2009
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