Overseas Supply Chains: What You Don’t Know May Hurt You

Third Quarter 2012
Corporate Board Member
by Craig Mellow

Apple Inc. has no ownership stake in Foxconn, the giant contract electronics manufacturer with headquarters in Taiwan, no seat on the board, and no formal say over Foxconn’s labor policies. Yet Foxconn’s mounting public relations problems over the past two years have become Apple’s problems, nonetheless.

Foxconn’s transformation into a byword for worker abuse started in early 2010, when a dozen young employees killed themselves or tried to in rapid succession at two of the company’s plants in Shenzhen, China. The Scroogean image was cemented this March when the Washington-based Fair Labor Association (FLA) released a stinging report finding that nearly half the Foxconn workers it interviewed had witnessed a workplace accident, and the company had violated at least 43 different Chinese labor laws or regulations.

Along the way, media coverage attached Foxconn’s perceived sins to Apple, one of its major customers. Witness the January 2012 New York Times headline: “In China, Human Costs Are Built into an iPad.” The FLA report tarnished the halo that had settled over the Silicon Valley powerhouse after a triumphant series of product launches and the untimely death of founder Steve Jobs. It is hard to symbolize advancement and personal freedom, as Apple likes to, against a backdrop of such lurid news.

Singling out Apple was unquestionably selective journalistic justice. Foxconn’s 1.2 million employees churn out 40% of the world’s electronic components, according to the Times, and supply most of the industry’s household names, including Microsoft, Motorola, Dell, Hewlett-Packard, and Amazon. The spotlight settled on Apple at least partly because it was the one that pushed the FLA to investigate, a classic paradox of no good deed going unpunished.

But that is just the point for any board or management depending on an ever more complex and far-flung global supply chain: It could happen to you. Cynics will argue that the flap over Foxconn has done Apple no visible harm. iPhones and iPads continue to sell like hotcakes, and the company has surged to the world’s most valuable business, according to stock market price.

Yet few brands can feel as bulletproof as Apple these days. Other big-name multinationals have lost business over perceived abuses in plants or suppliers overseas, notably sportswear manufacturers deprived of lucrative college sponsorship deals. And none of us wants to wake up in the morning feeling that our day’s work led a young man to jump off a dormitory roof in a distant corner of the world.

For board members looking to ensure their company does not become the object of the next Foxconn, the bad news is that compliance does not come cheap. American clothing companies and retailers spend roughly $2 billion a year monitoring labor, safety, and environmental standards at suppliers around the world, estimates Julia Hughes, president of the U.S. Association of Importers of Textiles and Apparel (USA-ITA). Her industry has dealt with these issues the longest, for obvious reasons, and includes most of the companies activists cite as role models for ethical sourcing: Levi Strauss & Co., Gap Inc., and VF Corp. (makers of Wrangler, The North Face, JanSport), among others.

Nor is compliance straightforward. Despite some fervent backroom discussions, no agreement has yet emerged to offer a generally accepted good sourcing seal of approval that multinational brands can slap on their jeans or laptops. Rivalries among the various watchdog groups can be quite strident.

Apple is just the latest household name to reach out to the FLA as a fair arbiter after getting negative attention from labor advocates or the press. Executives from Adidas and Russell Athletic, which have both had run-ins with student and faculty groups over their on-campus sales, now sit on the FLA board. Yet this sort of cooperation makes the Fair Labor Association suspect in the eyes of harder-core outfits like the Worker Rights Consortium (WRC) or Hong Kong-based Scholars Against Corporate Misbehavior (SACOM), which helped pushed the Foxconn story into the global media.

Beneath this contentious surface, a plethora of mostly private firms compete for market share in the fast-growing social audit business, each of them naturally eager to undercut the credibility of all the others. The result is a babble of certifications and checkoffs that might prove unconvincing in the court of public opinion. “I fear that we are creating a cottage industry in falsified records around the world,” says Eric Olson, head of advisory services at Business for Social Responsibility (BSR) in San Francisco.

Consumers also show limited willingness to pay more for ethically correct products, even if they could be systematically defined. At least that is the common wisdom for now. Fair Trade coffee may have found a growing niche market of shoppers willing to pay a bit extra for perceived ethical java. But clothing merchants are pessimistic about developing an analog. “A fair trade brand in textiles or apparel? I don’t think so,” USA-ITA’s Hughes opines.

The good news on compliance is that making faraway factories more humane does not necessarily increase the cost of goods, specialists say. Standard coverage of the issue frames it as a zero-sum game of raising worker salaries vs. maintaining competitive pricing and profit margin. But some changes—paying wages on time, for instance, or consulting employees rather than yelling at them in public—add considerably to workers’ dignity without costing anything, says Amy Luinstra of the International Finance Corp., the private investment arm of the World Bank.

Luinstra heads the IFC’s end of the Better Work Program, a joint initiative with the International Labor Organization that cooperates with some 60 different multinationals and their suppliers in seven countries from Cambodia to Nicaragua. Reforms that do raise costs often pay back in increased productivity and reduced turnover, which quickly becomes an issue as global manufacturing rolls out in each new low-cost destination, she claims.

“We have found over 10 years in Cambodia that once a factory becomes compliant with international labor standards, it never regresses,” Luinstra says. “If it were really costing them money, that wouldn’t be the case.”

Policing supply chain ethics
Ethical supply chain management is a young field full of growing pains.

The birth of the movement is generally traced to the so-called Kathie Lee Gifford scandal in 1996, when human rights muckrakers found 12 year-old Honduran children laboring under harsh conditions to sew clothing branded by the talk-show celebrity and sold at Wal-Mart. About the same time, sportswear giant Nike came under fire for wages and living conditions at “sweatshop” suppliers in Indonesia and elsewhere.

The FLA was formed in 1999 by apparel manufacturers under the aegis of Bill Clinton’s administration as an exercise in industry self-policing. The WRC launched the same year as an outgrowth of the campus movement United Students Against Sweatshops.

Corporations, even those with good-guy reputations, are tight-lipped about the details of how they enforce morality among suppliers, perhaps mindful of the hammering Apple took when it stepped forward to investigate Foxconn. But a case study prepared for University of Michigan business students in 2010 sheds light on the complexities of compliance in a world of fickle markets and divergent yardsticks.

In early 2009, a committee chaired by Michigan’s president convened to decide whether to cut off a longstanding relationship with Russell Athletic as a producer of licensed clothing with the university’s emblem or mascot. Russell, a division of Fruit of the Loom, which in turn is controlled by Warren Buffett’s Berkshire Hathaway Inc., stood accused of closing a factory in Honduras as retaliation for union activity among its workers. The plant was one of the few to have unionized in the Central American nation and was seen as a symbol of progress for the rights of labor.

Eleven universities including Duke and Georgetown had already kicked Russell off their licensee list over the incident. Michigan, the second-biggest licensor in college apparel, was seen as a bellwether whose rejection could close the whole $4 billion market to Russell and spur wider negative publicity about the company. Russell claimed the decision to close the plant was purely economic, part of a wider retrenchment across Latin America as the 2008 recession began to bite.

Michigan was advised by both the FLA and WRC, and it sent both of them down to Honduras to investigate. WRC found that union leaders at the disputed factory had been threatened both with the plant’s closure and physical violence and saw the shutdown as a union-busting move. FLA, though internally divided, backed Russell’s explanation that the factory was closed for legitimate business reasons.

Michigan did cancel its contract with Russell in March 2009, and the company made amends by employing its dismissed Honduran workers at a new unionized factory later that year. But most multinationals are not exposed to the hypersensitive college licensing business. Russell’s tortuous experience at a plant it actually owned might give them pause before committing to verify humanity at a long chain of outside suppliers.

Indeed, half a dozen contractors around the world can be involved in making a single pair of jeans these days, and a diversified apparel merchant like, say, Levi Strauss, will source from hundreds of firms in every corner of the globe, USA-ITA’s Hughes estimates.

If that were not enough to keep an eye on, compliance can involve taking responsibility for the external environment around suppliers’ facilities, she points out. A good example is the electricity network in Bangladesh, which has been overstrained by a manufacturing boom and is prone to causing dangerous fires in multistory industrial parks that may house a number of factories. “Your supplier on the eighth floor may be up to code, but you have to worry about a fire breaking out on the third floor,” Hughes relates.

The corporate community is literally divided on whether keeping direct tabs on suppliers’ labor and environmental practices is worth it, according to a survey of chief supply chain officers conducted by Stanford Business School professor Hau Lee. Just 23% reported that they monitor labor compliance among immediate suppliers at present, while half expect to significantly increase their efforts in the future. The other half back-burnered the issue. The most commonly cited reasons for not monitoring were “no measurable returns,” “customers do not care,” and “price pressure.”

“Many companies are not making progress. That’s the unfortunate reality,” says Glen Low, a principal at San Francisco-based BluSkye Sustainability Consulting. His firm gained prominence by advising Wal-Mart on greening its supply chain in recent years. Now it is working with the Sustainable Apparel Coalition, a group spearheaded by Wal-Mart and outdoor clothing icon Patagonia, which is looking to develop a ranking system for earth- and labor-friendliness in the garments we buy.

The effort may bear fruit in five years, Low says. Hughes thinks it will be more like 10 years.

Yet there are good reasons to persevere. Multinationals already have a tremendous wealth of knowledge about their global suppliers and the ability to track their performance in minute detail on questions they really care about. “If you can keep track of how many millimeters of glue are put on every shoe, you can make sure the workers are paid on time,” IFC’s Amy Luinstra argues.

More to the point, perhaps, a growing army of Internet-armed nongovernmental organizations (NGOs) around the world make once-remote operations ever more visible to outsiders. Pre-Facebook and Twitter, the catalytic suicides at Foxconn might well have remained obscure. Now an entire supply chain from field to shopping mall can be a click away from outside scrutiny. Apparel makers have to be on their guard, for instance, about using cotton from Uzbekistan, where rights groups have discovered child laborers among the pickers.

While shoppers may not seem to care about the provenance of most purchases, the bar for sourcing practices is being imperceptibly raised all the time, experts say. What “everybody was doing” 10 or 15 years ago—contracting from factories employing children, for instance—now looks cruelly out of step and could burn a brand that is behind the curve. “A slavery-free T-shirt for a dollar extra might not fly in the stores, but consumers expect the brands they favor to keep themselves out of trouble,” BSR’s Olson says.

Enforcement doesn’t mean diminished profits 
A number of joint NGO industry efforts are attempting to bring order to the chaos of ethical/sustainable auditing. Virginia-based Worldwide Responsible Accredited Production (WRAP) has set up a certification program for auditors backed by the USA-ITA. WRAP has put its stamp of approval on 300 auditors around the world after completion of a five-day course, says the organization’s president, Avedis Seferian.

The Supplier Ethical Data Exchange, or Sedex, in London is building a base of compliance information on contractors across the globe, so buyers can scan an ethical report card before doing business, and suppliers can be spared the agony of constant audits by every new customer. Sedex’s board is stocked withEuropean business heavyweights, including senior sourcing managers from U.K. retail giants Marks & Spencer and Tesco.

The most provocative argument for enforcing humane standards at global suppliers is that it can be good for business. Hidden beneath the morality-play headlines of the Foxconn scandal was the subplot that the firm’s business model was in danger for purely pragmatic reasons. The average new hire at Foxconn’s gigantic 400,000-employee complex in Shenzhen was quitting after just a few months, according to a 2010 New York Times story, an unsustainable turnover rate for any complex operation.

Pay was just one of the reasons driving workers away in droves—and the easiest to fix. Foxconn doubled wages as soon as the suicide epidemic became public in 2010 and said it would double them again this year. (World electronics prices have by some magic remained stable.) Critics also cited the company’s outdated pseudo-military culture involving humiliating drills, public “self-criticism,” and punishment at a supervisor’s whim. Ma Xiangqian, the 19 year-old young man who started the suicide spree, had recently been demoted from line worker to toilet cleaner after a run-in with one of his bosses.

Garment makers and other employers of low-skilled labor can and do reach beyond China to less-developed countries where workers are cheaper and more desperate. Bangladesh, Pakistan, and North Africa are among the new “virgin areas” for workplace relations and monitoring, says Angelo Valdevitt, a former U.S. Labor Department official whose audit firm ALGI is one of the industry veterans. Now the clothing industry is abuzz about opportunity in a newly accessible Burma, USA-ITA’s Hughes adds.

But Scrooge’s paradises don’t last long these days. Bangladeshi authorities doubled the minimum wage for the country’s three million textile workers two years ago after months of violent protests and at the quiet urging of at least some multinational customers. Cambodian employers are stressed to hold onto good workers, IFC’s Luinstra reports.

Makers of electronics and other higher-tech goods have no choice in any case but to deal with the increasingly demanding labor forces in China and other more advanced tigers. “If wages go up in China, maybe you can go somewhere else,” says Olson of Business for Social Responsibility. “But you have to think for how many more decades there will be somewhere else to go to.”

In this world of increasing transparency and empowerment, the knee-jerk assumption that treating workers better spells diminishing profit is incomplete at best, experts in the field say. On the vexed issue of long hours, workers’ and bosses’ interest are actually often aligned, WRAP’s Seferian says.

Employees tend to want to work overtime, within reason, and connive with employers to get around restrictive labor laws that are “a little outdated.”

Demoralization stems at least as often from factory owners being dictatorial and capricious: not meeting payroll on time, cutting corners on benefits pay or taxes, indulging a petty routine of inhumanity on the Foxconn model. Addressing these issues is harder culturally but cheaper financially than just raising wages and can be worth the effort morally and on the bottom line. “Some basic advances in HR can go a really long way,” Luinstra says.

Multinational customers’ insistence on speed and flexibility in the supply chain is more likely to conflict with improved labor practices than with sheer stinginess, Luinstra adds. Suppliers with secure, longer-term contracts are more likely to invest in a stable work force through better pay and conditions. But faraway corporations in choppy markets back home are eager to keep their options open in terms of terminating or switching suppliers at will.

Product competition in fast-moving fields like smart phones trickles down the supply chain into work demands that are extreme by any standard. Foxconn workers reported that they labored up to 13 days straight and slept on the factory floor when rush orders from the world gadget giants came in.

Exploitation is not an ideal the world’s best companies want to live up to. Speed and flexibility certainly are. Board members may have to think about some tradeoffs when the latter leads to the former among struggling workers in the developed world. The alternative may be finding one’s company on the wrong end of the next PR disaster.