Subcontractor labour compliance, or rather non-compliance, is an issue that multinational corporations (MNCs) operating in the developing world face with some trepidation. Many executives lose sleep over this issue, only to awake to the real-life nightmare that their brand is the latest to be vilified on the nightly news or popular newspapers as yet another example of a product made with sweat labour. Working wages, overtime issues, worker health and safety, prison labour and child labour are the areas most vulnerable to negative press reports.
Pressures on prices
Business models based on low-cost intensive labour production and a market that demands low price points cause many of the problems an MNC may face with subcontractors in an emerging market. The chain of command for labour intensive production is often a complex web linking MNCs, foreign managing agents and the layers of subcontractors utilised during production. All too often the result is a loosely controlled sub-contractor with little or no sense of account-ability or loyalty to the MNC's labour policies and standards.
To date, there have been relatively few exposes in China proportional to its massive production output. However, an employee of a prominent MNC in charge of implementing labour compliance codes of con-duct in China believes the number of cases there could mushroom. "I would suggest that the number of non-compliance incidents in China that have been reported is comparatively low," he says, "although the actual incidents of non-compliance are probably much higher considering there is limited monitoring and oversight on either the Chinese government side or on the side of those companies. What is going to happen, in my opinion, if these things start to surface, the floodgates may open and those that have not been paying attention to these issues are going to find themselves in very difficult situations."
Historically, MNCs' labour polices andstandards were merely an after-thought in the production process, while the main focus was on cost and quality. Today, MNCs are under increasing scrutiny to implement and enforce labour policies and standards required within their home country. The pressure is coming from many sides: public interest groups, the media, governments and shareholders, and the multitude of non-governmental watchdog organisations, such as Amnesty International. MNCs receiving negative press, lawsuits, shareholder opposition and increased governmental enforcement actions can expect a tarnished company image and potential damage to their business. Subcontractor labour non-compliance can also significantly impact worker morale, productivity, quality and customer demand.
Although labour compliance is currently a hot topic, it has not always been in the business spotlight.
This has changed, for a variety of reasons. First, the globalisation of markets has intensified price competition, which resulted in MNCs seeking lower production costs to sustain their profit margins. Particularly in the apparel and toy industries, the survival of a company can depend on minor differences in labour costs. This drive to lower labour costs can result in compromising on the proper treatment of the workforce.
Second, the advent of the information age has made it much easier for the world to hear about the misdeeds of subcontractors. As a result, ‘bad' news travels much faster today than it did even five years ago. An isolated subcontractor's non-compliance record could turn up on the front page of the Wall Street Journal even before a contractor has time to put up a defence. There have also been many cases in which investigative television news reports have featured an MNC's involvement with sweatshop subcontractors. Often these reports are presented during the busy holiday shopping season for heightened consumer impact.
In response, there is a growing business trend for companies to develop and implement their own ‘single set' of sourcing standards or code of conduct. These policies can be transformed into effective controls and monitoring mechanisms that will ultimately enable an MNC to benchmark and compare multiple foreign subcontractors in an efficient manner.
As part of the complexity of doing business overseas, an MNC has to understand and monitor the multiple layers of subcontractors. To simplify production management, many, MNCs contract with managing agents, who then subcontract the work to a revolving network of factories. Although this simplifies the MNCs' involvement, as shown in the case study above, it can lead to a serious lack of accountability and control over working conditions and the production process. In order to tighten control, several MNCs have significantly reduced the number of managing agents and subcontractors they use in an effort to ensure that their products are being manufactured in a way that coincides with the company's contract, policies and values.
The collapse of many Asian markets has heightened the focus on labour issues, with several MNCs being forced to lay off workers due to a drop in demand. The crisis poses another challenge for MNCs. Due to currency devaluations across the region, workers who were making a ‘living wage' may no longer be able to support themselves or their families. However, in some cases MNCs have directed their subcontractors to increase wages to compensate for the currency devaluation.
Turning risk into advantage
Reducing liability is a compelling reason to improve subcontractor compliance. As pressure increases on companies to comply with international labour standards, subcontractors and contractors will be confronting more lawsuits and fines. Already there have been several lawsuits filed in the US regarding Chinese subcontractor labour issues (see Adidas story below).
Ethics plays an important role in under-standing the business case for compliance. A strong sense of business ethics leads to longer and more meaningful relationships with subcontractors. In addition to the traditional measures of cost, quality and productivity, new subcontractors need to be screened and selected based on their compliance track record or ethical standards. This would help companies reduce their subcontractor risk exposure. For example, a sub-contractor who does not treat workers in an ethical manner, may not treat its contractor honestly and fairly, and may be more likely to participate in illegal and fraudulent activities that could cause an adverse financial impact on the contractor. By contrast, companies that instill and promote ethical values in their subcontractors usually gain positive press, which enhances their overall image in the media and the marketplace (see Levi's box).
Labour compliance issues, if better understood, may assist a company in improving its profitability. MNCs are increasingly realising the value of their workers. However, some of their subcontractors have been slow to reach this conclusion and have not considered labour compliance a business priority. If subcontractors would value the worker as an important resource, they would probably have fewer incidents of labour non-compliance. Sever-al US studies have indicated that workers who are treated fairly and have good working conditions often have a higher morale. This, in turn, can lead to higher productivity and overall quality.
Labour compliance issues, if better under-stood, may assist a company in sustaining or improving its profitability. MNCs are increasingly realising the value of their workers. According to Mr Phil Knight, chairman and chief executive of Nike: "Good shoes come from good factories and good factories have good labour relations."
Many MNCs are assuming the newly added responsibilities of ensuring that their subcontractors are complying with the labour standards. Some are being forced to address the issue after negative press, while others are taking a more proactive approach by tackling the issue before it becomes a major incident. Either way, MNCs must be prepared to deal with the new challenge, and be able to over-see and monitor their foreign operations and brand image regardless of how distant they are from the production processes. Their ability to manage subcontractors effectively and efficiently is a significant part in sustaining an MNC's long-term success.
Levi's confident of controlling the risks
Levi Strauss & Company, one of the world's oldest and largest apparel companies, is a leader in managing complex subcontractor relationships. Levi's management has taken steps in developing guidelines and standards for conducting business with foreign vendors and suppliers. It has also learned many valuable lessons with regard to balancing profits and corporate responsibility.
In 1991, Levi's was one of the first multi-national companies to establish guidelines for global sourcing and operations. Over the years, Levi's leadership in this area has received numerous awards including For-tune's Most Admired (US) Apparel Company, Business Ethics' 1993 Award for Excellence, and the Council on Economic Priori-ties Corporate Conscience Award for Commitment to Workplace Principles. It has also received highly positive media coverage from The Wall Street Journal, The New York Times, Newsweek, The Economist, Business Week and US News & World Report.
During the early to mid-1990s, Levi's adopted a policy of requiring its subcontractors to comply with certain standards. If problems were found, it worked with a sub-contractor to improve worker conditions, dropped a subcontractor or pulled operations out of an entire country – as it did in China in 1993, partly because of its concerns over the poor treatment of workers.
The company states that it is “rationalising its supplier base with development of business partnerships based on terms of engagement, service, financial stability, community support, and long-term mutual profitability, not simply low cost, as the key objective.” This shift in philosophy led to a significant reduction in subcontractors, which enabled Levi's to gain better control over the manufacturing of its products. Chairman and CEO Robert Haas explains how Levi's has benefited from reevaluating its subcontractors: "Our approach has helped us identify contractors who really want to work for Levi Strauss, gain customer and consumer loyalty, attract and retain the best employees, improve the morale and trust of employees, initiate business in established and emerging markets because government and community leaders have a better sense of what we stand for, and maintain credibility during times of crisis."
Recently Levi's announced that it would resume operations in China, developing both manufacturing capabilities and domestic distribution. Granted China's huge consumer market attracts all retailers, but it appears that Levi's is confident that it can implement effective labour compliance controls in China. Levi's positive experiences with other foreign subcontractors gives it the confidence to once again manufacture and sell in one of the world's largest markets. For example, in Indonesia Levi's worked with subcontractors to improve health, safety and workplace conditions for its employees. The changes resulted in redesigning the production line, which reduced overcrowding and improved production efficiency. Levi's proactive labour compliance initiative distinguishes Levi's from its competitors and will help it succeed in the highly competitive Chinese marketplace.
This article was written by Francis Bassolino, a senior consultant in the China Business Services Group of Deloitte & Touche in New York Francis specialises in cross-border investing. Telephone: (1) 212 436 6584 or email: email@example.com. John Queenan is a senior consultant in the Enterprise Risk Management Practice of Deloitte & Touch in New York. John focuses on corporate responsibility issues, such as labour compliance and environmental health and safety risks. Telephone: (1) 212 436 5171 or email: firstname.lastname@example.org
Adidas admits to lapses in oversight
In 1998 Adidas, the European sports-gear maker, faced charges that one of its sub-contractors has used Chinese prison labour to manufacture footballs. The allegations were made in a lawsuit by a former political prisoner, who claimed that he was forced to work up to 15 hours a day waxing leather soccer ball panels in preparation for sewing.
Although the political prisoner was not forced to work by Adidas, but by a subcontractor, he holds Adidas responsible for the treatment he had undergone during the past three years. An Adidas spokesman denied the charges and said, "the company isn't responsible," noting the company's contract with Molten Corporation "demands that they don't use child or prison labour.” However, Molten's management didn't seem to exercise the same level of care as the company expressed in the contract. "We have a subcontracting agreement with Shanghai Union Ball, but nothing more," said Molten's quality assurance manager. "We can't be too inquisitive about them."
So how can you be reasonably confident that goods manufactured under your brand name are not in violation of your codes and the law if your subcontractors don't monitor their subcontractors practices?
Obviously there is a need for contractors to actively monitor and enforce their con-tracts with subcontractors, and possibly their subcontractors etc., to gain assurance that their products are manufactured in accordance with the company's standards as well as local laws. Contractors should specify to subcontractors how to achieve compliance.
This mini-case also illustrates the need for contractors to know and understand the production process, particularly the who, how and where their products are manufactured. The collection and monitoring of this information will enable companies to perform appropriate due diligence and be prepared if allegations arise.
Responding to accusations by former subcontractor workers, Adidas conceded on July 1, 1998 that some of its licensees and contractors may have used prisoners at a labour camp near Shanghai to produce footballs. An Adidas spokesman said that the alleged contractual non-compliance occurred without the knowledge of company officials, and was a result of lapses in oversight of international subcontractors. Adidas's spokesman further said that his company has stopped all production by Mortex and production of football balls produced by Molten.
The circuitous path of these footballs from factory floor to the world market illustrates how easy it is to lose control of sub-contractors when multinational name brand manufacturers do not vigilantly monitor the subcontracting process. Adidas's chief executive officer, Robert Louis Dreyfus, said that his company's goal is to have full control over its name brand. He went on to say: "Sourcing our products plays an important role in the perception of our brand by our consumers… We are determined to directly control the whole value chain."
Source: Wall Street Journal, June 28