New Labour

Poor working conditions and other problems among suppliers in low-cost countries can damage a Western company’s reputation. Hilary Murdoch offers some simple steps companies can take to protect themselves.

Outsourcing to low-cost countries is a key business strategy for many companies today. In a recent example, Valeo, a leading French automotive equipment supplier, announced plans to source 70 per cent of its procurement expenditures from low-cost countries by 2010.

Although this percentage may seem exceptionally high, an Accenture survey in August 2004 suggested that over the next three years the proportion of overall procurement spending sourced from low-cost countries will double. Other studies have also estimated an increase of 70 per cent.

But low-cost country sourcing is not without risks. Graham Stevens, a member of the management group at PA Consulting, was recently quoted in the Financial Times as saying: “You can’t outsource your risk, your brand or your problems.” The mentality that he labels “out of mind out of sight outsourcing” is, he says, a serious mistake.

The Global Spend Management Survey by the Supply Management Institute in the United States revealed that many organisations were not adequately prepared to source from low-cost countries, with only a quarter of companies with suppliers in low-cost countries having built a close working relationship with those suppliers.

In low-cost countries, the enforcement of employment regulation is often lax, management skills may be poor and corners may be cut on working conditions to maintain low costs.

The International Labour Organisation estimated that annual deaths from workplace accidents per 100,000 workers in China is five times the level in the US. There are more than 2,000 reported accidents at work every day in China. Other issues in China include excessive hours, with some employees working up to 16 hours a day, seven days a week, low wages, discrimination and even forced labour.

The scandal of poor working conditions in companies’ supply chains can seriously dent what many see as a company’s most valuable asset – its reputation. This in turn can influence customers and investors. The media and the public hold companies accountable for working conditions in the supply chain, whether for products or services for resale or for internal company use.

However, there are also opportunities. Improving labour standards can increase business efficiency. Poor working conditions lead to increased accident rates and illness, tired and discontented workers and lower productivity and quality. There is also the opportunity to make good performance in this area a competitive advantage.

Most companies nowadays recognise the value of trying to make sure the organisations they deal with in their supply chains are run according to ethical principles. The dangers of not doing so have, on occasion, been all too apparent. But how do you go about building an ethical supply chain? There are certain simple steps every organisation can take.

1. Know your supply chain

The first step is to ensure you know where all your products come from. You cannot investigate and improve working conditions at a site unless you know where it is. This may involve sending a questionnaire to all suppliers and agents requesting information about the location of production sites. Agents may of course be reluctant to reveal sources but, as a minimum, they should be prepared to reveal the country and region if not the exact address. This information is an initial indication of the risk of labour standards issues.

2. Develop a policy

Define the labour standards that you expect from your suppliers. A code of conduct indicates the companies’ intention to source from suppliers with good working conditions. It acts both as a guide for members of staff who are in negotiations with suppliers and for the suppliers themselves.

Most codes of conduct require suppliers to comply with local law and with some international standards such as the International Labour Organisation Core Conventions and the UN Universal Declaration of Human Rights. A good code to use as a guide is the Ethical Trading Initiative Base Code (www.ethicaltrade.org). Companies need to determine whether the standards they set are minimum standards or aspirational. It’s important to set realistic goals considering the local context. Some companies have criteria for minimum standards and a further set of standards that suppliers can work towards.

Companies also need to discuss and agree internally how ethical sourcing will be managed, establishing responsibilities and resources. The day-to-day responsibilities may lie within the procurement team, with quality managers or a specially set up team.

3. Communicate your policy

Any strategy needs to be effectively communicated internally to all those it will affect – and particularly to those with responsibility for implementation.

Once the code and policy are published, many companies also post them on their website as a public demonstration of commitment. The code then needs to be effectively communicated to suppliers, which may be done at the same time as contracts are signed, or at the tender stage, or it could even be communicated in person during a visit. The supplier must in turn take responsibility for communicating it to relevant people at the production site.

4. Prioritise and target resources

Most purchasers carry out a risk assessment of their supply chains and focus their activities on high risk suppliers. Risk assessment may be based on country of origin, value, production process or answers to self-assessment questions.

Some products will pose a higher risk to your reputation than others, depending on how closely associated they are to your company and your brand. For example, promotional T-shirts are much more closely linked to your brand than the procurement of utilities. This ‘proximity to brand’ can also be used as a guide to where your resources should be targeted.

5. Understand the issues in your supply chain

For many companies, the next step has often been to carry out a series of ‘ethical audits’ to help assess their suppliers’ standards on working conditions, either using external auditing companies, agents or their own staff. This allows the purchaser to understand how suppliers are performing against their code of conduct.

There should be clear procedures about how the results of assessments will affect purchasing decisions and who will handle any actions plans. However, a number of recent studies have found that there has been a tendency towards over-reliance on the use of ethical audits. A study commissioned by The Local Authority Pensions Fund Forum on the overseas supplier labour standards activities of major UK retailers concluded: “An over-emphasis on the use of audits to monitor code compliance may result in the neglect of capacity-building programmes for suppliers and their workforces to help achieve compliance.”

Sometimes the short timeframes given for making improvements are unrealistic for tackling such fundamental problems such as low wages, child labour or excessive hours. Suppliers who are unable to deal with the problem in the time allowed can therefore be tempted to fake their records to conceal a lack of progress.

Even the GAP chief executive, Paul Pressler, has acknowledged the limitations of auditing. Earlier this year he stated: “Monitoring hasn’t solved all the problems, and almost no factory is in complete compliance with our standards. We also believe that violations are more widespread than we have been able to verify.

“Monitoring by itself is absolutely not the answer, and this has led us more and more to start building good partnerships with non-governmental organisations, governments and unions to try to tackle issues in this area.” When using audits it is important to set realistic timeframes and allow for continuous improvement rather than taking a “comply or die” approach.

6. Supporting your suppliers in making improvements

It often seems to be that organisations have managed to successfully outsource their production but have singularly failed to outsource the expertise needed to provide the products or services with the efficiency and good working conditions that we have come to expect. Clearly the safest way to reduce risk from poor labour standards in the supply chain is to work with suppliers to make progress together.

When moving to a low-cost sourcing country, it is vital to remember that suppliers may not have the management expertise to improve their human resource management on their own. Helping them by offering training and consultancy on developing management skills has proved to be the most effective way of making lasting improvements.

Hilary Murdoch is project manager at ethical trading consultancy Impactt (www.impacttlimited.com)