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The Price of a Cheap Suit

Companies spend millions to assess overseas suppliers. So why are they still missing so many problems?
Joseph McCafferty, CFO Magazine
August 1, 2005

It's 10:00 p.m., and Charlie Kernaghan is driving around the garment district in Dhaka, Bangladesh. It's well past quitting time for the fabric cutters and seamstresses who started work in the factories at 8 o'clock that morning. But the workers aren't coming out of the gray, decaying buildings, even though they have already worked for 14 hours. (A six-day, 60-hour workweek is the maximum allowable under Bangladeshi law.) Soon factory managers roll black crepe paper over the windows to conceal the workers toiling inside. By midnight, as work continues, the temperature hovers in the 90s outside and is even hotter inside the factories, forcing the managers to roll the paper back up. They're convinced that no one could be watching at such a late hour. But Kernaghan, director of the National Labor Committee, an antisweatshop organization based in New York, is there to observe them. "It's easy to see what's going on," he says. "Ask anyone in the neighborhood and they will tell you."

What's going on is that the workers, who are making clothes that will end up on the racks of large U.S. retailers, including Wal-Mart Stores Inc., are being forced to work extraordinarily long shifts. "If [their employer] is on a deadline, they will work until two or three in the morning and they'll do it for two or three days in a row," explains Kernaghan. Long shifts aren't the only infractions by the apparel factory owners and managers in Bangladesh: "Meager pay, unsanitary working conditions, and forced pregnancy tests (expectant mothers are often fired to avoid maternity pay) are all common practices in the factories," he adds.

No company wants to be associated with such a working environment. Apart from the moral issues inherent in the use of sweatshop labor, the business cost of the kind of exposé Kernaghan can produce — he famously brought TV personality Kathie Lee Gifford to tears and led a crew from "Dateline NBC" to the Bangladesh factory described above — can be substantial. Such exposés can cost billions of dollars in damage to brands, lost customers, and lost market capital from subsequent stock-price declines. Shares of Nike Inc. tumbled through the late 1990s, for example, as a stream of reports emerged about poor working conditions at Nike supplier factories in Vietnam and China, and college students organized boycotts of Nike goods.

But management of this supply-chain issue is, at best, a work in progress. True, in the past decade, scores of large retailers and apparel makers have developed codes of conduct that prohibit inhumane labor practices by the factories that manufacture their goods. The codes cover everything from wages to overtime practices to safe working conditions.

Companies also spend millions each year to monitor their suppliers' factories to make sure that the codes are being enforced. Wal-Mart says that it conducted more than 12,500 audits of supplier factories last year.

The trouble with such audits is that they go only so far. Leading companies like Nike and Gap Inc. have been candid about workplace problems. In its 2004 Corporate Responsibility Report, issued in April, Nike revealed that 27 percent of the 497 factories making Nike apparel scored a C or D, denoting serious code-of-conduct violations. And in Gap's 2004 Social Responsibility Report, president and CEO Paul Pressler noted that the retailer had taken important steps toward safer conditions and better treatment for overseas workers. But he added that "social responsibility issues across the industry remain immensely complex."

Indeed they do. Most companies haven't even developed effective monitoring. Some argue that, at this juncture, what the monitoring process needs is some strict financial discipline. "The activists are pushing for the types of disclosure and reporting that are very familiar to the CFO," says Pietra Rivoli, an associate professor at Georgetown University's McDonough School of Business and author of The Travels of a T-Shirt in the Global Economy.

Far-fetched? Not necessarily. Finance chiefs routinely oversee other aspects of supply-chain management and increasingly are charged with protecting the value of corporate brands. Nor, as Rivoli points out, are they exactly strangers to monitoring compliance programs. "They have the most practice with regular audits," she notes.

Coached to Lie
Of course, any finance chief will tell you that audits are only as good as the information they are based on. And therein lies the problem. Sweatshop operators go to great lengths to make sure nobody sees what is going on.

Indeed, as retailers and apparel makers have stepped up their compliance initiatives, factory owners have stepped up their deceptions. One of the biggest issues: many suppliers keep two or more sets of books to help hide overtime and wage violations. In fact, experts say software can be easily purchased in China to help factory owners maintain multiple sets of books. "It's a problem that is gradually increasing," admits Michael Kobori, director of global code of conduct for apparel maker Levi Strauss & Co. Kobori says the company will drop a supplier that is caught cooking the books.


Cheating can be difficult to detect, however. Kernaghan says he visited a factory in Bangladesh where the time cards for the next week were already stamped with the legal amount of hours allowed. He says lots of paperwork is falsified. "There is software they can buy," he says, "that will put just a few errors into the records so that they look clean, but not too perfect."

Interviewing workers is one way to smoke out fraud. In many cases, however, employees are coached to lie. They are told to say that working conditions are great — and are threatened if they tell the truth. Observers say that most workers won't talk openly in the factories for fear of losing their jobs. And "worker interviews are rarely conducted outside the factories," says Scott Nova, executive director of the Worker Rights Consortium, an antisweatshop group based in Washington, D.C. "It's the weakest part of these audits."

In extreme cases, factory owners set up front operations to fool inspectors. The fake facility may be one building of many the supplier operates, or even a factory owned by another company. "Factories always hide their actual ownerships and relationships," says Gregory Ray, managing director of The Shiny Penny Ltd., a sourcing and supply-chain management advisory firm based in Shanghai.

Complicating the picture, he says, is the fact that buyers sometimes outsource to other buyers, or factories subcontract the order. "An apparel company might have no idea where the products are really coming from," says Ray. "When they visit China, everybody's in collusion to show them a nice, clean showcase factory where all the workers are smiling."

Critics say some inspectors, bent on not uncovering problems, happily buy the ruses. In fact, Anne Lally, a worker advocate and consultant to the not-for-profit Fair Labor Association, claims that some unscrupulous corporations instruct their suppliers on how to cook the books so they can deceive other, more-stringent buyers that contract with the same factory. Why? Corrections at a facility could be costly to everyone, explains Lally. "The truth is expensive," she notes, "because then you might have to fix it."

Code of Conduct
Still, even the harshest corporate critics admit that U.S. businesses have made some strides in improving conditions for overseas workers. "Child labor is the third rail [for U.S. companies]. On that issue, they have really drawn the line," says Kernaghan. He says it is also rare to see systemic violence, sexual harassment, or forced contraception. "There's more pressure to have control over contract suppliers. If you sell it, or it has your name on it, you're responsible," he adds.

In part, that change can be traced to a meeting in a seventh-floor office in San Francisco in 1991. At the meeting, Levi Strauss's board of directors voted to adopt a code of conduct for suppliers — the first of its kind at a major U.S. corporation. A year later, the company put in place a monitoring system to make sure its suppliers were adhering to the code. Early on, Levi's relied on quality-control inspectors to ensure suppliers were cleaving to the new code. But management quickly learned that the quality-control personnel had no training in spotting workplace violations. "Those initial efforts were very much a learning process," says Kobori.

Today, Levi's employs 20 full-time inspectors to assess conditions in some 400 factories under contract in countries including Mexico, the Dominican Republic, India, China, and Turkey. "We shoot for 100 percent of the direct contractors," says Kobori. The company also requires inspections by Levi's-approved monitors of another 250 suppliers making goods that will be licensed to carry a Levi Strauss or Dockers brand name. The assessors, as Levi's likes to call them, conduct thorough inspections of the facilities, looking for safety and health violations. They also speak to managers and inspect the books and other documentation like time cards and payroll to make sure that overtime and wage rules are being enforced. The company then conducts interviews with the workers. More recently, Levi's assessors have attempted to speak to workers outside the factory. And Levi's is trying to conduct more surprise visits.

Kobori says suppliers are checked out before they can sign on to make goods for Levi's and are inspected at least once a year, more often if problems are found. "Suppliers must remedy [problems] immediately," he adds. "If they don't, we will reduce our orders with them."

Critics applaud Levi's policy of attempting to fix problems rather than parting with offending factories. When companies pull out, factories can go under, leaving workers without jobs. "Our goal is to improve working conditions," says Kobori. "We give suppliers every opportunity to improve."

Not all companies do. For some suppliers in Dhaka, it's easier to shut down a factory and open another one somewhere else. Other overseas suppliers argue that sweatshop factories exist in all countries — even the United States. They also argue that although pay in their facilities may be bad, it is better than nothing.

The Buddy System
Currently, most companies that monitor suppliers do their own audits, a practice that can lead to a fair amount of overlap at individual factories. "It's silly for a factory to get 40 different audits," says Caitlin Morris, compliance director at Nike. Inspectors say it's not unusual to walk into a factory in Bangladesh or China and see five or six different codes on the wall. Sometimes, a fire extinguisher will be constantly moved up and down the wall to satisfy different safety codes from different companies sourcing at the same factory. "The hope is to get to a model where brands are able to work cooperatively," says Morris.


Toward that end, a group of companies, including Nike, Gap, and Patagonia Inc., are working with a handful of worker-rights groups to develop a common set of labor standards, as well as a shared monitoring system. The idea: with agreed-upon standards and best practices, buyers and suppliers can rely on one set of audits. The program, called the Joint Initiative on Corporate Accountability and Workers' Rights, began a pilot program in April in Turkey, a center for apparel manufacturing. If successful, the initiative might eventually lead to the first commonly accepted global labor standards.

Anne Lally, who is currently in Istanbul working on the project for the Fair Labor Association, says the goal is not only to learn where rights groups are duplicating one another's efforts, "but also [to learn] where they are different — and with that knowledge, work more cooperatively in the future." Such cooperation would likely make the monitoring process cheaper. It would also improve the reliability of audits, since the data would come from independent sources — a crucial point for many shareholder-rights groups.

Some companies are already moving to more-independent monitoring. Levi's, for one, works with nongovernmental agencies to improve its overseas monitoring process. Similarly, Nike works with Lally's organization, which monitors about 5 percent of the company's factories independently.

Hiring for-profit, third-party groups to monitor supplier facilities can be more problematic. Some labor advocates charge that such investigators tell buyers what they want to hear to retain their business. They also claim that even well-meaning inspectors can be fooled by creative factory owners.

Indeed, PricewaterhouseCoopers exited the supply-chain monitoring business. One of the problems for audit firms, say observers, is that there is no certification process for individual monitors. "There's no equivalent of a CPA," says Lally. "It's a serious problem, with people out there functioning [as monitors] without any training."

Independent operators can be expensive, too. Ron Martin, compliance director at Lee Jeans maker VF Corp., says that third-party audits can easily cost $1,200 to $1,500 apiece, which can add up, considering VF's 1,500 active contractors. The company relies heavily on its own audits. "We don't want our products to be made in places where people are being treated unethically," says Martin. "We see social compliance in the supply chain as an investment in the brand."

What Will You Pay For?
With some suppliers reluctant to adhere to codes of conduct, a few corporations are looking to see how they can change their own operations. Nike, for example, is working to eradicate some of the causes of abusive employer behavior. One example: the apparel maker recently put together an internal overtime task force to look at ways the company might be unwittingly exacerbating the problem of long shifts. "We are looking at how we can improve our internal business practices to lessen the factors that contribute to excessive overtime," says compliance director Morris.

It's a start, say worker-rights advocates. Still, some believe the real problem is that enforcing supplier codes of conduct runs contrary to other pressures buyers put on factories — namely, price, turnaround time, and quality. Indeed, Kernaghan argues that Wal-Mart puts so much pressure on price that suppliers can't possibly afford to improve conditions. So instead, they lie. "The message is, 'There is 99 percent focus on price, and after that we'll talk about the other stuff,'" he says. Kernaghan claims that one executive from a rival retailer told him flat out, "We're not going to do any more than Wal-Mart does."

Certainly, Wal-Mart is a favorite target of critics who say the retail giant is a laggard in developing effective monitoring. As proof, they point to a lawsuit filed in June by a former Wal-Mart inspector who claims he was fired for refusing to certify supplier factories in Central America. The suit claims that "the factory certification process was designed only to create the impression that Wal-Mart was producing its goods under humane working conditions when, in fact, working conditions at the factories were terrible and violated the rules and regulations of Wal-Mart."

The company denies the allegations, and its management states it is serious about monitoring its contractors. "It's a priority for us," says Rajan Kalamalanathan, director of compliance for Wal-Mart's global procurement division. Executives at the retailer won't reveal how much the company spends on monitoring, but according to Kalamalanathan, "it does cost quite a bit." He says the retailer is shifting to more unannounced inspections — up from 8 percent of all inspections last year to around 20 percent this year. And he disputes accusations that the company's well-documented focus on price forces suppliers to cut corners. Says Kalamalanathan, "When we have suppliers say, 'It's going to cost me,' we say, 'Do it.'"

In the end, wiping out sweatshop labor might cost everybody, including corporations, shareholders, and customers. But easing cost pressures may be the only way to ensure that suppliers can afford to operate safe and profitable factories. "If you are serious about a code of conduct, it's going to cost you a little bit," says the Worker Rights Consortium's Nova. "The good news is, it's not that much. A tremendous amount of good can be done without upsetting the economic calculus."


Joseph McCafferty is departments editor at CFO.


No-Sweat Equity

While some apparel companies struggle to quiet the controversy surrounding inhumane working conditions, a small group of businesses are taking a different tack. They're making an issue of sweatshop labor.

No Sweat Apparel, for example, which was started by a group of labor-rights activists in Waltham, Massachusetts, trumpets the fact that it is a "sweatshop-free" employer (the company uses only suppliers that are unionized). Likewise, Los Angeles-based American Apparel, the largest garment manufacturer operating within the United States, refuses to use sweatshops. Even Bono, lead singer for Irish rock group U2, is getting into the act. Along with his wife, Ali Hewson, he launched Edun, a sweatshop-free clothing line that will sell at Saks Fifth Avenue.

These companies are striving to do what many retailers cannot: guarantee that their clothes aren't made in sweatshops. No Sweat sources from 14 factories in the United States, Canada, El Salvador, and Jakarta, Indonesia. Before any orders are made, the company insists on an independent audit of the factories. The inspections are done unannounced — and employees are interviewed outside of the workplace. "Since they are union shops, we're very confident in them," says No Sweat's CFO, John Studer "But we do inspections, just to make sure." (COO Anne O'Loughlin visited the Jakarta factory in order to view the working conditions firsthand.) Studer says the workers at the facility in Indonesia get six weeks of paid vacation and free health care. No Sweat shoots for wages at about 20 percent above the minimum wage.

The giant of the sweatshop-free trend, however, is American Apparel. The company employees 3,000 workers and operates 20 retail locations. All the clothes are made at a factory in Los Angeles, where the average worker is paid $12.50 an hour. The company recorded $150 million in sales in 2004, and expects to grow to $250 million this year.

But can socially conscious apparel be profitable? No Sweat's Studer thinks so. The company, which expects to more than double sales to $1.6 million this year, was able to eke out a small profit in only its second year of existence. "We want to show big brands that you can be profitable," says Studer, "and still effect positive social change."

It's not easy. SweatX, an antisweatshop brand launched by a venture-capital fund run by Ben Cohen (of Ben & Jerry's ice cream fame), closed its doors last year after two years of operating at a loss.

— J.McC.




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