Case 26 Detecting Unethical Practices at Supplier Factories The Monitoring and Compliance Challenges

CASE TEACHING NOTE 26

Detecting Unethical Practices at
Supplier Factories: The Monitoring
and Compliance Challenges

OVERVIEW

Importers of goods from China, Indonesia, Cambodia, Vietnam, Malaysia, Korea, Pakistan, Bangladesh, Sri Lanka, India, the Philippines, Peru, Honduras, the Dominican Republic, Tunisia, and several other countries in Latin America, Eastern Europe, the Middle East, and Africa have long had to contend with accusations by human rights activists that they sourced goods from “sweatshop” manufacturers who paid substandard wages, required unusually long work hours, used child labor, exposed workers to toxic chemicals and other safety hazards, failed to provide even minimal fringe benefits, and habitually engaged in assorted other unsavory and abusive workplace practices. Factories in China were particularly in the spotlight because of China’s prominence as the largest single source of goods imported into both the U.S. and the 25 countries comprising the European Union; U.S. imports from Chinese manufacturers amounted to about $320 billion in 2007. Political support in many countries for growing trade ties with countries where low-cost manufacturers were located, especially China, often hinged on the ability of companies with global sourcing strategies to convince domestic governmental officials, human rights groups, and concerned citizens that they were doing all they could do to police working conditions in the plants of suppliers in low-wage, poverty-stricken countries where sweatshop practices were concentrated.

Starting in the 1990s, companies began countering these criticisms by instituting elaborate codes of conduct for suppliers and by periodically inspecting supplier facilities to try to eliminate abuses and promote improved working conditions. A strong program of auditing labor practices and working conditions in supplier factories was a way for a company to cover itself and negate accusations that it was unfairly exploiting workers in less developed countries. By 2008, hundreds of companies that sourced goods from factories in less developed parts of the world had instituted strict codes for suppliers and either had an internal staff to conduct audits of supplier factories or utilized the services of recognized third parties with auditing expertise to inspect supplier factories. Most companies focused their efforts on improving working conditions at supplier factories, preferring to help suppliers comply with the expected standards rather than to impose penalties for violations and perhaps abruptly or permanently cutting off purchases.

But a number of unscrupulous foreign manufacturers had recently gotten much better at concealing human rights abuses and substandard working conditions. In November 2006, Business Week ran a cover story detailing how shady foreign manufacturers were deceiving inspection teams and escaping detection. According to the Business Week special report, Ningbo Beifa Group, a top Chinese supplier of pens, mechanical pens, and highlighters to Wal-Mart, Staples, Woolworth, and some 400 other retailers in 100 countries, was alerted in late 2005 that a Wal-Mart inspection team would soon be visiting the company’s factory in the coastal city of Ningbo. Wal-Mart was Beifa’s largest customer and on three previous occasions had caught Beija paying its 3,000 workers less than the Chinese minimum wage and violating overtime rules; a fourth offense would end Wal-Mart’s purchases from Beifa. But weeks prior to the audit, an administrator at Beifa’s factory in Ningbo got a call from representatives of Shanghai Corporate Responsibility Management & Consulting Company offering to help the Beifa factory pass the Wal-Mart inspection. The Beifa administrator agreed to pay the requested fee of $5,000. The consultant advised management at the Beifa factory in Ningbo to create fake but authentic-looking records regarding pay scales and overtime work and make sure to get any workers with grievances out of the plant on the day of the audit. Beifa managers at the factory were also coached on how to answer questions that the auditors would likely ask. Beifa’s Ningbo factory reportedly passed the Wal-Mart inspection in early 2006 without altering any of its practices. A lawyer for Beifa confirmed that the company had indeed employed the Shanghai consulting firm but said that factory personnel engaged in no dishonest actions to pass the audit; the lawyer indicated that the factory passed the audit because it had taken steps to correct the problems found in Wal-Mart’s prior audits.

The efforts of unscrupulous manufacturers in China and other parts of the world to game the plant monitoring system and use whatever deceptive practices it took to successfully pass plant audits had four chief elements:

1.Maintaining two sets of books—Factories generated a set of bogus payroll records and time sheets to show audit teams that their workers were properly paid and received the appropriate overtime pay; the genuine records were kept secret.

2.Hiding the use of underage workers and unsafe work practices—In some instances, factories in China, parts of Africa, and select other countries in Asia, Eastern Europe, and the Middle East employed underage workers. This was disguised either by falsifying the personnel records of underage employees, by adeptly getting underage employees off the premises when audit teams arrived, or by putting underage employees in back rooms concealed from auditors.

3.Meeting requirements by secretly shifting production to subcontractors—On occasions, suppliers met the standards set by customers by secretly shifting some production to subcontractors who failed to observe pay standards, skirted worker safety procedures, or otherwise engaged in abuses of various kinds.

4.Coaching managers and employees on answering questions posed by audit team members—Both managers and workers were tutored on what to tell inspectors should they be interviewed. Scripting responses about wages and overtime pay, hours worked, safety procedures , training, and other aspects related to working conditions was a common tactic for thwarting what inspectors could learn from interviews.

In many less-developed countries struggling to build a manufacturing base and provide jobs for their citizens, factory managers considered deceptive practices a necessary evil to survive, principally because improving wages and working conditions to comply with labor codes and customers’ codes of conduct for suppliers raised costs and imperiled already thin profit margins. Violations were said to be most prevalent at factories making apparel, but more violations were surfacing in factories making furniture, appliances, toys, and electronics. There was a growing awareness among companies attempting to enforce supplier codes of conduct that all factories across the world with substandard working conditions and reasons to hide their practices from outside view played cat-and-mouse games with plant inspectors.

Nike and Wal-Mart were two companies with supplier codes of conduct and rather extensive programs to monitor whether suppliers in low-wage, low-cost manufacturing locations across the world are complying with their codes of conduct. Both companies initiated such efforts in the 1990s because they came under fire from human rights activist groups for allegedly sourcing goods from sweatshop factories in China and elsewhere. This case lays out in some detail how Nike and Wal-Mart have gone about monitoring foreign supplier factories and trying to secure compliance with their codes of conduct for suppliers, thus allowing students to evaluate which company has the “better” monitoring and compliance program.

The case also includes information about such organizations as the Fair Labor Organization and the Fair Factories Clearinghouse that perform audits of foreign plants on behalf of their members (many of which are large corporations that source goods from plants located in countries where substandard workplace practices existed).

SUGGESTIONS FOR USING THE CASE

This 16-page case (which is an extensively updated and revised version of one which appeared in the 16th edition) poses a host of timely and relevant issues for students to wrestle with. Is it appropriate, indeed necessary, for companies like Wal-Mart and Nike, to monitor the working conditions and workforce practices of their foreign suppliers? Why should companies “police” the workplace practices of foreign suppliers’ factories as opposed to letting local government set and enforce standards for working conditions at factories within their jurisdictions? Monitoring supplier compliance is a costly activity–how far should companies go to try to detect and prevent human rights abuses and sweatshop working conditions in supplier factories? What constitutes a reasonable level of effort to detect and prevent sweatshop practices on the part of unscrupulous foreign manufacturers? Who has the stronger supplier monitoring program—Nike or Wal-Mart? What can concerned companies do to detect foreign manufacturers who are deliberately deceiving inspection teams?

The case will work nicely as a leadoff case for your strategy and ethics module taught either after your coverage of the material in Chapter 9 or towards the end of the course. The key teaching points can be gotten across adequately in a 45-60 minute time frame, making it an excellent case for class periods when you need to spend 10-15 minutes of class time on other matters. But there is ample substance in the case for a full 60-75 minute discussion as well.

The whole issue of monitoring foreign suppliers in developing nations where wages are low and factory working conditions are often substandard is a thorny one. There are no easy cut-and-dried solutions or approaches to detecting sweatshop practices and enforcing supplier codes of conduct. We’ve filled this TN with a host of questions you can pose to the class to stimulate a heated debate of the issues.

We do strongly suggest having students prepare note to the assignment questions for this case that are posted on in the Student Section of the Online Learning Center at www.mhhe.com/thompson. These questions match those in the Assignment Questions section of this TN. The caliber of your class discussion will be much higher if class members have spent some quality time thinking about and preparing thoughtful answers to the assignment questions prior to coming to class.

The rather extensive data this case has on the supplier monitoring programs at both Nike and Wal-Mart make it suitable for a short written assignment (either in or out of class). Our suggested assignment question is as follows:

Which company has the strongest supplier monitoring program—Nike or Wal-Mart? Explain and justify your answer in some detail.

ASSIGNMENT QUESTIONS

1.How important is it for companies such as Nike and Wal-Mart that source extensively from foreign suppliers located in countries where wages are low and substandard working conditions are common to institute supplier codes of conduct and undertake programs to monitor and ensure supplier compliance with these codes of conduct?

2.Which company has the strongest supplier monitoring and compliance program—Nike or Wal-Mart? Why?

3.Would you recommend that a company join the Fair Labor Association and use FLA’s standards and program of factory audits instead of trying to set up its own supplier monitoring and compliance effort?

4.What can a company do to detect and combat the efforts of unscrupulous foreign suppliers to deceive inspection/compliance teams?

TEACHING OUTLINE AND ANALYSIS

1.How important is it for companies such as Nike and Wal-Mart that source extensively from foreign suppliers located in countries where wages are low and substandard working conditions are common to institute supplier codes of conduct and undertake programs to monitor and ensure supplier compliance with these codes of conduct?

Ethically-minded students will take the position that it is very important—even essential—for companies like Wal-Mart and Nike to have a supplier code of conduct and to strictly enforce this code. There are at least two important reasons why compliance monitoring has merit for companies that outsource a high percentage of their products from foreign manufacturers:

1.The big hit to a company’s reputation and image that can flow from media coverage of accusations by human rights activists that the company is sourcing its goods from “sweatshop” manufacturers who pay substandard wages, require unusually long work hours, use child labor, operate unsafe workplaces, and habitually engage in assorted other substandard practices. Such adverse and negative publicity can not only do long-term damage to a company’s reputation but also erode its sales and customer loyalty.

2.Because it is unethical and socially irresponsible for a company to do business with suppliers who operate unsafe factories, use child labor, pay substandard wages, or otherwise engage in unsavory practices. A company that knowingly and as a matter of course does business with such suppliers (usually in the name of obtaining its supplies at the lowest possible price) cannot morally and ethically justify such sourcing practices.

Amoral students are likely to view supplier codes of conduct as a useful public relations tool but be tolerant of token or lax enforcement of such codes. They will tend to disclaim responsibility for policing the actions and practices of suppliers, arguing that such is the province of governmental authorities.

To stimulate debate of the issues pro and con, you can pose the following questions:

What reasons can you give for why a company that sources extensively from foreign suppliers located in countries where wages are low and substandard working conditions are common should definitely institute a supplier code of conduct and monitor supplier compliance with this code?

Why should a company concern itself with how suppliers operate their businesses?

Are human rights abuses on the part of suppliers something that a company should legitimately be concerned about and actively try to prevent? If a supplier factory habitually engages in human rights abuses, should a company cease doing business with that supplier?

Are substandard pay and working conditions in suppliers’ factories something that a company should legitimately be concerned about? If a supplier factory habitually operates a sweatshop, should a company cease doing business with that supplier?

Is supplier use of child labor something that a company should legitimately be concerned about? If a supplier factory habitually utilizes child labor, should a company cease doing business with that supplier?

Is supplier abuse of the environment something that a company should legitimately be concerned about? If a supplier factory refuses to operate in a manner that constitutes rape of the environment, should a company cease doing business with that supplier?

Why is it a company’s ethical or social responsibility to monitor the workforce practices of its foreign suppliers? Why is concern about working conditions in foreign factories and the payment of adequate wages and fringe benefits in these factories not the sole responsibility of governmental authorities in the country where the supplier is located?

Can a company that overlooks how its suppliers operate their factories (as concerns wages, work hours, use of child labor, worker safety, environmental stewardship, and so on) stand on high moral ground when it comes to judging how it conducts its business?

On what grounds can a company justify doing business with suppliers who operate unsafe factories, use child labor, pay substandard wages, or otherwise engage in unsavory practices?

2.Which company has the strongest supplier monitoring and compliance program —Nike or Wal-Mart? Why?

In all probability students will conclude that Wal-Mart has a stronger and more thorough supplier monitoring program than Nike—and by a significant margin.

Evaluation of Nike’s Compliance Monitoring Program

In 2004, Nike’s compliance team consisted on 90 people based in 24 offices in 21 countries. The typical Nike compliance team in each country spent about one-third of their time on monitoring and auditing activities, about half their time assisting and tracking factory remediation activities, and the remainder of their time on trouble-shooting and collaboration/outreach work. But Nike had only 46 employees in 2004 who conducted in-depth M-Audits in contract factories, most auditors were women under 30 years old (perhaps indicating a lack of savvy, experienced plant auditors).

Nike’s factory audits were announced rather than unannounced because “much of the information we require in our evaluation of a factory is dependent upon access to relevant records and individuals within factory management.” It is hard to believe that announced audits are as effective as unannounced audits in detecting noncompliance.

During 2003-2006, Nike utilized 4 types of factory audits:

1.Basic monitoring or SHAPE inspections: SHAPE inspections, used since 1997, sought to gauge a factory’s overall compliance performance, including environment, safety and health. They were typically performed by Nike’s field-based production staff and could be completed in one day or less. Nike’s stated goal was to conduct two SHAPE audits on each active factory each year, but the actual number of such audits had fallen short of that target.

2.In-depth M-Audits: The M-Audit was designed to provide a deeper measure of the working conditions within contract factories. As a general rule, Nike focused its plant inspection efforts on factories where non-compliance was most likely to occur. In 2003, Nike focused its M-audits on factories presumed to have the highest risk of non-compliance and the greatest size (as measured by worker population). In 2004 M-audits were focused on factories believed to be of medium risk for non-compliance. Nike’s stated goal was to conduct M-audits for approximately 25-33 percent of its active factory base each year. The M-Audit included four major categories of inquiry (hiring practices, worker treatment, worker-management communications, and compensation) and covered more than 80 labor-management issues.

3.MAV Audits: Starting in fiscal year 2006, Nike introduced a new audit focused on finding root causes of non-compliance issues that most impacted workers, specifically work hours, wages/benefits, grievance systems, and freedom of associations. Prior audit experience had led Nike’s staff to believe that root cause identification would help supplier factories remediate the problems that were identified. Nike conducted 42 MAV audits through fiscal year 2006.

4.Independent external monitoring: Beginning in 2003, Nike became a member of the Fair Labor Association, an organization that conducted independent audits of factories that provided goods to members. The FLA applied a common set of compliance standards in all of its factory audits.

In 2004 Nike had 46 employees who regularly conducted M-Audits. The typical M-Auditor was under the age of 30 and 74 percent were women. Nike tried to hire auditors who were local nationals and understood the local language and culture. In 2003-2004, over 9,200 factory workers were individually interviewed as part of the M-Audit process. Each interview took approximately 30 minutes. The typical M-Audit took an average of 48 hours to complete, including travel to and from the factory—travel hours accounted for between 25 and 30 percent of total M-Audit time.

It is hard to believe that M-Audits could be done in a very thorough manner in this amount of time.

M-Audits were conducted for only 25-33% of Nike factory base annually, meaning that on average each factory was audited only once every 3-4 years. In 2007, Nike reported that it had almost 700 factories in 52 countries actively engaged in manufacturing its products—this number was smaller than in earlier years.

To facilitate factory compliance with Nike’s Code of Conduct for suppliers, the company conducted or sponsored training and education programs for factory personnel. In 2004, over 16,500 factory managers and workers attended programs relating to labor issues, worker health and safety, and environmental protection.

While Nike’s compliance ratings of its contract suppliers in 2003-2004 resulted in 15% of the factories earning very commendable A ratings and another 44% earning B ratings, there were still some pretty low scores—25% involved grades of C and D, the average scores in Asia were only 58, and the scores in some factories ranged as low as 20 (see the data in case Exhibit 3).

Nike’s compliance ratings for 2005-2006 (shown in case Exhibit 4) resulted in more A ratings, considerably more B ratings in 2006 after a downward trend in B ratings in 2005, increases in C and D ratings in 2005, a flat trend in C ratings in 2006, declining trend in D ratings in 2006, and relatively flat trends in E ratings in both 2005 and 2006.

Nike’s efforts to correct problems in factories found to be out of compliance seem weak in comparison to Wal-Mart. In its 2004 Corporate Responsibility Report, Nike admitted, “With an average of one compliance staff for more than 10 factories—some of which are remote and some of which are large and complex businesses with 10,000 or more employees—tracking and assisting factory remediation is at times an overwhelming and incomplete body of work.”

When a factory was found to be out of compliance with the Nike Code of Conduct, Nike’s compliance team worked with factory management and the Nike business unit for which products were being manufactured to develop a Master Action Plan (MAP) that specified the factory’s needed remediation efforts. The Nike production manager responsible for the business relationship with the contract factory monitored MAP progress and exchanged information about progress or obstacles with Nike’s country compliance team. The Nike general manager for production monitored the progress of all factories within his or her purview, and weighed in when factory remediation progress was too slow. One wonders if the Nike plant inspection teams should also have been much more deeply involved in working with the factory to achieve compliance; managers from Nike’s business units may not be highly motivated to push non-complying suppliers hard to get in compliance—their priorities may lie in making sure Nike receives the needed products on time.

Some questions you may want to pose to class members here:

Does Nike’s general manager for production have strong incentive to push non-complying factories into compliance or to cut off orders to factories with chronically poor ratings?

Would not the general manager for production be primarily concerned about getting deliveries on orders from such plants and making sure that the plant’s product quality was good?

Does Nike put responsibility for factory compliance in the hands of the general manager for production (as opposed having the plant audit teams responsible for monitoring compliance) in order to “ensure” soft pressures for compliance, especially if the violations involve a plant with low costs or if cutting off orders from the plant would disrupt Nike’s deliveries to its customers?

A factory was cut from Nike’s supplier base when, over a period of time, Nike management determined that factory management lacked the capacity or the will to correct serious issues of non-compliance. The compliance team established action plans, which three different Nike business units worked with the factory to implement. After six months of continuous efforts, and no improvement, the factory was dropped. More typically, Nike’s decisions to end a business relationship with problem suppliers was based on a “balanced scorecard” of factory performance that took into account labor code compliance along with such measures such as price, quality, and delivery time. Thus non-compliance might be overlooked if a supplier’s scores on the other measures were high—a circumstance not calculated to induce suppliers to get into compliance quickly.

To supplement its own compliance monitoring efforts, in 2003 Nike joined the Fair Labor Association, an organization that conducted independent audits of factories that supplied products to FLA members. The FLA applied a common set of compliance standards in all of its factory audits. In 2006, FLA’s teams of independent plant monitors conducted inspections at 147 factories in 18 countries, the results of which were published in FLA’s 2007 Annual Public Report. The audits, all of which involved factories that were supplying goods to one or more FLA members, revealed 2,511 instances of noncompliance with FLA’s Workplace Code of Conduct, an average of 18.2 violations per factory (versus averages of 15.1 per factory in 2003 and 18.2 per factory in 2004). The violations included excessive work hours, underpayment of wages and overtime, failure to observe legal holidays and grant vacations (27.5 percent); health and safety problems (44 percent); and worker harassment (5.1 percent). The FLA concluded that the actual violations relating to underpayment of wages, hours of work, and overtime compensation were probably higher than those discovered because “factory personnel have become sophisticated in concealing noncompliance relating to wages. They often hide original documents and show monitors falsified books.”

In its 2006 Public Report, the FLA said that accredited independent monitors conducted unannounced audits of 99 factories in 18 countries in 2005; the audited factories employed some 77,800 workers. The audited factories were but a small sample of the 3,753 factories employing some 2.9 million people from which the FLA’s 35 affiliated companies sourced goods in 2005; however, 34 of the 99 audited factories involved facilities providing goods to 2 or more of FLA’s 35 affiliated companies. The 99 audits during 2005 revealed 1,587 violations, an average of 15.9 per audit. The greatest incidence of violations was found in Southeast Asia (chiefly factories located in China, Indonesia, Thailand, and India) where violations averaged about 22 violations per factory audit. As was the case with the audits conducted in 2004, most of the violations related to health and safety (45 percent); wages, benefits, hours of work, and overtime compensation (28 percent); and worker harassment and abuse (7 percent). The FLA stated in its 2006 report that the violations relating to compensation and benefits were likely higher than those detected in its 2005 audits because “Factory personnel have become accustomed to concealing real wage documentation and providing falsified records at the time of compliance audits, making any noncompliances difficult to detect.”

In its 2007 Public Report, the FLA said that accredited independent monitors conducted unannounced audits of 147 factories in 30 countries in 2006; the audited factories employed some 110,000 workers. The audited factories were but a small sample of the 5,178 factories employing some 3.8 million people from which the FLA’s affiliated companies sourced goods in 2006; however, 24 of the audited factories involved facilities providing goods to 2 or more of FLA’s affiliated companies. The 147 audits during 2006 revealed 2,511 violations, an average of 17.1 per audit.

While Nike’s membership in the FLA seems to be a positive thing on the surface, is it really? There are several questions you can pose to class members to arrive at an evaluation of whether Nike’ reliance on FLA audits is good:

Does the FLA audit enough Nike factories to matter?

Does the FLA have any leverage to secure compliance?

What should we make of the FLA’s statement that “Factory personnel have become accustomed to concealing real wage documentation and providing falsified records at the time of compliance audits, making any noncompliances difficult to detect.”?

Does Nike’s membership (or that of any other company) in the FLA just provide nice public relations cover in case of an embarrassing incident that comes into the public spotlight?

Evaluation of Wal-Mart’s Compliance Monitoring Program

In 2005-2007, Wal-Mart purchased goods from close to 9,000 factories in some 60 countries; about 2,500 of the 9,000 factories had recently come into Wal-Mart’s compliance and factory audit system due to mergers, acquisitions, and new factory construction. About 200 Wal-Mart personnel scattered across GPSG’s offices in all 25 countries were engaged in monitoring suppliers for compliance with Wal-Mart’s Standards for Suppliers. Suppliers covered by Wal-Mart Ethical Standards program had to disclose the factory (or factories) used to fulfill each order placed by Wal-Mart.

During 2006, Wal-Mart audited more factories than any other company in the world, performing 16,700 initial and follow-up audits of 8,873 factories. In 2005, Wal-Mart conducted 13,700 initial and follow-up audits of 7,200 supplier factories; in 2004, Wal-Mart conducted 12,561 initial and follow-up audits at 7,600 factories.

Wal-Mart’s audit methodology and factory rating system is described in Exhibit 5. Most class members are likely to conclude (we think correctly) that Wal-Mart’s factory rating system seems to be significantly more stringent than Nike’s.

A higher percentage of Wal-Mart’s factory ratings revealed significant compliance issues as compared to Nike—35.6% in 2004 and 52.3% in 2005 received Orange ratings (factories were rated Green, Yellow, Orange, or Red). A Green assessment was assigned for no or minor violations; a Yellow rating signified medium-risk violations; an Orange rating entailed high-risk violations (and was an automatic rating for factories where the use of one or two underage workers was discovered); and a Red rating indicated failure to pass the audit). Wal-Mart’s high percentage of Orange ratings was perhaps due to stricter ratings than Nike’s and/or because Wal-Mart’s suppliers were more prone to operate substandard facilities. Wal-Mart management said the greater incidence of Orange violations in 2005 compared to 2004, was primarily due to a 100 percent increase in unannounced audits, increased rigor of supplier standards, a reclassification of violations to strengthen and reinforce their severity, the implementation of team audits, and greater auditor familiarity with the factories and their workers.

A summary of Wal-Mart’s audit findings for 2004-2006 is contained in case Exhibit 6 on page C-475 of the textbook (for convenience, the data in this exhibit are shown below):

*In 2007, the re-audit period for Yellow-rated factories was changed to 180 days.

According to Wal-Mart management, the lower number of disapproved factories in 2005 and 2006 relative to 2004 was chiefly due to extending the disapproval period from 90 days to one year for factories receiving 4 orange ratings within a two-year period; other contributing factors were a revision of the ratings and Wal-Mart’s public announcement that it was expanding the percentage of unannounced audits to 20 percent in 2005 and as many as 30 percent in 2006. Also, starting in 2004, more rigorous supplier standards were instituted, certain types of violations were reclassified to increase their severity, and audits were conducted by 2-person teams instead of just a single individual. Increases in the number of audits had also resulted in Wal-Mart’s auditors becoming more familiar with the factories and their workers. About 52 percent of the supplier factories audited in 2005 were not included in the 2006 audit program because of supplier turnover, disapproved factories, permanently banned factories receiving Red ratings, and the two-year re-audit cycle for supplier factories receiving a Green Rating.

Red-rated factories were permanently banned from producing merchandise for Wal-Mart. Wal-Mart permanently banned orders from a surprisingly large number of suppliers (including those factories receiving 4 Orange ratings within 2 years)—729 in 2004, 171in 2005, and 219 in 2006; this signals an arguably tough and serious compliance monitoring effort.

Factories rated Orange with underage labor violations for only one or two workers were re-audited within 30 days. If the follow-up audit indicated that the use of underage labor had been corrected, the factory could continue production for Wal-Mart; a failure on the follow-up 30-day audit resulted in a Red rating and a permanent order ban. A factory receiving an Orange assessment four times in a two-year period was banned from producing for Wal-Mart for up to one year (the ban on orders for such factories was extended from 90 days to one year starting January 1, 2005, in order to strengthen the seriousness of program non-compliance). During 2004-2006, 861 factories were banned from supplying Wal-Mart due to 4 Orange rating within a 2-year period.

At supplier factories receiving Yellow and Orange ratings, Wal-Mart’s policy was to work with supplier factories to reduce violations and achieve steady improvement of workplace conditions. Wal-Mart’s policy of striving first to achieve compliance rather than immediately imposing harsh penalties was a practice widely endorsed by most human rights activists, concerned citizens groups, and non-governmental agencies striving for better factory conditions for low-wage workers.

To help promote higher levels of supplier compliance, Wal-Mart trained more than 8,000 supplier personnel in 2004 11,000 suppliers and members of factory management in 2005, and 5,000 supplier personnel in 2006. The training focused on increasing supplier familiarity with Wal-Mart’s Standards for Suppliers and encouraging an exchange of information about factory operating practices. Wal-Mart also actively worked with its foreign suppliers on ways to do better production planning, enhance plant efficiency, better educate and train workers, make supply chain improvements, and adopt better factory operating practices. Wal-Mart also consulted with knowledgeable outside experts and organizations on ways to accelerate ethical compliance and the achievement of better working conditions in supplier factories.

When Wal-Mart sourced goods for its foreign stores from suppliers in the same country in which Wal-Mart’s foreign stores were located, it used outside auditors to check supplier compliance. In 2005-2007, the outside auditing firms performing audits for some supplier factories included Accordia, Bureau Veritas, Cal Safety Compliance Corporation (CSCC), Global Social Compliance, Intertek Testing Services, and Société Générale de Surveillance.

Wal-Mart was addressing what to do about “audit fatigue.” It was not uncommon for the audit teams of different companies to be in some supplier factories as often as 10 times each month, not only leading to duplication of audit efforts but also audit fatigue and frustration on the part of factory managers. Wal-Mart recognized that multiple audits by multiple companies with varying standards and interpretations needed to be addressed. Its response had been to increase its collaboration with other companies and organizations that were engaged in monitoring to work toward a convergence of supplier codes of conduct and common interpretation of standards and local laws; Wal-Mart’s goal was to develop a unified and credible certification program for factories that would both facilitate compliance and reduce audit fatigue.

Toward this end, Wal-Mart had begun working closely with the International Council of Toy Industries (ICTI) CARE Process and the Global Social Compliance Program. ICTI consisted of toy trade associations from 21 countries and was engaged in promoting toy safety standards, fair labor treatment and safe working conditions in toy factories, and a responsible approach in advertising and marketing toys to children.

In July 2008, Wal-Mart announced that Intertek Group, plc, an independent supplier monitoring organization with 25 offices in China, would begin conducting audits of Wal-Mart’s supplier factories in China.

Drawing Some Conclusions about Which Company is Doing the Best Job of Compliance Monitoring and Enforcement To help catalyze the debate among class members as to whether Nike or Wal-Mart is doing the “best” job of compliance monitoring, you may want to pose some of the following questions:

Why do you think Nike does mainly announced audits?

Is Nike auditing the factories of its contract suppliers frequently enough? Should it be doing more M-Audits?

Is Nike’s compliance monitoring program adequately staffed?

Does Nike appear to grade its supplier factories as tough as Wal-Mart’s grades its supplier factories?

What evidence indicates that Nike is aggressive in pressuring its suppliers to achieve compliance, particularly when a supplier receives a below average score on its M-Audit (see the data in case Exhibit 3)?

Is Nike lax (too lax?) in pushing suppliers with violations to achieve compliance?

Is Wal-Mart’s compliance monitoring program adequately staffed?

Who has the best factory auditing methodology—Nike or Wal-Mart?

Do Nike’s factory audits appear to be more or less thorough than those done by Wal-Mart? Why?

What do you think accounts for why Wal-Mart has given so many supplier factories Red ratings and permanently banned orders from these factories?

Do all the Red and Orange ratings given to Wal-Mart’s supplier factories signal that Wal-Mart may be picking its foreign suppliers chiefly on the basis of low price and then finding out that many of these suppliers are out of compliance with its Supplier Code of Conduct?

3.Would you recommend that a company join the Fair Labor Association and use FLA’s standards and program of factory audits to monitor supplier compliance instead of trying to set up its own supplier monitoring and compliance effort?

Students can argue this pro or con. The FLA has what is likely to be appropriate standards of conduct for suppliers—as least as far as most candidate members are concerned. It already has experience in monitoring suppliers and conducting plant audits. It is a prominent and apparently well organized coalition whose members and affiliates include 194 colleges and universities, a number of concerned non-governmental organizations, and a group of 35 companies. FLA’s membership fees are likely to be substantially smaller than the amount of money a company would have to spend to conduct its own full-scale audit and compliance program.

But on the con side, the FLA conducts a relatively small number of plant audits annually:

The FLA conducted unannounced audits of 99 factories in 18 countries in 2005; the audited factories employed some 77,800 workers. The audited factories were but a small sample of the 3,753 factories employing some 2.9 million people from which the FLA’s 35 affiliated companies sourced goods in 2005.

In 2006, FLA’s teams of independent plant monitors conducted inspections at just 147 factories in 18 countries).

Moreover, FLA representatives are unlikely to have much clout in getting violators to correct their practices unless the affected member companies put real pressure on such suppliers to bring their factory operations into compliance.

The FLA has also admitted that violations at the plants it has audited are very likely higher than those it detected because of supplier efforts to deceive inspectors and conceal violations. The FLA concluded that the actual violations relating to underpayment of wages, hours of work, and overtime compensation were probably higher than those discovered because “factory personnel have become sophisticated in concealing noncompliance relating to wages. They often hide original documents and show monitors falsified books.”

It seems clear that the FLA’s plant inspection methodology definitely needs to be strengthened.

Astute class members might argue that membership in the FLA just provides nice public relations cover in the event of highly publicized allegations about substandard working conditions at the foreign plants of one or more of a company’s suppliers.

4.What can a company do to detect and combat the efforts of unscrupulous foreign suppliers to deceive inspection/compliance teams?

There are several ways for a company to combat supplier actions to deceive its inspection/compliance teams:

Conduct unannounced inspections.

Inspect supplier premises and records several times a year, especially when there are reasons to suspect that a supplier may be cheating on compliance.

Insist on interviewing a sizable number of employees, chosen at random (and certainly not chosen by the supplier); try to make sure that those employees who are interviewed are not subsequently punished by the supplier if they reveal information unfavorable to the supplier (ideally, the supplier should not know which employees are interviewed).

Make sure the members of inspection/compliance teams are experienced and savvy.

Conduct thorough, not superficial or perfunctory, inspections of supplier factories and records. A company must amply staff its inspection/compliance program and allow teams enough time to do a good job of conducting plant inspections.

Make it clear to suppliers in no uncertain terms that premeditated actions to deceive inspection/compliance teams will be dealt with harshly, including being permanently banned as a supplier (if the deception involves two or more separate instances).

Work closely with problem suppliers to achieve compliance—achieving compliance is far more important and of long-lasting benefit to all concerned that is administering swift and harsh punishment for violators (unless the violations are deliberate and repeated).

Recognize that compliance with the company’s code of supplier conduct imposes costs on suppliers (perhaps sizable costs) and thus may be a basis for agreeing to pay the suppliers a somewhat higher price for the product/service being supplied (unless a supplier’s operations are inefficient and the added compliance costs can be offset by working with the supplier to eliminate such inefficiencies)

Recognize that it is burdensome for suppliers to have to comply with a whole host of different codes of conduct. When a foreign supplier is supplying goods to several (or many) companies, those companies should strive to have compatible codes of supplier conduct (as opposed to widely differing requirements and expectations of suppliers). Moreover, they might want to join forces in conducting plant inspections of common suppliers—both to save on their own costs of monitoring suppliers and to economize on the time that suppliers spend dealing with compliance/inspection teams. In such instances, joining the Fair Labor Association, adopting the FLA’s Workplace Code of Conduct, and utilizing the FLA’s accredited independent plant monitors may be a useful way to go. But the FLA would have to significantly step up the number of unannounced plant audits that it conducts annually for this to be workable; moreover, the FLA or its members would have to take strong and decisive action to enforce compliance at those factories where code violations were found.

There is considerable merit in companies banding together to conduct plant audits and sharing audit results. Allied companies sourcing goods from the same factories would have considerable clout in jointly applying pressure on a supplier to improve its working conditions and comply with buyers’ codes of supplier conduct. Furthermore, allied companies could pool their audit information on off-shore factories, creating a data base on thousands of manufacturing plants. Once a plant was certified by a coalition company or organization, other coalition members could accept the results without having to do an audit of their own.

EPILOGUE

We have nothing further to report on the developments in monitoring foreign suppliers at the time this teaching note went to press in February 2009. For the latest developments at Nike, you can check Nike’s Web site (www.nike.com) and review the contents of its latest Corporate Responsibility Report. Wal-Mart has considerable information posted on its Web site (www.walmart.com) regarding its supplier monitoring program; there are regular updates of new developments.