Over the last couple of years, one of the firms that has popped up on the radar of firms whose labor conditions I felt were at some point going to come back to haunt them… and I think we have come a bit closer with the above CCTV report, an 11 and a half minute investigative report (in Chinese) where former employees of the Suzhou based Wintek facility speak about the physical ailments they experienced while working at the facility.

It is a report that covers all the bases. Interviews of former employees who detail the illnesses they feel come from working at the plant, people in the hospital who are still recovering, labor bureau officials, the cursory tours, some scientific facts on the chemicals used in the process of cleaning/ finishing the screens, and even a Wintek Manager interview.

It is a report, that while “unverified”, is unlike before when Apple (and its suppliers) had labor issues as it is a report that cannot be contained by suing a reporter or leveraging the brand to keep the story from entering the mainstream, and it is the “report” that I had in many ways been waiting for. That, as the reports of Apple’s supply chain issues were becoming more frequent in the international press, it was the potential spillover into the Chinese press that I was looking out for and in my opinion significantly heightens the risk to Apple locally.

Link to video (Chinese) here

Update: Shanghai Daily is reporting that Wintek admits to having 49 employeees exposed, and “taken care of”, a few months back.  That, the exposures were a failure of managers understanding the chemicals, and how to properly manage them.. and that following the 49 employees being sicked, they took immediate action. Interestingly enough, the hospital says that more than 100 employees have been received thus far, and that they are still coming in.

hmm.. I am guessing there isn’t an Apple employee with direct knowledge of the situation, but given Apple’s plans to open up a Apple store in Shanghai this summer, I would suggest they get books on the ground fast to work out what is going on.  Last thing they would want would be 2500 Wintek employees to go on another walk, but this time move the meeting point to Nanjing road.

Update 2: Turns out that Wintek is also a supplier to Nokia, and Nokia has sent out a very strongly worded message to put a lot of distance between them and the current issues at Wintek. Here are two passages that I believe are the most damning for Wintek – and ultimately Apple (emphasis mine)

#1 – Wintek is a Nokia supplier, and provides components for its mobile phones, but N-Hexane is and has NOT been used on Nokia’s production lines at this supplier. Nokia strictly forbids all use of chemicals which are illegal.

#2 – We became aware of the allegations regarding the use of n-hexane in July 2009 and started our investigation immediately. Although it was confirmed that the n-hexane was not used on our production lines at the supplier, as part of our assessment we agreed on a development plan for health and safety management at Wintek’s Suzhou factory and a series of corrective measures have been taken since then.

So, if I read this right, not only is n-hexane illegal, but this has been going on for nearly a year.

That is would have been more than enough time for Apple to have made the necessary adjustments had they put in the effort when the first Wintek strike occurred, or even the second one.  OR.. even when they did their supplier evaluations in as part of the 2009 supplier responsibility report.

This afternoon I was asked by someone why I am involved in CSR and sustainability.  It is a question that I seem to asked frequently, but one that I am not sure I ever answer with any measure of clarity as I have worked in a very wide range of issues related to these big topics, and my interests for each issue hit me in different spots.

But, if there is one common thread that I feel binds each of the issues I work on (see a recent list of 35 projects I am managing through my class at CEIBS), it is that of responsibility… or the lack there of.

That, regardless of the issue under the microscope, at any one time there are up to 5 different groups that share a role and responsibility, and that should one of those groups fail to assume their responsibility, or should one of those groups act in a deliberate manner to upset the balance, then they are by their very nature irresponsible and are taking on a measure of risk to their person or organization.

If this sounds a bit alien, then think back to Nike circa 1996-1997 when the entire world was given a glimpse into the realities of Indonesian labor standard.  It was a classic case of a model that was unsustainable. Nike outsourced all their manufacturing to largely Asian owned/ operated contract manufacturers (still does today), but with little oversight or belief that they had any responsibility of the conditions on the ground.  It was a denial of responsibility that lead to a huge PR disaster for them, and they took win huge losses as consumers walked away from them in what I would call an act of consumeristic responsibility.

Fast forward to 2006 when the international press got wind of an issue related to the dormitory conditions of the Suzhou factory that manufactured Apple’s famed iPod.  It was a story that immediately became controversial as Apple and Foxconn tried to skirt the stories and admit no wrong, but ultimately Apple did send over a team of investigators to Suzhou who:

In response to the allegations, we immediately dispatched an audit team comprised of members from our human resources, legal and operations groups to carry out a thorough investigation of the conditions at the manufacturing site. The audit covered the areas of labor standards, working and living environment, compensation, overtime and worker treatment. The team interviewed over 100 randomly selected employees representing a cross-section of line workers (83%), supervisors (9%), executives (5%), and other support personnel (3%) including security guards and custodians. They visited and inspected factory floors, dormitories, dining halls, and recreation areas. The team also reviewed thousands of documents including personnel files, payroll data, time cards, and security logs. In total, the audit spanned over 1200 person-hours and covered over one million square feet of facilities.

.. and what they found was:

Our audit of on-site dormitories found no violations of our Code of Conduct. We were not satisfied, however, with the living conditions of three of the off-site leased dorms that we visited. These buildings were converted by the supplier during a period of rapid growth and have served as interim housing. Two of the dormitories, originally built as factories, now contain a large number of beds and lockers in an open space, and from our perspective, felt too impersonal. The third contained triple-bunks, which in our opinion didn’t provide reasonable personal space.

To address this interim housing situation, the supplier acquired additional land and is currently building new dormitories. These plans were in place prior to our audit, and will increase the total living space by 46% during the next four months.

It was a report, a process, and reaction that while initially grabbed some press, was  in the end chalked up to  just another problem that overseas brands faced when outsourcing.  As the Wired article Judging Apple’s Sweatshop Charge seemed to conclude in their assessment:

The situation is too murky for a rush to judgment on Apple’s ethics here, and it may well meet minimum global standards. But for a company that has staked its image on progressive politics, Apple has set itself up as a potential lightning rod on global labor standards. Sweatshops came back to bite Nike after its customers rose up in arms; and Apple can expect a similar grilling from its upscale Volvo-driving fans in the months ahead.At this point,

It is at this point that Apple appears to have been genuinely woken up, or at least rattled, because 18 months later Apple released its first supplier Responsibility report (download here) where the findings of a complete review were released.  It was a report that was opened with the passage below:

Apple is committed to ensuring the highest standards of social responsibility throughout our supply chain. The companies we do business with must provide safe working conditions, treat employees with dignity and respect, and use environmentally responsible manufacturing processes wherever Apple products are made.

For the past several years, Apple has required suppliers to commit to a comprehensive Supplier Code of Conduct as a condition of their contracts with us. We drive  compliance to the Code through an aggressive monitoring program, including factory audits, corrective action plans, and verification measures.

Apple’s approach to supplier responsibility extends beyond compliance monitoring. We also provide detailed standards and ongoing training support to help suppliers continue to meet our expectations. And by making social responsibility part of the way we do business, we ensure that suppliers take our standards as seriously as we do.

.. but, it was a report whose contents were shocking as more than half of their suppliers were not in compliance.  There were material issues that were across the board (as the graphic below shows) with overtime, wages deductions, age limits, and so on, and regardless of whether or not these could be explained away or were “problems of the past”, the fact is that Apple should have at this very moment stopped dead in their tracks, realized that they were sitting on a problem, and made changes.  Changes in their partner relationships, changes in the way they monitor and measure relationships, and changes in their attitude about who is ultimately responsible for labor abuse (and other issues of corporate responsibility) within one’s supply chain.  Outsourced or not.

Sadly though, their own internal document did not provide the “come to Jesus” that it should have and last summer, again at a Foxconn site, a 25 year old employee committed suicide after he was interrogated by Foxconn employees over the theft of a prototype iPhone.  an event that I covered in my article Apple’s China Supply Chain Issues Require IMMEDIATE Attention and Action, and believe to this day that Apple should have taken the following actions:

1. Contact Nike to learn lessons of how to develop an IN-HOUSE program that manages and monitors the factory conditions
2. Get boots on the ground.  Pay the money for a team of people who will make inspections and be given the power to make corrections
3. Invite in third parties to not only verify what Apple has found and done, but to give public credibility to the process in place
4. Do the right thing and begin making better decisions about who their suppliers are, and what is expected.  If the profit from an iPhone is 50USD, spend the extra buck now to do the right thing.  It is not an expense, it is an investment
5. Make materials improvements, or make materials adjustments.  Give suppliers a chance to change, but do not wait long.  Begin developing parallel supply lines and force suppliers to comply through the threat of lost business (partial or whole).
6. Open Up

Once again, this event would not serve as a learning lesson for Apple either (they largely skirted their responsibility of this once again), and 7000 employees of another Suzhou based supplier Wintek went on strike in May of 2009 over poor working conditions, and another 2000 employees again went on strike this week over working conditions and pay.   As the China Daily article Workers protest over pay, toxic chemicals highlights:

He said at least four workers had died from overexposure to hexane, a toxic chemical workers had been asked to use for cleaning touch panels manufactured at United Win (China) Technology Ltd Co. The company is a subsidiary of Taiwan-based Wintek Corporation, one of the world’s leading producers of small mobile phone panels and touch panels. [...] Media previously cited local authorities as saying workers had been provoked by rumors that the company planned to cancel a year-end bonus, which company executives later dismissed and promised to distribute before the Chinese Spring Festival that is less than a month away.

But Zhu said it was not just about the money. “What we feel angry about is the company authorities’ apathy to our workers’ health,” he said.

Unconfirmed deaths aside, the fact that employees are being exposed to these chemicals at all should have been something that Apple’s inspectors should have picked up on.  Unless of course the team of inspectors were outside to Apple’s process, and really had no idea what they should have been looking for.  Plausible?  But, if it was Apple’s team, then they should have been looking for this type of issue, and had they found a chemical exposure issue, they should have taken action right away to make sure that employees had the equipment (suits, ventilation, etc) to protect themselves from exposure.

It just begs the question.  Does Apple feel any real sense of responsibility for the conditions of their supply chain, and why is it that a firm that is trying to crack the China market so willing to risk so much?

Is it that Apple is ignorant of the fact that these problems exist? Is it that they believe the brand is impermeable?  Or are they just scared of standing up their suppliers?

It is a horrible miscalculation in my opinion, and when speaking to a friend this evening who is in the audit business about the situation we were stuck on why a company with Apple’s size and cash position wouldn’t spend the 2-3 million USD it would take to fix this problem.

For me,it is a sign that Apple’s model is broken.  That regardless of how well they are selling now, or what the next gadget will be, that they will at some point experience the loss that Nike did in the late 90s, or larger.  That while there seems to be little recognition of Apple’s supply chain issues in the U.S, and no sustained pushback in China, Apple is playing with fire.

It has clearly set up a supply chain that allows suppliers to structure their operations in a manner that exploits the living conditions of employees.

A structure that, getting back to my first point, will become an issue of economic sustainability for Apple.

Earlier this week I received an email titled Five Pitfalls of Metals-Based Sourcing from old friend Lisa Reisman of Metalminer (her husband Jason writes Spendmatters) where she laid out what she sees are the five essential mistakes people make when sourcing metals in commodity form.

1. Misreading the supply market can result in the placement of large resting or standing orders as prices decrease, or in failing to place large, timely orders to avoid price increases.
2. Using a 3-bid monthly buy. Here the buying organization believes it has purchased at or below market because it went with the supplier who offered the best pricing and terms on a monthly basis, for that month’s orders. But bidding on a monthly basis is almost never the best lowest total cost option. In fact, we’d go so far as to say that companies that deploy this practice, nearly always have a substantial cost-savings opportunity available to them.
3. Failure to implement index-based buying strategies. The result here is a lack of visibility into the actual costs that comprise the delivered price.
4. Assuming that a buyer’s size or reputation guarantees that it receives the best price. Without using data to validate its assumption, the buying organization believes that because a particular supplier has been a “partner” for many years and receives $Xm of business from a customer annually, the supplier must be supplying at “better than market” prices.
5. Making purchases by unit or each, rather than by weight. There are a couple of exceptions where this practice is advantageous, but it generally is not. We have seen instances where suppliers/producers “ship light” selling metal on a unit cost basis that results in the buying organization overpaying for materials. Moreover, buying on a unit or each basis can prevent the buying organization from seeing the true costs (such as the raw material and the fabrication costs) that make up the total price.

It is a piece that is backed up by her recent white paper (download here), and I have a few comments on the above based on my own experience.

1.  Her first observation is spot on.  There is a lot of speculation in the market about the true source of demand for metals, and there is plenty of evindence to suggest that a lot of recent demand driving prices up is artificial (investors and mis-allocated funding from SOEs).  It is a dynamic market that has seen large swings in pricing, and while opportunities to buy on the dips exist for manufacturers/ traders, if one were a commodity trader the market could easily swing against you.

For myself, the last 6 months were a great time to stock up.  AL pricing was off nearly 50% from the highs of 2 years ago… and there was space in the warehouse.

2. This is an observation that I would say largely depends on the purchase cycles, sizes, and needs of the buyers.  3 month averaging is a great way to flatten things out, but if you were buying at 24,000RMB/ ton 2 years ago and it is swinging from 13,000 to 16,000 now, then perhaps some firms may find going to a month to month or spot market advantageous.  Especially if holding cash, and are willing to store for a few months

3.  Totally agree. For our largest client, we actually provided a spreadsheet where current RMB and metal pricing could be changed, and the final landed price would appear.  they really liked that level of transparency.

4. Without knowing the spot market prices in China, companies are in the dark, and trusting someone else to manage a commodity purchase in the blind is just asking for it.  Firms need to play an active role in managing these commodity costs, especially if the order sizes are significant.

5. This is an area where my experience differs a bit.  We have largely used per piece pricing, but we have people on the ground checking for quality and cross counts occur at multiple steps in the process.  Were we an offshore buyer with no one to count, then I would agree..  however, then the issue of alloys can easily become an issue, nd weights can be fudged.

Anyone else out there have a similar/ different experience to report?

Check out MetalMiner for more.

While it has been 2 years since Lead Paint Barbie hit the store shelves, I have seen a flurry of related activity over the last two weeks. From books on “Made in China”, to two Posts at China Law Blog The Six (Not Five) Keys To China Quality and Six More Keys To Quality Product Made In China., and wrapping up with another recall.

A recall whose roots are in poor design, much like those 18 million magnets that forced Mattel’s recall, and are now bring out the entire “Made in China” quality fade debate. The specific product that is forcing the recall is a plastic nail that is about 3 1/4 inches (7.6 centimeters) long

The Little Tikes Co. is recalling about 1.6 million toy workshops and trucks, after an 11-month-old boy got a plastic nail lodged in his throat.

… and to make sure they cover their bases, they are recalling 15 years worth of product!!

Now, I do not want to take anything away from this boys pain, nor do I want to suggest that brands like Mattel and Little Tikes do not have a responsibility to design products that cannot be swallowed, but I would like to once again What Level of Product Failure is Acceptable?

Is 1/1,600,000 a percentage that warrants the return of the remaining items?

If yes, then does it make sense to recall the entire set, or should (in the name of waste management) Little Tikes simply tell parents to mail in the nails for an exchange of a new product?

Over the next few weeks, look for more on this. Following my read of “poorly made in China”, my brain has been on fire over the subject. It is one of those books that offered an opportunity for me to see things between lines … and I will be putting together a series of posts focused on the myth that is quality fade, the underlying issues, and some strategies I have for minimizing supply chain failures.

News of a 25 year old committing suicide at Apple’s primary China supplier (Foxconn) has once again brought to the front burner the difficulties of managing outsourced operations, and the risk to the brand that these arrangements bring when improperly managed.

It is a situation that sadly I believe could have been avoided, and that unlike the 1997 Nike scandal where it took NGOs and the media to highlight the problems (for the first time), labor problems – particularly with its supplier – are neither new nor unknown.

Go back 36 months, when news (and pictures) hit the wires that Apple’s Suzhou supplier (Foxconn) was improperly housing employees, forcing overtime, and paying poor wages. A huge story for both the domestic and international press, Apple responded very quickly by sending their “crack” team to investigate the allegations. Allegations that ultimately Foxconn and Apple would own up to, almost.

However, more recently, signs that Apple’s China supply chain were really in poor shape came through another report that one of their suppliers, Wintek, was wrapped up in a number of disputes and strikes over labor conditions.   Conditions that violated Apple’s own Code of Conduct.

The most recent warning sign came in the form of Apple’s own internal document the release of the Supplier Responsibility 2009 Progress Report (download here) where the following highlights went public

45 of the 83 factories that built iPhones and iPods in 2008 weren’t paying valid overtime rates for those workers that qualified, while 23 of these weren’t even paying some of their workers China’s minimum wage.

A deeper look at Apple’s findings found that about 25 of the 83 also discriminated to some degree against people based on ethnicity, biological issues like disabilities, or political leanings. 22 didn’t meet environmental standards, while almost exactly a fifth also had problems with on-site living conditions and safety.

It is quite simply a report that should have set off an all hands on deck response in Cupertino, and were the press not obsessed with the health of the Dear Leader, perhaps the release of this document would have been a leading story.  Instead, it largely passed under the radar, and over the last few days we have come to see how poorly Apple assessed the risks and severity of the problems.

I by no means want to imply that had Apple taken steps beforehand that this situation would have been avoided, however I think it is important to point out that through its own issues in 1997, Nike began putting 1 full time inspector on site of factories.  inspectors who were independent of the supplier, an moved on a regular basis.  Suppliers who were the eyes and ears of the corporate, and could alert HQ of issues and manage the programs meant to minimize code of conduct infractions.  Infractions that Nike still admits openly it struggles with.

Apple’s consistent issues are a problem that goes far wider and deeper than a single guard, and like Mattel’s paint line, is in need a change. A systematic change.  A change that will be difficult, as they have completely outsourced all operations, I have a few suggestion of where I would start:

1) Contact Nike
Why contact Nike?  simple.  Nike and Apple are essentially one in the same, they are design and marketing firms who rely on others to bring their designs to the market.  At the same time, they take no equity stake in these firms, and like everyone else who outsources, are focused on the bottom line.

So, by contacting Nike to learn lessons, Apple will essentially be reaching out to a peer who has been through the same things.

2) Get Boots on the Ground
Simply allowing their suppliers to “manage” things is at this point negligent at best, and perhaps criminal.  Their own code of Conduct is simply being breached on a regular basis by an unacceptable number of their suppliers, and they need to take the reigns of this wild horse.

So, get inspectors from Cupertino on the ground.  NOW.

3) Invite in third parties.
Clearly Apple needs assistance in the process, and firms like Business for Social Responsibility would bring a significant amount of experience, independence, and credibility to the issue. Quite simply, at this point, whey would anyone trust another Apple report, and more than that, what is the risk that now external agencies, NGO, and media are given the access now (think Indonesia).

4) Do the Right Thing
Foxconn is not the one on the firing line, Apple is.. and it must make sure to either hold Foxconn’s head to the fire, or take the bullet themselves because in the end, it is Apple that lawyers will sue, that reporters will write up, and consumers will boycott.

5) Make materials improvements, or make materials adjustments
Going forward, breaches must end.  Period. Otherwise, Apple will need to look at being a manufacturer again.  That,while manufacturing is seen as expense by investors, the point will be made that the risk of brand damage will need to be made.

That it is a much better use of money to bring it inhouse vs. burning down the house.

6) Open Up
Apple’s previous life as the introverted firm with cool stuff is over, and like Nike, it will have to open itself up.

Managing global operations is not an easy task, and while this post is focused on Apple, the point that this could have happened to anyone needs to be made. 2 years ago, when we were in the middle of the “Made in China” crisis, I made the same point, and at the core the issues behind both are the same.

It comes down to investment. Investing in a process. Investing in people.

That treating China like a McDonald’s drive-thru is not sustainable over the long term, and regardless of whether or not breakdowns occur in China, the fact that breakdowns do occur is not a “China” problem.

Good friend Pierig Vezin of Wethica has written the piece below as part of his regular newsletter series, and he has graciously allowed me to report it in full.

It is about a subject, the impact of factory audits on suppliers, that I think many people really need to take more time to understand – particularly buyers and consumers – as it is a core issue to the long term stability of supplier relationships.

The Impact of Factory Audits in China

The real impact on labor conditions from conducting social audits in factories is key to the nature of our work.

Even if the audit is to only gather information and not to act on improving factory practices, the audit request from a buyer itself should not be ignored.

It still has an impact.

First of all, audits themselves have an impact as they are a testament to the buyer’s priorities and involvement. An audited factory feels more pressured to exert effort in complying, or at the very least, appear that they are, and an agent company selects factories that meet the social criteria. This impact is actually a good social risk management tool for buyers but the effectiveness is limited.

With no specific targets, the aim is vague with reduced impact. A poor factory will not transform into a good one just from being audited. This kind of change requires strategic planning, stronger involvement from buyer and factory in implementing corrective action plans with specified goals. And even then, the results are greatly reliant on the buyer’s approach and degree of involvement.

Yet, audits are important too in this approach (apart of factory assessing). The audit is one of the few opportunities the factories have to show the buyer their commitment to social improvement. In turn, the factories gauge the buyer’s commitment by their degree of involvement. But if the audit is not thorough and meticulous, it can easily mislead both parties and thwart efforts to gain insight to the actual situation, causing improvements to only tackle perceived issues without actually penetrating the source. Most factories try to ostensibly match with the buyer’s requirements, mostly in efforts to appear compliant.

During post audit consulting, we often encounter situations where the factory is surprised, whether feigned or genuine, on problems that were not identified in an earlier audit, and thus, at a loss on how to proceed on improving. In such cases, the audit can, in contrast, act as an impediment on factory improvements.

Hence, it is important that a pragmatic and transparent approach is taken with factories to avoid these pitfalls and to ensure the purpose of the audit is fully implemented.

Short and to the point, Perig has another article that elaborates further on the issue of hidden books and agendas called Half Truths, and while considering the issues above, I suggest you read this article as well

Earlier this week, old friend Dane Chamorro (General Manager of Control Risks Asia) sat down to discuss how business risks are changing/ increasing in China as the ripples of the economic crisis come ashore.

One of the most important issues he addresses is how employees can be impacted by the economic downturn, and how they will react. That a once trusted and loyal employee may participate in out of character behavior when they are uncertain about their job security, a behavior that may also arise should members of that employees family lose their job, their stock portfolio, etc.

Another important subject of conversation was the role that the recent turmoil may have on supply chains. That regardless of the direct impacts to your business, and how that impacts your order, if you competitor is ordering from the same supplier and they go under… your supplier may go under as well.

With his years of experience in risk management in China, Dan’s advice basically boils down to reach out to employees and suppliers to understand and anticipate how the economy will impact them, dust off contingency plans, and keep their ears to the ground. That in many ways, this situation is no different than normal in terms of how business should plan for risk – there is always risk – but it is the firms that fail to try and understand it or plan for it – that get hit the hardest.

The summer and fall of 2007 should have been a wake up call for anyone and everyone whose supply chain involved China.  The risks of doing business outside of one’s four walls smacked importing firms across the face as their products failed.  Lead paint barbie, tainted dog food, and others.

It was a time when “Made in China” became something tainted in itself, even though many of the failures had little to do with China itself, and one would have thought that through that time people would have learned a lesson.

Well.  It appears not.

The title of the recent Seattle PI article should say it all Honey Laundering: Tainted product still slips easily into U.S., and if it doesn’t than these paragraphs should capture your attention:

The newspaper’s five-month investigation into honey laundering — the intentional mislabeling of the country of origin — found that tons of Chinese honey coming into the U.S. is tainted with banned antibiotics.

But when the contamination is discovered by the industry through internal testing, insiders say, federal health or customs officials are almost never notified, and the honey ends up being dumped back on the market.

In particular, the article highlights Sue Bee Honey, which are finding (on average) a container of bad honey a month,  and rather than report ths shipment to the FDA or destroy the content, they are returning the product to their suppliers IN CHINA to handle it:

Bill Allibone, Sue Bee’s president, said the company has no intention of telling government regulators about the bad honey it finds.

It’s not really Sue Bee’s honey, he said, “because technically, it’s still (the importer’s) property until we pay for it.

“We have not notified the FDA in the past because we don’t have title to that property,” Allibone said.

“We deal with a core group of suppliers that have long, established ties in the import business, and we’re assuming that when we reject a load of honey, they’ll return it to the people they purchased it from.”

Allibone said he has no idea whether the tainted honey is resold to other U.S. packers. Asked whether the company had an obligation to take action to protect the public health, the president repeated: “It’s just not our honey.”

Isn’t that fantastic.

Their suppliers who have a “long history” of importing the honesy are selling them a bad container a month, but they are somehow entrusting them to do the right thing.

Perhaps I am over reacting here, but this is just a cop out on the part of  Sue Bee Honey, however this article also highlights a massive hole in the system.

Why are these groups not forced to report failures?

I began wondering this question actually when reading that the recent producer of Salmonella laced peanut butter had found salmonella through internal tests, but that there was no rule specifying that they must notify anyone of this, and they were able to ship the tainted products anyway.

So, once again we find ourselves faced with a systemic issue whereby Chinese suppliers are shipping failed products, corporations are looking out for their self interests, and the agencies are unprepared.

Just when I thought that progress was being made.

Following the rather quickly written post Why Layoffs in the US are a Bad Thing for China where I mentioned highlighted that these closures were likely to impact China’s real economy I thought it would be a good idea to spend a little more time looking at the real impacts to China’s economy. There have been a lot of “what if” and anecdotal evidence, but I thought rather than just leave my last post in the anecdotal, I would try and show how a single US firm closing its doors would reverberate through the supply chain.

So, beginning with the story Home Depot Layoffs: 7,000 Jobs Lost; Home Depot Expo to Close, I took a quick browse of the Expo Design Center site and found that the primary business model of Expo was to sell kitchen, bath, and flooring materials.to buyers who were looking to fit out their newly owned (or soon to be flipped) McMansions. It was a business model that 3 years ago provided Home Depot and others with strong earnings reports, high foot traffic, but as the recent economic crisis began to take hold of the mortgage and credit markets, these business began to see significant drops in business.

Where this business model, and more specifically its product line, strikes me as the most appropriate foundation for this series of posts is that it was an industry (wood products – furniture, home decor, etc) where Chinese products have penetrated the world markets very quickly, it is an industry that has several large geographic clusters that allows for a more focused geographic analysis, it is an industry that uses basic materials with minimal technology to create the finished products, it is an industry requiring high labor input.

Additionally, as you can see in the graphs, this was an industry whose products were seeing very high growth rates (thanks to lower cost of production) and while the indsutry istelf was highly fragmented, the primary economic centers were all located on the east coast by product clusters.

Quite typical of Chinese export model.

From the macro perspective, what the closure of the Expo Design Center (and others) could mean for the Chinese economy could be significant.

While the map above highlights the export manufacturing points, there are in fact long chains of activity supporting these groups. timber importers, ports, shipping companies, mills, equipment providers, and so on are all operating behind the exporters to provide goods that will become the finished product. There are an estimated 50,000 furniture manufactures who are operating in this space. and few if any of these firms have yet to achieve any real sense of scale or power within the industry.

Entire towns have developed as importers, others as processors, and others as assemblers… as can be seen the slides below.

That the economic shocks were going to happen at a much higher frequency, and severity, due to the fact that you had a large number of manufacturers who had little product differentiation packed together to supply firms whose business model proved unsustainable.. and with many of the firms who were buyers of finished products closing the stores (not simply slowing orders), the reality for policy makers and factory owners alike is that there is now a significant overcapacity will take hold, and that will mean a wider.. measurable.. impact on China’s economy as suppliers to these furniture/ cabinet/flooring manufacturers are forced to slow down their production…

Which of course will of course result in a further slow down at the ports, and in other countries – As you can see in the slides below.

Taking a different angle for the moment, a couple of examples of how this recently impacted several of our suppliers.

While visiting a kitchen cabinet maker with a client in the first half of 2008, we were already hearing that orders were off. A factory that was once adding capacity and enjoying the fruits of their product lines expansion, were now looking at finding alternative uses for idle space and staff. It was a scary turnaround for management, and as a sign of just how desperate they were for business, they were willing to work with our client on a basis that provided little upside for them other than some quick orders.

In perhaps a more ominous sign, when another supplier came to Shanghai to discuss the plans for the year, the mayor of his town came along with him to oversee things. It was clear that orders were being lost, and that even though we have been maintaining a good relationship with him for the last few years, the economic conditions on the ground meant that our relationship needed to adjust as well. Gone were the days where we could order materials 60 days ahead of time without deposit. Gone were the days of sending the container on credit. It was now a cash business for he and his fellow producers who had seen some of the large banks in the world fail, had seen their largest customers walk away, and who were managing the expectations of the staff -and mayor.

In the end, the 7000 layoffs announced by Home Depot are in reality just the tip of the iceberg. We have already seen layoffs at trucking companies and ports in the US, distribution ports and mills in Jiangsu, factories in Jiangxi, packaging companies in Zhejiang, and surly loggers in New Zealand. It is an industry whose chain stretches globally, and while administrations view these retail closures of failed business models of an unsustainable real estate bubble, the fact is that their policies are likely to fail to fully correct the core issues as they fail to understand just how long and how deep the problem goes.

Perhaps with this post, some of the void was filled, but sadly it still will not do much for those firms who have already closed.

Focusing on the difficulties of transparency within the supply chain, Melissa Brown of Association for Responsible and Sustainable Investment in Asia (ASRiA) sat down for an interview covering a lot of the angles surrounding the integrity of supply chains in China.

I highly suggest taking your lunch break to watch the 15 minute clip, and then think about some areas you feel may be at risk within your supply chain. I have listed the 7 questions she was asked along with a few bullets on what she said… and added a few thoughts of my own in italics

Questions asked during this clip are:

1) How easy is it to get details about Asian companies?
- Need to have a sense about what is know and how to compare
- Need to use different tools – policies are not set the same way, available resources can be limited

Getting information about Chinese firms is not terribly difficulty, it is about time and the amount of money one is willing to spend. One can approach firms from different angles, as a buyer, as a supplier, through a friend, through Alibaba.. you can even stake a factory out for a week. But it all comes down to how much time you want to spend, and the budget you are willing to allocate

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