How to Prevent Supply-Chain Scandals: a Stanford Professor Shares his Tips

gettyimages-82659764-compressorIn recent weeks, news emerged that refugee children from Syria were found in Turkey making clothes for top British fashion brands, including Marks & Spencer and online retailer Asos. The revelation came despite pledges by retailers around the world to lift their game following the highly-publicized collapse in 2013 of a garment factory in Bangladesh that killed more than 1,000 people.

Big multinationals including Nike, Apple and Sony know all too well the perils of trading with unethical suppliers, with each bearing their fair share of reputational damage over the years. But lessons can be learned from the various methods they and other companies have applied to discourage practices that put product quality and human safety at risk.

In a recent joint study, Stanford University and Duke University analyzed the sourcing practices of more than 1,000 companies. “We discovered a whole range of so-called incentives and penalties—the carrots and sticks that companies use,” Stanford Professor Hau Lee told Chief Executive.

“The simplest and most widely-used incentive was certification by non-for-profit groups such as EarthWatch, which is used by Starbucks, or the Fair Labor Association, which is used by Apple.

Supply Chain Certification and its Limits
The simplest and most widely-used was certification by non-for-profit groups such as EarthWatch, which is used by Starbucks, or the Fair Labor Association, which is used by Apple. A related method—auditing—strengthens certification by getting third parties to regularly visit factories and ensure they’re up to standard. Some companies, such as Apple, even have their own internal supply-chain auditors to complement the work of external bodies.

But the recent cases in Turkey show the limitations of these methods. Marks & Spencer said it employed auditing practices, but children are small and can easily be hidden from inspectors. Several British companies outed in the recent report, by the BBC’s Panorama program, also discovered suppliers were employing less-reputable third-party contractors without their knowledge.

And Lee points out that some far-flung locations are just too isolated for auditors to reach, at least regularly. Many coffee farmers, for example, live in high mountains in East Africa or remote villages on Indonesian islands. “When the audit instrument is out you may have to rely on other instruments to deliver the incentive,” he says.

Lee’s research found that while the majority of businesses apply certification and audit tools, around 10%-15% encourage ethical practices by offering sweeteners. Starbucks, for example, pays farmers an extra 5 cents per pound if they adhere to the company’s own internal quality standards, raising it to 10 cents if they meet them for at least two years.

Investing in Suppliers with the Gold Standard
The benefit here is two-fold: for one, offering rewards helps the company appeal to a segment of the market that values ethical practices. Lee, though, admits this segment is arguably quite small, with previous research showing most customers make purchase decisions based on price rather than warm and fuzzy certification stamps.

The other advantage is that rewarding suppliers could keep their businesses healthier, supporting higher-quality produce and removing the temptation to cut corners in the event of external challenges, such as with raw material costs. Supporting good suppliers with financial incentives also can prevent the need to initiate costly and time-consuming searches for new suppliers, which, in the case of coffee farmers, can be tempted to switch to cocaine farming.

A recent study by EarthWatch conducted in Puerto Rico showed that certified Starbucks coffee farmers receiving financial incentives produced higher-quality beans, and did so much more sustainably. According to Lee, though, the gold standard of supply-chain management involves companies investing directly in suppliers’ businesses so they no longer need to dish out punishment or incentives. This could involve sending experts into factories to teach managers how to run them more efficiently and even providing machinery and equipment to help things run more smoothly.

During the 1990s, Nike became the poster child of unethical supplier practices, so it’s of little wonder that the company is now leading the charge when it comes to investing directly in the efficiency and durability of its supplier’s factories. Last October, Nike formed a partnership with electronics company Flex that Lee says could allow it to licence new robot technology to shoe-makers.

“Shoe-makers are not the most advanced companies technologically, so giving or licensing the technology back to their suppliers would help them be more productive and better able to weather the storm,” Lee says. “I would say that is a very beautiful commitment to improve.”


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Ross Kelly
Ross Kelly is a London-based business journalist. He has been a staff correspondent or editor at The Wall Street Journal, Yahoo Finance and the Australian Associated Press.

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