In Order to Strengthen Weak Links in China’s Supply Chain, Build the Value Chain

Chinese government officials, global retailing giants, consumer groups, foreign governments, the world’s media, and most importantly individual consumers, are asking serious questions about the safety and quality of products in the Chinese supply chain that produces much of the world’s manufactured goods and food commodities. “Made In China” once suggested low cost and acceptable quality. However, by midyear 2007, the “Made In China” brand name was being associated with harmful products and massive product recalls. Attention has focused on an under-developed regulatory and inspection system in China’s new market economy, failures of foreign buyers to adequately test products, and a lack of business ethics in China’s “get rich quick” business culture. All are contributing factors.

However, attempting to correct only regulatory problems will not solve product quality and safety problems in China. Analyzing and reacting to China’s supply chain problems exclusively in policy terms will not suffice. Solutions must address the market forces that contributed to the current problems, because these same forces stand in the way of effectively implementing any regulatory or monitoring solution. Until market forces are converted into drivers supporting the production of safe Chinese products, the manufacturing output of the “the world’s factory” will continue to be problematic for the entire global market system. Addressing core economic problems in China’s value chain is critical to the integrity of the global economic system because these same problems exist throughout the supply chain of the global economy, and especially in developing countries where price competition reigns supreme.

The weakest of several weak links in China’s supply chain is a debilitating contradiction between constructive product quality and safety demands in the supply chain, and financial dis-incentives in the value chain . This contradiction exists even among “socially and environmentally responsible” companies where the contradictions can sometimes be most crushing. For example, it is now common for international wholesalers and retailers who buy Chinese products to establish their own manufacturer’s code of conduct, and/or apply some of a wide range of product and workplace standards created by international organizations or civil society bodies . These buyers periodically send auditors and certifiers to the factories from which they buy. This sends a message: social and environmental responsibility, product safety and quality, and environmental performance are important.

If we end our investigation at this point, it would be logical to assume that Chinese manufacturers continually fail to honor contract requirements for safe products and other social and environmental responsibility demands because they are greedy and/or careless, and the regulatory system does not compel compliance. We concede that this is often part of the reality.

However, ECOLOGIA has benefited from observing another set of factors in operation. The same foreign buyers who demand compliance with codes of conduct and safety standards routinely insist on continual price reductions for items they purchase. A Chinese manufacturer, who wins a competitive contract, must find a way to continually reduce production costs. He knows that the buyer is already taking his contract to competitors and asking, “can you beat this price?”. The message delivered by this purchaser’s action is, “price matters most”. The more troublesome implicit message is, “price matters more than safety and social responsibility, which we do not pay for.”

ECOLOGIA has repeatedly questioned the logic of requiring expenditures for compliance with product and workplace codes, and then not only failing to financially compensate the manufacturer for these costs, but insisting on price reductions. We were told that buyers work with manufacturers to help them to identify production efficiencies that can offset compliance costs.

We decided to investigate the theory in practice. We were fortunate enough to have a very open relationship with a Chinese supplier to a major global retailer, one of the great marketing success stories of the 20th century. Our Chinese colleague, who makes shower curtains, told us that he was required to share the details of his manufacturing process with his buyer. They wanted to know the source and cost for every component of the product. The buyer claimed that they would use this information to negotiate a mutually agreed on profit margin of a few percent. Presumably they were also going to help him become more efficient.

In fact, the foreign buyer took the supply information and set up their own Chinese production facility. The buyer then terminated their contract with the established Chinese producer. They planned to increase their profits and squeeze out the middleman using information obtained under false pretense.

But the story did not end here. The giant global retailer could not manufacture a product of sufficient quality for its stores. They came back to our colleague and asked him if he would continue to supply shower curtains temporarily. He refused. He had already found new customers who would pay and treat him fairly. The shower curtain manufacturer now operates outside of the formal guidelines of the code of corporate conduct that he previously followed, a code that he admits made his business better. An opportunity to permanently link responsible manufacturing to supportive economic incentives was thrown overboard in a failed effort to push wholesale prices a few cents per item lower. If this is the practice of a widely recognized socially and environmentally responsible company, what is going on with buyers who have no pretense of social and environmental responsibility?

One might argue that such extreme, even brutal, price competition is after all just part of the market system. Some argue that it serves consumers by finding the most efficient means for producing and delivering products. Since Adam Smith made this argument famous in his Wealth of Nations two centuries ago, the idea has become an operating assumption and part of the culture of the market economy and capitalist system. It is widely, if begrudgingly, accepted throughout China’s supply chain.

But what happens when globalized hyper-competition creates financial incentives so oppressive that Adam Smith’s famous butcher is tempted to put dangerous food additives in his beef because he can survive only in this manner? What is the butcher to do when he is squeezed so hard on price that he is forced to decide between financial ruin and cheating his customers?

Perhaps we need to re-examine price pressures in both the supply and value chains. What if continual brutal downward pressure on price does not originate entirely with consumers, but instead is an artifact of mass retailers’ hyper-marketing? In fact this is not a rhetorical question. Many of the most influential retailers in the world promise their customers not only “the lowest prices” but “continually lower prices”. Many retailers, including the one involved in our shower curtain case study, have created consumer expectations of price reductions forever. Elementary school math leads one to the conclusion that the manufacturer at the other end of the supply chain will eventually have to give his product away if the trend continues.

We have asked one of the world’s largest retailers why they do not educate their customers to pay a few extra cents on a ten-dollar item and then explain to the customer that these few cents can guarantee quality, environmental performance and relieve poverty. We have been told that this is not the business model on which they operate. They have built their business on price competition alone.

As a result, in the middle of 2007 we have massive recalls of Chinese toys, jewelry, pet food, tires, food additives and food commodities, that cost manufacturers millions of dollars. Consumers have been put at considerable risk. A nation’s brand name and economic growth have also been put at risk.

Significantly, one of the recent deaths attributed to product failures in the Chinese supply chain was a toy manufacturer, Zhang Shuhong. He hanged himself after his factory became the focus of a Mattel toy recall involving lead tainted paint supplied to his company by someone reported to be a very close friend. Mr. Zhang’s factory had supplied Mattel for 15 years and was the source of livelihood for 5,000 employees. Its license was suspended by the Chinese government as a result of the toy recall. One can easily imagine the stress of operating Mr. Zhang’s business and the burden of having so may families dependent on it. As one reporter noted: “Experts here say many Chinese factory owners — often under intense pressure to lower production costs — cut corners in making products and regularly use cheap and illegal substitutes. And indeed, in several of the recalls involving China this year, the government says companies intentionally used cheap or illegal substitutes.” [Reference: “Owner of Chinese Toy Factory Commits Suicide”, David Barboza, The New YorkTimes, August 14, 2007]

All of this is happening, in large part, because western consumers have been encouraged to develop artificial expectations of unsustainable and continually lower prices. And it is not just consumers who are threatened. One Chinese furniture manufacturer told me that he was concerned about the long-term sustainability of his entire industry because it was wastefully processing and overusing limited supplies of timber in an effort to supply very low-cost furniture to Europe and North America. Toy recalls in China are the tip of an economic, social, and environmental sustainability crisis that is building in the global marketplace and its value chain.

We have reached a moment in history when our economic system is beginning to push its product manufacturing cost accounting to, and even below, the economic sustainability level. Stricter regulations are only part of the solution. More socially responsible forms of marketing and consumer education are needed to correct critical broken links in the value chain.

Retailers who want to consistently offer their customers safe and healthy products produced in a socially and environmentally responsible manner must assume responsibility for educating customers about the relationship between fair value and price. They must then pass just compensation back down the value chain to incentivize quality performance and standards compliance that is in everyone’s long-term economic, social and environmental interest.

To provide feedback, please e-mail Randy Kritkausky - rkritkausky@ecologia.org