CASE Detecting Unethical
Practices at Supplier
2 Factories: The Monitoring
and Cotnpliance Challenges
Arthur A. Thompson
The University of Alabama
mporters of goods from Bangladesh, Cambodia,
China, the Dominican Republic, Honduras, India,
Indonesia, Korea, Malaysia, Pakistan, Peru, the
Philippines, Sri Lanka, Tunis ia, Vietnam, and several
other countries in Latin America, Eastern Europe,
the Middle East, and Africa have long had to con-
tend 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 work-
ers 10 toxic chemicals and other safety hazards,
failed to provide even minimal fringe benefits, and
habitually engaged in assorted other unsavory prac-
tices . Exhibit I provides a sample of the problems
in eight countries. Factories in China were par-
ticularly in the spotlight because of China's
prominence as the largest single source of goods
imported into both the United States 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 coun-
tries where low-cost manufacturers were located,
especially China, often hinged on the ability of
companies with global sourcing strategies to con-
vince 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 prac-
tices were concentrated.
Copyright 2008 by Arthur A. Thompson . All rights reserved .
C-462
Starting in the 1990s, companies began counter-
ing these criticisms by instituting elaborate codes of
conduct for suppliers and by periodically inspecting
supplier facilities to try to eliminate abuses and pro-
mote 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 used the services of recognized third parties with
auditing expertise to inspect supplier factories. Most
companies focused their efforts on improving work-
ing conditions at supplier factories, preferring to help
suppliers comply with the expected standards rather
than to impose penalties for violations and perhaps
abruptly and/or permanently cutting off purchases.
However, in November 2006, Business Week ran
a cover story detailing how shady foreign manu-
facturers were deliberately deceiving inspection
teams and concealing violations of suppIier codes
of conduct. I According to the BllsinessWeek speciaI
report, Ningbo Beifa Group-a top Chinese sup-
plier of pens, mechanical pens, and high1ighters 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 vis-
iting the company's factory in the coastal city of
Ningbo. Wal-Mart was Beifa's largest customer, and
on three previous occasions Wal-Mart inspectors
Case 26 Detecting Unethical Practices at Supplier Factories: The Monitoring and Compliance Challenges C-463

Exhibit 1 Comparative Labor and W orkplace C onditions in Eight Countries, 2006

I - - -- - - - - -
CO';lntry Labor and Workplace Overview

Brazil The primary problems in the manufacturing workplace are forced labor, inadequate occupational
safety (work accidents are common in several industries), and wage discrimination (wages paid to
females are 54% to 64% of those paid to males).
China Factories are most prone to ,ignore minimum-wage requirements, underpay for overtime work,
subject workers to unsafe and unhealthy working conditions, and suppress worker attempts to join
independent unions.
India The most common issues concern underpayment of minimum wages, overtime pay violations, use
of child labor (according to one estimate some 1'00 million children ages 5 to 14 work and at least
12.6 million work full-time), the use of forced labor (perhaps as many as 65 million people), and
inattention to occupational safety.
Indonesia The stand-out issues concern weak enforcement of minimum-wage rules and work hours in
factories, overtime pay violations in factories, subpar occupational safety (especially in mining and
fishing), and use of underage labor (particularly in domestic service, mining, construction, and
fishing industries).
Mexico Problem areas include sweatshop conditions in many assembly plants near U.S. border and
elsewhere, fierce opposition to unions, insistence on pregnancy tests for female job applicants of
Child-bearing age, and use of child labor in non-export economic sectors.
PerL! The worst workplace conditions relate to lack of enforcement of wage and overtime provisions
in factories, mandatory overtime requirements for many workers, and inattention to occupational
safety.
South Africa The most frequent offenses entail failure to observe minimum-wage and overtime pay rules
(particularl,y in the garment industry), use of child labor, occupational safety violations (especially in
non-export sectors where outside monitoring is nonexistent), and low pay for women.
Sri Lanka The most frequent violations relate to underpayment of wages, forced overtime requirements,
compulsory work on Sundays and holidays, and iFiattention to worker health and safety (such as
excessive noise, blocked exits, and disregard for worker safety-one study found 60% of grain and
spice mill workers lost fingers in work-related accidents and/or contracted skin diseases).

Source: Compiled by the author from information in "How China's Labor Conditions Stack Up Against Those of Other Low-Cost Nations,"
BusinessWeek Online, November 27, 2006, www.businessweek.com (accessed January 26, 2007). The information was provided to
BusinessWeek by Verite, a Massachusetts-based nonprofit social auditing and research organization with expertise in human rights and
labor abuses in supplier factories around the world .

had caught Beifa paying its 3,000 workers less than
the Chinese minimum-wage and violating overtime
rules. A fourth offense would end Wal-Mart's pur-
chases 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 Com-
pany offering to help the Beifa factory pass the Wal-
Mart inspection .2 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 regard-
ing 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.J 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.
WAGE AND EMPLOYMENT
PRACTICES IN CHINA
Minimum-wage rules in China were specified by
local or provincial governments and in 2007 ranged
from $36 to $ J 05 per month, which equated to
C-464 Part 2 Cases in Crafting and Executing Strategy
hourly rates of $0.21 to $0.61 based on a 40-hour
work;veek.4 In recent years, governments in most
Chinese locales had boosted minimum-wage require-
ments annually so as to preserve worker purchas-
ing power in light of the 5-7 percent annual rates
of intlation experienced in China. A comprehensive
study involving 57 million employees of larger Chi-
nese manufacturing enterprises revealed average
hourly compensation of $0.98 as of 2004, but there
were big variations from sector to sector (in textiles
and apparel wages averaged about $0.70 per hour,
whereas the hourly average was $1.35 in transporta-
tion equipment and $1 .59 in petroleum processing).5
Using more recent but somewhat sketchy Chinese
government income data compiled by the U.S.
Bureau of Labor Statistics and a Beijing consulting
firm, another study showed the average manufactur-
ing wage in China in 2005 was $0.64 per hour (again
assuming a 40-hour workweek) . While the standard
workweek in Chinese provinces officially ranged
from 40 to 44 hours, there were said to be numer-
ous instances where plant personnel worked 60 to
100 hours per week, sometimes with only one or two
days off per month. Such long work hOllrs meant
that the actual average manufacturing wage in China
was likely well below the levels based on a 40-hour
workweek. According to estimates made by a vet-
eran inspector of Chinese factories, employees at
garment, electronics, and other plants making goods
for export typically worked more than 80 hours per
week and earned an average of $0.42 per hour.6
Overtime pay rules in Chinese provinces offi-
cially called for time-and-a-half pay for all work over
eight hours per day and between double and triple
pay for work on Saturdays, Sundays, and holidays.
However, it was commonplace for Chinese employ-
ers to disregard overtime pay rules, and governmen-
tal enforcement of minimum-wage and overtime
requirements by both Beijing officials and officials
in local Chinese provinces was often minimal to
nonexistent. At a Hong Kong garment plant where
2,000 employees put in many overtime hours operat-
ing sewing and stitching machines, worker pay aver-
aged about $125 per month-an amount which the
owner acknowledged did not meet Chinese overtime
pay requirements. The owner said the overtime rules
were "a fantasy" and added: "Maybe in two or three
decades "\'e can meet them."? Many young Chinese
factory workers were tolerant of long hours and less
than full overtime pay because they wanted to earn
as much as possible, the idea being to save enough
of their income to return to their homes in the coun-
tryside after a few years of factory employment.
Chinese export manufacturing was said to be rife
with tales of deception to frustrate plant monitoring
and escape compliance with local minimum-wage
and overtime rules and supplier codes of conduct.
Indeed, a new breed of consultants had sprung up in
China to aid local manufacturers in passing audits
conducted both by customer companies and industry
alliance groups. x
GROWING USE OF
STRATEGIES TO
DELIBERATELY DECEIVE
PLANT INSPECTORS
The efforts of unscrupulous manufacturers in China
and otller parts of the world to game the plant-moni-
toring system and use whatever deceptive practices
it took to successfully pass plant audits had foW"
chief elements:
1. Maintaining two sets of boob-Factories gen-
erated a set of bogus payroll records and time
sheets to show audit teams that their workers
were properly paid and received the appropri-
ate overtime pay; the geJ1lline records were
kept secret. For example, at an onsite audit of
a Chinese maker of lamps for Home Depot,
Sears, and other retailers, plant managers pro-
vided inspectors with payroll records and time
sheets showing that employees worked a five-
day week from 8:00 a.m. to 5:30 p.m. with a
30-minute lunch break and no overtime hours ;
during interviews, managers at the plant said
the records were accurate. But other records
auditors found at the site, along with interviews
with workers, indicated that employees worked
an extra th.ree to five hours daily with one or
two days off per month during peak produc-
tion periods; inspectors were unable to verify
whether workers at the plant received overtime
pay.9 According to a compliance manager at a
major multinational company who had overseen
many factory audits, the percentage of Chinese
employers submitting false payroll records had
Case 26 Detecting Unethical Practices at Supplier Factories: The Monitoring and Compliance Challenges
risen from 46 percent to 75 percent during the
past four years; the manager also estimated that
only 20 percent of Chinese suppliers complied
with local minimum-wage rules and that just 5
percent obeyed hour limitations. 10
2. Hiding the use of underage workers and unsafe
work practices-In some instances, factories in
China, parts of Africa, and select other coun-
tries 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 get-
ting underage employees off the premises when
audit teams arrived, or by putting underage
employees in back rooms concealed from audi-
tors. A memo distributed in one Chinese fac-
tory instructed managers to "notify underage
trainees, underage full-time workers, and work-
ers without identification to leave the manufac-
turing workshop through the back door. Order
them not to loiter near the dormitory area.
Secondly, immediately order the receptionist
to gather all relevant documents and papers."ll
At a toy plant in China, a compliance inspector,
upon smelling strong fumes in a poorly venti-
lated building, found young female employees
on a production line using spray guns to paint
figurines; in a locked back room that a fac-
tory official initially refused to open, an appar-
ently underage worker was found hiding behind
coworkers. 12
3. Meeting requirements by secretly shifting pro-
duction to subcontractors-On occasion, sup-
pliers met the standards set by customers by
secretly shifting some production to subcontrac-
tors 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 com-
mon tactic for thwarting what inspectors could
learn from interviews. However, in instances
where plant inspectors were able to speak confi-
dentially with employees away from the worksite,
C-46S
they often got information at variance with what
they were told during onsite interviews-plant
personnel were more inclined to be truthful and
forthcoming about actual working conditions and
pay practices when top-level plant management
could not trace the information given to inspec-
tors back to them.
There was a growing awareness among compa-
nies attempting to enforce supplier codes of conduct
that all factories across the world with substan-
dard working conditions and reasons to hide their
practices from outside view played cat-and-mouse
games with plant inspectors. In many less-developed
countries struggling to build a manufacturing base
and provide jobs for their citizens, factory manag-
ers 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. Vio-
lations were said to be most prevalent at factories
making apparel, but more violations were surfacing
in factories making furniture, appliances, toys, and
electronics.
However, large global corporations such as Gen-
eral Electric, Motorola, Dell, Nestle, and Toyota that
owned and operated their own offshore manufactur-
ing plants in China and other low-wage countries had
not been accused of mistreating their employees or
having poor working conditions. The offshore facto-
ries of well-known global and multinational compa-
nies were seldom subject to monitoring by outsiders
because the workplace environments in their foreign
plants were relatively good in comparison to those
oflocal manufacturing enterprises that made a busi-
ness of supplying low-cost components and finished
goods to companies and retailers in affluent, indus-
trialized nations.
Corporate sensitivity to charges of being
socially irresponsible in their sourcing of goods
from foreign manufacturers had prompted hundreds
of companies to establish supplier codes of conduct
and to engage in compliance monitoring efforts of
one kind or another. The clothing retailer Gap had
an internal compliance team of more than 90 people
to audit approximately 2,000 factories of its garment
suppliers; Gap's team conducted 4,316 inspections
in 2005. \3 The retailing giant Target had 40 full-
time compliance employees, including more than
C-466 Part 2 Cases in Crafting and Executing Strategy
20 foreign-based auditing staff, and conducted 100
percent of its factory audits unannounced . Hewlett-
Packard had a program to monitor conduct at some
550 supplier factories . Moreover, an increasing
number of companies, many with common suppli-
ers, had begun collaborating to establish standards
for suppliers and to conduct factory audits. For
example, in 2004, Hewlett-Packard, Dell, IBM,
and five other electronics companies that relied
heavily on outside manufacturers to supply com-
ponents or assemble products had created the Elec-
tronics Industry Code of Conduct; the new code
replaced individual codes used by these companies
and sought to establish industrywide standards for
supplier factories regarding labor and employment
practices, worker health and safety, ethics, and envi-
ronmental protection. Other electronics companies
were invited to voluntarily adopt the same stan-
dards, because it was simpler for supplier factories
to comply with a single set of standards as opposed
to scrambling to satisfy the different code require-
ments of different companies.
FOREIGN SUPPLIER
COMPLIANCE PROGRAMS
AT NIKE AND WAL-MART
Nike and Wal-Mart were two companies with sup-
plier codes of conduct and rather extensive programs
to monitor whether suppliers in low-wage, low-cost
manufacturing locations across the world are com-
plying with those codes. 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.
of C nduct
Nike was the world's leading designer, distributor,
and marketer of athletic footwear, sports apparel ,
sports equipment and accessories, but it did no man-
ufacturing. All of Nike products were sourced from
contract manufacturers. [n 2007, Nike reported that
it had almost 700 factories in 52 countries actively
engaged in manufacturing its products; of these,
about 148 were in China (including Hong Kong and
Macau); 63 in Thailand, 35 in Indonesia, 29 in Korea,
35 in Vietnam, 34 in Malaysia, 18 in Sri Lanka,
18 in India, 26 in Brazil , and 9 in Honduras. 14 Nike 's
contract factories employed roughly 800,000 work-
ers, an estimated 80 percent of whom were women
ages} 8 to 24 performing entry-level, low-skill jobs.
In fiscal year 2006, Nike approved 81 new contract
factories for the Nike brand, down from 83 in 2005
and 122 in 2004. Of the new contract factories, 11
were in the Americas, 6 in the Europe/Middle East!
Africa region, and 64 in Asia.
Nike drafted a code of conduct for its contract
factories in 1991, distributed the code to all of its
contract factories in 1992, and directed them to post
the code in a visible place and in the appropriate
local language. The code had been modified and
updated over the years, and in 2007 also included a
set ofleadership standards that was adopted in 2002.
Nike's code of conduct is presented in Exhibit 2. In
1998, in a move to strengthen its opposition to the
use of child labor in factories, Nike directed its con-
tract factories to set age standards for employment at
16 for apparel and 18 for footwear ; these age stan-
dards were more demanding than those set in 1991
and exceeded the International Labor Organization's
age minimum of 15 .
Nike's System for Monitoring Contract
Manufacturers During 2003- 2006, Nike used
four approaches to plant monitoring: 15
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 fal len
short of that target.
In -depth M-Audits: The M-Audit was designed
to provide a deeper measure of the work-
ing conditions within contract factories. As
a general rule, Nike focused its plant inspec-
tion efforts on factories where noncompliance
Case 26 Detecting Unethical Practices at Supplier Factories: The Monitoring and Compliance Challenges C-467

Exhibit 2 Nike's Code of Conduct for Its Suppliers and Contract lVIanufacturers, 2006

Nike, Inc. Was Founded on a Handshake

Implicit in Ihat act was the determination that we would build our business with all of our partners based on trust, teamwork,
honesty and mutual respect. We expect all of our business partners to operate on the same principles.
At the core of the NIKE ~orporate ethic is the belief that we are a company comprised of many dif,ferent kinds of people,
appreciating Individual diversity, and dedicated to equal opportunity for each individual.
NIKE designs, manufactures, and markets products for sports and fitness consumers. At every step in that process,
we are driven to do not only what is required by law, but what is expected of a 'leader. We expect our business partners to do
the same. NIKE partners with contractors who share our commitment to best practices and continuous improvement in:

1. Management practices that respect the rights of all employees, including the right to free association and collective
bargaining
2. Minimizing our impact on the environment
3. Providing a safe and healthy work place
4. Promoting the health and well-being of all employees

Contractors must recognize the dignity of each employee, and the right to a work place free of harassment, abuse or
corporal punishment. Decisions on hiring, salary, benefits, advancement, termination or retirement must be based solely
on the employee's ability to do the job. There shall be no discrimination 'based on race, creed , gender, marital or maternity
status, religious or political beliefs, age or sexual orientation.
Wherever NIKE operates around the globe we are guided by this Code of Conduct and we bind our contractors to these
principles. Contractors must post this Code in all major workspaces, translated into the language of the employee, and must
train employees on their rights and obligations as defined by this Code and applicable local laws.
While these principles establish the spirit of our partnerships, we also bind our partners to specific standards of conduct.
The core standards are set forth below.

Forced Labor
The contractor does not use forced labor in any form-prison, indentured, bonded or otherwise.

Child Labor
The contractor does not employ any person below the age of 18 to produce footwear. The contractor does not employ
any person below the age of 16 to produce apparel , accessories or equipment. If at the time Nike production begins, the
contractor employs people of the legal working age who are at least 15, that employment may continue, but the contractor
will not hire any person going forward who is younger than the Nike or legal age limit, whichever is higher. To further ensure
these age standards are complied with, the contractor does not use any form of homework for Nike production.

Compensation
The contractor provides each employee at least the minimum wage, or the prevailing industry wage, whichever is higher;
provides each employee a dear, written accounting for every pay period; and does not deduct from employee pay for
disciplinary infractions.

Benefits
The contractor provides each employee all legally mandated benefits.

Hours of Work/Overtime
T,he contractor complies with legally mandated work hours; uses overtime only when each employee ,is fully compensated
according to local law; informs each employee at the time of hiring if mandatory overtime is a condition of employment; and
on a regularly scheduled basis provides one day off in seven, and requires no more than 60 hours of work per week on a
regularly scheduled basis, or complies with local limits if they are lower.

Environment, Safety and Health (ES&H)

The contractor has written environmental, safety and health policies and standards, and implements a system to minimize
negative impacts on the environment, reduce work-related injury and illness, and promote the general heallh of employees.

Documentation and Inspection

The contractor maintains on file all documentation needed to demonstrate compliance with this Code of Conduct and
required laws; agrees to make these documents available for Nike or its designated' monitor; and agrees to submit to
inspections with or without prior notice.

Source: www.n ike .com (accessed January 25, 2007) .

C-468 Part 2 Cases in Crafting and Executing Strategy
was most likely to occur. Factories located in
highly regulated countries where workers were
more informed about their rights and work-
place laws and regulations were enforced were
deemed less likely to be out of compliance. In
2003, Nike focused its M-Audits on factories
presumed to have the highest risk of noncom-
pliance and the greatest size (as measured by
worker population). In 2004, M-Audits were
focused on factories believed to be of medium
risk for noncompliance. 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 catego-
ries of inquiry (hiring practices, worker treat-
ment, worker-management communications,
and compensation) and covered more than 80
labor-management issues.
In 2004 Nike had 46 employees who regu-
larly 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, more than 9,200 fac-
tory 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 accOlmted for between 25 and 30 percent
of total M-Audit time.
MAV Audits: Starting in fiscal year 2006, Nike
introduced a new audit focused on finding
root causes of noncompliance issues that most
impacted workers, specifically work hours,
wagesibenefits, grievance systems, and freedom
of associations. Prior audit experience had led
Nike's staff to believe that root cause identifica-
tion would help supplier factories remediate the
problems that were identified. Nike conducted
42 MAV audits through fiscal year 2006.
Independent external monitoring: Beginning in
2003, Nike became a member of the Fair Labor
Association (FLA), 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's compliance team consisted of
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 troubleshooting and col-
laboration/outreach work. 16 In its 2004 Corporate
Responsibility Report, Nike said:
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. 17
Nike's 2003-2004 factory audits were announced
rather than unannounced because "much of the
information we require in our evaluation of a fac-
tory is dependent upon access to relevant records
and individuals within factory management.,,18
When a factory was found to be out of compliance
with the code of conduct, Nike's compliance team
worked with factory management and the Nike
business unit for which products were being man-
ufactured 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 gen-
eral manager for production monitored the prog-
ress of all factories within his or her purview and
weighed in when factory remediation progress was
too slow.
To further facilitate factory compliance with
Nike's code of conduct for suppliers, the company
conducted or sponsored training and education pro-
grams for factory personnel. In 2004, more than
16,500 factory managers and workers attended pro-
grams relating to labor issues, worker health and
safety, and environmental protection. 19
Nike's Compliance Rating System Nike's
factory ratings for SHAPE and M-Audits resulted
in numeric scores ranging from 0 to 100 (a score
Case 26 Detecting Unethical Practices at Supplier Factories: The Monitoring and Compliance Challenges C-469

of 100 indicated full compliance); these numeric Exhibit 3 presents a summary of Nike's factory
scores were then converted to one of four overall ratings for fiscal years 2003-2004. Exhibit 4 shows
grades (see table below):2o the ratings for fiscal years 2005 and 2006 .

I
Grade
, . Criteria
A Isolated violations of standards, but none considered serious or critical; no more than 5 minor
issues outstanding on a factory's master action plan (MAP) for improving working conditions
and achieving higher levels of compliance with Nike's code of conduct
B Isolated violations of standards, but none considered serious or critical; more than 5 minor
issues outstanding on the MAP, but none considered serious or critical
C Noncompliant with serious failures and making little progress in remedying them. Examples of
C-Ievel issues include:

Factory does not provide basic terms of employment (contracts, documented training on
terms, equal pay, discriminatory employment screening).
More than 10 percent of employees work between 60 and 72 hours each week.
More than 10 percent of employees exceed annual legal limits.
More than 10 percent of employees work seven or more consecutive days without a break.
Factory violates local migrant labor laws.
Non-income-related benefits fall short of legal provisions.
Some evidence of verbal or psychological harassment or abuse.
One or more serious issues on MAP, but none considered critical.

D Noncompliant; general disregard for Nike's code of conduct; and evidence of deliberately
misleading auditors. Examples of D-Ievel issues and problems include:

Management refuses or continues to demonstrate unwillingness to comply with Nike

standards.
Management provides false information (statements, documents or demonstrates coaching).
Factory fails to provide verifiable timekeeping system to accurately record work hours.
Factory fails to pay legally mandated minimum wage.
More than 10 percent of employees work more than 72 hours each week.
More than 10 percent of employees exceed daily work hour limits.
More than 10 percent of employees work 14 or more consecutive days without a break.
Factory requires pregnancy testing as condition of employment.
Factory uses workers under the minimum legal age.
Factory uses bonded, indentured or prison labor.
Factory uses force to compel illegal work hours.
Audit finds confirmed evidence of physical or sexual abuse.
Factory management denies access to authorized compliance inspectors.
Factory denies freedom of association for workers, including demotion or dismissal of
workers seeking to exercise their rights.
Factory provides no benefits tied to security (workers' compensation, medical coverage,
social security, retirement funds).
Factory outsources to unauthorized facilities or issues homework to employees.

E Not enough information to measure compliance

C-470 Part 2 Cases in Crafting and Executing Strategy

Exhibit 3 Summary of Nike's Audits of Supplier Factories, Fiscal Years 2003 and 2004

Geographic Region

Europe, Middle
Americas East, Africa Northern Asia Southern Asia Worldwide Total

Number of SHAPE*
audits in 2004 178 157 378 303 1,016
Number of M-Auditst
in 2003 and 2004 148 56 198 167 569
M-Audit numeric
scores in 2003-2004
Lowest score 46 49 25 20 20
Average score 78 70 58 58 65
Highest score 94 96 95 95 99
Compliance ratings
for contact factories
as of June 2004
Grade of A 32 15 34 25 106 (15%)
Grade of B 64 40 147 76 327 (44%)
Grade of C 18 7 33 65 123 (17%)
Grade of 0 5 35 14 8 62 (8%)
Grade of E 18 7 22 70 117(16%)

*SHAPE audits were a monitoring tool used by Nike since 1997 and provided a basic gauge of a factory's compliance performance.
tM-Audits, NiKe's main auditing tool in 2003-2004, provided a deeper assessment of a factory's management practices. Worker popula-
tion in M-Audited factories was 375,000 in fiscal year 2003 and 213,000 in fiscal year 2004.
Source: Nike's 2004 Corporate Responsibility Report, pp. 20, 34, and 35.

Nike's Corrective Actions to Deal with Non-
complying or Nonperforming Suppliers
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 noncompliance.
One suppl ier in China, for example, was cited for
repeated violations of overtime standards and falsi-
fication of records. 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 improve-
ment, the factory was dropped . In November 2006,
Nike severed its business relationship with a Paki-
stani supplier of soccer balls that failed to correct
serious code of conduct violations.
More typically, Nike's decisions to end a busi-
ness 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. For example, a manufacturing group
in South Asia had performed poorly on a range of
issues, from overtime and worker-management
communication to the quality of product and ship-
ping dates. After a series of performance reviews,
Nike management infonned the factory group that
it would not be placing orders for the next season.
Nike did not report on factories dropped solely from
noncompliance reasons related to its code of conduct
because management said "it is often difficult to
isolate poor performance on compliance as the sole
reason for terminating a business relationship.,,21
To give its contract manufacturers greater incen-
tive to comply with Nike's workplace standards and
expectations, during crunch production periods Nike
management and plant auditors had given some fac-
tories latitude to institute long workweeks (above
72 hours) and not hold them to a strict standard of
I day off out of every 14 days if the employer gave
workers more days offduring slack production periods.
Nike was also working to streamline its methods of
designing shoes and placing orders with key suppliers
and helping foreign factories develop more efficient
Case 26 Detecting Unethical Practices at Supplier Factories: The Monitoring and Compliance Challenges C-471

Exhibit 4 Summary Results of Nike's Audit Grades for Contract Factories, Fiscal Years
2005-2006

Factory Rating Trends FY2005

Jun 04 Jul 04 Aug 04 Sep 04 Oct 04 Nov 04 Dec 04 Jan 05 Feb 05 Mar 05 Apr 05 May 05

300

B (\ "-

~
250 '-
~ -- ~
.0
200 """"
J'I.
150
~ ~
100
C
A I~
>< - V .r.
-0-"'" ~

-"' - ~
~
J\.
v

-' I
50
~
D
E
';! O. J\.
~
-"
~ .J

o
A B c D E

Factory Rating Trends FY2006

Jun 05 Jul05 Aug 05 Sep 05 Oct 05 Nov 05 Dec 05 Jan 06 Feb 06 Mar 06 Apr 06 May 06

300
1\ -0

-
v

_ ~v ~ I-'""'"
250

B
._1'....- ~
v
200
..0
J>.
c l)
J; 0-
-v
~ ~
150 0--1"""
A

100
D 0.-
r-o-
50

o
E I

1 1- -
- .J\

v
J' , ~

A B c D E
Note: Of the 42 M-Audits that Nike conducted through fiscal year 2006, 7 supplier factories re.ceived a grade of A and 13 factories
received a D rating; Nike found the two big drivers of noncompliance were ignorance of the law or Nike standards and a lack of systems
to manage people and processes.
Source: Nike fiscal year 2005-2006 Corporate Responsibility Report, pp. 30 and 31 .
C-472 Part 2 Cases in Crafting and Executing Strategy
production techniques, so as to help contract factories
eliminate the need to institute long workweeks and
excessive overtime. According to Nike's vice presi-
dent for global footwear operations, "If you improve
efficiency and innovation, it changes the cost equa-
tion" for factories. 22
In 2008, Nike discovered serious breaches of
conduct involving unacceptable living conditions,
withholding of worker passports, and garnishing of
wages at a contract factory in Malaysia. To correct
the problem, Nike announced that it was requiring
the supplier to immediately make the following non-
negotiable changes: 23
1. All current migrant workers will be reimbursed
for fees associated with employment including
but not limited to recruiting fees paid to agents
and worker permit fees.
2. Going forward, any and all fees associated with
employment will be paid by the factory as a cost
of doing business.
3. Any worker who wishes to return home will be
provided with return airfare, irrespective of their
contract requirements.
4. The majority of housing has been found to be
unacceptable. All workers will be transitioned into
new N ike-inspected and approved housing within
30 days. This transition has already begun.
5. All workers will have immediate and total free
access to their passports. No restrictions.
6. Workers will have access to a 24-hour Nike hot-
line should they be denied access to their pass-
ports by factory management. All claims will be
promptly investigated .
7. Communication to the workers of these changes
will be delivered verbally as well as posted in all
communal areas in all appropriate languages.
Nike also announced that during the next 10 days, it
would review its entire Malaysian contract factory
base and require factories to institute these same
policies.
1- art' Supplier Code
f Conduct nd Complianc
oni in
In 1992 Wal-Mart established a set of standards for
its suppliers and put in place an ethical standards
program to monitor supplier compliance with these
standards. 24 Since then, Wal-Mart's standards for
suppliers had been periodically evaluated and modi-
fied based on experience and feedback from the eth-
ical sourcing community. The company's standards
for suppliers covered compensation, working hours,
forced labor, underage labor, discrimination, com-
pliance with applicable national laws and regulation,
health and safety practices, environmental abuse,
freedom of association and collective bargaining,
rights concerning foreign contract workers, and the
right of audit by Wal-Mart.
Prior to contracting with any supplier, Wal-Mart
required suppliers to review and sign a supplier
agreement, which incorporated an expectation that
the supplier would comply with Wal-Mart's stan-
dards for suppliers. In addition, it was mandatory
that all suppliers display Wal-Mart's "Standards for
Suppliers" poster in all of the suppliers' factories.
Factory management was required to sign that it had
read and fully understood the "Standards for Suppli-
ers" poster, and a copy of the poster in the relevant
language had to be posted in a public place with.in
the factory. Wal-Mart's "Standards for Suppliers"
poster was available in 25 languages.
In February 2002, Wa:I-Mart created an entity
called the Global Procurement Services Group
(GPSG), which was charged with identifying new sup-
pliers, sourcing new products, building partnerships
with existing suppliers, managing Wal-Mart's global
supply chain of di.rect imports, providing workplace
standards training to suppliers, and enforcing compli-
ance with Wal-Mart's supplier standards. All Wal-Mart
personnel engaged in monitoring supplier compliance
became part of the GPSG. In 2008, the GPSG con-
sisted of about 1,700 people working from offices in
25 countries, including China, Indonesia, fndia, Paki-
stan, Sri Lanka, Bangladesh, Honduras, Nicaragua,
Guatemala, Mexico, Brazil, and Turkey (countries
where supplier compliance presented big challenges).
In 2005-2007, Wal-Mart purchased goods from
dose 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 construc-
tion. About 200 Wal-Mart personnel scattered across
the 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
Case 26 Detecting Unethical Practices at Supplier Factories: The Monitoring and Compliance Challenges
the factory (or factories) used to fulfill each order
placed by Wal-Mart.
Wal-Mart's Supplier Auditing Program and
Compliance Rating System 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 con-
ducted 12,561 initial and follow-up audits at 7,600
factories. The company's audit methodology and fac-
tory rating system is described in Exhibit 5. A sum-
mary ofWal-Mart's audit findings for 2004-2006 is
contained in Exhibit 6. According to Wal-Mart man-
agement, 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 four Orange ratings
within a two-year period; other contributing factors
were a revision of the ratings and Wal-Mart's pub-
lic announcement that it was expanding the percent-
age 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 insti-
tuted, certain types of violations were reclassified to
increase their severity, and audits were conducted by
two-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 sup-
plier turnover, disapproved factories, permanently
banned factories receiving Red ratings, and the two-
year re-audit cycle for supplier factories receiving
a Green Rating. Rather than promptly banning the
placement of orders 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 con-
ditions, a position 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 manage-
ment in 2005, and 5,000 suppliers and members of
factory management in 2006. The training focused
C-473
on increasing supplier familiarity with Wal-Mart's
standards for suppliers and encouraging an exchange
of information about factory operating practices.
Wal-Mart 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 organiza-
tions on ways to accelerate ethical compliance and
the achievement of better working conditions in sup-
plier factories.
Upon learning of the incident in the Business-
Week report cited in the opening of this case, Wal-
Mart began an investigation of the Beifa factory in
Ningbo. Wal-Mart acknowledged that some of its sup-
pliers were trying to deceive plant monitors and avoid
complying with Wal-Mart's standards for suppliers.
Audit Fatigue on the Part of Supplier
Factories In 2008, supplier monitoring had
become a standard practice for many retailers and
brand owners that sourced their goods from factories
in foreign locations where working conditions were
often less than satisfactory. It was not uncommon for
the audit teams of different companies to be in some
supplier factories as often as 10 times each month,
leading not only to duplication of audit efforts but
also to audit fatigue and frustration on the part of
factory managers. While the supplier codes of con-
duct of various retailers and brand owners tended to
be similar, the interpretation of standards and local
laws frequently varied by company, thus resulting
in situations where factory managers were asked to
comply with a variety of interpretations.
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 sup-
plier 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 Indus-
tries (lCT!) CARE Process and the Global Social
Compliance Program. ICT! consisted of toy trade
C-474 Part 2 Cases in Crafting and Executing Strategy

Exhibit 5 Wal-Mart's Factory Audit Methodology and Factory Ratings System, 2006

Opening Meeting-The Opening Meeting consisted of (1) confirmation of the factory and its information, (2) an
introduction by the Wal-Mart auditors to factory management and supplier representatives, (3) a presentation and
signing of the Wal-Mart Gifts & Gratuity Policy (which forbids any offer or receipt of gifts or bribes by the factory or
the auditor), and (4) a request by the auditors of factory documentation related to personnel, production, time and
pay records.
FactoryTour-The auditors conducted a factory walk-through to examine factory conditions. The walk-through
Ilad minimal factory managers present because auditors asked production employees questions about machinery
operation and other working conditions. Auditors also followed up with workers interviewed in previous audits
about conditions since the last audit. The tour lasted up to three hours, depending on the size of the factory.
Worker Interviews-During factory tours, auditors typically choose workers off the shop floor to interview,
although additional workers could be requested to verify factory records during the documentation review
process. Factory management had provide a private location for interviews, and under no circumstances were
interviews conducted with factory management or supplier representatives present. Workers were interviewed in
same-sex groups. The objectives of the interviews were to discover what interviewees had to say relevant to the
audit, verify findings and observations made by the auditors, and ensure that workers understood their rights. A
minimum of 15 workers were interv,iewed. The number of workers interviewed depended on the size of the factory.
Factory Documentation Review-Auditors conducted an on-site inspection of payroll records, time cards,
personnel files, and other pertinent production documents. For Initial and Annual audits, document review required
records dating back at least three months and up to one year. Follow-up audits not only included reviewing findings
from the previous audit, but also always included review of hours and compensation. Any factory that failed or
refused to comply with this requirement was subject to immediate cancellation of any and all outstanding orders.
Closing Meeting-Auditors summarized the audit findings, described any violations found, made
recommendations to remedy the violations, and gave factory management a chance to ask any questions
about the audit. Factory management and the auditor both signed the on-site audit report. Auditors left a
copy of the signed audit findings and recommendations. Factory management was expected to act on all the
recommendations in the on-site report and to present a completed action plan to the auditor during, the follow-up
audit opening meeting so auditors could validate that the actions were taken. Suppliers and factory management
were encouraged to contact the regional Wal-Mart Ethical Standards office to discuss any concerns or questions
about The on-site report and recommendations.
Factory Ratings-Factories were rated Green, Yellow, Orange, or Red.
A Green rating was assigned for factories having no or only minor violations
A vellow rating signified medium-risk violations.
An Orange rating entailed high-risk violations (an Orange-Age rating was automatic for factories where the
use of one or two underage workers was discovered). Factories receiving four Orange ratings within a two-
year period were disapproved for producing goods for Wal-Mart for one year; after a year, the factory could be
approved to supply Wal-Mart if it achieved a Yellow or Green rating.
A Red rating indicated failure to pass the audit because of such egregious violations as use of prison or
forced labor, extremely unsafe working conditions, employing more than two underage workers, serious
worker abuse, or exceptionally long work hours. Red-rated factories were immediately and permanently
banned from producing merchandise for Wal-Mart.

Starting in 2006 , Green-rated factories had re-audits every two years instead of annually. Yellow- and Orange-rated
factories had follow-up audits after 120 days to allow time for corrections and verification that corrective actions
had been implemented. Factories rated Orange with underage labor violations for only one or two workers were an
exception to the timeline for re-audits; such factories were re-audited within 30 days. If the follow-up audit for these
factories 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 noncompliance) .
Use of Outside Auditors-When Wal-Mart sourced goods for its foreign stores from suppliers in the same country
in which the 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 Societe Generale de
Surveillance.

Source: Wal-Mart's Report on Ethical Sourcing, 2005 and 2006, posted at www.walmart.com (accessed January 25, 2007, and
September 18, 2008).
Case 26 Detecting Unethical Practices at Supplier Factories: The Monitoring and Compliance Challenges C-475

Exhibit 6 Comparison of Wal-Mart's Factory Audit Results for 2004, 2005, and 2006
,
I 2004 2005 2006
Total number of factory audits 12,561 (8% were 13,600 (20% were 16,700 (26% were
unannounced) unannounced) unannounced)
Number of factories audited 7,600 7,200 8,873
Audits resulting in Green ratings
(re-audited after 2 years) 19.1% 9.6% 5.4%
Audits resulting in Yellow ratings
(re-audited after 120 days") 38.8% 37.0% 51.6%
Audits resulting in Orange ratings
(re-audited after 120 days) 32 .5% 52.3% 40 .3%
Audits resulting in Orange-Age
ratings (re-audited after 30 days) 0.8% 0.4%
Factories disapproved for
producing for one year-four
Orange assessments in a
two-year period 8.8% 0.1% 2.1%
Audits resulting in Red ratings- 164 (141 of these
factories permanently banned related to the use of
from receiving orders 0.8% underage labor) 0.2%

'In 2007. the re-audit period forYel/ow-rated factories was changed to 180 days.
Source:Wal-Mart's Report on Ethical Sourcing, 2005 and 2006. www.walmmt.com (accessed January 25.2007. and September 18,
2008).

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. ICTI had developed a code of busi-
ness practices that included high standards for labor
practices and employee health and safety. Its CARE
Process was aimed at providing a single, thorough,
and consistent audit program for monitoring toy
factories compliance with the code; most of ICTI's
auditing activities were concentrated in China, where
70 percent of the world's toy volume was manufac-
tured. Wal-Mart had begun accepting lCTI's audit
results in lieu of conducting its own audits.
Wal-Mart was a cofounder of the Global Social
Compliance Program (GSCP). The GSCP was an
initiative to promote uniform global standards for
supplier conduct and acceptable factory working con-
ditions, particularly as concerned health and safety,
child labor, discrimination, and compensation. Fac-
tory monitoring was an important component of the
program. Although much of the work to put the pro-
gram in place was being done by ClES, an interna-
tional association of food retailers and suppliers, the
scope of the GSCP covered both food and nonfood
production. While the current members of GSCP
were companies, it was envisioned that there would be
extensive collaboration with trade unions, governmen-
tal organizations, and nongovernmental organizations.
In July 2008, Wal-Mart announced that Intertek
Group, PLC, an independent supplier monitoring
organization with 25 offices in China, would begin
conducting audit of Wal-Mart's supplier factories
in China. Intertek was among the several outside
groups that Wal-Mart used to help conduct audits of
its supplier factories .
COMPLIANCE EFFORTS OF
INDUSTRY GROUPS AND
NONGOVERNMENTAL
ORGANIZATIONS
Some companies, rather than conducting their own
supplier monitoring and compliance effort, had
banded together in industry groups or multi-industry
coalitions to establish a common code of supplier
C-476 Part 2 Cases in Crafting and Executing Strategy
conduct and to organize a joint program of factory
inspections and compliance efforts. For example,
Hewlett-Packard, Dell, and other electronics com-
panies that relied heavily on Asian-based manufac-
turers to supply components or else assemble digital
cameras, handheld devices, and PCs had entered into
an alliance to combat worker abuse and poor work-
ing conditions in the factories of their suppliers.
The F or Lab A sociatioD
One of the most prominent and best organized
coalitions was the Fair Labor Association (FLA),
whose members and affiliates included 194 col-
leges and universities, a number of concerned
nongovernmental organizations, and a group of 35
companies that included Nike, the Adidas Group
(the owner of both Reebok and Adidas brands),
Puma, Eddie Bauer, Liz Claiborne, Patagonia,
Cutter & Buck, Russell Corporation, and Nordstrom.
As part of its broad-based campaign to eliminate
human rights abuses and improve global workplace
conditions, the FLA had established its Work-
place Code of Conduct, a document to which all
members and affiliates had subscribed. To aid
in winning supplier compliance with the Work-
place Code of Conduct, the FLA conducted unan-
nounced audits of factories across the world that
supplied its members and affiliates.
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 supply-
ing 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).25 The
violations included excessive work hours, under-
payment 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 mon-
itors falsified books."26
In its 2006 public annual 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. 27 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 compa-
nies. The 99 audits during 2005 revealed 1,587 vio-
lations, an average of 15.9 per audit. The greatest
incidence of violations was found in Southeast Asia
(chiefly factories located in China, Indonesia, Thai-
land, 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: "Factory personnel have become accustomed
to concealing real wage documentation and provid-
ing falsified records at the time of compliance audits,
making any noncompliances difficult to detect.,,28
In its 2007 public annual 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.29 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 viola-
tions, an average of 17.1 per audit. Over 80 percent
of all the reported violations were in Asian countries;
there was an average of 37.4 violations per factory
visited in South Asia. Most of the 2006 violations
related to health and safety (46 percent); wages,
benefits, hours of work, and overtime compensation
(30 percent); and code awareness (9 percent). Once
again, the FLA stated in its report that the violations
relating to compensation and benefits were likely
Case 26 Detecting Unethical Practices at Supplier Factories : The Monitoring and Compliance Challenges C-477

higher than those detected in its prior-year audits

because "Factory personnel have become accustomed
THE OBSTACLES TO
~o conc~aling real wage documentation and provid-
mg ~alslfled records at the time of compliance audits,
ACHIEVING SUPPLIER
makmg noncompliances difficult to detect.,,30 COMPLIANCE WITH
h if tori ringh e CODES OF CONDUCT IN
The Fair Factories Clearinghouse (FFC), formed in LOW-WAGE, LOW-COST
2004, was a collaborative effort to create a system for
managing and sharing factory audit information that
COUNTRIES
would facilitate detecting and eliminating sweatshops
Factory managers subject to inspections and audits
a.nd abusive workplace conditions in foreign facto-
of their plants and work practices complained that
nes. Members as of 2008 included ASICS America,
strong pressures from their customers to keep prices
L. ~. Bean, Timberland, Hudson's Bay Company,
low gave them a big incentive to cheat on their com-
LevI Strauss & Co., Macy's Merchandising Group,
pliance with labor standards. As the general manager
Mark 's Work Wearhouse, Nike Inc., Patagonia,
of a factory in China that supplied goods to Nike said,
Starbucks Coffee Company, and VF Corporation.
"~y improvement you make costs more money. The
Membership fees were based on a company's annual
pnce [Nlke pays] never increases one penny but com-
revenues, with annual fees ranging from as little as
pliance with labor codes definitely raises costs.,,32
$5,000 to as much as $75,000 (not including one-
The pricing pressures from companies sourcing
time initiation fees of $2,500 to $11,500). The idea
components or finished goods from offshore facto-
underlying the FFC was that members would pool
ries in China, India, and other low-wage, low-cost
their audit information on offshore factories creat-
locations were acute. Since 1996, the prices paid for
ing a database on thousands of manufacturing' plants.
men 's shirts and sweaters sourced in China were said
As of October 2007, HC's database included 25000
audits of 13,000 factories. Once a plant was c~rti
to have dropped by 14 percent, while the prices of
clocks and lamps had dropped 40 percent and the
fied by a member company or organization, other
prices of toys and games had fallen 30 percent. 33
members could accept the results without having to
Such downward pressure on prices made it finan-
do an audit of their own. One benefit of collaborative
cially difficult for foreign manufacturers to improve
audit-sharing via an organization like FFC was that
worker compensation and benefits, make their work-
members sourcing goods from the same factories
places safer and more pleasant, introduce more effi-
could band together and apply added pressure on a
cient production methods, and overhaul inefficient
supplier to improve its working conditions and com-
plant layouts. Many factory managers believed that
ply with buyers ' codes of supplier conduct. 31
if they paid workers a higher wage, incurred other
Aside from the audit-sharing appeal of makin a
compliance costs, and then raised their prices to
factory audit programs less expensive, audit-sharin;
cover the higher costs that their customers would
had the additional appeal of lessening the time that
qU.ickly cut and run to other suppliers charging lower
factory managers had to spend dealing with the
pnces. Hence the penalties and disincentives for
audit teams of many different customer companies
compliance significantly outweighed any rewards.
that conducted their own audits, thereby reducing
The CEO of the Fair Labor Association, Auret
"audit fatigue ." Some large plants with big customer
van Heerden, in a 2006 interview with Business Week
bases were said to undergo audits as often as weekly
offered a number of reasons why underpayment of
and occasionally even daily; in addition, they were
wages and excessive overtime in supplier factories in
pressured into having to comply with varying provi-
China were such difficult problems to resolve:
sions and requirements of each auditing company's
code of supplier conduct-being subject to varying The brands book and confirm orders really late. And
and conflicting codes of conduct was a factor that they often change their orders after booking. The
induced cheating. brands want to order later and they don 't want to hold
C-47S Part 2 Cases in Crafting and Executing Strategy
product. Then you add price pressures into that and
it is really tough for the supplier [to not overwork its
workers].
But the factory often doesn 't order the materials
until too late and they are often delivered late [to the
factory], too. The factOlY production layout is often a
mess, so the supplier gets behind schedule and over
budget even before they know it. Then they have
to catch up. And to save money, they extend hours,
but don', pay overtime premiums. And the suppliers
also lack proper training. The styles [of clothing and
footwear] are becoming more complicated and are
changing more frequently.
Endnotes
I. Dexter Roberts and Pete Engardio, "Secrets, lies, and Sweatshops;'
Business Week, November 27, 2006, pp. 50-58.
2. Ibid., p. 50.
3 lbid.
4. www.chinatownconnection.com(accessedSeptember 17, 2008).
5. Judith Bannister, "Manufacturing in China Today: Employment and
Labor Compensation," Conference Board, November 2007, p. 22.
6. Roberts and Engardio, "Secrets, lies, and Sweatshops," p. 54.
7. Ibid., p.54.
Blbid., p. 50.
9. Ibid., p. 55.
10lbid., p. 53.
II. Ibid., pp. 55-56.
12. Ibid., p. 53.
13. lisa Roner, "Wal-Marl's Ethical Sourcing: Green Does Not Mean
Ethical," October 19, 2007, www.ethica lcorp.com (accessed
September 22, 2008).
14. Nike FY2005-06 Corporate Responsibility Report, www.nike.com/
nikebiz (accessed September 19, 2008), p.28.
15' lnformation posted at www.nikebiz .com (accessed on January 26,
2007): Nike's 2004 Fiscal Year Corporate Responsibility Report,
pp.21-24.
16. Nike's 2004 Fiscal Year Corporate Responsibility Report, p. 28.
17lbid., p.29.
lB. Ibid., p. 20.
Muhiple codes are a big problem. The classic
example is the height that a fire extinguisher should
be kept off the ground--how high varies according to
different codes . Companies like McDonald's, Disney,
and Wal-Mart are doing thousands of audits a year
that are not harmonized. That's where audit fatigue
comes in.
And auditing in itself tells you a little about the
problem, but not enough, and not why there is a prob-
lem. So you have an overtime problem, but you don't
know why. Is it because of electricity shortages, labor
shortages, or a shorter order turnaround time? You
don't know. 34
19. Ibid .. p. 30.
20. Ibid., p. 25.
21. Ibid., p. 26.
22. Pete Engardio and Dexter Roberts, "How to Make Factories Play
Fair," BusinessWeek, November 27,2007 , p. 58.
23 . Company press release, August 1, 2008.
24.The content of this section was developed by the case author from
information posted in the supplier section at www.wa lmartstores.com
(accessed January 25 , 2007).
25. Fair Labor Association, 2005 annual public report, www.fairlabor.org
(accessed January 23, 2007).
26. Ibid., p. 38; also quoted in Hoberts and Engardio, "Secrets, lies, and
Sweatshops," p. 54.
27'Fair tabor Association, 2006 annual public report, www.falrlabor.org
(accessed January 23, 2007) .
28. Ibid., p. 40.
29. Fair Labor Association, 2007 annual public report, www.fairlahor.org
(accessed September 19, 2008).
30. Ibid., p. 48.
31. Roberts and Engardio, "Secrets, Lies, and Sweatshops," p. 58.
32. As quoted in ibid., p. 53.
33. Ibid., p. 58.
34. As quoted in Dexter Roberts, "A lion for Worker Rights:' Business-
Week Online Extra, November 27, 2006, www. bu~inessweek . com
(accessed on January 23, 2007).