Untangling the Chinese Puzzle

Governance and risk management concerns surrounding supply-chain management where international outsourcing is involved escalated dramatically in the second half of 2007. Companies that outsourced to China the manufacturing of product components or products themselves, such as toys and pet food, were in crisis mode as recalls related to product safety ramped up and investors in those companies started to scrutinize their product quality controls.

Now many analysts and investment managers who have enthusiastically embraced the use of international outsourcing to reduce costs are looking closely to make sure that companies are taking a best practices approach to inspections and testing procedures to ensure that suppliers maintain high standards. “Anytime you've got a product that can do potential harm such as causing death or illness, especially to children and pets, it's a very emotional thing that can greatly impact a company's reputation, which goes to future business,” says Marjorie Doyle, of LRN Consulting Services in New York, who formerly was executive vice president and chief ethics and compliance officer at DuPont. “I believe that more and more investors are thinking about this, and Mattel, for example, could be even more damaged in the future than it already has been by its current financial losses.”

Analysts and investors who haven't yet increased their focus on environmental, social, and governance (ESG) factors in their investment decisions are likely to take the issue more seriously now that powerful nonprofit groups are conducting new and more comprehensive product testing and widely publicizing their findings. The Ecology Center, a Michigan-based nonprofit organization, released in mid-December the results of their testing of 1,200 popular children's toys for toxic chemicals. Along with the Washington Toxics Coalition and other leading environmental health groups across the country, the organization developed a Web site to better inform consumers about the products they would be purchasing over the holiday season.

Still, outsourcing to China continues to grow because of the benefits of low-cost production. The Wall Street Journal reported in December that General Motors expects the value of its auto-parts purchases in China to continue to increase at an average of 25 percent annually to 2010.

What best practices can companies put into place to ensure that Chinese suppliers are meeting their quality standards? “It comes down to making sure that you have the right suppliers and having an inspection process in place at the source to make sure that suppliers are making what they've contractually agreed to make to the specifications you've agreed to,” says Steve Payne, president, REL Consultancy. “If somebody is manufacturing something of poor quality, when sourcing is local you can pick up on it and you can fix the issue. But when you're sourcing from so far away and the inventory is on the water for 10, 12, or 16 weeks and you find that you've got a problem once the product reaches the U.S., your ability to impact the flow of inventory is hindered enormously. So it goes back to where you're doing your inspections.”

To help minimize the risk of faulty products, General Motors has 200 employees in Shanghai to work with suppliers.