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Engagement – who has the real power ?

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Sustainable investment is often described as having two vital components; first, analysing environmental, social and governance (or “extra-financial”) factors when making investment and commercial decisions; and second, becoming an “active investor”, engaging with portfolio companies and business partners to encourage socially responsible business conduct.

Asian supply chain companies have for many years been at the centre of prominent engagement activities, led by a range of stakeholders, from NGOs to sourcing companies and investors.  A number of large, public victories, such as the campaign in the 1990s against Nike for using suppliers in several Asian countries which were operating so-called “sweat shops”, have established a precedent for successive actions affecting businesses in the region.

It is worth noting that the success of this kind of stakeholder engagement inevitably depends on the power balance between the relevant parties involved in the commercial or investment arrangement and the competitive dynamics of the specific business sector.

In Nike’s case, for example, many of the goods in question were relatively easy to produce and the threat of switching business to another supplier was a credible one.  Last summer, a similar “sweat shop” scandal was reported in factories in India that manufacture clothing for major Western brands, including Gap, Next and Marks & Spencer.  The companies launched inquiries into the alleged abuses and pledged to end wage violations and excessive overtime.  All three confirmed their commitment to ethical trading, with Next describing the situation as “deplorable” and warning that it would drop the factory unless conditions improved rapidly.  While there are low-cost factories all over Asia eager for this kind of business, the power definitely lies with the customer.

Contrast this situation with last year’s debacle at Foxconn, named by RepRisk as fifth on its list of top ten most environmentally and socially controversial multinational companies.  Foxconn was denounced for harsh labour conditions at its facilities in China and accused of attempting to cover up facts surrounding a series of worker suicides.  International media attention moved up the supply chain to fix on the electronics manufacturers which are Foxconn’s customers: companies including Apple, Dell and Hewlett Packard.

Apple, in particular, received a great deal of negative publicity, as Foxconn is a key producer of iPhones and iPads.  In Hong Kong, for example, non-profit group Students and Scholars Against Corporate Misbehaviour staged protests at Foxconn’s local headquarters and announced a “Global Day of Remembrance for Victims of Foxconn” on the date scheduled for the launch of the fourth generation iPhone.

Investors in the company have demanded information from Apple on the situation and its wider implications.  For example, fund manager Trillium reports that during fourth quarter 2010 it engaged with the company (and other Foxcomm customers) on the rights of their workers and quality of life in the workers’ dormitories throughout their supply chain.

However, while it is surely safe to assume that workers’ rights were important to the management of Apple, at the time the company was limited in its flexibility to respond because of the complexity of reworking the assembly lines and supply chains that contribute to the manufacture of its sophisticated products.  Were Apple to decide to purchase iPhones from an alternative supplier, shifting production to another firm would cause a huge interruption in the flow of finished products.  In a market that churns as fast as consumer electronics, this could have a significantly negative impact.

The dynamics of stakeholder dialogue, therefore, are inevitably influenced by the complexity of the manufacturing process and supply chain relationships.  As a general rule, perhaps customers and other stakeholders hold more power when engaging with suppliers of lower value-added products, raw materials and commodities.

Indeed, Asian natural resources companies have more recently been the focus of stakeholder engagement.  Last month saw a widely welcomed statement from Indonesian palm oil company, Golden Agri-Resources Limited, that it will work with the Government of Indonesia and other groups, including the Forest Trust, on forest conservation.  The company will support the creation of a fully sustainable palm oil industry and will aim to limit deforestation, with no development on high carbon stock or high conservation value areas.

This policy shift by Golden Agri has been prompted by increasing concern from multiple counterparties in business and civil society.  Intense lobbying by green groups, such as Greenpeace, over allegations of illegal forest clearing led major palm oil buyers to suspend sourcing from the company.  Global food giant Unilever, for example, halted purchases from PT Smart, a unit of Golden Agri, in December 2009.  At the time it accounted for 3% of Smart’s total annual palm oil sales of around US$1 billion.  Nestle followed suit in March 2010, and US based fast food chain Burger King Holdings in September.

By the beginning of this year, the company was receiving pressure from all sides.  Not only were key customers halting their purchasing, but at least one of the company’s brokers suspended coverage of its stock until Golden Agri was prepared to demonstrate responsiveness to environmental concerns.  Faced with this mounting opposition - and given that palm oil is a widely available commodity - Golden Agri perhaps did not have the competitive strength to resist the calls of the market.

It will be interesting to see what the outcome of similar discussions may be when the commodity in question is in short supply and highly sought after.  Take rare earths, such as gallium, europium, samarium and thorium, which are essential for the production of a wide variety of electrical components and clean energy technologies.  Mining of rare earths (almost all of which currently takes place in China) has had negative outcomes for the environment, including water pollution and creation of radioactive waste.

However, it may not be too cynical to suspect that the ability of investors and NGOs to influence those companies which are end-users of rare earths to put pressure on their suppliers - when it is those suppliers that have the bargaining power due to the scarcity of the materials - may be limited.  In the future, when all the easy battles are won, the challenge will be to devise strategies which are effective with those further up the value chain.

Alexandra Tracy is chairman of ASrIA, based in Hong Kong

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