How unauthorized subcontracting can affect your business
The relationships between vendors, factories and sub-contractors are often complex and delivered across multiple geographies. This lack of production visibility, combined with increased financial and time pressures, can generate an increased risk of unauthorized subcontracting. Expert estimates suggest that anywhere between 40-60% of vendors and factories in China subcontract without prior authorization. Continued pressure on factory margins and a shifting geopolitical landscape are likely to further increase these risks.
Subcontracting is a normal part of production. It is mainly driven by pressures on timing, pricing and technical production processes. Subcontracting can occur at the supplier and factory level and be used for a variety of products or component parts.
Unauthorized subcontracting presents significant risks for supply chain continuity and compliance with quality, social and environmental production standards. Investors and insurers increasingly request visibility into production as part of determining their portfolios and premiums. It all impacts the bottom line. Together these drivers are motivating brands and retailers to build more transparent relationships with suppliers. These improved relationships enable better management of the business and reputational risks, delays, and quality inconsistencies that can be caused by unauthorized subcontracting.
“Findings from ELEVATE have stimulated a profound change in how vendor relationships are managed and increased awareness of how vendors adapt to customer behavior.”
– Ethical Sourcing Manager, large general merchandise retailer
How can your business detect and manage this challenge?
Take, for example, a large general merchandise retailer that sourced a variety of hard and soft goods from China for their garment and household product ranges. The retailer suspected unauthorized subcontracting based on observed irregularities and the inability to verify whether a factory associated with a vendor was the actual place of production.
The retailer’s management sought to increase visibility into tier 2 and tier 3 production and selected ELEVATE to carry out a clear risk assessment and detect specific cases of unauthorized subcontracting.
An effective approach to detecting unauthorized subcontracting
Step 1: To identify which production sites would receive unannounced site visits by our assessors, we segmented the retailer’s supplier base, considering risk exposure and levels of influence.
Step 2: The ELEVATE team then conducted site-specific capacity assessments at those higher risk production sites. Capacity assessment is a process of approximating production rate per worker and product category and comparing a factory’s ability to produce with actual total product outputs. Differences in these figures can indicate whether subcontracting may be taking place to increase capacity.
Step 3: Since many factories manufacture products for a number of clients, our next step was to assess the purchase orders (POs) for a specific customer. Our on-the-ground experts followed specific investigation protocols covering a combination of visual observations, document checks and capacity analysis based on previous audit data, thus allowing them to cross-reference site capacities with purchase order volumes.
Lastly, the ELEVATE team developed tailored responses to address each case, carried out investigations to understand root causes, and prepared preventive measures. This included measures for both the factory and for the general merchandiser buying teams.
Key findings and lessons to support remediation
- Initial on-site investigations by ELEVATE confirmed that around 70% of high-risk production sites were subcontracting without prior authorization
- Social compliance audits combined with production capacity assessments can be an effective approach for revealing subcontracting
- Evidence of subcontracting may only be present in specific records or identified through the absence of relevant production machinery, waste audits, suspicious transport vehicles etc.
- A retailer’s purchasing practices can inadvertently incentivize (unauthorized) subcontracting where there are short lead times, late order changes, significant time pressures etc.
- Investing in relationships with production sites directly, as well as with vendors, to increase transparency and trust is beneficial for retailers in the long term
How to develop your own approach to minimize risk of unauthorized subcontracting
ELEVATE recommends introducing a program of work that includes four stages of understanding, preventing, detecting and remediating unauthorized subcontracting:
Implementing this program of work through these four stages could significantly reduce your business risks, lead to more effective oversight, and generate business value in the following ways:
- Strengthening the code of conduct with clear expectations with regards to subcontracting
- Changing relationships with key suppliers, vendors and factories from transactional to partnership-oriented and supporting continuous improvement
- Generating more confidence in due diligence processes and therefore increased reliability of information on tier 2 suppliers; risk is decreased
- Boosting internal visibility and external transparency
For further information on our supply chain consulting and improvement services for brands, retailers, vendors and factories, please contact ELEVATE.