Companies using sweatshops are in a lose-lose situation

There are two types of storylines about Apple that seem to crop up every few days: one is about some rumour of another amazing new gadget that is going to take the world by storm; the other is an expos of the terrible conditions at the factories in China that supply the firm.

Over the past two years, there has been a long string of scandals over the factories where all those slick iPhones and iPads are actually assembled. Yet, so far at least, none of that seems to matter to Apple's shareholders. The share price keeps on soaring into the stratosphere. Apple has now secured its place as the world's largest company, measured by market capitalisation. But maybe it should be more worried and perhaps so should shareholders in all the other big companies that depend on supply chains in the developing world.

Rightly or wrongly, Apple has taken a lot of flak over the past two years for the conditions at its factories in China. A series of investigative reports have highlighted the wretched working practices where the parts for Apple's gadgets are made and the final products assembled. It is invariably Dickensian stuff; low-paid workers slogging their guts out in brutal factories for savage bosses. None of it makes the company look good.

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Nor is it just Apple it simply attracts more headlines because it is the biggest company in the world. Plenty of other large firms have suffered similar exposs; those that haven't were probably just lucky. Every major business now depends on factories in the developing world churning out cheap goods. The conditions at most of them probably are not any better. Some may well be worse.

Apple has responded as best it can. It has introduced new codes of conduct, insisted on better conditions at the factories, and tightened up the vetting of its suppliers.

But much of the criticism is unfair. Tough working conditions are part of the process of industrialisation. That was true in Victorian England and it is true of China and Vietnam and Indonesia today. It is why we use the term Dickensian' to describe them. It is a part of a process whereby countries get richer.

It is hard to argue that those nations would be better off if they didn't industrialise. Harsh though the conditions may be at the factories supplying the developed world with cheap goods, all the available evidence suggests that wages are higher and terms of employment better than the alternatives in the domestic economy. These, after all, are poor countries life is tough everywhere.

And here's the rub it isn't really possible for Apple or other companies to up sticks and go elsewhere. The network of factories and suppliers, and the trained labour forces for volume electronics-manufacturing don't exist in Europe and America anymore.

But just because the allegations of exploitation often don't make a lot of sense, it doesn't mean they don't matter at all and can simply be ignored. Many of the companies that use vast supply chains of developing-world labour depend critically on their brand image.

Apple can only make margins of 50% because it is perceived as being cool. If its customers didn't view it as such, it would just be another mass manufacturer of phones and computers, lucky to make a 5% margin in a good year. The same is true of many fashion, sports and electronics brands. A fashion house can make mark-ups of 300% or 400% because its products are considered to be desirable. Lose that image and you lose the edge over lower-priced competition.

If horrific labour stories keep coming, it is going to be hard to maintain Apple's image. After all, what's cool about a £400 iPad when you keep reading that it only costs £10 to assemble and is put together by people earning $2 for putting in 14 hours on a production line? And how may people really want to be seen with a £500 handbag when there are constant allegations about how they are made in sweatshops where the workers don't earn that amount in a whole year?

If companies lose their brand image, then they have to compete on price instead. But that is a far harder part of the market to thrive in. And it usually means your profits get devastated as well. You don't exactly need to be a financial wizard to work out that the journey from a 50% profit margin to a 10% margin is not a comfortable one.

Of course, companies could move their supply chains from the developing to the rich' world. The infrastructure may not exist at the moment, but a company such as Apple, with billions sitting in the bank that it hardly knows how to spend, could build factories in California or Madrid. The wages would be far higher but the conditions far better and it wouldn't face sweatshop allegations anymore. The trouble is, that will hit margins as well. Costs would be higher, and profits correspondingly lower. Maybe it would be better in the medium term but not in the short term.

So, in effect, it is a lose-lose situation. Lose your brand or lose your margins. When a company is faced with that choice, its shareholders should watch out.