Retailers Adopt Two Safety Plans for Bangladeshi Suppliers

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Major U.S. retailers, such as Wal-Mart Stores (NYSE: WMT) and Gap (NYSE: GPS), have agreed to a five-year safety plan that addresses safety standards for the hundreds of factories in Bangladesh that supply goods to Western retailers. Since the April collapse of Rana Plaza, a factory where more than 1,100 workers were killed, and a series of fires in other factories, there’s been pressure on these companies to address safety issues at these factories. The recent approval of this pact by mostly U.S. retailers coincides with a safety accord adopted by a majority of European retailers, like H & M Hennes & Mauritz (NASDAQOTH: HNNMY.PK) and Indetix SA.

Two safety pacts – is one better than the other?

The individual cost impact on each company participating in these safety agreements should be know once inspections are completed. Seventy retailers have approved the European accord, which is backed by labor organizations in Bangladesh, while the U.S. plan has 17 participants so far. Both plans have similarities such as mandatory factory inspections and a training program for workers.

Labor groups favor the European accord over the U.S. plan because retailers are required to provide sufficient funds to cover safety improvements. Any disputes that arise are resolved through arbitration and are legally enforceable. U.S. retailers took objection to the potential unlimited liability presented by the European plan and decided to devise their own separate plan. So far, the U.S. plan has raised $42 million and some companies have also agreed to provide over $100 million in loans and access to capital to factory owners.

Wal-Mart and Gap back U.S. safety pact

Wal-Mart utilizes 279 factories in Bangladesh that provide the company with a portion of its inventory, valued at $43.1 billion as of the first quarter of 2013. Inventory increased during this period by 4.4% from the same period in 2012. The costs related to addressing factory safety is sure to impact one of Wal-Mart’s top priorities: growing net sales faster than its operating expenses, which since 2010 has held steady at just over 19% of net sales. The expenses related to resolving Bangladesh’s factory safety issues may add cost pressures to future sales that are facing headwinds over the near term.

So far, Wal-Mart has spent $1.6 million on fire safety training and is expected to pay a maximum of $1 million per year for the next five years under the new safety plan. Wal-Mart is also expected to contribute to the over $100 million in capital that will be provided to factory owners.

Gap also joins Wal-Mart as a participant in the U.S. safety pact. So far, the company has spent $22 million on fire safety improvements for the 70 Bangladeshi factories it uses. The company had merchandise inventory levels, as of the first-quarter of 2013, of $1.72 billion, an increase of 8.3% over 2012’s first-quarter inventory of $1.59 billion. Operating expenses as a percentage of sales were 27.2% for the first quarter of 2013, down from the 28.1% reported in the first quarter of 2012. Unlike Wal-Mart, Gap is not a low-cost leader, and uses a lower number of factories so the cost impact on the company should be easier to manage.

Similar to Wal-Mart, Gap will need to pay into a pool that is funded based on production levels. When annual production exceeds $250 million, the company must pay $1 million every year during the five-year agreement. Gap may also provide funding for the $100 million in additional capital. Under the U.S. safety pact, both Wal-Mart and Gap are subject to limited liability.

H&M favors the European Safety Accord

Swedish retailer H&M is taking part in the European safety accord. Under the European accord, H&M must pay for program administrative costs based on production volume and other criteria, up to an annual maximum of $500,000 for five years. The company is also responsible for funding safety renovations of its factories and may be subject to additional costs that could be brought on by legal claims.

H&M uses approximately 165 factories in Bangladesh. The company’s inventory during the six-month period from December 2012 to May 2013 increased by 12% from the same period last year. Operating expenses as a percentage of sales have been 41.5% through 2011 and 2012. For the first six months of 2013, the amount went up to 43.1%.

My Foolish conclusion

The retailers mentioned have been able to maintain their inventory levels despite the recent disaster-related events. While the European accord imposes greater accountability, European retailers also have more at stake with about 60% of merchandise coming out of Bangladesh’s factories versus 25% for U.S. retailers, according to the New York Times.

At this time, factory inspections are underway and could take up to a year to complete. Estimates from safety experts gathered by the Workers Rights Consortium speculate that the cost of factory improvements could reach $600,000 per factory, according to MercuryNews.com.

Investors should expect to see higher operating costs from H&M, which could lead to higher prices from these retailers down the road. If the U.S. plan, which requires local participation, is enough to resolve this issue, Wal-Mart and Gap will be better able to limit their long-term costs and maintain more stable pricing. This could provide an advantage over rival H&M and other participants in the European accord. 

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Eileen Rojas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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