Huddled inside Target Corp.’s headquarters in downtown Minneapolis, a team of investigators spent the summer trying to answer what should have been a simple question: What were hundreds of thousands of the retailer’s sheets actually made of?
What they discovered has undermined trust in a global luxury product and set off a salvo of class-action lawsuits that have created a king-sized public relations challenge for the Indian textiles industry and the U.S. companies it supplies.
Turns out that major American retailers, including Target and Wal-Mart Stores Inc., have been selling premium-priced sheets purportedly made of Egyptian cotton -- a byword for luxury in linens -- but that may in reality be woven with lower-quality cotton blends.
Three suits seeking to be certified as class-actions have been filed against supplier Welspun India Ltd. -- and a separate one last week was directed at Wal-Mart. The complaint, filed in New York by customer Dorothy Monahan, accuses the world’s largest retailer of questioning the fiber content of Welspun’s products as early as 2008, but not halting its sales until after Target did so in August. Wal-Mart said it will “vigorously defend” itself.
The other lawsuits, all filed in the U.S. against Welspun, allege the company fraudulently labeled its bed sheets as Egyptian cotton. Welspun declined to comment on the suits. Managing Director Rajesh Mandawewala told analysts during a conference call in August that “the error is on our side so we have to take responsibility for it.” Target, meanwhile, hasn’t been sued.
“The marketing has created this image in our heads that high-quality cotton and Egypt are synonymous," said Louis Rose, a Memphis, Tennessee-based cotton industry consultant. “Consumers should be skeptical of these marketing claims. They’ll be under a lot more scrutiny now.”
The fake Egyptian sheet episode came to light after exhaustive work by Target investigators who analyzed sheet fibers under microscopes and tracked their journey through a global supply chain. The probe found that 750,000 of Target’s "Egyptian cotton" sheets, sold for as much as $75 a pop, didn’t contain any Egyptian cotton at all, but an amalgam of lower-quality fibers from cheaper sources.
That July discovery touched off a scandal spanning from Minnesota to Mumbai and Cairo that threatens the future of Welspun, part of a $3 billion conglomerate headed by entrepreneur Balkrishan Goenka. It may also hobble Indian textile manufacturers in the race to supply Western consumers with high-quality sheets and towels, creating an opening for competitors from China and elsewhere to grab the business, according to industry analysts.
The Welspun-made sheets Target examined were sold under the Fieldcrest brand. While it has interests in steel, energy, and infrastructure, textiles are the bread and butter for Welspun, which says it supplies one in five towels sold in America and posted revenue of about $900 million in the 2016 fiscal year. Tennis stars like Roger Federer mop their brows with Welspun towels at the Wimbledon championships -- a fact the company highlights in investor presentations.
Target has cut ties and ended all of its $90 million in annual business with the company. Wal-Mart Stores and Bed Bath & Beyond Inc. also stopped selling Welspun sheets that had been labeled 100% Egyptian cotton. Those are significant blows coming from some of Welspun’s biggest customers, and have sent its stock down about 40% since Aug. 19 when Target announced its decision.
The sheets fiasco reflects a simple reality: There’s a scarcity of Egyptian cotton. It first became a key export product in the early 19th century, when it arrived in France and became sought after for its silky feel. Production has been falling since the 1990s, however, and last year Egypt’s post-revolutionary military government ended subsidies for cotton farmers to shore up the state budget. A gradual decline in output has become a precipitous plunge. The U.S. Department of Agriculture estimates there will be a 53% decrease in production this year, to an all-time low of 160,000 bales.
The system for certifying Egyptian cotton is administered from Cairo by the Cotton Egypt Association, an industry group that grants stamps of approval to suppliers of 100% Egyptian cotton products. To receive one, CEA executive director Khaled Schuman explained, a manufacturer pays an initial fee of $5,000 and submits records of Egyptian cotton purchases and product samples, which undergo DNA analysis to identify whether the fibers were grown in Egypt or elsewhere. The companies are charged an additional $3,000 annually for the certification, according to Schuman.
But once a certification is granted, producers are mostly left alone until they need to renew their label a year later. “You can’t put an employee from the association on each production line to inspect” every item being produced, said Mohamed Negm, who conducts testing of certification samples for the association to verify the fibers are Egyptian-grown. Typically, suppliers like Welspun purchase cotton in raw form from Egypt for import to Asia, where it’s turned into finished products for sale in the U.S. and elsewhere, he said.
The highest-quality Egyptian material costs twice as much as the standard grade sourced from India, providing a powerful incentive to cheat. “Factories have mixed the Egyptian cotton with other low quality cottons to make profit, which has ruined the reputation of Egyptian cotton,” said Negm, adding that’s what the DNA testing and certification aim to curtail.
During the set-up of the CEA’s DNA testing program, Negm said, it started analyzing random samples taken from store shelves globally; 90% were fake, mixed with low-quality cottons from the likes of Sudan, Burkina Faso and Pakistan.
“It’s very easy to play it loose during the production process if you want,” said Liu Dang Dang, a foreign sales manager at Chinese manufacturer Jihua 3542 Textile Co. U.S. retailers “should have realized how obvious it is,” he said, adding that the company, which supplies Egyptian cotton fabric to manufacturers in the U.S. and Europe, doesn’t engage in the practice. “The price they want to pay for Egyptian cotton sheets is so low when the price of Egyptian cotton is so high.”
Blending is widespread in the industry and quietly tolerated by many retail chains, according to two executives at producers other than Welspun who asked not to be identified discussing the procedure. Sometimes that means mixing good-quality non-Egyptian cotton that maintains the same feel amid shortages of the real thing, but it also often includes using cheaper grades to save money, said the people, citing their experience with cotton processing departments and export requirements for U.S. retailers.
The CEA formally announced its DNA testing program in April, saying the “gold seal” it would give manufacturers who passed would help “rid the supply chain of falsely labeled goods.” Awkwardly, the first company to receive a gold seal was Welspun, for bed linens as well as towels and bath rugs.
Target has decided not to rely on CEA certifications going forward, according to a person familiar with the retailer’s decisions who asked not to be identified discussing internal matters. Wal-Mart, by contrast, has said it will continue to rely on the CEA standard. Schuman said the organization is “making good efforts to make the system tougher" to avoid future problems, for example by increasing the role of third-party auditors and monitoring suppliers’ inventories more closely.
After discovering problems with Welspun sheets, Target quickly decided to terminate its entire relationship with the company, citing “the trust that our guests place in us." It also opted to offer refunds to customers who’d purchased them -- even if they’d been sleeping on them for years. Wal-Mart has also offered refunds.
Although Welspun knew Target was investigating its products, its executives believed that, at worst, the retailer would drop only its Egyptian cotton sheets, according to a person privy to the discussions. Target didn’t warn Welspun beforehand about its Aug. 19 announcement that it was ending all its business ties, the person said, which left the company blindsided.
At the time chairman Goenka’s wife Dipali, who leads Welspun’s home textile business, had just returned to India from meetings in the U.S.; she turned around immediately to do damage-control with clients, according to a person familiar with the events. In Mumbai, her husband had called an emergency meeting of department heads. He told them to ignore the company’s plunging share price and to focus on their day jobs, and that Welspun would bounce back over time, the person said. Both Goenkas declined to be interviewed.
Welspun, which has said the issue never affected the quality or safety of its products, hired the audit firm EY to evaluate its practices and supply chain. The company reports quarterly earnings Tuesday.
The scandal is creating an opportunity for rival Indian supplier Trident Ltd., which has picked up a significant chunk of Welspun’s business from Wal-Mart, Target and Ikea, said a person familiar with the situation, who asked not to be identified because the information is private. Ikea often uses more than one supplier for the same product, according to a spokesperson for the Swedish company, adding that Welspun continues to supply the furniture retailer while it’s also worked with Trident for many years. Ikea said it doesn’t buy products made from Egyptian cotton due to sustainability concerns.
Chinese textile producers may also benefit, analysts said. Big U.S. retailers tend to “go for Indian companies because they are cheaper," particularly thanks to lower labor costs, said Jack Yang, an executive at Chinese manufacturer Yantai Pacific Home Fashion.
Anyone trying to capitalize, though, faces the same problem: a shortage of Egyptian cotton. That, in turn, might assist U.S. manufacturers of Pima cotton, another high-quality grade that promotes itself as a rival to the Egyptian variety.
Back in Cairo, the guardians of the country’s sole global brand argue their efforts will be enough to rein in fakes, and they say the controversy might even have a silver lining.
“If what was happening had continued, in a few years there would be zero Egyptian cotton,” Schuman said. “The turbulence now is positive. It’s raising awareness, and we are doing everything we can to protect the value of our product.”
--With assistance from Salma El Wardany, P R Sanjai, Rachel Chang, Sam Chambers and Rajhkumar K Shaaw.
© 2016 Bloomberg L.P