ESG Essentials for Corporates: The environmental angle #5 - Sustainable supply chains

04 September 2020

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Supply chains create on average up to four times the GHG emissions of a company’s direct operations with further impact on air, water, biodiversity and resources.

At the same time, customers, regulators, investors and the public in general expect businesses to adhere to social responsibility principles. Therefore, companies are revisiting their supply chains with the objective to create environmental, social and economic value for all stakeholders involved; in short, building sustainable supply chains.

This article looks at the risk exposure of supply chains and how businesses can address these while defining and building a sustainable supply chain, that’s not only climate resilient and fair, but can also help to significantly improve corporate financial performance.     

Jargon buster

UN Global Compact: The voluntary business initiative, which brings together 8,000 business participants and 4,000 non-business participants, provides a universal language and a framework for corporate responsibility

We Mean Business Coalition: A global non-profit coalition that brings together 7 leading non-profit organisations, to work together with the world’s most influential businesses to take action on climate change.

BSR: BSR is a global non-profit organisation that works (as part of the We mean Business Coalition) with its network of more than 250 member companies and other partners to build a just and sustainable world. 

Sustainability Consortium: A global non-profit organisation, driving innovation for more sustainable supply networks.

Sustainable supply chains produce results and deliver returns

Embedding sustainable business practices in food and agriculture supply chains could deliver an annual $2.3 trillion windfall globally, according to a study by the Business and Sustainable Development Commission[1].

Companies with mature sustainable supply chains, that have lowered their overall carbon footprint, protect workers, adapt to changing technology and meet regulatory demands, report benefits across the board; ranging from risk mitigation, cost savings, and improved innovation to higher competitiveness and new market opportunities[2].

Likewise, firms with a sustainable supply chain enhance corporate reputation and as a result attract new customers, increase employee satisfaction and can lower their costs of capital, with ESG investors acknowledging the performance of such companies with regards to environmental, social and governance factors[3].

Where to start? Looking through an environmental lens a sustainable supply chain aims to:

  1. achieve a minimum of (scope 1-3) emissions,
  2. reduce material waste to zero or close to zero, while also reducing the resources required for its various production steps,
  3. continually review and take measures to ensure its resilience in case of external disruptions, such as we’ve just experienced during the pandemic, or for example caused by extreme weather events, which have started to occur more frequently over the past years; and
  4. develop a deep understanding of its exposure to various risks and determine the gap between the status quo and the three objectives listed above.

Let’s start with looking at the risks before outlining measures to achieve objectives 1 to 3.

Risk management is vital for supply chains 

Climate change and the increasing public awareness for environmental and societal issues has made supply chains more vulnerable, pushing risk management to the top of the supply chain agenda for corporate decision makers.

What are the risks?

Policy and legal risks result from a number of sources: climate policies to reduce GHG emissions or to halt land degradation can require rigorous measures in a defined period of time, to which every supply chain member will have to comply and act upon, or can result in additional costs, such as tax on taxes, along the entire supply chain. At the same time, multinational companies are exposed to country-specific regulations in the regions where their suppliers are located. Furthermore environmental regulations are continuously tightening, and what might have been a voluntary corporate initiative can turn into a mandatory action, bringing with it disclosure requests from the regulator.

One such example is the UK Modern Slavery Act, which requires large firms with operations in the UK and global annual revenues of £36 million or more to produce an annual modern slavery statement. The report must describe the main actions a company has taken during the financial year to deal with modern slavery risks in the supply chain and its own business[4]. Consequently, firms need to do a deep dive of their supply chain to ensure there’s no slavery, forced labour or trafficking; all of which requires a considerable amount of time, and, in particular, full visibility of the supply chain.

Climate change risks impact the speed (in a worst case scenario leading to a temporary disruption or longer shutdown), resilience, quality and costs of supply chains. Climate risks also alter the availability of raw material and energy supply to a company and its suppliers[5].

Acute physical risks include extreme weather events such as cyclones, hurricanes, and floods; while chronic physical risks stem from longer-term shifts in climate patterns, resulting in heat waves, droughts or sea-level rise. Unilever estimates that it loses some €300 million per year as worsening water scarcity and declining agricultural productivity lead to higher costs in its supply chain[6].

Similar to climate risk, global health risks can be equally disruptive: The COVID-19 lockdowns forced most suppliers in chains to temporarily cease production, and logistics providers could no longer transport goods as seamlessly, particularly across borders.

Market risks include changing customer preferences, for example due to heightened environmental awareness. Risks of higher costs of capital also fall under this category – investors might either demand a higher coupon or even turn away from companies if they can’t show that their supply chains are ESG compliant.

Reputational risks arise if suppliers do not comply with a company’s sustainability principles and bad practice becomes public before the supply chain leader can interfere. A child labour scandal hit Adidas in 2000 when a journalist uncovered the barbaric treatment of underage workers in two Indonesian factories that produced clothes for the sports firm.

Management of Emissions

In many industries, Scope 3 emissions account for the biggest amount of GHG emissions due to the fact that the majority of large companies depend on complex supply chains, which they don’t directly control. Estimates show that over 60% of a company’s emissions lie outside its own operation, in the supply chain[7].

The difficulty to calculate Scope 3 emissions in order to identify and introduce measures to reduce those, lies in the nature of supply chains, which usually stretch across a number of regions and locations and can entail as many as 28,000 supply

partners such as in PepsiCo’s Sustainable Farming Initiative[8].

CDP data can be a first step to dive deeper into the environmental footprint of suppliers: in 2018, 115 of the world’s largest companies requested environmental information for more than 5,500 suppliers from CDP[9]. In addition, new technologies such as data analytics, smart sensors, and blockchain can help to significantly increase the insight into global supply chains.

However, in particular companies in the food sectors with a vast number of suppliers are directly engaging with their partners, acknowledging that only close collaboration and education will see them achieve emissions and other targets. Cereal maker, Kellogg’s, for example, has committed to reduce value chain emissions by 20% from 2015), while also aiming to reduce scope 1 and 2 emissions by 65% until 2050. Partnering with WWF, World Resources Institute and CDP the company has begun to engage with 75% of its 400 suppliers, leading to the set-up of 35 programmes globally designed to help farmers decrease their footprint[10].

Supermarket chain, Tesco, which switched to 100% renewable electricity in the UK and the Republic of Ireland and invested £8 million in onsite generation in Asia in 2016 to reduce its scope 2 emissions, conducted a full supply-chain footprint survey to identify hotspots that should be targeted for scope 3 emission reductions. The company said it learned through this process that it needed to set different targets for agricultural emissions and emissions from food manufacturing in order to get everyone on board and ensure efforts to reduce the carbon foot print across the supply chain are continuing[11].

And such initiatives are starting to show convincing results: CDP recently reported that suppliers have cut CO2 emissions by 563 tons in 2019, the equivalent to removing 119 million cars from the road for a year, while also achieving subsequent savings of a staggering $20 billion[12].

Reducing waste and material use in supply chains

Focusing on waste minimisation yields significant savings and positive environmental outcomes. A number of studies have shown that the true cost of waste can be up to 10 times higher: apart from waste management and recycling costs, there are hidden costs, which include the cost of the materials that have been wasted, labour costs associated with the waste and regulatory costs[13].

While many are arguing that supply chain modelling still doesn’t put waste limitation and recycling at the heart of the process[14], companies are starting to proactively engage with their supply chain partners in order to reduce waste by improving manufacturing processes and reviewing product designs to identify the potential to not only reduce waste during the production, but also lower the resources input.

Swedish furniture maker IKEA, for example, buying products from more than 1,300 suppliers in 50 countries, specifies in its code of conduct for suppliers, called the “IKEA Way of Purchasing Home Furnishing Products (IWAY)” that waste should be avoided, and where it does occur, IKEA encourages suppliers to try to use it in the manufacture of other products.

The IWAY, which complies with international legislation, also outlines to suppliers that they should use energy efficiently and when a product comes to the end of its life-cycle, it should be possible to reclaim or recycle the materials that make up the product. Key to the success of IKEA’s suppliers playing an active role in helping the firm be sustainable, is the direct dialogue between the Swedish company and its many partners, also involving collaborative product designs to minimise the use of materials, such as tables made out of recycled plastic or rugs made of material clippings that would otherwise be wasted[15].

Meanwhile, academia is getting involved, too, helping supply chains to cut out waste and minimise resources: Loughborough University and the Carbon Trust are developing a water resource efficiency methodology for assessing water foot-printing and mitigating water risk in the supply chain, while another strand of Loughborough’s work focuses on developing innovative circular economy business models for entire supply chains[16].

Enhancing supply chain resilience

A resilient supply chain encompasses adapting to external challenges in order to maintain business continuity. To achieve this, successful companies are going different ways: business continuity plans remain a vital tool, but often today go much further and can lead to firms diversifying their supplier base in order to achieve resiliency by creating portfolios of suppliers in case of external shocks.

PepsiCo’s coconut water supply chain for its “Naked Juices”, for example, has some built in capacity buffering by using three co-packers in Southeast Asia, which are far enough apart from each other, that if a typhoon disrupts the processes of one packer, the others are not likely to be in the zone of destruction. To add a further layer of safety after experiencing a number of severe weather events, PepsiCo also added additional co-packers in the US to be used if necessary[17].

To anticipate weather events, a growing number of businesses are working with meteorologists to understand expected weather patterns and build this into their resiliency planning. Drawing up such supply chain resilience roadmaps can also be used to identify assets within the supply chain that are particularly vulnerable to weather events in order to implement measures to better protect them.

Resilience thinking doesn’t stop with the supply chain. Companies may look to innovate or redesign products to adapt to external factors. One such example is grain that can grow in the desert, developed by food companies to respond to challenges relating to drought[18].

Building a sustainable supply chain is a team effort

Successfully creating and maintaining a sustainable supply chain, which churns out sustainable products, requires significant investment and time – both to draw-up initial sustainability frameworks for the entire supply chain, and then to continuously engage with suppliers on an ongoing basis.

Successful companies follow a similar process to achieve supply chain sustainability:

  • Establishing a vision for sustainability and defining expectations for the suppliers: Apart from defining sustainability frameworks for suppliers, which detail targets, measures and track progress, revised Supplier Codes of Conduct can outline expectations around supplier sustainability. Companies are extending their Supplier Code of Conduct to enlist environmental principles, for example, from the UN Global Compact, as well as new, more comprehensive international labour and anti-slavery principles; all of which they expect their suppliers to adhere to.
  • Determining the scope of efforts by identifying the greatest actual and potential risks in the supply chain: Gaining visibility into the risks and underlying drivers of negative supply chain impact poses one of the biggest hurdles because of the scale and complexity of many supply chains, with primary suppliers routinely subcontracting portions of orders to other firms[19].

This means that companies need to engage with both direct and sub-tier suppliers. However, a recent survey found that 45% of procurement managers only have visibility into tier-1 suppliers, and an even smaller number, 23%, into tier-2[20], confirming similar surveys over the last few years showing that, despite increased efforts, the majority of companies can’t yet determine the sustainability performance of their own supply chain due to a lack of transparency[21].

Organisations such as the Sustainability Consortium are offering tools (e.g. the “Commodities Mapping Tool”) to help SMEs improve supplier visibility, while larger companies – as mentioned earlier – are turning to CDP in order to get relevant data about their suppliers.

  • Working directly with suppliers to improve their sustainability performance, or sourcing new responsible suppliers that fit the bill: Establishing a continuous communication process, which works top-down as well as bottom-up is crucial, in particular if suppliers are spread across different countries to tackle arising issues early and keep suppliers up-to-date on domestic regulations, which they must adhere to as well. Appreciating that suppliers differ in their know-how and education, larger corporates – in particular food companies that have small family farms in their supply chain – have set-up extensive training programmes to cascade sustainability practices further down the supply chain.

In this context, companies have started to merge supply chain panels with their consumer panels, creating platforms for their supply chain members to hear directly from customers about their views on sustainability and green preferences[22].

  • Tracking performance against agreed goals: In order to reliably measure progress, supply chain visibility and proactive engagement with suppliers is key. Large corporates are going one step further – Unilever, which announced mid-July that it is creating a new €1billion Climate and Nature Fund to achieve a deforestation-free supply chain that promotes regenerative agriculture, said it’ll use satellite monitoring, geo-location tracking and blockchain to increase traceability and transparency within its supply chain. The firm also pledged to build and prioritise partnerships with suppliers who have set their own science-based targets and can declare the carbon footprint of the goods and services they provide to Unilever[23]

To support companies in their efforts towards supply chain sustainability, a number of sustainability networks offer advice: BSR’s “Supply Chain Leadership Ladder”, for example, outlines the most impactful practices for delivering on business strategy, human rights, climate change, and inclusive economy in a supply chain[24]. AIM-PROGRESS is a forum of leading consumer goods manufacturers and suppliers, founded to share knowledge to build sustainable supply chains[25].

The Ten Principles of the Global Compact and Supply Chain Sustainability

The Ten Principles

Relationship to Supply Chain Sustainability

Human Rights

Companies have a responsibility to respect human rights. The baseline responsibility is not to infringe on the rights of others and address any adverse impacts that occur. The Guiding Principles on Business and Human Rights (the Guiding Principles), endorsed by the UN Human Rights Council in June 2011, provide a globally authoritative standard for how companies can meet this responsibility. The Guiding Principles state that companies should have in place policies and processes appropriate to their size and circumstances, including a process of continuous human rights due diligence, to “know and show” that they respect human rights. The Guiding Principles provide conceptual clarity and content to the corporate responsibility to respect human rights described in Principle 1 and 2 of the UN Global Compact. In other words, the corporate responsibility to respect human rights in Principle 1 of the UN Global Compact is the same one described in the

Guiding Principles1. It should also be noted that the Guiding Principles include labour rights in the sphere of human rights for workers. Therefore, the responsibility to respect human rights also applies to Principles 1 to 6 of the UN Global Compact.

Additionally, business can go beyond addressing harm to human rights by taking steps to support and promote the realisation of human rights through core business activities, strategic social investment, philanthropy, public policy engagement, advocacy partnerships as well as collective actions, and there are good business reasons to do so. They should also establish operational-level grievance mechanisms as a key support tool to provide access to remedy for the rights-holders.

Principle 1: Businesses should support and respect the protection of internationally proclaimed human rights; and

Principle 2: make sure that they are not complicit in human rights abuses.

Labour

Labour conditions in offices, in factories, on farms and at natural resource extraction sites such as mines often fall significantly below international standards and national regulatory requirements and can lead to serious human rights abuses. In these contexts, businesses should respect international labour standards within their supply chains, including by ensuring that suppliers respect the rights of freedom of association and the right to collective bargaining, abolishing forced and child labour and eliminating discrimination.

In addition, workers in many countries may be vulnerable to other human rights abuses, including unsafe or hazardous work, excessive work hours, unpaid wages, degrading treatment by employers and inhibited movement. In order to avoid complicity in abuses, businesses should seek to ensure that they do not cause or contribute to the infringement on the rights of workers and that such infringements are not directly linked to their operations, products or services through their business relationships, including with respect to the right to freedom of movement, freedom from inhumane treatment, the right to equal pay for equal work and the right to rest and leisure. The rights of all peoples to work in safe and healthy working conditions and to have access to social protection measures are critically important as well.

Principle 3: Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining;

Principle 4: the elimination of all forms of forced and compulsory labour;

Principle 5: the effective abolition of child labour; and

Principle 6: the elimination of discrimination in respect of employment and occupation.

Environment

Environmental impacts from supply chains are often severe, particularly where environmental regulations are lax, price pressures are significant and natural resources are (or are perceived to be) abundant. These impacts can include toxic waste, water pollution, loss of biodiversity, deforestation, long term damage to ecosystems, water scarcity, hazardous air emissions as well as high greenhouse gas emissions and energy use. Companies should engage with suppliers to address environmental impacts, by applying the precautionary approach, promoting greater environmental responsibility and the usage of clean technologies.

Principle 7: Businesses should support a precautionary approach to environmental challenges;

Principle 8: undertake initiatives to promote greater environmental responsibility; and

Principle 9: encourage the development and diffusion of environmentally friendly technologies.

Anti-Corruption

The significant corruption risks in the supply chain include procurement fraud and third parties who engage in corrupt practices involving governments. The direct costs of this corruption are considerable, including product quality, but often are dwarfed by indirect costs related to management time and resources dealing with issues such as legal liability and damage to a company’s reputation. Companies that engage their supply chains through meaningful anti-corruption programmes can improve product quality, reduce fraud and related costs, enhance their reputations for honest business, improve the environment for business and create a more sustainable platform for future growth.

Principle 10: Businesses should work against corruption in all its forms, including extortion and bribery.

 

Read the other articles in the series:

Green commitments and green legislation

The business case for corporate environmental action

Investing in a smarter and greener infrastructure part 1 – clean energy and sustainable land use

Investing in a smarter and greener infrastructure part 2 – sustainable cities

“Carbonomics” – the future of energy

 

Corporate clients who would like to discuss this topic further should contact:

Dr Arthur Krebbers, Head of Sustainable Finance, Corporates or

Varun Sarda, Head of ESG Advisory

 

[1] http://businesscommission.org/our-work/valuing-the-sdg-prize-in-food-and-agriculture

[2] https://resources.ecovadis.com/2019-barometer/2019-sustainable-procurement-barometer

[3] https://www.bsr.org/reports/BSR_Climate_and_Supply_Chain_Management.pdf

[4] https://www.gov.uk/guidance/publish-an-annual-modern-slavery-statement

[5] https://www.bsr.org/reports/BSR_Climate_and_Supply_Chain_Management.pdf

[6] https://www.mckinsey.com/business-functions/sustainability/our-insights/starting-at-the-source-sustainability-in-supply-chains

[7] https://carbon.ci/insights/seven-ways-to-reduce-emissions-in-your-supply-chain-demystifying-scope-3-greenhouse-gas-emissions/

[8] https://www.pepsico.com/docs/album/esg-topics-policies/sfp-scheme-rules.pdf?sfvrsn=fb5b95cf_4

[9]  https://www.forbes.com/sites/mikescott/2019/02/11/companies-look-to-supply-chains-for-sustainability-gains/

[10] https://sciencebasedtargets.org/case-studies-2/case-study-kellogg/

[11] https://sciencebasedtargets.org/case-studies-2/case-study-tesco/

[12] https://www.cdp.net/en/research/global-reports/changing-the-chain

[13] http://www.wrapni.org.uk/sites/files/wrap/Waste%20Minimisation%20Across%20the%20Supply%20Chain%20-areas%20to%20focus%20on.pdf

[14] https://www.integrated-skills.com/en/2017/04/28/supply-chain-waste-reduction/

[15] https://businesscasestudies.co.uk/building-a-sustainable-supply-chain/

[16] https://www.ncub.co.uk/success-stories/creating-sustainable-supply-chains

[17] https://www.ey.com/Publication/vwLUAssets/EY-building-responsible-and-resilient-supply-chains/$FILE/EY-building-responsible-and-resilient-supply-chains.pdf

[18] https://www.ey.com/Publication/vwLUAssets/EY-building-responsible-and-resilient-supply-chains/$FILE/EY-building-responsible-and-resilient-supply-chains.pdf

[19] https://www.unglobalcompact.org/what-is-gc/our-work/supply-chain

[20] https://resources.ecovadis.com/2019-barometer/2019-sustainable-procurement-barometer

[21] https://www.sustainabilityconsortium.org/wp-content/themes/enfold-child/assets/pdf/2016-impact-report.pdf

[22] https://www.seafish.org/article/supply-chain-and-consumers-panel

[23] https://www.wemeanbusinesscoalition.org/blog/unilever-launches-e1bn-climate-and-nature-fund/

[24] https://www.bsr.org/reports/BSR_Supply_Chain_Leadership_Ladder_2017.pdf

[25] https://aim-progress.com/introduction

 

ESG/Sustainability


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