Beyond the Barcode: the new era of supply chain accountability
The past year has seen legislative developments one after the other and really does feel like a shift in the way companies are expected to do business.
A lot of this focus has been on the wave of EU legislation coming into effect over the last few years, ranging from the Critical Raw Materials Act (CRMA) and Deforestation Regulation (EUDR), to the Forced Labour Regulation. However, as we reported recently, this is a global trend, originating with the California Transparency in Supply Chain Act and now more recently with Australia and Canada’s Modern Slavery Acts.
Eyes are also on wider sustainability/ESG legislation that is in force from this year, such as the EU Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive (CSDDD), and the United States Securities and Exchange Commission (SEC) Climate Ruling. The UK is thought to be just behind the EU on most of this legislation, with proposed legislation such as the Sustainability Disclosure Requirements (SDR) not currently in force but under review.
But what do all of these have in common? They all point to where our products and materials come from and how e.g., supply chains.
The legislation all stems from the increased pressure from investors, governments, and consumers on better supply chain practices and more transparency to make these judgments. This is particularly important for more developed countries that import many of the products and services. Aside from the legislation, we have also seen a large uptick in companies reporting voluntarily against supply chain standards, or frameworks that include sustainable supply chain practices. Examples include, the Global Reporting Initiative (GRI) and the Carbon Disclosure Project (CDP).
Supply chains are something we are all tangled up in and there is no avoiding the fact businesses need to take more responsibility for the impact they have on wider society and the planet through their supply chains. So we asked our supply chain expert, Wiebke Flach, for a few insights on the topic.
What trends have we seen in legislation in recent years around supply chain management?
Wiebke: So I would say that there is an overall trend towards more legal requirements with teeth, compared to previously primarily voluntary efforts. It’s also no longer just the EU and the UK who are leading with this but also increasingly North America, Australia and New Zealand and I would say that within the types of legislation that regulate supply chain management there’s at least five trends.
- Transparency: it’s always about visibility, traceability, how well you know your supply chain all the way upstream.
- Accountability: it’s no longer just this opaque concept of ‘the business has to do it’ but there’s an increasing expectation of robust governance around this and individuals who have technical expertise and who have clear responsibilities. Importantly, this implies that businesses can in future be fined for being non-compliant with regulation. If we think of CSDDD, it could be up to 5% of global revenue that they can be charged. So this is definitely a big shift from what used to be a voluntary approach.
- Materiality: it’s increasingly all about materiality. For example, what are the risks that are particularly important for your industry and for your business, from the perspective of risks to your business as well as risks to the environment and to people in your supply chain. This concept is termed Double Materiality.
- Shared Responsibility: The shared responsibility concept requires contractual adjustments and acknowledgements of brands to do more than just articulating their expected standards to their suppliers. They now need to inform and educate their suppliers. They need to support them in due diligence, and of course in remediation should something go wrong. And they may also have to support them on costs for audits for instance. It is no longer sufficient to have a policy that is very comprehensive and just cascade that down your supply chain and say, “I told you so. You signed here. You didn’t do it. You’re non-compliant. Goodbye” that is no longer acceptable. Businesses will have to work with their suppliers to improve performance, instead of moving business elsewhere. One practical example for shared responsibility is responsible disengagement. Responsible disengagement from business partner relationships should be applied as a “measure of last resort”, where severe impacts outweigh the negative consequences of contract termination. This requires careful comparative analysis, effective stakeholder engagement and likely a phased withdrawal.
The regulation is basically just responding to what we see, which is more disrupted supply chains in the sense that we have more severe weather events that have impacts on supply chains. We have more issues with increases in modern slavery globally that requires more scrutiny. All of the risks are getting worse and therefore, there’s more incentive for governments to regulate because voluntary approaches have not been successful.
On the positive trend though, I would say that there’s been some research from the CCLA, which is a British investment management company and The Mekong Club, which is a nonprofit organization and a business membership organization, that see more and more businesses are willing to publicly disclose issues in the supply chain that they have identified. So there is an element of uptake that we see and that’s moving in the right direction. Transparent businesses can focus on addressing these issues and no longer be busy with trying to negate that there are any issues.
How does this all relate to the general ESG/sustainability movement?
Wiebke: I think it’s important to acknowledge that it would be inefficient and ineffective for businesses to separate their efforts on environmental due diligence and human rights due diligence. This applies equally, their impact measurement, their data measurement, their supply chain measurement and their risk analysis. All of these business processes can tackle environmental and human rights issues because they are interlinked at the community level. For example, if an apparel manufacturer has poor wastewater management in the community then this has a direct environmental impact on the biodiversity of the area. It also has a very real impact on the local community that is exposed to maybe toxic waste water in drinking water. The Just Transition movement is a response to acknowledging that.
So for instance an increasing use of electrification and battery usage might have some beneficial impacts in terms of reduced carbon emissions. However it could have negative implications on a human level. We need to consider how minerals for example are mined and what the implications are for the workers in these mines and the human rights risks they are exposed to there. So I increasingly see an interlinking of environmental and social issues in supply chains at the beginning of the due diligence processes. Of course, they then eventually diverge again and need technical knowledge for in depth analysis. But as a starting point, I think businesses will be able to be more efficient and more effective if they look at human rights and environmental impacts together from a Just Transition perspective.
This is reflected in the most recent legislation, with the CSRD and CSDDD covering environmental and social risks together.
What are the wider benefits of successful supply chain management?
Wiebke: I think ultimately businesses need to understand that this is an element of risk management that they need to do because environmental risks and human rights risks are definitely on the up. The complexity of supply chains also continues to increase with increasing product complexity. The lack of visibility particularly in the lower tiers is still a very big issue for many brands and retailers. So the clear benefit would be for businesses to invest in robust due diligence and robust risk management in order to avoid supply chain disruption.
1. Avoided cost and disruption
These are the most costly for businesses as we see in the cases of the automotive sector for instance in the US where finished products from the likes of Volkswagen, BMW and Jaguar Land Rover could not be sold without adjustments due to not meeting legislative requirements.
Greenheart note: All three manufacturers were caught out when the Senate finance committee uncovered that elements of some vehicles were sourced from the Xinjiang region of China which has been found to use forced labour of ethnic minority groups.
There’s a huge cost risk for businesses and that’s on the product side but in terms of the compliance side it should be made clear to businesses that prevention, while it seems a lot of effort and cost to begin with, will always be cheaper than remediation.
Greenheart note: costs can be in different forms:
- Fines for non-compliance: in the case of the EU CSDDD for example, businesses could be fined up to 5% of global revenue
- Reputation: revenue loss from a loss of good reputation can be catastrophic for businesses. Regulatory bodies in the EU for example have openly threatened to name and shame those not complying.
- Distribution: Having to withhold the sale of products, or replace elements that are non-compliant can be extremely costly in terms of the delay in revenue, termination of contracts and also the remediation cost of replacing these at late notice.
Source here
2. Public perception
There is so much more scrutiny on what companies can legally communicate on their green credentials or their efforts in preventing any negative impacts on their workforce or on human rights. Any company who invests in that and understands their supply chain and has done proper due diligence is able to match the reality of their operations much better to their narrative in the public domain. This protects their brand and their reputation effectively.
3. Recruitment and retention
Talented Gen Z’s are increasingly saying they are motivated by working for companies that can demonstrate their commitment to ethical business practices. Responding appropriately to the current regulation by embedding robust due diligence processes will help with retention and recruitment.
4. Staying true to business values
So, many businesses have the best intentions, but unless they really put some effort into this, they might unwittingly make a lot of things worse in their supply chain. To understand the impact of your business, you need transparency of your value chain.
What is the biggest challenge you see for businesses in their supply chain?
Wiebke: I think visibility in particular in the lower tiers, so upstream, is still a huge challenge. Generally the more vertically integrated a business is, the more transparent and the more effective the risk management usually is. But, with the ones that are not vertically integrated, lower tier visibility is still very difficult. Obtaining quality data is tedious and that’s a hurdle for businesses. It makes it harder for them to prioritize and meaningfully understand and measure their risk or measure their progress.
Another big challenge is over reliance on compliance through traditional audit tools. We see a trend in businesses acknowledging that audits are just one tool in the toolbox and a moment in time that may not reflect what is really going on in their supply chain. These businesses therefore shift away from rewarding suppliers for being compliant and instead actually reward them for being transparent. This is because, you can’t get more transparency if all you monitor is compliance. Requiring your suppliers to demonstrate compliance is almost counterproductive to the transparency you need to really understand your risk as a business. So some large businesses such as Walmart for instance, are experimenting with this to try to build more trust with their key suppliers. That is an interesting shift because it addresses the core problem of an ongoing issue around data quality and visibility by saying: okay, let’s not make this about compliance let’s make it about transparency and from there investigate together and understand root causes, scale and severity of these issues, and then try to address them.
The concept of responsible disengagement is another very important regulatory shift that businesses should be aware of. They can no longer simply exit contractual relationships in case of risks or non compliances. Instead, the negative implications of contract termination need to be considered and only if business continuation would cause more harm, responsible disengagement is acceptable.
How do businesses need to take a different approach to procurement than they have historically?
Wiebke: Historically a starting point for businesses would have been to do a policy review and that would have been commonly recommended as well as a logical starting point. So clarifying your commitments and then being able to communicate that to your supply chain partners. I no longer think that’s a meaningful starting point. I would say it’s important for businesses to start with a self assessment and really hold up the mirror in terms of trying to understand where they’re at, what they are procuring and what are their purchasing practices, really looking at that first and foremost. There are tools out there for that, for instance, baseline assessments by The Mekong Club.
Secondly, focus on the risk assessment from a double materiality perspective. Understand what the main risks to the business are, for example, raw material shortages and supply chain continuity. And then looking at the businesses impact on human rights and the environment.
The policy review and formulating a commitment should come after because the business has established a good understanding of the status quo and the severity of the issues that are impacting them and their industry specifically. Doing a self assessment and materiality assessment before formulating business commitments and policies is more honest because it is rooted in operational reality. It is important to include procurement teams much more than they historically were. The difficulty is that sustainability touches on many different business departments. Procurement has so far been very focused on commercial targets that have not been influenced by ESG targets and KPIs. The shared responsibility concept mentioned under CSDDD is certainly trying to end such segregation. So when you review your policies you also need to review your supplier contracts, supplier training and very importantly also internal staff training for procurement teams amongst others.
Ideally, brands should have monitoring tools to track how far their suppliers are able to work with them in integrating environmental and social criteria. Supplier scorecards can be rolled out consistently through various departments and incentivise good practice amongst contractual partners.
Conclusion
There is a lot of complexity in supply chain management and many businesses feel ill equipped to meet the increasing regulatory demands. A robust review of existing processes is needed for many to avoid costly mishaps and at worst, negative impact on people and planet.
Starting points could be:
- A Double Materiality Assessment
- Compliance horizon scan
- Supply chain mapping and hotspot analysis
What next?
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