Three Critical Tracks for Embedding ESG in Supply Chain

Editor’s note: This is the sixth article in an ongoing series on the crucial role of supply chains in balancing the evolving needs of customers and making progress toward meeting ESG (environmental, social, and governance) goals and an evolving landscape of government regulations.

As illustrated throughout this series, the supply chain serves as the pivotal hub for setting and achieving environmental, social, and governance (ESG) goals and complying with the growing array of supply chain due diligence regulations. Every company navigates a tightrope, balancing business growth, supply chain resiliency, and ESG risks and performance. Companies will fail if they treat the supply chain function as merely being the messenger passing requirements onto suppliers. To excel in this expanded role, supply chain leaders must effectively orchestrate three interrelated tracks: supplier cooperation, data availability, and internal buy-in.

Much has been written about using ESG as a metric to gauge a company’s material, non-financial risks to gain a better understanding of long-term growth and sustainability. To improve their standing in this area, companies have made pledges, published reports, and appointed ESG or sustainability leaders. Making public commitments has proven to be much easier than achieving the stated goals. To a large extent, the challenges come from the supply chain whether it is carbon-emissions or human rights in the workplace.

To start, every company must understand their customer’s ESG expectations, whether businesses or consumers. After extensive conversations with over 30 global companies, it is evident they face mounting pressure to help their customers meet ESG goals. To do this effectively, companies must understand their role in their customers’ supply chain and how their supply chain influences these customers. Material, component, and transportation suppliers are starting to promote carbon reduction, water conservation, or fair labor practices as a key part of their offerings. This is another example of why the supply chain must do the Frontside Flip to align with marketing and product development.

Emerging from the expectations of customers and other key stakeholders (e.g., investors, employees) the ESG goals must be aligned with and integrated into the overarching business strategy. Because supply chain owns the supplier relationships and so much is riding on those relationships, the supply chain leader must take the lead in orchestrating both internally and with the suppliers.

Supplier cooperation

Building trust and transparency with suppliers is an essential step in gaining their cooperation. Historically, the dynamic between a large buyer and often small and mid-size suppliers on ESG issues has resembled a cat-and-mouse game. The buyer’s ESG or sustainability department sends out a supplier code of conduct and hires independent auditors to monitor performance against the code. Often, the supplier’s and the buyer’s supply chain departments have vested interest in performing perfunctory checks to pass audits and ship products. However, new regulations and enhanced technology-enabled visibility into supply chain practices make check-the-box exercises increasingly dangerous. It’s useful to think in terms of the UN Guiding Principles to honestly determine if you could be seen as causing a negative impact on a supplier, contributing to the negative impact, or whether you could be linked to it.

Related:

Read part 1: Supply chain: The intersection of ESG and the new customer

Read part 2: The supply chain is the hub for creating new constellations of value

Read part 3: Unlocking competitive advantage through strategic data sharing

Read part 4: Supply chain must lead the shift from risk mitigation to competitive advantage

Read part 5: Supply Chain Due Diligence: New Regulations and What You Need to Do

Companies need the cooperation of their suppliers to collaborate to meet the requirements of the supply chain due diligence regulations and, equally important, to get reliable data to meet reporting and disclosure requirements. To get supplier cooperation, you will first need to build a unified front in your company, so you are sending the supplier a consistent message. More on this when we talk about the internal buy-in track.

Here are some tips on getting supplier cooperation:

• Incorporate ESG performance metrics into supplier evaluations or scorecards along with traditional business criteria. Some companies are now allocating up to 20% of the evaluation to ESG performance.

• Explain your ESG goals or supply chain due diligence program to suppliers and seek their collaboration as a partner trying to solve a problem – not a punishment.

• Prioritize areas where you need their support instead of asking them to do everything at once.

• Establish a “preferred supplier” program that has ESG performance requirements and clear business benefits (e.g., longer term contracts, more consistent order volumes)

• Provide resources to help suppliers measure and improve the maturity of their ESG program, making it easy for them to improve, which, in turn benefits you.

Data availability

Much of the data you need for reporting will come from suppliers. The data must be reliable and timely. Ideally, your organization has considered data availability when setting goals, so this isn’t a complete scramble. Either way, in our conversations we’ve heard over and over that getting data from suppliers is a big job. While the supply chain function is not responsible for compiling ESG reports, you play a key role in getting the data. Many companies rely on industry averages for measuring carbon emissions, but with key suppliers, actual data is crucial for establishing baselines and tracking actual carbon reduction. To meet supply chain due diligence laws, you need accurate data on a range of environmental and human rights issues in your suppliers.

Here are some tips for managing data availability:

• Establish a strategic data sharing relationship asking suppliers to provide needed ESG data while identifying valuable data you can provide them.

• Approach relationships with key suppliers as a collaborative partnership rather than a policing action, making it clear that accurate, trusted data is the most important thing and that there is no penalty or harm if their current performance is worse than desired. The point is to measure and improve.

• Assist suppliers in finding efficient ways to collect the data you need rather than leaving them to figure it out on their own.

• Share ideas with suppliers about how they can use the data to improve their business performance or even gain a competitive advantage in attracting new customers.

• Use qualified people in the collection and verification process.

Internal buy-in

Companies often contend with conflicting interests and commitment levels regarding ESG performance and reporting. New regulations amplify the potential liability for inaccurate or misleading reporting. In response, many companies are pulling back on public announcements, reducing disclosures, and even changing the terminology they are using.
The need for cross-functional collaboration is greater than ever. Supply chain leaders play a central role in guiding the cross-functional process to set and achieve meaningful ESG goals. Tough questions will need to be addressed and the supply chain leader is uniquely situated to gauge the overall impact of decisions. For example, what if a shipping company claims a 10% reduction in carbon emissions but shipping costs go up by 3%? What if a supplier says they can eliminate excessive working hours in their factory, but it will increase lead times by 10 days?

To address these tough questions, aligning internal performance metrics and compensation becomes essential. Just as companies need to include ESG performance in supplier evaluations, companies need to align internal performance metrics otherwise internal buy-in will never be achieved. Conflicting performance metrics between the sales, supply chain, and ESG functions will lead to conflicting messages to your suppliers, often leading to a lack of transparency, false reporting, and things like the use of unauthorized subcontractors.

Conclusion

Supply chain leaders can be a powerful force for change as ESG is integrated into a company, or they can be a roadblock resisting change. Customers, consumers, and stakeholders seek to buy from, work for or invest in companies that are integrating ESG into operations. It is incumbent upon supply chain leaders to accept the challenge and orchestrate these three tracks. Companies that do this successfully will gain a sustainable competitive advantage.

About the author:

Craig Moss is executive vice president of Ethisphere and director of the Digital Supply Chain Institute.

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