Supply chain management is a complex domain governed by different standards, regulations, and strategies. Supply chain risk materializes more and negatively impacts businesses without these standards.
The Environmental, Social, and Governance (ESG) criteria are integral to these standards or regulations. The ESG criteria is a set of guidelines for eco-friendly, socially acceptable, and ethical supply chain operations.
Although the ESG criteria cover all supply chain operations, it primarily focuses on procurement, sourcing, and supplier management. So, what exactly is ESG? How does it impact a business in the supply chain? How can a company remain compliant? Today’s article will answer these questions based on evidence. Read on!
What is ESG?
ESG refers to environmental, social, and governance. It is a set of regulations, guidelines, or standards for a business’s behavior used by environmentally and socially conscious investors to monitor and analyze potential investments.
For example, the environmental (E) criteria focus on how a business in the supply chain protects the environment. It involves a company’s corporate policies and strategies that address global warming and climate change.
In addition, social (S) criteria require a company in the supply chain to streamline relationships with suppliers, employees, customers, and communities. The last one is “governance (G),” which examines a company’s
- Executive pay
- Internal controls
- Shareholder rights
- Internal audits
Environmental issues experienced by supply chain companies are corporate climate policies, waste, pollution, energy use, treatment of animals, and natural resource conservation.
Implementing an ESG strategy or following the guidelines can help your company assess environmental issues and risks. It also allows you to develop risk mitigation strategies and improve supply chain operations. For instance, you can:
- Reduce greenhouse gas emissions
- Manage waste, including toxic products
- Follow the environmental regulations
- Educate employees and stakeholders
“Social” is an integral component of the ESG standards or criteria. It evaluates a business’s relationships with stakeholders, including internal and external stakeholders. Besides, it allows your company to determine whether suppliers have their ESG standards.
It also enables you to analyze how much your company should donate a profit percentage to the local community. Following the social standards allows you to streamline your workplace conditions and ensure it reflects a high regard for your workers’ health, wellbeing, and safety. Most investors seek businesses that focus on socially and ethically conscious domains. These are:
- Social justice
- Community focus
- Corporate ethics
- Overcoming discrimination, including
- Donating a percentage of profit to the local community
ESG governance standards are critical for a company to improve efficiency, accuracy, and transparency. It focuses on a company’s administration, allowing it to implement leadership diversity and integrity. It also makes a business more accountable to shareholders.
The purpose is to streamline operations, avoid conflicts of interest, and choose the board of directors, board members, and senior executives on merit. Following the governance, criteria is an excellent way to prevent political interference, illegal conduct, and preferential treatment.
Why Is It Important?
ESG plays a crucial role in business development, growth, operations, profit, employee retention, brand reputation, etc. Supply chain companies implementing an ECG program or strategy perform better and stand out from the competition.
According to EDELMAN, 86% of consumers expect chief executive officers (CEOs) to focus on societal problems and play their role in overcoming those problems and complications.
WTW reports that 58% of employees consider ESG standards and commitments when applying for jobs or choosing supply chain companies for their careers. Research shows that 64% of millennials avoid applying for a job in a company without solid sustainability practices.
In addition, WTW highlights a company is three times more likely to retain employees by implementing and maintaining ESG standards. Besides, employees are 1.5 times more engaged and increase their productivity, improving a company’s operations and boosting its overall bottom line.
A company with a responsible corporate ESG model or program stands out from the competition. However, implementing and maintaining an ESG program is daunting and time-consuming because it requires careful planning and preparation.
According to UNPRI, not following or maintaining ESG standards in supply chains can lead to severe consequences. Neglecting ESG can lead to various complications, including:
- Disruption in materials’ flow, including raw materials
- Negative impact on products’ delivery times
- Adverse effects on customer satisfaction
- Corruption and lack of internal audits
- Ineffective supplier audits
- Poor financial management
- Poor brand reputation due to
- Human rights abuses
- Carbon emissions
- Increased supply chain costs
- Decreased employee retention rates
How Can a Company be Compliant?
Implementing ESG standards in your company’s compliance program is an excellent way to streamline operations and improve supply chain networks. However, not all supply chain companies understand the criteria, rules, standards, regulations, and steps to craft a solid strategy and remain compliant. Here are the steps to achieve your goals.
Step 1: Set Goals and Objectives
Setting SMART goals and objectives is critical to establishing an ESG compliance program for your company and improving supply chain operations. So, you must develop specific, measurable, attainable, realistic, and timely goals to reduce the impact of stakeholders, consumers, and employees on the environment, society, and governance.
Besides, your goals must also emphasize legislation, supply chain networks, appeal to investors, business improvement, providing consumers with quality products, and implementing a fair recruitment system in the company. Remember, you can create as many goals based on your requirements. However, your plan must align with the ESG compliance guidelines.
Step 2: Seek Business Support
Today, investors focus on ESG compliance and support businesses to obtain long-term sustainability. So, you will attract more investors when you remain compliant to the ESG standards.
More investors mean an increased number of funds to streamline your operations. Perform thorough research to understand the investors’ requirements to provide funds to supply chain companies.
The research will help you collect real-time data, and you can analyze it to generate valuable insights. These insights will help you make an informed decision and seek business support from investors that provide funds based on ESG compliance.
Step 3: Choose the Right Framework
Selecting and implementing a compliance framework is essential to optimizing the overall process. However, the framework you choose must align with your company’s goals. For instance, you can choose from generic compliance frameworks, such as ISAE 3000 or ISO19600.
The good news is that you can modify the framework based on your requirements. The purpose is to cover numerous aspects of your business. On the other hand, you can apply a more specific framework to each ESG topic/concept.
For example, you can apply the “Green House Gas Protocol & Corporate Accounting” standard. Besides, implementing the framework requires you to incorporate a reporting system in a format easily understood by investors.
We recommend taking your time and identifying obligations that require fulfillment on a priority basis. Once you have set priorities, develop communication policies, focus on resources, and implement protocols for achieving each objective defined in the compliance framework.
What are the ESG Risks Related to the Supply Chain?
Supply chain networks have become more complex, particularly during the Covid-19 pandemic and due to the Russia-Ukraine war. About 80% of trade passes through global supply chains.
Most companies outsource production to suppliers in countries with a significant cost advantage. The purpose is to save money and achieve substantial economic benefits.
Although new policies, regulations, and technology innovations have streamlined supply chain operations, most companies are vulnerable to risk in different domains, including ESG issues that can lead to operational and reputational risks for businesses.
Although some industries generate more carbon emissions, climate risks impact all sectors. For instance, most financial organizations evaluate a supply chain company’s operation before financing. Banks, lenders, investors, and other key players provide funds to supply chain companies that focus on eco-friendliness and sustainability.
Besides, nature-related risks from supply chain operations are deforestation without following the rules/regulations, raw material depletion, and waste of water and other natural resources.
So, supply chain companies that work with resource-intensive industries, such as manufacturing and agriculture, must focus on these risks and develop strategies to reduce them. The purpose is to remain ESG compliant.
One of the most significant social risks in the supply chain industry is the violation of human rights. A company that follows the United Nations’ “Universal Declaration of Human Rights” performs better and remains compliant with ESG standards.
These include rights to life and liberty, the right to work, and the right to health and safety. A supply chain company must also follow labor standards. Risks around workplace conditions and salaries are more likely in companies and industries with large workforces.
Some supply chains experience forced labor and child labor, which clearly violate human rights. The problem is more prevalent in third-world countries. However, even if the supply chain does not have these issues, authorities must treat their workers fairly and provide them with reasonable wages.
Corruption is one of supply chain networks’ most significant governance risks. For example, a dispersed supply chain prevents companies from monitoring suppliers, vendors, and other stakeholders. The problem worsens when business partners are far-off jurisdictions.
Corruption in the supply chain is directly proportional to reputational damage. It may also cause a company to experience legal penalties. Supply chain companies with an infective internal control or management system experience risks.
It leads to decreased revenues, reputational damage, and reduced employee retention. Therefore, you must develop and implement a solid audit system to achieve accuracy, transparency, reporting, and compliance.
For example, if a supplier lacks proper internal controls, you may not know their financial wellbeing and strategy to monitor, manage, and report on ESG-related problems.
Why is Supplier Audits Important to Reducing the ESG Risks?
The supply chain has become complex because it continuously grows and creates a more complicated network of manufacturing hubs, logistics, and distribution centers. A large supply chain is more vulnerable to risks and complications.
These include working with companies within unregulated markets, dangerous working conditions for employees, low-quality products, corruption, etc. Embedding ESG frameworks is an optimal way to identify and reduce risks faced by companies in the supply chain.
The purpose is to achieve an ethical, resilient, community-driven, and sustainable supply chain. A supplier audit is an excellent method to inspect and analyze a supplier’s usage of regulation practices, including ESG standards emphasizing environmental, social, and governance-related aspects.
In addition, a supplier audit covers a wide range of practices, allowing companies to streamline operations by identifying and mitigating ESG risks. Remember, the supplier auditing process differs for each industry in the supply chain network, from agriculture and food to manufacturing and distribution of goods.
An internal team of an organization led by the quality department performs the supplier audit. It collects information from suppliers and determines whether the auditing process should be carried out in-house or through a third-party auditor.
We recommend conducting a supplier audit through a neutral third-party company. A third-party inspection company assesses a supplier’s compliance on your behalf and focuses on specific quality standards and requirements. A supplier audit offers the following benefits in accordance with the ESG guidelines.
Improves Quality Standards
Your final product’s quality primarily depends on the suppliers’ quality and efficiency in operations. We recommend enforcing ESG standards across the supply chain to ensure efficiency, reliability, and consistency.
For example, compliance with quality management, industry standards, and ESG criteria are essential to measuring, and you do this through a quality management system. A professional supplier audit will discover non-compliant material and help you develop a strategy to ensure conformance to the ESG and industry standards.
Risk Identification and Management
A supplier audit is a reliable method to identify areas of potential risk. For instance, you can perform traceability and product genealogy of each part, leading to operational excellence and sustainability throughout the product lifecycle.
Besides, a supplier audit helps identify gaps in ESG compliance, supplier quality, design/engineering change process, manufacturing procedure, and shipping activities. So this allows you to close the loop on delays, nonconformances, and deviations.
Streamlines Cost Management
ESG requires a supply chain company to comply with environmental, social, and governance criteria. However, not auditing your suppliers can increase ESG risks and cause quality issues.
Remember, quality issues mean increased costs and less revenue. Therefore, you must perform a supplier audit to evaluate the supply chain performance. Suppliers have a substantial effect on the cost of quality.
Numerous factors lead to this problem, but the most significant one stems from supplier-related activities. An audit allows you to identify the potential risks and recover the cost of poor quality.
However, this requires you to collaborate with the supplier and focus on a strategy that improves quality and recovers costs. Moreover, this may involve supplier chargebacks to fully recover the cost of defective products.
Faulty products can negatively impact consumers and go against the ESG guidelines, putting your company’s reputation at risk. Therefore, a supplier audit is essential to streamlining your ESG program or strategy.
Enhances Communication Regarding ESG Guidelines
A supplier audit improves supplier/vendor/manufacturer communication, allowing them to collaborate and implement ESG programs. It enhances visibility into supplier-related operations and provides an open exchange of real-time data and information to ensure transparency and compliance with ESG.
We suggest scheduling regular audits to streamline your relationship with suppliers and meet goals. The purpose is to achieve mutually beneficial goals that align with ESG criteria.
What is the ESG Effect on the Supply Chain?
The concept of ESG has become increasingly important for companies in the supply chain network, allowing businesses to optimize their operations, follow the regulations to overcome environmental, social, and governance issues, and stay afloat in the market. Here is how ESG affects the supply chain.
Increases Supply Chain Efficiency
While ESG is an essential aspect of your business that brings value, it increases supply chain efficiency. For instance, sustainable operations allow companies in the supply chain to better align their processes with ESG goals and reduce waste, resources, and water usage. ESG can improve supply chain operations and ensure efficiency by:
- Reducing costs through decreased waste, pollution, and energy utilization
- Meeting regulatory requirements, such as reducing carbon dioxide emissions
Research shows that Anglian Water is a reputable water company in the UK that has implemented the ESG guidelines, and since 2010, it has 38% of waste and 63% of carbon emissions.
Improves Supply Chain Visibility
ESG data can help a company analyze and understand how the supply chain performs. It enables you to identify performance-related issues and areas that need continuous improvement.
So, real-time data can help you make SMART decisions and improve supply chain performance. Suppose the supplier does not comply with ESG criteria or fails to meet its commitments, such as quality and delivery times. In that case, you may end the contract and look for another supplier that follows the ESG guidelines.
Enhances Business Reputation
Implementing an ESG program is an excellent way to attract new investors, suppliers, and clients. For instance, consumers purchase products that align with their requirements, needs, and values.
On the other hand, if your product’s quality is not up to the mark, you will lose customers and negatively impact your brand’s reputation. Complying with the ESG guidelines can help retain existing customers and attract new ones.
Likewise, employees with positive workplace experiences have increased productivity. Not only do they provide value to your company, but they also stay on the job for a prolonged period. So this enables you to improve employee retention rates.
The “social” aspect of ESG is essential to streamlining productivity at the workplace, leading to increased revenues. It requires you to address challenges in the supply chain, particularly the ethical, human resource, and health & safety problems.
Streamlines Risk Mitigation
Complying with ESG and leveraging real-time ESG data can benefit numerous business areas. It mitigates risk, allows you to implement performance management systems, and measure growth strategies.
So, you must follow the ESG guidelines and modify your strategies accordingly to minimize risks associated with suppliers, business partners, stakeholders, investors, and customers. An ESG program can help you overcome the following:
- Toxic waste issues
- Water pollution
- Loss of biodiversity
- Carbon emissions
- Damages to ecosystems
- Greenhouse gas emissions
- Energy wastage
Moreover, you can overcome social risks in the supply chain, including human rights violations and community welfare, development, and safety issues. Governance issues can take a massive toll on the supply chain.
It can affect your organizational culture, employee retention, and other aspects, including recruitment and onboarding. One of the most significant problems faced by supply chain companies is corruption, leading to reputational damages, loss of revenue, and reduced trust among business partners and consumers.
The good news is that you can implement the ESG program and modify your supply chain governance strategy to initiate, develop, and maintain relationships with all “links” in the supply chain. It streamlines financial, material, and human resources and ensures the flow of the ESG framework.
A supply chain company’s ESG impacts its overall business operations. For instance, if your company uses child labor in manufacturing products/goods, you will experience reputational damage and face legal penalties after consumers discover this inhumane act.
Therefore, implementing and maintaining ESG compliance programs is essential for companies in the supply chain to streamline business operations, increase revenues, improve brand reputation, and achieve long-term sustainability goals that favor the environment, society, and your company.