Sustaining the supply chain

Authors: Donald Reed and Cope Willis.

As supply chains become more complex and extended, managing the sustainability risks of disruption and interruption have become ever more critical and difficult. How can your business overcome the vulnerabilities in its supply chain and turn strategic sourcing safeguards into competitive advantage?

Both the mounting costs and heightened vulnerability have brought supply chain disruption to the top of the risk register in recent years. In 2008, a PwC study of 600 companies that had experienced supply chain disruptions showed that, relative to peers, their average share price declined by nearly 20%, share price volatility was higher, and return on sales and return on assets were lower.1

As companies become more global in scale and dependent on emerging markets, these risks can only escalate. Social and environmental issues are creating further vulnerability. One recent example of a supply chain disruption attributed to climate change was the unusually prolonged drought in Russia over the summer of 2010. By early August, over one-fifth of Russia’s wheat crop had been destroyed and the government banned all grain exports, contributing to wheat price futures reaching their highest point in nearly two years. General Mills was one of many food manufacturers that faced significant price pressure as a result, announcing increases between 4% and 5% in September 2010.2

As businesses come under increasing customer, investor, media and other stakeholder pressure, leading companies are developing more proactive strategies to manage sustainability risks and strengthen resilience in their supply chains. This article examines today’s leading practices and opportunities for further innovation and development.

Assessing the risks

Sustainability risks take a variety of forms. The primary focus of this article is:

  • Climate change and related extreme weather events, such as floods, droughts and forest fires
  • Environmental damage, such as critical habitat destruction, threats to iconic species, chemical spills and other pollution
  • Social, safety and labour practice issues, including unsafe working conditions, human trafficking, use of child labour and damage to health

The potential impact includes breakdowns in the supply of key parts or commodities, which can disrupt production and core business operations. It also includes swings in the price of raw materials, which can erode margins and revenues. In turn, incidents within the supply chain can tarnish the brand, spurring customers to switch their business and leading to resulting falls in revenues and share values. If such supply chain disruption and reputational damage are not addressed quickly, the short-term financial losses may become more serious strategic issues as competitors move in to seize lost market share.

Figure 1 highlights some examples of social and environmental supply chain disruption that have affected companies since 2010. In the autumn of 2011, for example, unusually intense monsoon conditions in Thailand flooded more than 1,000 factories in the central region of the country, severely disrupting the global supply of hard drives due to the concentration of assembly plants in the affected region.3 The knock-on impact led to fourth-quarter revenue downgrades by a number of leading global computer manufacturers. This included Acer, the world’s fourth-largest PC maker, who cut its fourth-quarter sales projection by 5% to 10%.4

Pressure from consumer groups has also forced companies to tackle social and environmental issues in their supply chains. For example, cocoa sourcing in West Africa has been contentious for its association with child labor. Some companies have responded to this by working with industry groups and NGOs to source certified cocoa.

In a further example, Apple has faced growing scrutiny over working conditions among its suppliers after two workers were killed and over a dozen injured by an explosion at an iPad manufacturing facility in May 2011.5 In response in February 2012, Apple hired the Fair Labor Association to conduct audits of its final assembly suppliers.6

Some of the incidents outlined in Figure 1 are too recent to fully gauge the commercial impacts. But a 2010 study documented case studies of sustainability-related supply chain incidents affecting six companies between 1999 and 2008. These resulted in direct costs per incident of between $11 million and $250 million, and/or indirect costs associated with declines in stock value of 5% to 18%.7

Meeting stakeholder expectations

To safeguard supply chains, stakeholders have pushed for a variety of voluntary and regulatory sustainability standards. These primarily focus on raw material production and sourcing, manufacturing practices and public disclosure of supply chain impacts.

The result has been a proliferation of industry-specific and cross-industry supply chain initiatives that promote voluntary social and environmental standards. Initiatives such as the Electronic Industry Citizenship Coalition (EICC) and the Supplier Ethical Data Exchange (SEDEX) have gained wide participation among companies seeking to demonstrate their commitment to responsible supply chains. In agricultural commodities, consumer groups have brought together relevant stakeholders in the industrial products, food manufacturers, agribusiness and consumer goods industries to develop voluntary sustainability standards for commodity production, including beef, cotton, soy, cocoa, palm oil, coffee, tea and paper.

Play not to lose

Companies are implementing a variety of strategies to manage emerging supply chain risks and stakeholder expectations, utilising operational and strategic levers. These strategies often begin with basic risk management measures such as implementing supplier codes of conduct that establish minimum standards of environmental and social performance. These ‘play not to lose’ approaches seek to protect and maintain existing operational and reputational integrity. As companies seek more active management of sustainable practices in their supply chains, they often begin to integrate social and environmental criteria into their procurement decision making, selecting suppliers that can demonstrate better performance or products that have been certified as sustainably produced. Some companies have engaged their suppliers to collaboratively tackle particularly challenging sustainability issues.

Play to win

As companies move further along this spectrum (see Figure 2), their supply chain efforts become increasingly ‘play to win’ strategies, which seek to mark them out from their competitors, enhance the brand and build new platforms for growth. Leading practices combine ‘play not to lose’ and ‘play to win’ strategies to manage operational and reputational integrity in an integrated way. This is underpinned by clear goals on tangible (cost reduction, revenue from new sustainable products or services) and intangible (enhanced brand) benefits.

Figure 2: Assessing the techniques for managing supply chain risk

Sustainable growth

Optimising supply chain sustainability and managing the associated risks are still emerging elements of corporate strategy. One lesson is clear — a range of approaches is likely to be necessary to effectively reduce your supply chain risk exposures. However challenging, improving supply chain performance may be the single greatest contribution you can make to reducing sustainability risks, which opens the way to secure growth while improving social and environmental conditions across the globe.

1From vulnerable to valuable: how integrity can transform a supply chain, published by PwC in 2008
2Reuters 22.09.10
3New York Times, 07.11.11
4Financial Times, 28.10.11
5Reuters, 22.05.11
6Apple Inc media release, 13.02.12
7Value of Sustainable Procurement Practices, PwC, EcoVadis and INSEAD, 2010.