Sustainability in the Supply Chain -- It's More Than Just 'Being Green'

May 20, 2011
In today's business environment, where supplier failure can pose an immediate risk, and where customers and other stakeholders demand greater transparency, such a proactive program for accurately and credibly assessing supplier viability and sustainabilit

In today's business environment, companies are being held accountable to a growing list of stakeholders who assess company performance against a variety of criteria, from financial and operational performance to labor practices and environmental issues. The pressure for greater transparency in all areas of performance is increasing -- not only for consumer-facing companies, but for all business entities throughout the supply chain -- including manufacturers who are several steps removed from the ultimate consumer.

To be effective, a supplier risk-assessment program must address sustainability issues in the broadest sense, assessing vendors' financial and economic viability as well as social responsibility and environmental sustainability.

The Challenge: Defining Sustainability and Quantifying Risk

In many businesses, the procurement, internal audit and enterprise risk management functions provide focus on supplier risk concerns and offer language that helps describe risk. Yet industry research indicates there is still a significant lack of clarity in terms of how and what to measure in order to accurately assess risk in the supply chain.

For example, more than half of the businesses in a recent Compliance Week study expressed dissatisfaction with their current approach to supply chain risk assessment, even though they said managing supply chain risk was a top priority. The top challenges these companies cited were a lack of good data on vendors, poor visibility into the use of subcontractors, and limitations in their ability to compare vendor risks.

Such shortcomings become even more critical in today's industrial environment, where lean production practices make manufacturers more vulnerable to short-term supply disruptions.

Beyond these fundamental supplier viability measures, the concerns of today's broader range of stakeholders must also be addressed. These concerns are measured against social and environmental criteria such as reduced waste, lower carbon emissions, minimized environmental footprint, and a host of social issues, from fair labor practices to immigration and employment policies.

A Bi-level View of Supply Chain Sustainability

Corporate responsibility involves much more than just "being a good corporate citizen." In the broadest sense, corporate responsibility encompasses a business's financial and economic responsibility to its stakeholders including customers, suppliers and investors as well as doing business in a way that is socially and environmentally responsible.

In the same way, sustainability -- including sustainability in the supply chain -- involves much more than just "being green." Broadly speaking, sustainability means managing performance in a way that supports the long-term viability of both the business and the wider community in which it exists.

These multiple facets of sustainability affect an organization on several levels, and their impact on a company's financial performance is demonstrated over varying time frames. In this sense, any effort to improve supply chain viability must address at least two levels: economic and financial sustainability at a basic level, and social and environmental sustainability on a second level.

Economic Viability

The risk of supplier failure is always a concern for manufacturers, but it grows even more acute during periods of economic fluctuation. A recent CFO Magazine study determined that approximately one out of every seven midcap companies poses a potential credit risk. Moreover, the study found significant risk across nearly three dozen disparate industries.

The consequences of supplier failure can be devastating, causing a crippling effect on a company's day-to-day operations and even threatening its ultimate survivability. In today's lean manufacturing environment, where inventories are kept to a minimum and critical equipment and skilled labor are stretched thin, supplier failure very quickly leads to stalled production and lost revenue. Moreover, switching critical suppliers during a crisis following an unexpected failure is, at best, a costly and difficult response.

Unfortunately, traditional supplier risk management initiatives typically track and respond to after-the-fact performance and quality metrics, rather than focusing on forward-looking elements of disruption risk that could provide an early warning of the risk of supplier failure.

Environmental Sustainability and Social Responsibility

A comprehensive supply chain sustainability initiative must also address the second level of issues, ascertaining that suppliers' business practices are sustainable from an environmental and social perspective. In recent years, many leading retail and consumer goods companies have taken high-profile steps in this area, assessing their suppliers' performance against an array of metrics that fall under the general heading of "corporate responsibility."

To cite one prominent example, Walmart several years ago broadened its annual report on "Ethical Sourcing" to encompass the wider topic of "Global Responsibility." In addition to requiring vendors to demonstrate a commitment to sound business ethics, the retailer's assessment tool also addresses such issues as energy consumption, greenhouse gas emissions, the sourcing of raw materials, reduced waste, more effective use of resources, and support for more vibrant workplaces and communities.

In a similar vein, the Corporate Responsibility Officers Association (CROA) recently announced its 12th annual "100 Best Corporate Citizens List," which is based on publicly available information from companies in the Russell 1000. This year, for the first time, the organization augmented its honor roll by issuing a companion "Black List," citing the 30 least transparent companies.

CROA noted that, of the 1,000 companies in the Russell 1000, about 600 offered no discernable disclosure related to their performance on broad environmental performance issues, and 161 companies did not provide basic disclosure about employee benefit programs. As such announcements gain wider exposure, the reputational risk associated with such failures will increase commensurately.

Moreover, even though many mid-tier manufacturers might not be directly measured by initiatives such as these, the effects of such assessments cascade throughout the supply chain. As a result, more and more manufacturers not only are required to assess their own performance, but also must make sure their suppliers do the same.

Accessing and Assessing Supplier Information

Addressing both aspects of supply chain sustainability -- that is, both the immediate financial and economic factors and the longer term social and environmental issues -- can be especially challenging when some critical vendors are privately held rather than publicly traded. Most privately held companies are understandably protective of financial information, especially if they fear their disclosures could put them at a competitive disadvantage or weaken their negotiating position on pricing or other contract terms.

In the same way, your company's public assessment of its corporate responsibility performance might be called into question if the only source of information is the self-reporting of suppliers whose records are sealed. As many businesses have discovered in recent years, the potential of a backlash against such perceived "greenwashing" poses its own type of reputational risk.

To be effective -- and to be credible -- the information that a supplier sustainability assessment gathers and presents should be timely, proactive and objective. Each of these attributes is essential:

Timely -- In view of the speed with which supplier failure can affect lean operations, traditional, dated financial reports are inadequate. What is needed is a rapid deployment supplier rating process that will provide early visibility to key financial performance indicators. In the same way, the company must be made aware of changes in its suppliers' social or environmental risk immediately.

Proactive -- The financial indicators being tracked must be leading indicators of coming performance, rather than reactive indicators of past performance. A proactive approach identifies potential risks, such as a supplier's anticipated cash flow or credit problems, in advance, while there is still time to address these risks before they affect delivery of critical materials.

Objective -- Just as suppliers are reluctant to share confidential financial information, they might hesitate to report comprehensive raw data on environmental or social concerns. In both cases, an effective way to overcome this reticence is through the intervention of an objective third party that can assure confidentiality. A CPA firm, for example, can analyze suppliers' proprietary raw data -- financial and otherwise -- and then report results to the buyer in abstracted, risk rating form. Confidentiality is thus maintained, and suppliers can be more forthcoming in sharing critical information.

What You Can Do Now

Developing and implementing a supplier viability initiative is obviously a long-term undertaking requiring ongoing commitment, but following are four immediate steps an organization can take to get started.

  1. The first step is to identify the subset of suppliers that are most critical to the company, and then identify those about which the company is lacking important information -- both basic financial viability metrics and longer-term corporate responsibility indicators. This analysis must consider the strategic objectives of the organization and incorporate an understanding of the risks that could have the most impact on these objectives.
  2. Next, develop a credible set of supplier financial viability metrics that reflect your company's specific supplier risk profile. Ideally, this will encompass a diverse set of inputs including data generally not available as part of traditional supply chain management.
  3. Concurrently, develop a comparable set of corporate responsibility metrics. Begin with widely recognized standards and best practices, such as those compiled by CROA or other professional organizations, and then adapt them to reflect the particular environmental and social issues most pertinent to your business.
  4. Finally, develop and implement a program for timely and accurate reporting of all key metrics, employing third-party intermediaries as necessary to encourage supplier compliance and openness. Third-party support is often critical because of the hesitancy of private suppliers (especially troubled ones) to share their information directly with the customer.

In all instances, the risks being mitigated must be weighed against the costs of accessing and presenting such information. The goal is to strike a pragmatic balance that accurately assesses critical economic, social and environmental concerns.

In today's business environment, where supplier failure can pose an immediate risk, and where customers and other stakeholders demand greater transparency, such a proactive program for accurately and credibly assessing supplier viability and sustainability can be critical to a manufacturer's continued success.

Doug B. Schrock is a partner with Crowe Horwath LLP in Indianapolis, Ind. Gregg E. Anderson is a director with Crowe Horwath LLP in Oak Brook, Ill.

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