Starting at the
source: Sustainability in supply chains
By
working closely with their suppliers, consumer companies can lessen their
environmental and social impact and position themselves for strong growth.
The next 10 to 15 years will present major opportunities for consumer
companies. Some 1.8 billion people are expected to join the global consuming
class by 2025, a 75 percent increase over 2010. Consumer spending should rise
even more than the number of consumers as household incomes swell and people
use bigger shares of their budgets to buy consumer goods. China, for example,
is on track to gain 100 million working-age consumers by 2030, and it is
expected that their spending on personal products will be double the current
rate.
These trends contribute to a strong growth
projection for the consumer sector: 5 percent a year for the next two decades.
For investors, this level of expected growth should be good news. The worth of
a company can be expressed as the sum of two values: the present value of the
company’s current cash flows extended into the future, and the present value of
the expected growth in its cash flows. When we studied the enterprise value of
the top 50 publicly traded consumer-packaged-goods (CPG) companies, we found
that their expected cash-flow growth makes up roughly half of their current
value. Because of this, factors that alter these companies’ growth projections
will also have a major effect on their total returns to shareholders .
One condition that can slow a company’s
growth is poor sustainability performance, as measured in environmental and
social impact. To make and sell goods, consumer businesses need affordable,
reliable supplies of energy and natural resources, as well as permission from
consumers, investors, and regulators to do business. But companies can no
longer take those enabling factors for granted. Indeed, scientific consensus,
along with pledges by governments and business leaders—including the leaders of some of the largest consumer
companies—calls for dramatic improvements in sustainability performance.
For example, the Paris
Agreement, reached by 195 countries at the United Nations
climate-change summit in December 2015, aims for reducing global greenhouse-gas
emissions enough to prevent the planet from warming by more than two degrees
Celsius. To cut their emissions in line with the Paris target while increasing
sales at the projected rate of 5.3 percent a year, CPG companies would have to
lower their carbon intensity—the amount of greenhouse gas emitted per unit of
output—by more than 90 percent between 2015 and 2050.
This figure suggests that consumer
companies will have to greatly reduce the natural and social costs of their
products and services in order to capitalize on rising demand for them without
taxing the environment or human welfare. To that end, some companies will
benefit from innovations that allow products to be made using less energy and
material and to be reused or recycled with ease. As we explore in the rest of
this article, consumer businesses are likely to find that their supply chains
hold the biggest opportunities for breakthroughs in sustainability performance.
Supply
chains: A missing link for sustainability
A high-functioning supply chain—the entire
hierarchy of organizations, including energy providers, involved in making and
distributing goods—can allow a consumer company to manage two types of
sustainability-related risks. One type of risk has to do with the
sustainability impact of providing goods and services to customers. The typical
consumer company’s supply chain creates far greater social and environmental
costs than its own operations, accounting for more than 80 percent of
greenhouse-gas emissions and more than 90 percent of the impact on air, land,
water, biodiversity, and geological resources. Consumer companies can thus
reduce those costs significantly by focusing on their supply chains.
A second type of risk occurs because
sustainability impact can interfere with consumer companies’ supply chains.
GrainCorp, a large Australian agriculture business, reported that a drought cut
its grain deliveries by 23 percent, leading to a 64 percent drop in 2014
profits. Unilever estimates that it loses some €300 million per year as
worsening water scarcity and declining agricultural productivity lead to higher
food costs. In 2014, a ranking of the world’s 100 most reputable
companies included 8 apparel companies. Of those, 2 were dropped from the
ranking in 2015, following the deadly collapse of the Rana Plaza factory in
Bangladesh, which had been making goods for them, and they were left off the
list in 2016.
Notwithstanding the sustainability risks that
lie in supply chains, relatively few companies are working with their suppliers
to manage these risks. As an example, consider how businesses are addressing
the climate impact of their supply chains. Of the companies that report their
greenhouse-gas emissions to CDP, a nonprofit organization that promotes the
disclosure of environmental impact data, only 25 percent say they engage their
suppliers in efforts to reduce emissions.
Even when companies
attempt to influence their suppliers, they are likely to run into challenges.
The biggest one may be that consumer companies do not deal directly with all
the firms in their supply chains. Primary suppliers routinely subcontract
portions of large orders to other firms, or they rely on purchasing agents to
place orders with other firms. Subcontracting is especially common in the
apparel industry; the fast-fashion business in
particular requires large volumes of garments to be made in short time frames.
Subcontractors can be managed loosely, with little oversight regarding workers’
health and safety.
Conditions such as these prevent consumer
companies from knowing what sustainability impact occurs in segments of the
supply chain where the impact is likely to be worst. In a recent survey by The
Sustainability Consortium (TSC), a nonprofit organization dedicated to
improving the sustainability of consumer products, less than one-fifth of the
1,700 respondents said they have a comprehensive view of their supply chains’
sustainability performance. More than half reported being unable to determine
sustainability issues in their supply chains.7Until consumer companies identify the
sustainability problems in their supply chains, they cannot begin to work with
their suppliers on solving those problems.
Three
approaches to improving sustainability in supply chains
In the eyes of shoppers and investors who
are concerned about the sustainability of the goods they buy and the companies
they own stakes in, consumer businesses are responsible for ensuring that their
supply chains are managed well. These companies are also in a strong position
to influence their suppliers. We believe three approaches can help consumer
companies make their supply chains more sustainable. These include identifying
critical issues across the whole supply chain, linking the company’s
supply-chain sustainability goals to the global sustainability agenda, and
helping suppliers manage their impact.
Locate
critical issues across the whole supply chain
To understand the
impact of making consumer goods, companies must determine how natural and
human resources are used at
every step of the production process, whether in the supply chain or in direct
operations. Companies must also consider a wide range of environmental, social,
and economic issues. The tremendous variety of consumer products means that
these issues can differ significantly from one product to another. For example,
manufacturing LCDs causes the emission of fluorinated greenhouse gases, while
coffee plantations are prone to hire underage workers to cultivate and harvest
coffee beans.
Several organizations offer measurement
frameworks and instruments that can help companies find the most critical
sustainability issues in their supply chains:
·
TSC has built a set of performance indicators and a reporting
system that highlights sustainability hot spots for more than 110
consumer-product categories, covering 80 to 90 percent of the impact of
consumer products. TSC identified the hot spots and developed the performance
indicators for them by reviewing scientific research and consulting with more
than 100 stakeholder organizations.
·
World Wildlife Fund (WWF) offers more than 50 performance
indicators for measuring the supply-chain risks associated with the production
of a range of commodities, as well as the probability and severity of those
risks.
·
The Sustainability Accounting Standards Board has developed
standards that help public companies across ten sectors, including consumer
goods, to give investors material information about corporate sustainability
performance along the value chain.
·
CDP and the Global Reporting Initiative have created standards and
metrics for comparing different types of sustainability impact.
Link
supply-chain sustainability goals to the global sustainability agenda
Once companies know where their
supply-chain issues are, they can set goals for lessening the resulting impact.
Ideally, they will base their goals on scientists’ recommendations for bringing
various types of sustainability impact under thresholds that will maintain or
improve human well-being.
For example, the Intergovernmental Panel
on Climate Change, a scientific body established by the United Nations, has
defined global targets for reducing greenhouse-gas emissions. Based on these
recommendations, CDP and WWF have calculated that the consumer-staple and
consumer-discretionary sectors in the United States should cut their
greenhouse-gas emissions by 16 to 17 percent and 35 to 44 percent,
respectively, to produce their fair share of global reductions between 2010 and
2020. Reaching those targets would also allow the consumer-staples sector to
save $15 billion and the consumer-discretionary sector to save $38 billion in
costs. The same report suggests that setting aggressive reduction targets makes
it more likely that companies will achieve these goals and realize greater
returns on their investments in reducing carbon emissions.
General Mills used this approach to set an
emissions-reduction goal for its entire value chain that corresponds to the
internationally agreed-upon target of lessening emissions by 41 to 72 percent,
from 2010 levels, by 2050. With more than two-thirds of its total
greenhouse-gas emissions occurring in its supply chain, General Mills announced
in late 2015 that it would endeavor to cut emissions “from farm to fork to
landfill” by 28 percent within ten years. To reach these goals, the company is
encouraging its agricultural suppliers to follow sustainable practices and has
pledged to obtain 100 percent of ten priority ingredients from sustainable sources
by no later than 2020.
Some suppliers have set sustainability
targets of their own, ahead of receiving mandates from their customers. For
example, Cargill has committed to creating a transparent, traceable, and
sustainable palm-oil supply chain by 2020.
Assist
suppliers with managing impact—and make sure they follow through
The purchasing power held by consumer
companies and retailers gives them significant influence over their suppliers’
business practices. Relatively few companies in the consumer and other sectors
use that influence to get their suppliers to reduce sustainability impact,
though that is changing. Between 2010 and 2015, membership in CDP’s
supply-chain program rose 30 percent but still stands at fewer than 100
companies, including 19 consumer companies. The number of suppliers reporting
through the program increased fourfold, from 1,000 to more than 4,000. The
supply-chain collaboration has led to a reduction in carbon emissions of more
than 3.5 million tons, with suppliers saving an average of $1.3 million per
emissions-reduction initiative.9
In recent years, consumer companies and
others have adopted more sophisticated and effective methods for changing their
suppliers’ practices. They have gone from disseminating codes of conduct,
performing audits, and fielding questionnaires to helping suppliers design and
implement sustainability programs that directly support the companies’ own
goals. Campbell Soup Company, in collaboration with the Environmental Defense
Fund, offers farmers technologies, guidelines, and products to help them
optimize their fertilizer use and improve soil conservation.
Digital technology has also increased
companies’ ability to assist large numbers of suppliers. In 2014, Walmart
launched a program to help thousands of its Chinese suppliers make their
factories more energy efficient through the use of an online tool. The program
has enabled the average supplier to reduce its energy consumption by an average
of 10 percent. Unilever uses a software tool, developed with the University of
Aberdeen, to collect data on whether farmers in its supply chain are using
sustainable practices. Unilever offers them the tool for free, with the aim of
procuring 100 percent of its agricultural content from sustainable sources by
2020.
To reinforce efforts like these, companies
should monitor suppliers’ sustainability performance and hold them accountable for
it. Ultimately, consumer companies can only achieve ambitious sustainability
goals if they set high standards for their suppliers’ performance and stop
doing business with suppliers that fall short—just as they do with other
considerations, such as the cost and quality of goods and the timeliness of
shipments.
Consumer companies can also offer their
suppliers incentives for improving sustainability performance. Walmart has
pledged that by the end of 2017, 70 percent of the goods it sells will come
from suppliers that use the company’s Sustainability Index, a
supplier-sustainability scorecard that employs TSC’s supply-chain performance
indicators and reporting system. On Walmart’s e-commerce site, companies with
the highest Sustainability Index scores have their products tagged as “made by
Sustainability Leaders,” giving them an incentive to participate. Likewise,
with the International Finance Corporation, Levi Strauss established its $500
million Global Trade Supplier Finance program to provide low-interest
short-term financing to those that rate highly on Levi’s own sustainability
scorecard for suppliers.
Because supply chains overlap in many
consumer sectors, companies have recognized the benefit of collective action
and have begun working together to involve their supplier networks in
sustainability efforts. For example, the Consumer Goods Forum (CGF), a global
network of more than 400 retailers, manufacturers, and other companies, made a
collective commitment in 2010 to achieve zero net deforestation by 2020. CGF
members are pursuing that goal through the responsible sourcing of four key
commodities: beef, palm oil, pulp and paper, and soy.
Another example is the Accord on Fire and
Building Safety in Bangladesh, which was set up after the collapse of the Rana
Plaza factory. The accord aims to improve safety at factories by supporting
independent inspections, remedial action, training, and disclosure of
inspection reports. More than 200 apparel companies have pledged to inspect all
of the 1,600 factories they work with. By December 2015, they had completed
some 1,380 inspections.
For years, most consumer companies paid relatively scant
attention to whether their suppliers managed the social and environmental
impact of their business activities. This is beginning to change, as consumer
companies have come to appreciate the extent to which their supply chains
contribute to global sustainability challenges, as well as the effects that
poor sustainability management can have on their growth and profitability. A
few leading consumer businesses, along with civil-society institutions, have
created a widening array of practices and tools for working with their
suppliers to lessen sustainability impact and have begun to realize the
benefits of their efforts. Their experiences illustrate the possibilities for
many more companies to initiate similar activities. Companies that manage their
supply-chain impact may well be best positioned to gain from the boom in
consumer spending that is expected to take place over the next decade and
beyond.
By Anne-Titia Bové and Steven Swartz
http://www.mckinsey.com/business-functions/sustainability-and-resource-productivity/our-insights/starting-at-the-source-sustainability-in-supply-chains?cid=sustainability-eml-alt-mip-mck-oth-1611
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