Transforming Global Supply Chains with ESG

Supply chains shift in tandem with business. As companies across the US and global economy are realigning business models to emphasize ESG initiatives and regulation, businesses must emphasize proper resource use, emissions, community, workforce diversity, corporate social responsibility (CSR) and many other aspects of everyday business to score well on ESG ratings.

While some ESG initiatives may present significant upfront costs, positive externalities largely outweigh any potential negatives. Consumers care about ESG. In the consumer packaged goods sector alone, products with ESG-related claims experienced an annualized 6.4% retail growth between 2018 and 2022, compared with 4.7% for non-ESG products. In general, how a business presents itself and its products can clearly impact sales and investment potential.

Supply chains may appear as a minor facet of ESG alignment, but proper resource management can prove critical to improving ESG scores, building positive reputations, garnering greater investment potential and generating higher sales. Manufacturers must ensure supply chains are resilient, sustainable and diversified to thrive in an increasingly complex global economy.

Navigating supply chain disruptions 

Modern manufacturers rely on a complex web of interconnected suppliers, subcontractors and specialists to produce the majority of consumer products, often relying on methods like just-in-time inventory management to meet consumer demand. This practice enables companies to focus on core competencies, incorporate the latest technology and cut costs, translating into lower prices, greater sustainability and higher consumer demand. However, just-in-time inventory management comes with severe risks; manufacturers are left heavily exposed if key suppliers face production shortages.

Automakers are a prime example of this shortcoming. Car manufacturers rely extensively on specialized semiconductors, often depending on a single supplier for a critical aspect of production. The COVID-19 pandemic exposed these fault lines, as automakers lost an estimated $450 billion globally and missed production quotas by more than five million vehicles. Between the pandemic, the Russian invasion of Ukraine and conflicts in the Red Sea, automakers have proven unprepared and unable to adapt to supply chain disruptions. While other manufacturers struggled amid chip shortages, automakers were left especially exposed, given their reliance on legacy chips.

Manufacturers must identify risks and adapt to changing environments to remain successful. For example, companies can create a “buffer zone,” ordering excess inventory to compensate for high-risk suppliers. However, buffer inventories also need to be carefully managed, as companies can over-order supplies, leading to extra money spent on storage and a greater carbon footprint, especially when inventories lose value in warehouses.

Instead, many producers have increased their influence on supply chains, forming strategic partnerships, engaging new suppliers to supplement existing sources and vertically integrating to improve efficiency. For example, Stellantis and Foxconn have partnered to create SiliconAuto, a joint venture dedicated to selling semiconductors to automakers. Many automakers have also opted to design their own hardware and software rather than go through dozens of third parties, streamlining ordering systems and simplifying the production process. This practice reduces lag periods and waste, reducing costs and driving sustainability in the manufacturing sector and the US economy in the long run.

Rare earth metals pose new challenges

Increasing supply chain complexity poses a new set of challenges relating to ethical sourcing. For example, pressure to extract and process rare earth metals for nearly all electronics has skyrocketed over the past decade to support Net Zero Emissions goals. However, rare earth metal extraction comes with severe environmental and social concerns; extraction and separation are expensive, heavily relying on energy and water while generating significant waste. Many radioactive metals also pose health and environmental pollution risks for workers and local communities.

Rare earth metal mining operations and conflict maps are also intertwined, with severe social unrest and exploitation marring supply chains. Myanmar highlights the human and environmental risks associated with many electronic inputs, with reports suggesting the theft of resource-rich land by brutal militias and increased authoritarianism. Many countries have floated regulations ranging from bans to disclosure requirements to improve supply chain transparency, but currently, most actions rely entirely on disclosures from private companies.

While ethically and sustainably sourcing rare earth metals may increase costs in the short term, this practice can lead to significant long-term benefits. For one, ethical sourcing lessens the risk associated with potential conflicts. Additionally, companies can advertise sustainable and ethical supply chains, generating stronger sales and higher returns. Also, ESG-compliant companies often receive higher valuations, opening them up to more public and private investment than competitors.

However, sustainability often comes with a premium. For many industries, ESG benchmarks are becoming baseline barriers to entry; for others, sustainability is a premium worth investing in as consumer interest shifts. Many companies have raised prices, using consumer interest to indirectly subsidize ESG premiums. Other companies have relied on “green bonds,” often set aside specifically for sustainable investment. However, companies must foster genuine interest and compelling enough change to supply chains to garner interest from investors and consumers.

Ethical labor practices

Because global suppliers often have looser labor standards, many companies have outsourced production to countries with fewer regulations to reduce costs, including China, Mexico, Vietnam, Malaysia and India. In particular, concerns over forced labor in the Xinjiang region have had wide-reaching effects on global agriculture, textile and manufacturing industries.

As a result, the US has banned numerous companies that rely on forced Uyghur labor from the UFLPA Entity List, leading to numerous investigations of US-based producers. Most notably, multiple automakers have faced Senate inquiries into links to these suppliers. BMW, Jaguar Land Rover (JLR) and Volkswagen have all been implicated in unethical supply chain sourcing. While these companies have denied knowledge of forced labor in supply chains, the inaction and potentially willful ignorance may prove more damning. Senator Wyden of the Finance Committee had scathing remarks regarding automakers’ lack of oversight: “Automakers are sticking their heads in the sand and then swearing they can’t find any forced labor in their supply chains. Somehow, the Finance Committee’s oversight staff uncovered what multi-billion-dollar companies apparently could not.”

Many consumers may feel the same, so, in a highly competitive auto market with ample substitutes, they choose to switch to a competitor, especially as buyers prioritize ESG-friendly products. So, companies across the US economy must express greater oversight to avoid common supply chain issues. The solution is simple in principle, yet incredibly complex in execution. For instance, BMW and JLR received auto components through tier 1 supplier, Lear Corp. In turn, Lear purchased electronic components from a subcontractor, Bourns. Previously, Bourns purchased LAN transformers from Xinjiang-based tier 2 supplier, Sichuan Jingweida Technology Group, turning into a liability for the entire supply chain. Thus, closer supply chain monitoring is essential, but may prove difficult to accomplish.

Key strategies for incorporating ESG principles in supply chains

Adopt new technology

Adopting new technology is a fairly straightforward path toward ESG-alignment for supply chain professionals and executives. New technology can improve efficiency while reducing emissions, production downtime and waste. This strategy can also support data collection and reporting, enabling manufacturers and consultants to make decisions based on real-time data, optimizing numerous aspects of the supply chain, ranging from water usage to labor allocation. For example, blockchain and other traceability technologies enhance transparency in the supply chain, ensuring fair labor practices, ethical sourcing and compliance with human rights laws.

Supplier code of conduct

Increasing supply chain complexity and globalization have highlighted the necessity of supplier codes of conduct, direct partnerships, closer monitoring and other strategies to ensure proper and ethical sourcing at every level of the value chain. Recent Senate inquiries have shown that companies can’t absolve themselves from unethical practices by their tier 2 or 3 suppliers. Supply chain professionals can help companies draft codes of conduct, outlining clear expectations on deliveries, inputs and other key qualities to align with sustainability and ESG goals. Careful monitoring of suppliers is a necessity, especially as more consumers value sustainable products.  

ESG risk research

Identifying, assessing and attacking specific ESG-related risks that can impact financial success and operational capacity are critical for supply chain professionals and executives. Companies with high environmental risks might face regulatory fines, increased operational costs, or damage to their reputation. Poor social practices can lead to legal challenges, boycotts, or loss of consumer trust. Weak governance can result in mismanagement, fraud, or conflicts of interest, which could negatively impact financial performance and stability. Proactively researching and managing these risks can prevent most negative externalities, leading to more robust financial performance and stable market positions. 

Prioritize circular economy practices

Adopting circular economy principles can enhance supply chain sustainability by minimizing waste and promoting resource recovery. Supply chain professionals may focus on designing products and processes that facilitate recycling, remanufacturing and reuse. Encouraging suppliers to adopt similar practices and exploring opportunities for product lifecycle extension can greatly reduce the reliance on raw materials and decrease waste. By incorporating circular economy practices, organizations contribute to environmental conservation and also realize cost savings and efficiencies.