The ESG, or Environmental, Social, and Governance, is sort of a framework that emerged from the Corporate Social Responsibility (CSR) framework and is now an integral part of modern-day businesses. This focuses on companies' environmental impacts, social responsibilities, and structures for governance.
ESG and sustainability have remained front and centre for many reasons throughout recent years, whereas some form of social or philanthropic focus has been present in business for decades:Investors, stakeholders, and customers expect that the companies focus on environmental, social, and corporate governance in the matter of climate change and universal human rights.Sustainable practices are good business sense with gaining operational efficiency over time – even in fast-changing marketplaces. These serve as requirements for business sustainability: environmental protection, ethical business practice, and worker safeguarding in the fast-paced market.
It has been erroneously conceived that implementing ESG practices, hence an investment, becomes costly for the firm, leading to cynical views on the very need to imbibe such business behaviour. In truth, the opposite is the case once the firm embraces ESG as an investment. To illustrate, emission management and the shift to renewable energy are indeed costly at the beginning but will return midterm gains in the form of reduced operational costs and increased good publicity for the company.
So where does the supply chain fit? In following ESG rules, policies, and expectations, companies must apply the same rigour to their supply chain. For instance, 80-90% of a company's carbon footprint is considered to be in its supply chain.
Equally important is noting that ESG is not just for big corporations. Any size company, including small businesses, can gain from the practice of ESG in accessing new markets, appealing to investors, satisfying consumer demand for sustainable products, among others.
Defining ESG and Its Importance in Supply Chains
ESG has become an essential pillar of the modern business ecosystem. Initially meant to guide corporate behaviour in sustainability, ESG continues to help structure supply chains today, whereby companies must take an active look at the environmental and social ramifications of their operations and suppliers. According to a report by McKinsey, 70 percent of consumers will pay an extra 5 per cent for products made by companies engaged in positive social and environmental impact. Clearly, integrating ESG into supply chains creates a major competitive advantage.
Steps to Navigate ESG Risk in Supply Chains
There are six steps to bring ESC accountability to global supply chains.
Create Transparency: It would be ideal to create transparency in this case. The first step is, as it were, all the way down, with the organisation gaining a deep understanding of its supply chains, which can be global and multi-layered, including all the steps in the sourcing and manufacturing processes. Trace out a supply chain completely, and then it should assess trade flows by countries and suppliers involved. After that, it will be able to pinpoint the possible ESG risks that form the basis for calculating risk scores.Calculate the scores of risks: After learning about all supply chains and material flows, companies can evaluate ESG risks in their own sites, like factories, distribution centres, warehouses, and other facilities across the supply chain levels; these are often where they face larger risks. Each will have a score specific to the category/country that it could occur in, the risk involved, and the tier of supply chain within which this score exists. These scores will serve to provide companies better management of the likelihood of violations.Develop Risk-Specific Measures: Engaging suppliers closely for risk identification and incident response is essential. Developing a toolbox standardised for the organisation will allow companies to identify the risks and mitigation measures existing along the procurement chain.Lay down New Cornerstones: There is much to be done in terms of audit before the organisation switches to a new operating model where ESG risk management becomes and remains core to the fabric of operations decision-making. Most focus on policies currently in place, functions involved, roles, and responsibilities as they currently exist.Establish a Centre of Excellence: After a refinement of the operating model that ensures it takes into consideration all ESG matters, roles are defined to operate it. All responsibilities for execution in the organisation's business and functions should therefore be transferred. Some leaders set it as an organisational node, the centre of excellence. This centre, in fact, enables a clear view of risk management and mitigation across the company. This also provides development consistency in formulating internal guidelines under ESG, dissemination of best practices, and tracking development performance. A centre could also catalyse internal collaboration by setting guidelines and requirements for each unit and providing toolboxes for supplier risk assessment, supplier engagement, and risk mitigation. For example, a European supplier of aerospace components has recently set up such a centre of excellence whose scope involves tackling supply chain-related ESG issues on two fronts. First, it tracks ESG risks, trains employees and manages mitigation in supply chains. Second, it also defines supplier standards and tracks business units' performance on improving them.Monitor, Audit and Campaign: Most ESG leaders formulated a special set of parameters and utilised digital means to constantly monitor them in the management of risk over time. In addition, they perform routine audits and reviews for the improvement of their suppliers, especially for the smaller vendors.The Framework for Due Diligence of ESG Supply Chain1. Identifying and Assessing Risks in the Supply Chain
Risk identification and assessment in the supply chain constitute an important step in ESG due diligence, in which ESG refers to environmental, social, and governance issues potentially stemming from the operations of the suppliers. In a McKinsey survey, it was found that 44 per cent of supply chain disruptions are associated with ESG issues, which sets outrageous standards for a thorough risk assessment.
Environmental risk may consist of pollution, resource depletion, or climate change. The British Academy for Training and Development offers a comprehensive Short Professional Diploma in Environmental Management to enhance skills in the environmental field and manage environmental risks.Social risk includes labour practices, effects on communities, or human rights violations.Governance risk could spin off from corruption, regulatory infractions, or unethical acts.
The process often begins with mapping the supply chain so as to identify all stakeholders and understand the vulnerabilities of each link. Some of the tools necessary for this stage are supplier audits, risk assessment matrices, and stakeholder consultations. In Accenture's words, “A proactive approach to risk management not only strengthens resilience but also provides strategic advantages.”
2. Putting ESG standards into operations
The next step will be to implement ESG standards in operations, having identified the risks. This necessitates putting down clear policies and expectations that the company would expect of its suppliers in accord with international standards of practice, e.g., UN Global Compact and ISO 26000. Forbes states, “70 percent of executives believe integrating ESG standards creates long-term value.”
Develop a set of ESG policies that align with the values of the organisation and best practices within the industry.Engage suppliers by considering ESG criteria in contracts and procurement practices.Train and equip suppliers to meet the established standards.
Technological interventions like blockchain ensure that transparency and traceability are enhanced throughout the entire supply chain to ensure compliance and accountability.
Challenges in ESG Supply Chain
The two main challenges of the ESG supply chain are:
1. Common Problems Businesses Face
With environmental, social, and governance (ESG) standards gaining importance within business organisations, many businesses grapple with the most obvious obstacles in applying due diligence to their supply chains. As reported by Deloitte, "Only 16% of companies report full visibility into their supply chains." And, indeed, the lack of transparency makes it difficult to identify and mitigate ESG-related risks.
Inconsistent Regulations: The major setback challenge is studying different countries' regulatory requirements. Most of them find it difficult to follow the different international standards.Supplier Engagement: Many suppliers might be unwilling or unable to comply with stringent ESG criteria due to cost or capability constraints.Data Collection: Obtaining credible ESG data from suppliers is notoriously very challenging, often resulting in inaccurate evaluations.2. Balancing Cost with Compliance
Meeting ESG compliance while at the same time keeping costs in check is a tightrope walk for most organisations. According to an investigation by McKinsey & Company, "companies' ESG programmes' ROI would increase up to 20 per cent by having them actively integrated into the supply chain operations."
Technology Investment: Businesses need to invest in technologies that enhance supply chain transparency without inflating operational costs excessively.Changes to Operations: Most times, implementation of EGS requires drastic changes, thus escalating costs.Balancing Short-Term Costs Vs. Benefits in the Long Run – Short-term cash outflows might appear to be associated with ESG compliance; however, in the long run, they can prove to be cost-effective and mitigate risks.