5 supply chain initiatives to combat ESG risks

Environmental, social, and governance (ESG) risks are a threat to both the operational health and reputation of diverse companies. But supply chain initiatives can help businesses mitigate these risks and improve their ESG performance in the meantime.

Investors and consumers are increasingly looking for companies that operate ethically and sustainably. A 2023 report by Glow and NIQ shows that half of surveyed consumers changed the food and grocery brands they purchase based on ESG considerations, for example. And that figure rises to 70% among millennials.

At the same time, ESG risks are a growing concern for businesses. A 2022 paper commissioned by Dun & Bradstreet found that companies failing to meet their ESG goals faced tangible challenges that can lead directly to increased operational and financial risk.

As the focal point for achieving potential ESG-related optimization, the supply chain is one important lever that can be used to increase a company’s resilience against ESG risk. And, as a natural by-product, companies that strive to build that resilience also have the chance to grow by attracting ESG-conscious customers.

What are ESG risks?

ESG risks can be defined as risks that relate to a company’s environmental, social, and governance activities. They can arise due to events or situations that could result in legal action, harm the organization’s reputation, or impact its value in the future.

Environmental risks

Environmental risks relate to a company’s potential to negatively impact the physical environment. Environmental risks can include:

• Use of natural resources, including water
• Land use, deforestation, and biodiversity
• Pollution and toxic products
• Waste prevention and recycling
• Climate change
• Greenhouse gas emissions
• Carbon footprint

To mitigate environmental risks, companies should aim to conserve natural resources, minimize waste, and reduce their carbon footprint throughout their entire supply chain.

Social risks

Social risks cover the possibility of communities or individuals being negatively impacted by business operations. This can include:

• Employee relations, including wage equality and diversity, equity, and inclusion
• Employee welfare and data privacy
• Workplace safety and training
• Supplier labor practices, including child labor and modern slavery
• Product safety and quality
• Customer privacy and data security

From a social standpoint, companies and their suppliers and partners are expected to treat workers fairly, respect human rights, and ensure that products are safe.

Governance risks

Governance risks refer to potential negative consequences due to misconduct by senior executives, employees, and the general poor running of a company. Specific risks may relate to the following areas:

• Board composition and diversity
• Executive remuneration
• Company integrity and business ethics, including political donations and lobbying
• Tax strategy, accounting methods, and ESG regulation compliance and disclosures
• Anticompetitive practices
• Bribery and corruption
• Illegal conduct and fraud

From a governance standpoint, companies – and their supply chains – are expected to operate ethically and transparently and be accountable to all stakeholders.

How ESG relates to supply chains

Up to 90% of an organization’s ESG footprint lies within its supply chain, meaning ESG risks can also be seen as supply chain risks. The disclosure of a single instance of ESG non-compliance, such as environmental damage, modern slavery, or child labor, can be disastrous for a business.

Conversely, the rewards can be considerable for businesses that launch ESG initiatives and take steps to mitigate ESG risks – and companies are paying attention. A 2022 survey by EY revealed that eight in ten supply chain executives are increasing their efforts toward sustainable supply chain operations.

ESG-friendly supply chain initiatives

Companies seeking to mitigate ESG risks and improve their ethical and sustainable performance can consider adopting the following ESG initiatives:

1. Build an ESG-compliant supplier base

To address ESG risks, companies need to put ESG at the forefront of how they do business – and that starts with the procurement process.

During supplier selection, companies should apply appropriate procedures and use suitable metrics to select suppliers that align with the company’s ESG policies and broader values. Suppliers’ ESG performance should also be monitored over time.

By choosing suppliers with proven ESG credentials, companies will be better placed to collaborate with those suppliers to minimize any reputational risks while maximizing the stability of the supply chain.

2. Track and report on ESG supply chain metrics

Before companies can improve their ESG performance, they first need to be able to measure their current performance to provide a benchmark.

Monitoring ESG supply chain metrics, which may range from greenhouse gas emissions and waste reduction to product safety and labor policies, is key when it comes to managing risk and evaluating the sustainability of a company’s supply chain.

By harnessing technology and adopting suitable ESG measurement and reporting systems, businesses will be better placed to manage risk, increase efficiency, and improve customer loyalty.

3. Adopt digital supply chain management (SCM) for real-time transparency

Managing large and complex global supply chains brings major challenges for businesses. To minimize risks, companies need systems that can help them ensure the smooth flow of materials and products, manage huge amounts of data, and interpret and understand the information gathered.

Adopting a digital supply chain management platform makes it easier for companies to gain oversight across the entire supply chain, track supply chain activities, measure performance against targets, and identify risks.

4. Rethink inventory management strategy

Sustainability and optimal inventory levels go hand in hand. Businesses that hold too much inventory needlessly use resources to source, produce, store, and transport items that might not even be sold.

By using an appropriate inventory system compliant with ESG principles – for example, by adopting a just-in-time approach to inventory management – businesses will be better placed to minimize excess inventory and avoid wasting resources.

However, businesses also need to consider the risks associated with this approach, such as being unable to meet an unexpected product demand surge. Digital SCM can play a role in mitigating this risk by tracking inventory and alerting businesses when stock levels are low.

5. Incentivize strong ESG supplier performance

Given that a significant portion of a company’s ESG risk lies in its supply chain, companies can also address ESG risks by incentivizing suppliers to adopt more ethical and sustainable practices.

Companies can benchmark their suppliers against recognized standards through sustainable supplier finance solutions and reward those who perform best.

This might involve using data from ESG ratings providers and/or company scorecard data to measure suppliers’ ESG performance. Suppliers can then be incentivized to improve that performance for preferential rates on early payments via supply chain finance (SCF) and dynamic discounting (DD) programs.

This way, companies can build more sustainable supply chains, demonstrate their ESG credentials, strengthen brand loyalty, and maintain or improve their competitive edge.