SUPPLY CHAIN & CLIMATE RISK

Pastures new

Disordered by geopolitical risks, macroeconomics and the pandemic, global supply chains are rebuilding in the context of a growing focus on climate risk. Jeremy Hughes looks at how companies are finding synergies between the two to create mutually beneficial outcomes

The Covid-19 pandemic triggered a dramatic and swingeing realignment of global supply chains. Around the world, businesses and industries that relied on extended supply chains experienced disruptions and delays that called into question the very basis of their business models, in some cases driving companies to the brink of bankruptcy.

Even without the unexpected invasion of Ukraine in February 2022 which prolonged the economic downturn and hampered business recovery, supply chains were ripe for a radical shake-up. While this is underway, increasing climate risk disclosure requirements are creating an urgent imperative to uncover and manage supply chains’ inherent ecological risks.

Whilst there is work to be done to both reduce supply chain risks and address climate change risks, there are synergies to be found between the two otherwise separate fields that can – and do – lead to mutually beneficial outcomes.

Opening new doors

Manufacturers and retailers looking to reduce supply chain risk have taken steps to increase resilience by cutting distances and dependencies.

One key strategy for US manufacturers has been to regionalise, onshore or nearshore production to reduce reliance on Asia, particularly China. Apple, for instance, has shifted some of its production from China to India, while Foxconn, a major Taiwanese Apple supplier, has opened facilities closer to iPhone’s home in Mexico.

Thanks to lower labour costs, proximity to the US market, and trade agreements such as the United States-Mexico-Canada Agreement, Mexico has seen an influx of US brands in recent years, and is now home to new facilities for such major names as Ford, General Motors and Whirlpool, among others.

Collaboration is a key strategy for reducing supply chain risk. Whilst supply chain relationships have historically been jealously guarded, many are now working together to improve efficiency, reduce costs, and enhance overall performance.

In vendor-managed inventory arrangements, for instance, suppliers are taking responsibility for monitoring and restocking a customer’s inventory. They gain access to real-time data on the customer’s stock levels, and can proactively replenish supplies as needed, ensuring the customer never runs out of essential items.

And with joint product development agreements, manufacturers and suppliers collaborate to develop new products or improve existing ones, reducing time-to-market and enhancing product quality in the process. Cross-docking arrangements enable products to be transferred directly from inbound transportation to outbound transportation without being stored in a warehouse, while more companies are partnering with third-party logistics providers to manage transportation, warehousing and distribution.

Technology and data analytics have a critical part to play. Enhanced capability in internet of things sensors enables data collection for shipments with greater granularity than ever before, while distributed ledger technology or blockchains not only provide secure tracking, but advanced automation as well.

In one innovative implementation of DLT, Singapore’s adoption of electronic bills of lading for processing on a blockchain-enabled platform has enabled simultaneous handling of complex customs and trade finance procedures which until recently were paper-based, requiring time-wasting manual treatment. Taking the slack out of shifting cargoes in this way promises reduced downtime for shipments and greater precision in delivery timings.

Technology and big data are also key to better risk prediction, and emerging developments in artificial intelligence and big data hold great promise in this arena. Predictive analytics, for instance, uses statistical modelling, data mining and machine learning to identify vulnerabilities in supply chains. The resulting insights can help to forecast demand, optimise shipping routes, and enhance warehouse efficiency.

Finding synergies

Policymakers seized on the fundamental reset forced on the world by the pandemic to refocus on sustainability. President Biden’s Build Back Better framework, the EU’s Recovery Plan for Europe, NextGenerationEU, and China’s 14th Five-Year Plan all set out new intentions to embed greater sustainability into programmes designed to rebuild the global economy. At the same time, these efforts also drove enhanced ESG disclosure standards for companies.

In the EU, the Corporate Sustainability Reporting Directive was enacted in January 2023, while in the US, the Securities and Exchange Commission directs all public companies to disclose data that is material to investors, including information on ESG-related risks.

The UK’s Financial Stability Board created the Task Force on Climate-related Financial Disclosures to advance proposals on what information companies must disclose, and the IFRS Foundation and the International Accounting Standards Board’s Sustainability Disclosure Standards for companies, S1 and S2, will take effect in January 2024.

In short, companies already engaged in de-risking their supply chains are also required to look into, quantify and publicise their environmental and social risks. The burden falls heaviest on larger corporations in high-emitting sectors, including power generation, heavy manufacturing and transport.

Most, if not all, have started by addressing the most obvious risks, such as GHG emissions. The GHG Protocol, jointly produced by the World Business Council for Sustainable Development and the World Resources Institute, places this into three categories across a company’s operations.

Scope 1 emissions originate from sources owned or controlled by an organisation; Scope 2 are indirect greenhouse gas emissions – such as at power generation plants.

Scope 3 includes all other indirect emissions in an organisation’s value chain, including both upstream and downstream, often beyond its direct control.

Investors increasingly require companies to declare these risks as they become more active in exercising their voting rights on all aspects of ESG. On top of this, corporate financing is increasingly tied to sustainability criteria. This means quantifying risks as accurately as possible has a direct financial consequence for the company – and done well, could offer a significant competitive advantage.

While none is complete or comprehensive, consultancies have brought a range of measurement, quantification and analysis services to market. Value-adds include advice on managing carbon footprint, reporting and adaptation.

The Big Four auditing firms all offer variations of this service, while newer specialist consultancies now provide sustainability advisory services. And market information providers such as S&P, Moody’s and Fitch leverage their position in analysing corporations’ risks to include environmental, social and governance factors.

Responsible response

Faced with growing pressure to mitigate their carbon footprint and consider their impacts on communities, businesses are adapting their operations – if not their business models – to comply. And it stands to reason that the companies that adapt best will be the winners of the future.

Adaptation was a major focus at COP27 held in Egypt last year. UN Climate Change Executive Secretary Simon Stiell said, “[While] adaptation alone cannot keep up with the impacts of climate change, which are already worse than predicted, adaptation actions are still crucial and are critical to upgrade small-scale, fragmented and reactive efforts.”

According to the World Economic Forum’s Global Risks Report for 2023, failure to adapt to climate change is the second-greatest risk for companies over the next ten years. Such adaptation includes more than limiting supply chain risks. From enhancing infrastructure resilience and disaster preparedness to education and community engagement, adaptation re-quires he involvement of every area of the business.

Business leaders are aware of the implications; according to PwC’s 2023 Global CEO Survey, almost 40 per cent of CEOs believe their companies will no longer be economically viable in ten years’ time if they do not adapt. In addition, although climate change was less prominent as a risk within the next year compared with other global risks, CEOs still anticipate climate change significantly affecting their cost structures (50 per cent), supply chains (42 per cent) and physical assets (24 per cent) to a moderate to substantial degree. As a result, 48 per cent of CEOs are modifying their supply chains: 46 per cent are adjusting their presence in current markets and/or expanding into new markets, while 41 per cent are diversifying their product or service offerings.

Fresh fields

Adaptation can also be a spur to innovation. Apart from new technologies under development to generate, store and distribute clean energy, or to capture and sequester CO2, fresh ways of producing and consuming goods are rapidly emerging in a drive to reduce waste and prolong utility. While many ew business models will take time to gain scale, others may evolve from incumbents not content to sit still while the landscape changes around them.

As Boston Consulting Group points out: “Once companies move beyond what can be achieved though technical and operating efficiencies, most will need new operating models and ways of working.”

And PwC states that, in the context of digital transformation, “the starting point for enterprise transformation of this sort often is a reimagination of a company’s place in the world – looking beyond the current portfolio of businesses and products to determine what value n organisation will create, and for whom.”

For example, Danish multinational energy provider Ørsted, founded as a natural gas supplier in the ‘70s, in 2009 adopted its ‘85/15 vision’ strategy to switch its activities from 85 per cent based on fossil fuel to 85 per cent based on green energy. Today it provides offshore and onshore wind, solar and storage solutions, which together provide 92 per cent of its energy output.

In the consumer goods sector, Global big-hitters Unilever and Nestlé have both invested time and capital in alternative proteins which, compared with traditional meat production, require less land, water and energy, resulting in lower emissions and reduced ecosystem disruption.

Growth has been significant, perhaps driven by consumers’ need to economise during the recent cost-of-living squeeze. Boston Consulting Group calculates that the US retail alternative protein market grew by nine per cent in 2022. Overall, the alternative protein industry attracted US$5 billion in disclosed investments in 2021 – a fivefold increase over three years.

Furthermore, the consulting firm estimates that the combination of technology and business model innovation has the potential to reduce greenhouse gas emissions by up to 80 per cent over current levels.

Perhaps the most compelling outcome from the current wholesale redrawing of global supply chains is that, thanks to reduced emissions and technical innovation, the benefits of investments in adaptation accrue to stakeholders beyond those the investing corporations service. Getting to grips with supply chain risks, be they financial or environmental, has a net-work effect that will help to address the most pressing threats to communities and ecosystems.



This article was published in the Q4 2023 issue of CIR Magazine.

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