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Episode 36: A Simple Guide to ESG in the Supply Chain

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Bob Trebilcock: Welcome to The Rebound where we'll explore the issues facing supply chain managers. As our industry gets back up and running in a post COVID world. This podcast is hosted by Abe Ashkenazi, CEO of the Association for Supply Chain Management, and Bob Trebilcock, Editorial Director of Supply Chain Management Review. Remember that Abe and Bob welcome your comments. Now, to today's episode. Welcome to today's episode of The Rebound, a simple guide to ESG in the supply chain. I'm Bob Trebilcock.

Abe Ashkenazi: I'm Abe Ashkenazi.

Bob: Joining us today are Alan Amling and Simon Knowles. Alan is a distinguished fellow at the Global Supply Chain Institute at the University of Tennessee. He's also the author of the report that's the basis for this podcast. Simon is the chief marketing officer for SGS-Maine Pointe, a global supply chain, and operation consulting firm. Alan, Simon. Welcome.

Alan Amling: Good to be here.

Bob: We're thrilled to have you guys, and this is a great topic I think, and very timely. Supply chains have been talking about sustainability as well as the broader umbrella of corporate responsibility and diversity inclusion for some time. It has often felt as if it's one step forward and two steps back, but there's a sense that corporate responsibility or the new umbrella term, environmental, social, and governments or ESG has been reignited during COVID. If you're looking for evidence, read the January 18 article on Larry Fink in The New York Times.

Now, if you don't know him, Fink is the CEO of BlackRock, a firm that manages $10 trillion and who recently wrote a 3,300-word letter arguing that investors and executives should really care about whether the companies they invest in and manage are reducing your carbon footprint to ensure long term viability. Fink added that BlackRock is going to vote with its checkbook saying access to capital is not a right. When a guy with $10 trillion says he's watching you, people tend to listen.

To that end, Maine Pointe, the firm where Simon works is sponsoring a series of insight pieces from the University of Tennessee just on this topic. Alan is the author or the first. Alan, let's start with one of the first topics you address or what is ESG and why is it important?

Alan: Hey, thanks, Bob. Thanks for bringing this topic to your listeners. ESG, so it's essentially how investors, customers, employees, judge the social and environmental consciousness of your organization. You talked about the three separate components. Most people when they hear ESG, they relate it just to environmental sustainability and that's one pillar and it's really important. The environmental pillar covers things that we love in logistics: energy. efficiency, capacity management, all of that goes into environmental as well as reducing greenhouse gas emissions. There's a lot of information, a lot of momentum around electric vehicles.

That's all part of that pillar. As well as water management, deforestation, circular economy, or revers logistics would fall into that. The S and the G are really important too, that's social, diversity, and inclusion, employee relations, human rights, governances. Not just reporting, it's also risk management, something that is near and dear to the hearts of logisticians everywhere. It's compensation, it's board structure, it's cybersecurity. There's a lot under ESG. It's all about the long-term performance of the organization. It's similar to the triple bottom line that we've been talking about for profit, people and planet, that's been around for about 25 years.

I would say probably the biggest distinction with ESG has more of a stakeholder focus. Everything customers, shareholders, lenders, employees, supply chain partners, communities and also as you alluded to in your opening, a tighter connection to the financial mechanisms of capitalism that drives behavior. You mentioned Larry Fink in his annual letter. He was really clear saying that ESG is capitalism.

It's driven by mutually beneficial relationships between you and the employers, customers, suppliers, and communities that you rely on. Just think of the social aspect and employee relations and employee engagement. How important is that as turnover drives up expenses, drives down productivity, and erodes culture and corporate memory. It's not just about doing good, it's about the bottom line of the organization.

That's one of the things that we really try to drive home in this series of ESG papers which we're talking about the introduction paper, that'll be followed by best practices followed by an ROI of ESG because at the end of the day, companies have to be financially sustainable to be environmentally and socially sustainable.

Abe: Simon, let me pick up on that topic here because it's a really relevant topic for a lot of organizations in determining the investment in ESG, where too often they think it's a cost of either compliance with regulatory or reducing their carbon footprint. This is a challenging decision criterium for a lot of organizations. Why is ESG an investment Alan is bringing out as opposed to a cost? Why can't we focus on ROI?

Simon Knowles: Well, that's a great question. Let me start off by saying that your ESG improvement journey doesn't necessarily have to cost you anything. Now that's a bit of a controversial statement maybe, and I'll put the question maybe. Let me unpack this for you a bit further and bring to light that there are ways to reduce, or even eliminate some of your ESG investment costs. In some cases, deliver a significant return on your ESG investment in the short term.

The question is how? We're all familiar with the term offset your carbon footprint. I like to talk about ESG investment offsetting, or you can offset your ESG investment and drive short to medium return on the business. Let me share with you a great example of a global energy company we were working with from an ESG improvement and cost-saving perspective.

To give you a bit of a background for this particular company, one of their five core values was sustainability. However, this really didn't translate into action across their supply chain, and then to compound matters further, their field logistics division was excessively using third party charter flight services that had a knock-on effect to the utilization of their own fleet resulting in high costs.

Now, we actually took a holistic approach with them to sustainable supply chain and operations improvement, which moves away from just looking at the supply chain from a cost efficiency and speed perspective, but looks at what's needed for the next generation supply chains from an enhancing the visibility, agility, resilience, the supplier optionality aspects, obviously efficiency service, and obviously, what we're talking about today, the sustainability perspective, too.

The goal set were not only to help drive efficiency and cost savings, but also to reduce their carbon footprint across their aviation division. From an ESG perspective, we helped the company not only define their metrics for sustainability, but set those sustainability targets in their business. We also help them define and sustain their processes as part of their operations control center so they could report on those savings and improvement programs and benefits from an ESG initiative. Then we link that to a balanced scorecard and also a benefits evaluation process that tracked the reduction of tons in CO2, for example.

The results, well, the company achieved annualized savings of 20%. They also reduced fuel use by 28% and also from a ESG or environmental perspective reduced carbon emissions equivalent to 2,173 passenger vehicles taken off the road. Not only that, the return on investment of that particular initiative was seven to one. Hopefully, that shows how you can drive a supply chain improvement initiative that hits multiple birds with one stone and is not just seen as a cost

Abe: Simon, let me dig into that a little bit because one of the areas that we often see, and to your point is the establishment of targets. More often than not, we see more than 50% of organizations establish targets. We did a study with the Economist and they came back and said that while the targets may be set less than half the companies, approximately 42%, haven't set or achieved or reported out on targets. Give me a sense of the rhetoric versus action and how do you sell it to management? How do you get action from them?

Simon: That's a great question. I think that depends on how you position it. I would advise that if you are wanting to sell the benefits of ESG improvement and you need to align your messaging with the needs of your executive management team, rather than just saying, this is the right thing to do because it's socially responsibility. I have four key business impact areas that I believe will resonate with senior executives and it has been resonating with senior executives that we talk to.

Firstly, it's around top line growth. It's about tapping into new markets, but also expanding into your existing ones. Just look at Tesla, the competitive advantage that they've taken by investing in electric vehicles. Look at the growth in socially responsible brands. Then we're also starting to see the rise in consumer activism. We all know that customer is king and in Alan's paper, he talks about 86% of global consumers now expect CEOs to lead on societal issues. If we don't and if they don't, customers and potentially investors will walk, having a direct impact on your top line.

The second business impact area is clearly cost savings. I alluded to that on that example just now. The reduction of transportation costs, the driving of fuel efficiencies yields, utilization rates, all have an impact on cost savings and also have an ESG impact, but also there's the lower cost of capital with preferential interest rates. For example, there's many loans now the terms are tied to ESG ratings that can have a substantial impact on a company's borrowing costs. The third business impact area I highlight is very pertinent in today's challenges, labor shortages, so talent.

That's not just in North America, but Europe and across the world. There is a big issue with labor shortages. Again, in the paper that Alan has written, 58% of employers consider a company's ESG commitments when deciding where to work, it's even higher with millennials. From a retention perspective, employees are three times more likely to stay if they're part of a purpose-driven organization.

Then my final point from a business point of view in terms of selling this to management, is the risk component. Every board, every CEO, is worried about risk. Let me just use one example in the UK, a fashion retailer called Boohoo very well known, lost $1.5 billion in market value in two days. Investors and customers balked at reports that workers in Leicester in the UK, the manufacturing plant, were being paid less than £3.50 that's around about $5 without proper PPE during the pandemic.

Hit The Times newspaper, hit the press. $1.5 billion wiped off their market value in two days. The risk associated with not having visibility of their supplier that they hadn't seen for two years. There was no ESG or social compliance alignment with the business. The lessons learned for companies is that you have to have visibility across your extended supply chain because consumers and investors give no pass when these things hit the press. Hopefully, that gives a feel for how you could sell that to management.

Bob: Alan, in the article you quote Smokey and the Bandit. You used a line that I used in one of our other podcasts which ought to make people think twice about our Netflix choices, but it's, we've got a long way to go in a short time to get there. Why are supply chains the front line whether we like it or not? Where are we in that long way to go?

Alan: Well, Bob, I'm glad you like the Smokey and the Bandit reference. Although I don't think a bet to truck 400 cases of beer from Texarkana to Atlanta was probably great for the environment, but still, it's appropriate. When you consider that over 200 companies have pledged to go net zero by 2040, that's less than 20 years away. When I was 20 years old, 20 years seemed like an eternity. Now it seems like the blink of an eye. All of these to really meet these, this goes to Abe, your question last is that you have to act now if we're going to hit those long term goals. When you say I'm going to be net zero by 2040, and just for your listeners, net zero all that means is that the carbon you emit into the environment is balanced against methods to remove carbon. There's technologies that do that, restoring forests and so forth.

The idea is you lower your carbon output and you offset what you still produce. We're a long way from there and the way to get there is-- and you really know when companies are serious because they're not just saying we're going to do this in 2040 when the CEO is long retired, they're setting really tangible interim goals to hit it. The best of the best are tying those goals to executive performance metrics in compensation, and that really changes behavior.

In terms of the transportation sector, the transportation generates 29% of the greenhouse gas emissions in the US and 14% worldwide. Not just as supply chain companies, but every company that has a product has a supply chain. Not only do we have our own greenhouse gas emissions, but we are part of the greenhouse gas emissions of retailers, manufacturers, and all our other customers.

Like it or not, logistics is right in the middle of ESG. We talk about the transportation sector, but it's also our distribution centers. It's reducing returns going into the landfill. There's so much that we can do. As an industry, we're waking up to it. There was the 3PL survey. The 2021 3PL survey showed that 83% of companies included ESG and their supply chain and growth strategies. I think that's great, but again, it's not about goals, it's about action. I was seeing ESG questions in logistics contracts when I was with UPS years ago.

About five years ago, I was seeing these ESG questions and logistics contracts. What I would say is companies should expect that these relatively soft questions to evaluate vendor practices and contracts will be increasing over the next few years. It's not just going to be looking at what you've done, it's going to be committing your company to hit certain metrics, ESG metrics, because remember, you are part of the extended supply chain of your customer and whatever commitments that they've made on ESG, you're going to be part of fulfilling. That's a really, really important point for everyone in the supply chain profession to understand. I would say like it or not, we're right in the middle of it.

Abe: Simon, let me throw this back to you here. I think Alan set the question up for me, I've got a lot of listeners out there and among the questions that they've got is where do I get started on the E, on the S, on the G? Where is my biggest return? Then couple that with the visibility or the relationships that you need to have with all your partners. We saw, in the pandemic, one of the primary challenges was visibility. That organizations didn't have visibility into their extended supply chain. Give me a sense of what supply chain managers are looking at in terms of where do I get started and how do I hold all these partners accountable?

Simon: That's great question, Abe. We're seeing that the ESG movement and the conversations we're having is not just with the supply chain managers or leaders, but also with CEO's and the board now because investor scrutiny there's over $100 trillion worth of investments already under the UN principles of responsible investment. I think there really is no one size program that fits ESG performance across all businesses just like there's no one supply chain.

I think the key thing that I would recommend supply chain leaders and executives is to start asking questions of where in your supply chain are you facing the challenges or the demands whether it's coming from your customers to improve ESG visibility across your own business all through to your suppliers’ suppliers, and identify the opportunities to not only drive measurable savings, efficiency savings, visibility, and improvements, we talked about suppliers, but also the ESG improvement aspects.

To give you a couple of fields and I'll come to the point about working with your supplier base and visibility in a minute, but from an E perspective, an environment perspective, look at some practical ways of where can you drive efficiencies that can be tied to your carbon reduction initiative? From an S or a social perspective, how do you de-risk your supply chain and look at it improving your sourcing optionality to de-risk the business? Maybe broaden your horizons and consider sourcing more locally to support your local communities and businesses. Then from a G, a governance perspective, the reporting and disclosure, we touched on working across the ecosystem of your supply chain. Implement supplier visibility tools to track compliance of your ESG standards and across your suppliers.

We saw the impact of not doing that with Boohoo, and then also maybe consider the independent verification of your ESG performance which is going to become even more important especially for your customers if they're demanding that you have ESG performance. You need to build confidence in your stakeholder community. Where do you start? If you're not sure where to start? Well, maybe consider getting an external organization to help you assess where those opportunities lie.

Bob: Alan, I do have a question here, but one real quick thing I'd like to ask based on something you talked about a moment ago, which was when you were at UPS, you were seeing ESG type questions in contracts. What I wondered is when I've heard about these things, the past, that it's been typically around supplier diversity and I wondered if A, was that typically the thing that people were asking about in the past, and do you think that's going to be changing? Not just supplier diversity, but what are you doing around your carbon footprint or whatever it might be. How's that evolving?

Alan: Oh, that's a great question, Bob. I think it started out as supplier diversity, but I was actually, even five years ago, I was starting to see questions about what are you doing in terms of managing your carbon footprint managing energy efficiency, things like that, but we're going to see it ramped up. The reason is because earlier we talked about BlackRock, well, it's not just BlackRock. During the UN Climate Conference at the end of last year, there's a group called the Glasgow Financial Alliance for Net Zero.

They represent over 130 trillion of private capital, and they pledge to mobilize at scale to achieve net zero emissions for 2050. SEC Chair Gary Gensler has ordered his agency to propose rules that would require companies to report on climate risk. That's why I say these requests from your customers are going to be heightened because part of their future ability to access capital is going to require them to be able to report on how they're doing in both environmental and social sustainability. As their supply chain partner, you are going to have to be able to supply that to them.

When customers are seeing this, they're already beginning to prepare for it. It is going to be broader than just supplier diversity. It's going to be whatever the key performance metrics around ESG that your customers are holding themselves accountable. They're going to be holding you, as their supply chain partner accountable for, it as well.

Abe: Simon, final question here. Let's make it real. We've got a lot of acute issues that we're dealing with today. There's no lack of challenges from environmental challenges, cybersecurity, obviously the Suez Canal pandemic, all across the supply chain, we're seeing significant challenges. How do you get a focus on long-term impact when you're trying to deal with the acute crisis that you're dealing with today? What's the cost of ultra-focus on today versus the long-term cost of ignoring ESG?

Simon: It's a real challenge out there in the short-term issues. I think you've got to put the fires out whilst thinking about the future. I think again, it's trying to prioritize those short-term initiatives with building in programs for improvement that are going to support you in the medium and long term as well. I think my recommendation is to be smart in the way you look at the challenges that you're facing and the opportunities that organizations are facing out there.

I personally would look at highlighting the four business impact areas that I mentioned and always think of that in that perspective, the revenue cost, talent, and risk. Clearly, if there’s material shortages and you can't get parts to build that's causing production bottlenecks and fulfillment issues, you've got to solve those issues. Look at when you are looking at maybe other sourcing optionality routes, you could build in ESG criteria as you are opening up and looking at sourcing optionality to address maybe some of those short-term issues, but also solve some of the ESG challenges going forward in your evaluation of onshore, nearshore, and offshore suppliers.

Then I'd also say ESG is a big elephant. It's a big topic. I think it's about eating that elephant one spoon at a time, and you need to do that practically and I would recommend that you identify more of a bite-sized ESG initiative that's well defined, that has a strong ROI business case in it, and supported to support the short, medium and longer-term for the business.

The cost of ignoring this, if organizations don't do it and just spend always firefighting the short term-- Here is my view. Those firms that don't invest in ESG improvement will, in the not too distant future, start experiencing a loss of revenue and market share, loss of customers, investors, it'll accentuate your challenge to hire and retain talent because you're not being seen as an ESG or socially friendly organization and expose your company to unexpected risks across your supply chain.

The result will have a direct impact on your share price and market capitalization if we don't do this. It's just unfortunately another challenge that executives and supply chain leaders need to adjust. Having said on the positive side, for those companies and executives that do demonstrate leadership in ESG, ESG can actually ultimately become a differentiating factor for your organization and have the potential to enable them to achieve competitive advantage.

Abe: Simon, Allan, thank you so much. We could continue this conversation for another hour to two hours. Of all the challenges that we're facing today, I think this is one of the areas that we need to keep our eye on, not only for the short term, but as you indicated, Simon, for the long-term impact that it has on the environment, economies, and our supply chains, and more importantly on us as people. Special thanks to Allan and Simon for sharing their insights with us. Finally, a special thanks to all of you for joining us for this episode of The Rebound. We hope you'll be back for the next episode. For The Rebound, I'm Abe Ashkenazi.

Bob: I'm Bob Trebilcock.

Abe: All the best, everyone. Thanks.

Bob: The Rebound is a joint production of the Association for Supply Chain Management and Supply Chain Management Review. For more information, be sure to visit ascm.org and scmr.com. We hope you'll join us again.

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