In Short : The question of whether big businesses have a moral obligation to help suppliers improve their sustainability is subjective, but it aligns with evolving corporate social responsibility (CSR) expectations. Many argue that larger corporations, given their influence and resources, bear a moral responsibility to encourage and support sustainability initiatives among their suppliers. Collaborative efforts can lead to positive environmental and social impacts, creating a more responsible and sustainable business ecosystem.
In Detail : When it comes to large-scale corporate behavior modification, global regulatory and legislative bodies generally have two tools at their disposal: carrots and sticks. The carrots come in the form of tax incentives, like the ones we’ve seen in the U.S. with the Inflation Reduction Act (IRA), which has introduced billions of dollars in subsidies to incentivize ventures such as domestic battery manufacturing and solar and wind projects. The sticks, of course, come in the form of penalties, fines and sometimes even the threat of jail time for failure to comply with new regulations, as we’ve seen in France’s adoption of the European Union’s (EU) Corporate Sustainability Reporting Directive (CSRD).
Things get a little more complicated, however, when these sweeping reforms start trickling down into the complex networks of third-party suppliers that big companies rely on for everything from raw materials to manufacturing to shipping to services. In many cases, these businesses are either too small to trigger regulatory oversight in their own right, or they are located in jurisdictions that have yet to implement the same level of sustainability compliance requirements that are being introduced in the U.S. and Europe.
Local Supplier, Global Risk
However, just because these smaller companies themselves may not yet be mandated to disclose and report on their operations, that does not mean they are not facing significant pressure. The newest crop of sustainability focused regulations is addressing the risks posed by suppliers by holding the corporations who use them accountable for their actions. The CSRD, for example, which took effect this month, requires in scope companies to disclose specific sustainability related risks in their own business and in those of their suppliers across the value chain. Moreover, it also includes the same requirement to have that information evaluated and signed off by independent assessors for assurance purposes as for their own operations.
And that’s just the beginning. A litany of new federal and local regulations including the EU Corporate Sustainability Due Diligence Directive, the Germany Supply Chain Act, the Uyghur Forced Labor Protection Act and the California Transparency in Supply Chains Act, and several others, are pushing big brands to take a hard look at the sustainability of their supplier networks.
In practical terms, that means that some high-profile companies who are currently under enormous pressure to provide full transparency on their sustainability-related risks could have their reputations – and their bottom lines – impacted by a single, small supplier operating on the fringes of good governance. This could be a big issue.
Imagine, for example, a mainstream consumer brand that has been working on its sustainability initiatives for the past several years, only for one of its suppliers to be found to be non-compliant with local regulations related to issues such as human rights or the improper disposal of chemicals. This is not such a stretch of the imagination; a number of companies have already found themselves in this position. The headlines on these stories do not typically contain caveats about third-party supplier relationships. Instead, they focus on the household brand name that’s run afoul of regulatory requirements.
Third-Party Sustainability Risk Management
This creates a tough paradox for companies who are heavily reliant on their supplier networks and value chains, particularly in those highly specialized sectors where there may not be many alternatives available. Do they take a punitive approach by threatening to end their relationship if certain standards cannot be met, and risk having to scramble to find a new supplier that can deliver? Or, do they offer a carrot by taking an active role in helping suppliers improve their operations to be in line with new global standards?
More and more, anecdotal evidence is pointing to the later approach. The term ethical supply chain is rapidly becoming a mainstream concept and the spotlight is starting to shine on the responsibility top tier companies have to bring their suppliers along with them on the sustainability journey.
Moreover, research has shown that the punitive approach does not always work. In fact, as Jodi L. Short and Michael W. Toffel illustrated in Harvard Business Review, code-of-conduct audits of suppliers’ factories can often produce wildly mixed results depending on where in the world those factories are located, prevalence of union labor and even the particular style and approach used by auditors. In some cases, these approaches work, and the audited companies improve their working practices, and in others they do not.
One early experiment in a more collaborative approach to supplier risk management was introduced this past November by H&M Group. Launched as part of its Green Fashion Initiative, the fashion brand has partnered with a financial firm and a sustainability consultant to help suppliers fund sustainability improvement initiatives. Under the program, suppliers who commit to specific greenhouse gas reduction targets will gain access to financing with highly favorable terms, along with technical guidance on required factory improvements.
So far, at least one supplier has taken advantage of the initiative by financing the installation of solar panels, energy efficient motors and water conservation technologies at its facility.
Whether or not the strategy will work on a larger scale remains to be seen, but the approach is certainly more in line with the spirit of ethical supply chains than a punitive approach to supplier management, or worse, complete ignorance of supplier actions.
In the future, we’re likely to see a combination of both strategies being deployed much more frequently as the CSRD and other sustainability-related supply chain regulations start to show their teeth.