ESG and supply chains: assessing the growing risks

Supply chain disruptions are becoming more frequent and more severe. A continually changing operating environment may require an analysis of processes and suppliers to increase resilience and create opportunities to intervene and prevent potential future crises. This analysis should incorporate environmental, social, and governance (ESG) risk aspects.

Businesses have experienced a number of supply chain disruptions recently: Record vessel delays have clogged ports and crammed warehouses in the wake of the Covid-19 pandemic, which has disrupted already fragile global supply chains. A semiconductor crunch and petrochemical shortages have caused supply ruptures. Smaller companies have had to fight to secure expensive space on container ships to keep production and sales moving. Other events that recently impacted supply chains include Brexit and a container vessel stuck in the Suez Canal. More recently, the Ukraine conflict has amplified existing and created new challenges. China’s string of COVID-19 lockdowns is causing shipping containers to stack up at ports (opens a new window) as trucks struggle to unload cargo due to strict permit regulations.

Furthermore, climate-related shocks such as extreme weather events are set to become more common and severe as the world warms, and could further upend interconnected supply chains, according to the UN’s Intergovernmental Panel on Climate Change (opens a new window).

In 2021, material shortages, price increases and transportation/logistics were the main drivers of disruptions for businesses, according to the 2022 Supply Chain Resilience Report, which surveyed (opens a new window) 437 respondents from October 2021.

Top supply chain disruptions that have impacted businesses in 2021. Source Supply chain resilience report 2021 update.

Source: Supply chain resilience report 2021 update (opens a new window)

Supply chain disruption can have longer-term brand and reputational consequences as well as immediate impact in the form of reduced sales and revenues. It is currently perceived as the second greatest external risk to businesses after cyber threats, according to business leaders surveyed in the 2022 State of Ecosystem and Application Integration Report (opens a new window). Among the sectors most affected (opens a new window) are manufacturing as well as wholesale and retail trade.

Business strategies aiming at reducing cost have often created long and complex supply chains. But cross border delays, high inflation, and an inability to source needed raw materials can cause significant financial strain to companies.

As a reaction to recent disruptions, some businesses have started to explore near-shoring or re-shoring to reduce the supply chain risk. Near shoring can lower supply chain risk due to shorter transportation distance and a better mutual understanding of existing vulnerabilities. As part of a supply chain assessment, businesses are critically reviewing lean production methods known as “just-in-time” and looking to shift to a more resilient and sustainable supply chain strategy.

The public discourse over ESG risks has also increased the need to monitor suppliers more closely from an ethical and environmental perspective to better protect the brand and reputation. Sourcing materials and products closer to consumers can increase transparency and may also support sustainability efforts. Staffing shortages in many sectors have also caused businesses to reconsider their employment policies and practices and employee benefits to remain attractive to applicants.

Reassessing the supply chain

Supply chains that stretch across the globe are complex and inevitably subject to some level of disruption. Shortening the supply chain where possible and reducing dependency on external parties is likely to leave a business less vulnerable to potential disruptive events.

These are the most effective measures to reducing supply disruptions in the future, according to the Supply Chain Resilience Report survey (opens a new window):

Most effective measures to reduce supply chain disruptions, source: 2022 Supply chain resilience report.

Source: Supply chain resilience report 2021 update (opens a new window)

Adjusting the supply chain:

As seen during the height of the coronavirus pandemic, entire countries or regions can be affected by disruption, potentially cutting supplies to zero. Businesses should therefore avoid relying solely on a select number of suppliers, or even a single geography. Instead, it’s advisable to diversify the sourcing of goods and raw materials and look to near-shoring and re-shoring as options. The aim is to build a quality-vetted, geographically distributed network of engaged suppliers that you can rely on to take on more capacity when needed and that support your ESG/sustainability agenda.

ESG considerations may include:

  • sourcing raw materials in a renewable and non-destructive manner

  • using fair labour practices to support worker retention and satisfaction

  • employing capital from responsible sources that share sustainability objectives

  • deploying environmentally friendly logistics for transportation of materials or end products

  • reducing the use of resources in the value chain through materials management

  • reusing resources across the entire value chain

  • recycling by breaking down resource materials into components and reprocessing them into new forms

Increasing visibility

In areas where it is hard to control the risks or to react fast enough, increasing the visibility over the supply chain to spot oncoming disruptions faster can help extend the time to react. Improving communications with partner organisations through automated supply chain warnings could be an option worth exploring. This approach may need to be extended to tier two suppliers.

Through a closer monitoring of suppliers across all tiers, businesses will be able to spot warning signs well before disruption takes effect. However, monitoring a supply chain from the raw materials to the finished product can be a complex and lengthy process. Developing deeper relationships with a select group of suppliers may be a less burdensome alternative. By informing suppliers of any changes in demand or order changes, and perhaps involving them in product decisions, the business may in return receive earlier updates and alerts of future disruptions further down the supply chain.

Recommendations for risk managers:

  • Ensure that supply chain-related risks are appropriately articulated within organisational risk registers

  • Undertake criticality mapping of third parties, including risk assessments for services/goods received

  • Implement a formal risk assessment process for new suppliers and conduct an annual review around existing third parties

  • Reduce operational costs through automation, redesigning of operational processes

  • Create redundancies in the supply for critical parts

  • Plan for disruptions by spreading the risk

  • Break organisational silos

  • Communicate regularly with supply chain partners

  • Bring procurement, financing, logistics functions together

  • Coordinate supply and demand, inventory

  • Explore a joint initiative with suppliers

  • Explore a collaborative planning for customer replenishment

  • Include ESG risks in the conversation with suppliers as part of the procurement process and not only cost considerations

  • Include risk management into product design as choice of material and components can increase resilience/shorten lead times

  • Embed risk management into the procurement process, increase responsiveness and resilience

  • Design a resilient supply chain including an alternative or parallel path for agile response

  • Improve forecasting by augmented visibility on real demand, compressing lead times

  • Request a business continuity plan (BCP) from suppliers

  • Look to include workarounds for loss of key suppliers within own BCP

  • Augment visibility and control over the global pipeline

  • Identify critical assets in the inventory flow and alert trigger levels

  • Develop strong crisis management capabilities

  • Ensure that crisis management arrangements are regularly tested through scenario-based exercising

  • Develop supply chain business analytics and performance indicators

  • Explore predictive analytics, modelling of different scenarios and potential responses

Bespoke global insurance programmes can reduce the residual risk and provide liquidity when needed. They can also help address challenges unique to international operations, such as taxes and admitted regulations. It is worth regularly considering adjustments to retention levels to reflect the specific risk appetite in the current environment, as well as alternative solutions such as captives.

For further information, please contact:

Mark Black, Team Leader Lockton Risk Control Services

T: +44 (0)7584 382447

E: mark.black@lockton.com

Matthew Couchman, Risk Management Executive – Risk Control Services

T: +44 (0) 20 7933 1549

E: matthew.couchman@lockton.com

Mark Black

by  Mark Black

Team Leader Lockton Risk Control Services

mark.black@lockton.com (opens a new window)

For more info

Matthew Couchman

Risk Management Executive – Risk Control Services

+44 02079331549 (opens a new window)

matthew.couchman@lockton.com (opens a new window)

Mark Black

Team Leader Lockton Risk Control Services

mark.black@lockton.com (opens a new window)

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