During the 1990s, Procurement professionals were at the heart of strategic sourcing initiatives, focusing on reducing costs, enhancing quality, expanding services, and founding organizations like the International Association of Outsourcing Professionals and the Sourcing Industry Group. Composed of buy-side procurement professionals and their organizations, today these groups provide education, tools, and resources. Ethics and sourcing techniques have greatly matured throughout this century, but whether organizations and suppliers can address and comply with the myriad of ESG risks and regulations of today’s increasingly diverse and complex global supply chains remains a question. Success will absolutely require collaboration and partnership within your own organization and your third parties.
In its 2020 eBook “Eliminate Barriers to Responsible Sourcing,” Gartner notes three out of four organizations surveyed have formalized responsible (ethical) sourcing programs. Gartner also found many organizations faced obstacles when it came to making those programs more than just well-intended declarations of standards. Gartner’s eBook addressed three specific challenges:
Sustainable supply alternatives are more expensive and/or not available
Responsible sourcing initiatives are difficult to monitor and enforce
Misalignment between responsible sourcing goals and internal procurement metrics
And that was before the pandemic, social and political unrest, global inflation, and the war in Ukraine. It cannot be underestimated how events of the past two years have made the scope and size of those challenges greater; if anything, they’ve proven that meeting them with strategic, effective, and responsible programs is essential.
In another report from January 2020, The Harvard Law School Forum on Corporate Governance cited evidence of links between a company’s ESG rating and its financial performance, although whether those higher performance levels stemmed from the ability of larger companies to commit greater resources to ESG programs or vice versa was not conclusive. What is known, and documented by Allianz, is that ESG considerations influence both consumer behavior and investor sentiment, especially among Millennials and Gen Z, who comprise the majority of the global population. From every perspective, having a solid ethical sourcing strategy is good for business. It’s not financial value vs economic and social values, it’s financial value plus economic and social values.
How to create an ethical sourcing strategy?
Implementing a successful strategy depends on Procurement, which has the frontline role in executing an organization’s ESG strategies. On offense, Procurement is the gatekeeper. On defense, it performs due diligence, upholds standards, and may be involved in auditing both potential and existing vendors and sources.
While Ethical Sourcing is just one part of an organization’s larger ESG concerns, it might be the most challenging because unlike government regulations and environmental measurements, its definition is open to subjective interpretations. Sedex defines ethical sourcing as “an approach to sourcing and supply chains. Sourcing ethically means that when businesses buy products from suppliers, they consider the impacts those products have on the people and communities who create them.” More specifically, consumers and investors are likely to interpret “ethically sourced” to mean products and services used in each point of a business’s supply chain are obtained in an ethical way, which includes upholding human rights, decent working conditions, health and safety, good business ethics and more, including climate considerations.
Despite the clarity of those terms, interpreting them can be an exercise in ambiguity, exacerbated by the lack of national and globally accepted standards defining ESG protocols and boundaries. Recent moves by the Biden administration and the International Organization of Securities Commissions (IOSCO) hint at eventual regulations addressing at least some of ESG’s grey areas.
Procurement’s Role in ESG
Shared Assessments Gary Roboff agrees the lack of clarity around policy expectations is an obstacle, which gets to the question of how an individual organization can address that issue.
During an interview with Supply Chain Bran, Bill Michels, VP of Operations, Americas at the Chartered Institute of Procurement & Supply (CIPS) said a major problem is most people don’t know what’s in their supply beyond the first tier, which leads to unpleasant surprises resulting in legal, financial, and reputational problems. He suggests three steps to get on the right path:
- Know your own policies, principles, standards and expectations- educate your employees, vendors, and contractors.
- Confirm your vendors follow the same policies through certification and audits.
- Map your supply chain, confirm your vendors and their vendors, audit them, and know where your money is going.
Ultimately, Michels believes the C-level owns responsibility for ethical sourcing, but that responsibility needs to extend across the entire procurement team: “When selecting a supplier, they’re architecting the supply chain for the future, so it’s critical that they have compliance and education. Otherwise, it could damage the reputation of the company.”
Roboff concurs: “That’s a critical starting point and if an organization can’t articulate its procurement principles and control expectations, it may send a signal that the C-suite and board – for whatever reason – are not appropriately engaged with the firm’s ethical behavior.” In such circumstances, there is a case to be made that procurement has a responsibility to run a reg flag up the organization’s management chain to start a conversation and hopefully steer the process in the right direction.
In firms where there is a seeming executive-level commitment but little progress beyond a high-level set of principles in a sea of standards, experts suggest selecting a sustainability framework and set of standards that most closely align with the firm’s principles and risk appetite. Choose what to focus on within those frameworks and standards based on your organization’s specific lines of business, operating structure, governance, and ERM practices.
At an elevated level, Roboff suggests there is no need to wait for perfect standards clarity, and there may be the harm in doing so. The jumble of standards and regulations will eventually sort itself out. Regulators, on an international basis, sponsor working groups aimed at harmonizing ESG regulations wherever possible, although different jurisdictions will evolve at different paces. Frameworks and standards are coming together, as shown by the recent announcement from the International Sustainability Standards Board (ISSB) on the launch of public consultation on two proposed global sustainability standards. The first sets out general sustainability-related disclosure requirements and the other specifies climate-related disclosure requirements.
Roboff also agrees with Gartner’s point about responsible sourcing initiatives being difficult to monitor and enforce is “on the mark, and will get worse when scope 3 emissions emerge as a reporting requirement in the coming years.” That challenge presents an opportunity for Procurement. Roboff remembers Marco Baren’s comments about Philip’s experience. That firm found that nearly half of Phillips’ suppliers’ self-reported ESG compliance measures exposed previously hidden serious problems, such as child labor, environmental degradation, and fraud. But Philips found that by working with suppliers it could make many of them into ESG all-stars over time. During a Procurement Leaders Session, Barren told Procurement Leaders’ moderator Stephen Hall that his vendors thanked Philips for their help. One of their suppliers sent Baren a letter, saying “Finally! We do not need sustainability policing, we need sustainability doctors, and that’s exactly what you do, so thank you for your help… thank you for helping us to improve – the improvements are staggering.” That vendor’s improvements in ESG scores were 40% in the first year, and 20% in the second year. That result requires that outsourcers have a good due diligence capability, a willingness to collaborate with suppliers to achieve the desired ESG outcomes, and the ability to make the economic case that ESG supplier outreach is often the most effective way to meet all an organization’s procurement goals.
As ESG concerns continue to grow in response to recent events and conditions unfolding across the globe, the potential consequences for organizations without effective ESG strategies and practices could grow increasingly severe, including attacks from civilian “hacktivists.” Successful ESG strategies require multiple components, and while ethical sourcing may be difficult to implement and maintain, it may be the most important. To succeed, Procurement needs buy-in and guidance at the C-level, followed by consistent support, with clearly defined expectations, policies, and responsibilities.