Market Values

31 March 2009

In a tough economy, socially sensitive procurement programmes may not seem a priority, but as Richard Clarke of Arthur D Little tells CEO, taking a responsible approach is a necessary element of business survival.

Faced with growing uncertainty, the second half of 2008 witnessed a tide of survival-based, quick-fix decisions from businesses consumed with keeping in the black as global markets constricted.

Despite recent events, expectations of how companies conduct their business in a socially and environmentally conscious manner are encompassing the entire supply chain of products and services. Where once these expectations may have been limited to niche groups, stakeholders at all levels are beginning to see such concerns as the norm.

Business with integrity

"In its simplest form, a sustainable procurement strategy looks to balance and entwine operational and commercial ambitions with those objectives that demonstrate company values and integrity."

Sustainable procurement is an approach to the purchasing of products and services that takes into account the environmental, social and wider economic implications of buying and manufacturing choices.

It places these considerations alongside other traditional drivers such as price, quality, availability and functionality. Sustainable procurement also considers the reputational exposure and benefits associated with product manufacture. This could include social changes such as alleviating poverty or improving the working conditions for those involved in the production of products.

In its simplest form, a sustainable procurement strategy looks to balance and entwine operational and commercial ambitions with those objectives that demonstrate company values and integrity.

A sustainable procurement programme reinforces supply chain integrity. This assures stakeholders that their expectations will be met. It also enables the company to give appropriate and proportionate consideration to social and environmental issues. It is important to note that this could mean a reduction of effort in certain areas if the response has been too great for the underlying risk.

The cost of environmental and social failure can often be overlooked or not fully appreciated because the underlying risks are frequently intangible. Failure may give rise to significant costs in terms of corrective action. This could include product recalls or damage to a company’s reputation caused by, for example, the use of child labour in the manufacturing process.

Adding value

For any procurement strategy to be truly sustainable, it must come from corporate strategy. In turn, corporate strategy must be shaped by the expectations of the external operating environment.

Throughout the 1990s and the first half of this decade, many businesses took the opportunity to command premium pricing through products with ‘green’ or ‘socially responsible’ labels. The credit crunch has perhaps limited this opportunity in the short term, with cash-strapped consumers more reluctant to pay the premium these products have typically demanded. However, expectations of customers, regulators and shareholders for companies to take action on social and environmental issues remain strong.

Increasing regulatory requirements can affect a company’s bottom line. Emerging regulation in the area of sustainable procurement is no different. It is a company requirement to understand the effect of such regulation and its implications on long-term company growth. To illustrate this, the EU recently issued directives requiring white goods and automotive manufacturers to include disposal costs in their P&L analysis. Another directive bans electrical and electronic equipment containing certain hazardous components from being sold within the EU.

The volatility of the current economic climate makes establishing a robust, sustainable procurement programme a key component of supporting the ‘survivability’ of businesses. The overarching intention of establishing a sustainable procurement strategy that recognises, evaluates and monetises social and environmental issues is that it is able to add business value from the outset and indefinitely. It therefore needs to be able to respond to and meet company and market requirements in the immediate, mid and long term.

Companies looking to achieve coherence between social and environmental considerations and mainstream business objectives can do this through five key steps.

The first step focuses on cost leverage, brought about by factors ranging from enhanced compliance with government regulation, lower consumption of energy and other natural resources in production. In recent years many companies have experienced significant financial and reputational costs because their supply chains have failed to meet social expectations.

Recent examples include Nike and British Airways. In both instances the failings were due to cuts in their supply chain that did not consider reputational implications. In Nike’s case, the allegation was that it provided poor working conditions at production sites in Asia. In BA’s case, its cost efficiency exercise led to the company’s outsourced catering firm laying off more expensive union staff and replacing them with low paid non-union workers, prompting a subsequent wildcat strike. In both instances, Nike and BA were held accountable due to their cost-cutting demands; Nike’s sales and reputation suffered, and BA cancelled some 600 flights, costing approximately £45m.

Conversely, Allied Distillers, which, after several years of implementing a waste minimisation programme across its sites, decided to involve its key suppliers in an initiative to encourage resource efficiency.

Through the initiative, the supply chain was able to achieve cost savings of £1.2m per year, with the potential to increase savings to £1.7m per year.

The second step for consideration is risk reduction, which can be achieved by minimising the potential of supply chain disruption and grounds for litigation. These risks can be lowered by integrating social and environmental performance metrics and targets into the supplier assessment process or during the contract renewal process. This can help mitigate the risk of suppliers’ non-compliance with regulation or the expected standards of the buyer.

"For any procurement strategy to be truly sustainable, it must come from corporate strategy. In turn, corporate strategy must be shaped by the expectations of the external operating environment."

For example, a study of 800 instances of supply chain disruption experienced by publicly traded firms showed the firms experienced between 33% and 40% lower stock returns relative to their benchmarks over a three-year period. Share price volatility in the year after the disruption was 13.5% higher compared to the previous year.

The third step is to create business options by meeting the expectations of customers, consumers and other legitimate stakeholders, including the growing number of socially responsible investment analysts, ratings agencies and indices. These stakeholders expect companies to conduct their business with integrity, demonstrated through their relationship with society and the environment.

Customers and consumers will often develop a preference towards those companies and brands presenting a sound response to environmental and social issues. Other businesses in a supply chain are experiencing the same market challenges. Preference is likely to be given to those providers presenting the least risk of exposing the supply chain to disruption or those which most effectively support the buyer’s integrity.

The fourth step is to build stakeholder support through the company by being more highly valued by potential and existing customers, insurers and credit sources and by supporting the development of supplier relationships. This can contribute towards brand reinforcement and an enhanced reputation. Shareholders, the investment community and analysts also place significant value on a company’s ability to deliver steady performance. Disruptions to a company’s supply chain, or the perception that a company is significantly exposed to potential disruption could damage company valuation.

Finally, provide an early warning system to identify potential problems and weaknesses in the procurement process. This can be done by using performance indicators to ensure problems are identified and addressed before disruption to the supply chain occurs. By being able to confidentially identify social and environmental risks throughout the supply chain, the company will be able to extract itself from exposure to others’ failures thereby protecting the integrity and confidence held in them.

Make the right choice

With purchased products and services accounting for more than 60% of an average company’s costs, the resulting exposure to supplier activities is significant, as is the vulnerability to adverse environmental and social performance of suppliers and goods purchased. While the responsibility for addressing sustainable procurement is often delegated to the CPO, accountability for a company’s ability to demonstrate sustainable procurement rests with the CEO.

In this changing business landscape, companies have three strategic choices in relation to sustainable procurement.

They can adopt a reactive strategy, moving towards a greater understanding and consideration of social and environmental issues only when forced to do so by regulation, loss of business, or as a result of a major reputational crisis. Companies that adopt this strategy constantly maintain a high risk of losing competitive advantage, incurring fines and other penalties and losing customers and staff.
An alternative strategy is to keep up with regulation and with peers. This strategy can protect revenue, but fails to encourage business opportunities or better understanding of potential risks.

The third possibility is a strategy of anticipation, through systematic evaluation of procurement options, followed by implementation of measures designed to maximise the business benefits delivered through sustainable procurement.

Questions to consider

When looking to understand how the potential value of implementing a sustainable procurement strategy will improve company performance, its scope and its reach, the following questions should be considered:

Does the company’s current procurement strategy communicate, deliver and reinforce business objectives and values throughout the supply chain?

Does the strategy identify where reputational risks might exist as a result of failure to meet stakeholder expectations?

Can the company provide an approach to effectively manage social and environmental risks and to capitalise on product innovation or operational efficiency? If progress has already been made in this area, is the response proportionate to the potential risk?

What is in place to enable the company to evaluate the wider implications or disruption to the supply chain that might be caused by attempts to reduce costs?

As the challenging economic climate continues, the need to carefully manage risks becomes increasingly more important. Can you afford not to include sustainability considerations within your procurement strategy?