Supply chain sustainability: ESG path to manufacturing resilience

Recent years have brought new challenges that require manufacturers to rethink their priorities, with supply chain sustainability unquestionably topping the list. Environmental, social, and governance (ESG) frameworks not only entice companies with the promise of sustainable value, but also demand companies to comply with related laws and regulations.

By embracing sustainability, addressing risks, and complying with regulations, manufacturers are better equipped to enhance business continuity and long-term viability, while building a positive reputation, engaging stakeholders, and driving resource efficiency at the same time. In such an environment, innovation and adaptability flourish, positioning companies to navigate challenges more effectively and maintain operational stability during disruptions.

In this blog, we expand on the supply chain sustainability section of our recent white paper, Supply chain resilience: a modular framework for sailing through disruption. Specifically, we will cover the following aspects:

• Data to empower decision-making, including optimization of spending and resource allocation;
• Digitization with ESG in mind: IT/OT considerations and roadmapped initiatives;
• Innovation based on value, ensuring that ESG-related initiatives fuel business resilience.

Read on to explore how manufacturers can develop actionable and measurable strategies for implementing and evaluating sustainability to enhance overall performance.

Supply chain and sustainability: business role of ESG

Amidst economic turmoil, the pace of regulatory response is accelerating, and there is a growing public demand for ESG initiatives. To better understand these initiatives, let's take a moment to review the key components of sustainability in the supply chain, summarized in Table 1:

Table 1: Key ESG requirements

Sustainable future, regulated

As industry rules continue to change, new regulations, behaviors, trends, and innovations are shaping the landscape. While some aspects of supply chain sustainability are universal, specific requirements may vary across countries. For instance, the US Inflation Reduction Act (IRA) offers tax reductions for carbon footprint reduction investments, and imposes fines for non-compliance. States like California have their own sustainability-related bills, such as the Climate Corporate Data Accountability Act and Greenhouse gases: climate-related financial risk legislation, which require large companies to disclose greenhouse gas (GHG) emissions and detail climate change-related financial risks. Europe’s regulations also mandate sustainability actions and reporting to mitigate greenwashing.

The fines and sanctions associated with these regulations emphasize the importance of ESG for supply chain resilience. Consider, for example, the German Supply Chain Due Diligence Act (LkSG), which demands environmental and human rights considerations for companies with 3K+ employees (1K+ from 2024) or branches in Germany. Non-compliance or failure to report required documentation results in fines (up to 2% of annual turnover), reputational damage, and exclusion from public contracts for up to three years.

Upcoming regulations, such as the UK Sustainability Disclosure Requirements and the EU Corporate Sustainability Due Diligence Directive further underscore the need for sustainable operations. Investing in sustainability brings various opportunities for manufacturing businesses, while neglecting ESG initiatives poses significant risks. For a comprehensive summary of these opportunities and risks, refer to Table 2:

Table 2: The impact of prioritizing/deprioritizing ESG efforts on manufacturing businesses

Supply chain resilience requires transparency and baselines

The cornerstone of any supply chain resilience framework is strengthening the data foundation, and this is crucial for a specific reason. Nearly all supply chain initiatives rely on data to assess the present situation, set baselines, and prioritize actions and metrics to attain resilience goals.

In light of this, let's examine a comprehensive framework for GHG emissions:

Figure 1 illustrates a high-level overview of the GHG emission framework. To contextualize it within various manufacturing end-products' supply chains, Figure 2 highlights the discrepancy in scope 1, 2, and 3 emissions across different industries:

Considering the global distribution of supply chains and the applicability of ESG-related laws and regulations mentioned earlier, several deductions can be made:

1. Manufacturers must monitor sustainability-related Key Performance Indicators (KPIs) throughout the entire supply chain.
2. Optimization efforts should commence with a comprehensive assessment to determine their impact on the entire chain and be shared across all stakeholders.
3. Strategic actions for supplier diversification should include evaluating their sustainability strategies and policies.

Therefore, the baseline for sustainability initiatives should be established on the following principles:

1. Data from the entire supply chain ecosystem should be considered.
2. Standardized intelligence from internal, in-house, and outbound sources should be incorporated.
3. Timely and actionable insights are essential for informed decision-making and proactive issue resolution, averting incidents or violations.

Actionable and measurable sustainability: steps to resilience

Recognizing that there is no one-size-fits-all solution for sustainability requirements, let's explore the changes necessary for the manufacturing sector and the considerations organizations must bear in mind when planning their ESG-related endeavors. To effectively translate environmental and social goals into continuous improvement projects across the supplier network, the following steps and focal points are essential.

Step 1: Map the path and milestones

Begin by establishing a baseline for sustainability efforts and align it with ESG goals and objectives. This will enable the identification of key performance indicators (KPIs) and sustainability standards applicable to your own facilities. Subsequently, extend these measures to the first-tier suppliers and beyond in the supply chain.

Table 3: Stages and milestones for mapping sustainability efforts to your use cases

As previously mentioned, supply chain models vary, and the phases and milestones in Table 3 can be adjusted based on conditions, urgency, and specific needs.

Step 2: Bridge the gap between the milestone and the results

The milestones provided in the earlier table intentionally offer broad definitions, allowing manufacturers to tailor them to their company's requirements and unique circumstances.

For instance, a food manufacturer may improve operational efficiency and reduce waste through better demand forecasting and shipment planning solutions, while the automotive industry may require IoT combined with AM anomaly detection to address the same challenges. Technological solutions and key performance indicators (KPIs) for hygienic actions and tracking ESG efforts are explored in this section.

1. System integration capabilities:
   1. Data readiness: Capture real-time operational data along the heterogeneous IT landscape for measurement and reporting of ESG metrics. Drive enterprise system integration between finance, sourcing, legal, and enterprise risk functions.
   2. Data utilization: Build a central supplier repository to monitor progress towards ESG objectives and bolster business resilience. Ensure an audit trail and cohesiveness for reporting requirements.
   3. Prioritize digitization of internal systems based on tangible data and the state of the IT/OT ecosystem.
2. Supplier risk management:
   1. Develop optimization algorithms that include ESG criteria in decision support and leverage harmonized, validated data sources when evaluating various scenarios.
   2. Perform risk due diligence of your supplier base.
   3. Optimize sourcing and logistics using advanced algorithms and explore sustainable logistics options beyond product or packaging sustainability.
   4. Develop or demand last-mile delivery service providers to offer more sustainable delivery options to capture market share and increase customer loyalty.
3. Custom dashboards and alerting:
   1. Modernize planning systems to optimize inventory, production and demand forecasting.
   2. Enhance traceability and connectivity across assembly stages and suppliers to meet ESG laws and regulations. Respond timeously to potential issues to prevent violations.
   3. Incorporate ESG into the supplier network from onboarding and contracts to audits and reporting. Tailor risk due diligence based on countries, commodities, etc.
   4. Map the supply chain to gain clarity on all actors, processes, outputs, and interconnections.
4. Digital transformation:
   1. Increase and automate quality control to reduce waste.
   2. Leverage AI/ML to identify data gaps in current operations.
   3. Use digital twins to model greener approaches with improved ROI.
   4. Optimize and track workforce schedules automatically to ensure fair labor practices.

Upward spiral: Role of sustainability in supply chain resilience

Given the growing global challenges, sustainability can become a competitive advantage while safeguarding financial resilience. However, achieving sustainability is not a uniform path and requires investment, analysis, and supplier renegotiation. Manufacturers must address challenges related to transparency, differing regulations, public scrutiny, and the ability to conduct risk assessments and respond quickly to violations.

Benefits and opportunities

Improving supply chain sustainability impacts various operational layers, providing significant benefits to people involved in adopting sustainability practices:

• Internal stakeholders
  • Employee satisfaction and quality of life
  • Productivity
  • Decreased turnover
• Stakeholders (governments, investors, suppliers)
  • Increased share price
  • Increased revenue
  • Higher profits
  • Better management of operational risks
• Customers and shareholders
  • Loyalty
  • Publicity
  • Compliance with laws and regulations

Challenges

ESG regulations worldwide make compliance a mandatory path. However, achieving sustainable supply chains is not a straightforward journey; it demands upfront investments, careful analysis, and renegotiation with suppliers. Additionally, manufacturers must be aware of the following risks:

• Transparency: Ensuring transparency in all sustainability efforts, both within the organization and from suppliers, is crucial for meeting ESG objectives and reporting accurately.
• Divergent Regulations: Regulations can vary significantly across regions and may even contradict each other. Navigating these complexities requires careful attention to comply with the specific requirements in each jurisdiction.
• Public Scrutiny: Manufacturers may face public scrutiny, especially if suppliers are not fully committed to sustainability initiatives. Negative attention can harm the brand's reputation and stakeholder trust.
• Risk Management: Regularly conducting risk assessments is essential to identify potential violations or non-compliance with ESG regulations. Manufacturers must respond swiftly to rectify any issues that arise to avoid penalties or reputational damage.

Toward sustainability: grasp opportunities and minimize risks

To advance toward sustainability and minimize risks, manufacturing companies worldwide must coordinate and formalize their ESG efforts, integrating them throughout their supply networks. As corporate sustainability expectations rise, compliance with regulations necessitates the swift digitization of business processes, encompassing:

• Processes: Embedding sustainability procedures and preventive measures into the entire value chain, from raw material extraction to the disposal and recycling of finished goods.
• People: Educating all stakeholders about sustainability practices, ensuring their readiness to comply, and taking corrective action if any issues are identified.
• Technology: Digitizing business processes related to supply chain and supplier management, integrating systems to efficiently track, respond to, and report ESG data cohesively.

To address ESG requirements in your supply chain and identify gaps and risks, consider the following questions:

• How can sustainability be embedded into a resilience framework tailored to your supply chain model?
• What is necessary for effective supply chain and supplier risk management?
• How can alerting systems and planning/assessment dashboards be set up and operationalized?
• How can actionable data be obtained from siloed systems throughout the chain?

Reach out to Grid Dynamics to discuss and discover the answers.