Integrating ESG into supply chain operations

Environmental, Social and Governance (ESG) requirements are increasingly being recognised as an indispensable part of corporate strategy. KPMG’s 2023 CEO Outlook Survey of more than 1300 global CEOs found that over two-thirds (69 percent) have fully embedded ESG into their business to create value. A quarter (24 percent) believe that over the next 3 years, ESG will have the greatest impact on their customer relationships, and 16 percent believe it will help build their brand reputation. However, even with this awareness, 60 percent indicate that their ESG progress is not strong enough to withstand potential scrutiny.

One role that is in a prime position to support CEOs to drive ESG improvements is the supply chain leader. While ESG was once considered the remit of the Corporate Social Responsibility team, there has been a shift towards ESG being owned by the supply chain and procurement functions. This makes sense, as there are several ESG challenges in the supply chain, which if resolved, could dramatically improve an organisation’s overall ESG standing. 

Supply chain leaders focusing on ESG face the challenges of decarbonising to meet Scope 3 needs while helping to abate climate change; meeting new and demanding regulatory requirements; rethinking sustainability goal prioritisation and perhaps engaging co-financing; and improving operational performance aligned to business performance – for example, by creating circular value chains.

Scope 3 impact

Traditionally, supply chain leaders have focused on meeting customer expectations, getting products delivered when customers want them, in the right format, and to the right collection point. Speed, reliability, cost effectiveness, and managing operational risk have been the key priorities. While these factors remain, new Scope 3 reporting expectations aligned to the Paris Agreement are increasing the pressure on supply chain leaders to support their organisation to achieve emission reductions.

To address carbon measurement and reduction, Scope 1 and 2 focus on the carbon an organization produces and what it purchases from the energy grid. Scope 3 goes further, measuring the carbon emissions beyond the organization’s own products and services (far into the value chain). This could include the extraction and production of purchased materials, the transportation and use of products, and the transport and disposal of waste.

Scope 3 requires supply chain leaders to have full industry value chain awareness, and knowledge of interactions with their entire ecosystem of trading partners. Many of these partners are tier two suppliers and beyond, therefore are unknown today. Supply chain leaders will need to adopt new digital approaches to identify, capture and validate data on these partners for ESG/Scope 3 reporting purposes.

If organisations fail to manage Scope 3, they will likely fail regulatory responsibilities, and they could face commercial and reputational issues. Meeting Scope 3 can also become a competitive differentiator, as organisations will seek out suppliers who are compliant and can provide the supporting data.

New and emerging regulations

In addition to Scope 3, supply chain leaders are facing new and emerging local and global regulations that must be addressed to be compliant. It is essential to understand the regulatory impacts on specific commodities or components within the supply chain, and to find compliant alternatives. 

Four recent regulations to be aware of include the Carbon Border Adjustment Mechanism (CBAM), a charge on embedded carbon content upon importation into the EU; the Corporate Sustainability Due Diligence Directive (CSDDD), which focuses on human rights and environmental due diligence; the EU Deforestation Regulation (EUDR), which demands proof that products do not originate from recently deforested land; and the EU Batteries Regulation, which focuses on companies which are placing batteries in the EU market.

Failing to be compliant can lead to quite significant repercussions. Organisations may face fines, the seizure of goods at borders, market entry denial, reputational issues, or leaders may even face imprisonment. Therefore, it is important to make compliance manageable by looking for correlations across the different requirements, as many of the data needs are similar. It is possible that an organisation will already have much of the data, and it just needs to be linked in the right way to streamline reporting.

Visibility and sustainability

Supply chain leaders have been working to improve the visibility and traceability of products flowing through the extended industry value chain. However, to meet Scope 3 as well as new and emerging regulatory obligations, this is an urgent priority.

Visibility and traceability are vital right throughout the supply chain to identify, manage, and measure any ESG obligations and concerns for any supplier or third party. This insight should extend as far back as product origin, and right down to the end consumer/consumption point.

Gaining this insight enables further investigation into the availability and quality of data from potentially thousands of suppliers, its validity and trustworthiness, and undertaking due diligence. Organisations will likely require a data and digitisation strategy that includes data standardisation, and blockchain-enabled data collection and validation systems. Data automation and artificial intelligence (AI) will increasingly play a role, helping supply chain leaders to aggregate data and bring the right information together, and make sense of it in near real-time.

Refining sustainability goals

While focusing on Scope 3 and compliance, supply chain leaders have an opportunity to help shape the organisation’s sustainability goals, and to prioritise their organisation’s path toward net zero. This means finding the areas of focus that will likely have the most impact.

One way to scope and prioritise is with a double materiality assessment (DMA). This means looking at everything that affects the organisation from a sustainability point of view, then considering every way the organisation makes a sustainability-related impact. This can revel where the biggest sustainability challenges are, and where changes should be prioritised. CEOs have an opportunity to assess the prioritised changes and establish initiatives that drive both compliance and performance outcomes.

Another way to prioritise goals is to engage in Science Based Targets. Supply chain leaders can start with a target date for net zero, then work backwards from that date to plot where and how emission reductions may need to be made. This reveals where the most difficult problems sit, and what needs action now.

For some of the longer term, complex challenges, supply chain leaders should be resourceful and consider (co)-financing strategies. This can help them to prioritise and deliver the initiatives that support growth, reduce risk, and minimise negative impact, but may have limited short term financial benefits. 

Sustainable operations and performance improvement

A further organisational impact that supply chain leaders can make is to align more sustainable supply chain operations with business performance. For example, minimising resource consumption, improving energy efficiency, reducing emissions, promoting the recycling of materials, and fostering responsible employee engagement could positively impact both outcomes.

Strengthening the link between sustainable operations and business performance can be helped by incentivising leadership to act. ESG-performance metrics can be aligned to executive remuneration, and this concept can be cascaded across the organisation.

Another approach is to start with a business problem, then unlock technology solutions or approaches that embed sustainability into supply chain operations and drive performance outcomes. KPMG US helped achieve this with an electronics manufacturer. The company forecast that demand for a necessary rare earth material was going up, but supply was going down, so cost increases were imminent. KPMG helped develop a circular economy strategy where the mineral could be removed from products at their end of life, then reused – a clear benefit for both sustainable operations and business performance.

A proactive approach

With both Scope 3 and the new ESG regulations, there is clearly a lot for supply chain leaders to manage. For many, significant preparation and transformation are required. Visibility and traceability need to be established right along the supply chain, sustainability goals refined, and links built between sustainable operations and business performance. KPMG firms support supply chain leaders with the methods, solutions, and tools to overcome these challenges. To find out more, get in touch.