Supply chains are subject to – and creating – more risk than ever. They may rely on suppliers in countries that are politically unstable or subject to sanctions, or be hit by a pandemic or other unexpected disruptions, such as a semiconductor factory fire in Japan or the Ever Given blocking the Suez Canal. Downstream suppliers may create environmental, social and governance (ESG) risks and additional risks may arise from new regulations.
The COVID-19 pandemic has put pressure on supply and demand in supply chains. When demand began to rebound quickly after the first lockdowns, it added additional pressure to already disrupted supply flows. There are persistent supply-side disruptions due to sporadic closures of parts of the supply chain (particularly in East and Southeast Asia), the movement of shipping containers, labor shortages and a decrease in freight capacity due to reduced commercial travel. Policy interventions have had only minor impact because the bottlenecks are compounding, mutually reinforcing, and not limited to a single country.
The reduction in the supply of raw materials due to Russia’s invasion of Ukraine adds new pressures. Ukraine and Russia are major global exporters of agricultural raw materials, fertilizers, barley, wheat, corn and essential (often non-substitutable) minerals, such as platinum group elements, neon, titanium and nickel. The combination of these factors exacerbates a general upward trend in inflation, causing shortages and hoarding of raw materials. In developing countries, and in the absence of an appropriate action plan, this can lead, among other things, to humanitarian crises and food shortages. Additionally, sanctions on Russian oil imports and reduced gas supplies have significantly increased energy prices and even generated energy supply shortages. Some factories have temporarily stopped production due to shortages or high energy costs.
Other risks to consider include the potential for increased risk from Tier 2 suppliers (a Tier 2 supplier is a supplier to your direct supplier – i.e. the Tier 1 supplier), due to less visibility into them, as well as the 7.6 million Tier 2 supplier relationships with Russian entities globally.1. Intertwined global supply chains will also have knock-on effects and inflated demand (in an effort to secure goods) will drive prices even higher. In addition, the Asia-Europe land (train) route passes through Russia, Ukraine and Belarus. This could pose prohibitive risks, leading to stranded goods and a return to shipping, impacting already congested ports and record freight rates.
At the same time, there is a growing trend to take ESG considerations into account in supply chains, in order to mitigate and prevent ESG issues in the sourcing, manufacturing and transportation of commercial goods. In finance, environmental risks are increasingly converging with financial risks, with more companies disclosing their supplier emissions. This is made possible by better monitoring and evaluation through the use of new technologies. We are also seeing Net Zero commitments, new regulations and standardization.
Beyond climate, biodiversity is attracting more attention, since more than half of global GDP depends moderately or heavily on nature.2. The Taskforce on Nature-related Financial Disclosures (TNFD) was officially launched in June 20213 develop and provide a transparent and practical framework for organizations to report and act on evolving nature-related risks. Water supply will also become a key factor in supply chain security, as concerns grow over drought, flooding and energy access.
When it comes to human rights, the International Labor Organization (ILO) created the Declaration on Fundamental Principles and Rights at Work – but voluntary efforts are ineffective and European citizens are under increasing pressure to act. Regulators and businesses are feeling this pressure and know they need to act sooner rather than later.
Some companies are not yet addressing the underlying structural issues in the supply chain, and the problem is being pushed to the sidelines. Other companies are undertaking major projects to address supply chain vulnerabilities and improve their resilience and sustainability. In the short term, a key role of the board will be to ensure that management rethinks and examines the risks and resilience of its supply chain and that the topic has a place in strategic discussions.
At the same time, boards need to focus more on the company’s efforts to manage a wide range of ESG risks in its supply chain, which pose not only significant regulatory and compliance risks, but also critical risks to the company’s reputation.