Buying your way into trouble? The challenge of responsible supply chain management

Insight Investment, 2004

Insight has significant holdings in many companies that source the products they sell from the developing world. These companies do so primarily because of the cost advantage those countries offer at present over more developed countries. In principle, this is a business strategy that Insight supports. It can reduce costs, enhance margins and, ultimately, profitability and returns for shareholders. Moreover, the expansion of manufacturing and agricultural production capability in developing countries can bring much-needed economic and social development and help to raise their populations out of poverty.

However, companies face real ethical challenges associated with using supply chains in these countries, particularly with respect to labour standards abuses in suppliers' operations. As many companies have recognised, failure to respond effectively to these challenges as they move into less developed markets can give rise to significant operational and reputational risks that can threaten to undermine any potential gains from doing so.

Managing supply chains so as to maximise buying power, flexibility and efficiency,  hile at the same time upholding any commitments to responsible supply chain  anagement that companies may have made can, therefore, be a substantial hallenge.

Many companies have acknowledged that they have a responsibility to play a part in  rying to stamp out labour standards abuses in their supply chains. To this end, they have begun to map out their supply chains and to identify the countries or suppliers that pose the greatest risk. In addition, they have set up auditing systems,  nderpinned by policies and codes of conduct, to try to identify and, if required, to rectify those abuses.

However, few companies seem to look at the supply chain as an integrated system and most importantly, at how their own buying practices affect suppliers' ability to meet their own commitments to uphold international labour standards.

This report, prepared by independent specialist consulting company Acona for Insight Investment, is intended principally to stimulate discussion among senior executives with responsibility for two areas: purchasing and responsible sourcing.

The principal issues this report sets out to explore are:

- Do current supply chain management practices and the drive for ever-greater efficiency put pressure on suppliers' factories or farms, essentially forcing them to contravene some f the ethical standards in order to meet the buyer's requirements?

- In order to find practical ways to improve labour standards in suppliers' businesses, do we need to look at the very nature of corporate buying practice?

Current thinking on best practice in these aspects of supply chain management is summarised in this report, with a particular focus on understanding how companies seek to improve and refine their approach. Three elements of modern supply chain management that seem to have a considerable impact on suppliers' ability to uphold labour standards emerge:

- The need to produce quickly and at low cost: time and speed.

- Issues around flexibility and seasonality.

- The search for lower prices and better deals: cost and risk.

This report explores how each of these characteristics links to, and may undermine, commitments in typical supply chain labour standards codes of practice. For example, the need for flexibility - responding quickly to changes in demand from customers - can lead to high levels of compulsory overtime, which is often discouraged within most ethical trading codes; seasonality - the demand for certain products all year round and the need for high volumes at peak times - can raise the demand for contract and temporary employment, and undermine suppliers' ability to provide secure and regular employment; and constant price pressure can feed through into pressure for suppliers to reduce wages below levels defined by legislation or companies' own ethics codes.

The research leads us to the tentative conclusion that some companies may be inadvertently pursuing a buying strategy that creates tension, or in some cases directly conflicts, with their commitments to ethical sourcing. Ironically, it also indicates that pressures of this kind of are quite often placed on suppliers needlessly. They result simply from bad buying practices - inefficiencies, indecision, badly designed incentives and a lack of trusting business relationships. Such failures are therefore doubly undesirable: they cost companies money and undermine their commitments to source responsibly.

It appears that companies may benefit from taking a more integrated approach to the challenge of maintaining a competitive, low-cost supply base, while at the same time upholding their commitments to trade ethically.

Important elements to consider, which emerged from the research, are:

- Improving critical path management - minimising slippage and improving communication among all those involved in the buying process.

- Improving the accuracy of forecasting to reduce last-minute demands on suppliers.

- Better understanding of the costs of failure in the supply chain.

- Reviewing management and appraisal frameworks for buyers.

- Creating a buying culture in the company that supports the achievement of ethical standards and reduces consequent negative effects on suppliers.

Insight believes that these issues should be examined closely by the senior management of the companies for which they are relevant - particularly those with extensive, high risk, developing country supply chains. We encourage those executives to review whether their purchasing and pricing practices support or undermine their commitments to uphold supply chain labour standards and how improvements could be made to better align their commercial interests and ethical commitments.

Available for download at

http://www.insightinvestment.com/uk/responsibleinvestment/riandcg/engagement/supplychains/