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Why Is It So Hard to Reduce the Carbon Footprint of Supply Chains?
Six Challenges for Companies — and Six Opportunities for Entrepreneurs — to Tackle
For over a decade, I led Panjiva as CEO, and we provided our customers with huge amounts of data about millions of suppliers. During that time, I spoke with many supply chain executives. Amazingly, no one — not a single supply chain executive — ever asked for data about which suppliers were using clean energy.
Today, as companies wrestle with how to reduce their carbon footprint, supply chains are getting a lot of attention, and rightly so. For the typical company, according to CDP, carbon emissions from supply chain activity are greater than direct emissions, by a factor of 11. Today, most supply chains are global in scope, extending to countries around the world. This is why decarbonizing economic activity inside the United States, while certainly worth doing, will only have a limited impact in the fight against climate change.
When we outsourced our manufacturing over the last few decades, we also outsourced our pollution. For Americans — or companies headquartered in the U.S. — to reduce our overall carbon footprint, we will need to drive down the use of fossil fuels in the supply chains that create the products we buy. This will be really hard.
Below is a (non-exhaustive!) list of challenges that need to be tackled in order to make supply chains climate-friendly. In my opinion, there’s a business to be built around tackling any one of these challenges.
1. Reducing the Cost of Carbon Footprinting
It’s way too expensive and takes way too long for companies to measure their carbon emissions. Establishing a baseline is critical, however, for companies that want to brag about their progress in reducing emissions. Also, a clear understanding of the drivers of a company’s emissions helps to pinpoint where there are needle-moving opportunities for improvement. I.e., which suppliers you should focus on convincing to switch to clean energy.
What’s so hard about carbon footprinting? It’s not running the calculations. Rather, it’s getting the data that powers the calculations. Data about your company’s direct emissions is probably scattered across multiple systems. When you’re calculating supply chain emissions, you need to get data that’s scattered across multiple companies.
Traditionally, consultants have taken the lead in helping companies map their carbon emissions. Now, there are several software companies working on the carbon footprinting problem: Watershed, Persefoni, Sinai, Emitwise, among others. In my opinion, the winner will be the one that pulls off the hat-trick: making it easy to pull data from a variety of systems, cracking the code on engaging suppliers to provide missing data, all while keeping the cost low enough for the small and medium-sized companies — not just the Fortune 500’s — to understand where there are opportunities to substantially reduce carbon emissions.
2. Creating Incentives for Suppliers to Reduce Their Emissions
How do you convince a supplier to focus on reducing its emissions? Really big companies can use a stick and simply mandate that their suppliers reduce emissions, or risk losing contracts. Other companies are experimenting with carrots. For example, Tesco is teaming up with Santander to offer favorable terms on trade financing for suppliers that meet sustainability goals.
Where about small and medium-sized companies that want to decarbonize their supply chains? They typically won’t have the leverage to drive change on their own. Perhaps financial institutions will create an off-the-shelf program like Tesco’s that smaller companies can plug their suppliers into. More likely, small and medium-sized companies will ride on the coattails of the bigger companies. For instance, smaller companies will be able to seek out suppliers that have already made the switch to clean energy in order to satisfy their larger customers.
What could drive rapid, widespread adoption of clean energy by suppliers? Government incentives could do the trick, of course. But so too could changes in consumer buying patterns. If consumers consistently choose goods manufactured with renewable energy, companies and their supply chains will shift gears to meet demand. Keep an eye on consumer labeling initiatives, any one of which could prove to be a catalyst in driving changes in consumer behavior. Check out, for instance, the Climate Neutral label and Amazon’s Climate Pledge Friendly label.
3. Providing Turnkey Solutions to Suppliers that Want to Switch to Clean Energy
Let’s assume that companies, perhaps themselves nudged by governments or consumers, start nudging their suppliers to switch to clean energy. What might prevent suppliers from actually making the switch? Probably many of the same factors that prevent consumers from making the switch. They don’t want to make an upfront investment, even if they will save money in the long run. Or they don’t want to have to learn how to operate a microgrid. Or there just isn’t time to focus on it, given competing priorities.
The companies that want to make rapid progress on decarbonizing their supply chains will do more than just offer incentives to their suppliers. They’ll overcome resistance to change by connecting suppliers with partners that can provide turnkey solutions. Ideally, the pitch will be, “Sign here, we’ll handle everything, you’ll save money each month, and if you’re unhappy we’ll switch you back to the grid.” There’s a lot to learn from the years-long push to introduce solar into the Commercial and Industrial (C&I) sector. One of the most important lessons is that it’s harder to get people to say yes than you might think.
4. Verifying that Suppliers are Using Clean Energy
Today, a relatively small proportion of suppliers use clean energy. Hopefully that number will grow. When it does, we’ll want a database that tracks which suppliers are using clean energy. (@SPGMI_Panjiva, I’m looking at you.)
As always, there will be concern about fraud — suppliers claiming to use clean energy when they are in fact using grid energy. The traditional, but costly, approach to verifying supplier claims — about product quality, treatment of employees, or environmental impact — is on-site inspections. Hopefully, we’ll find another, more efficient approach, like pulling data directly from a supplier’s microgrid and/or its energy bills.
5. Tracking Participation (or Lack Thereof) in Energy and Offset Markets
There’s another version of the fraud problem that I’m oddly fascinated by — it’s the double-spend problem. The concern here is that a supplier could switch from grid energy to clean energy, tell its customer that it’s using clean energy, and simultaneously sell a renewable energy credit or a carbon offset to a third party. In this scenario, the customer thinks its supplier is powered by clean energy, but that’s not really a fair assessment, since the supplier has sold away the clean attribute of the clean energy.
What’s the solution? There needs to be a trusted, frequently updated source of information on who owns renewable energy credits (RECs) and offsets. If we get this right, it will also help suppliers that are getting to carbon neutral by buying RECs or offsets. Because there will be a way to verify that they have in fact bought the required assets. Check out an early stage project that advances the ball on this.
6. Driving Engagement with the Deep Supply Chain
Most modern supply chains have several layers. A retailer will buy finished products from tier 1 suppliers, which are buying parts from tier 2 suppliers, which are buying raw materials from tier 3 suppliers. If the retailer wants to understand its carbon footprint, it will need to gather information not just from the tier 1 suppliers, but also from suppliers all the way through the extended, deep supply chain. And if the retailer wants to decarbonize its supply chain, it needs the suppliers at lower tiers to switch to clean energy, too.
Problems 1-5 would be hard enough to tackle in the context of working just with tier 1 suppliers. Once you go to deep supply chain partners, it gets even harder. You don’t have direct relationships with these companies, so you have even less leverage than you do with your tier 1 suppliers. And sometimes your tier 1 suppliers won’t even tell you who their suppliers are!
So far, a lot of companies have glossed over this problem by estimating the carbon footprint of key products by leveraging industry averages. This is fine for developing a rough baseline. But when it comes time to actually reduce emissions and track the reductions, companies are going to need actual information from the deep supply chain. And they’re going to need to drive action throughout the deep supply chain.
One approach to solving this problem is simply demanding that tier 1 suppliers solve it on your behalf. I’m skeptical that this will work. I think customers that are serious about decarbonizing will need to offer to solve the problem by working directly with suppliers at lower tiers. Or at a minimum, customers will need to provide tier 1 suppliers with tools and a roadmap for engaging suppliers at lower tiers.
There are two big challenges that I haven’t covered yet: decarbonizing raw materials and decarbonizing shipping. And, for many companies, these will be key obstacles to driving down carbon emissions in their supply chains.
A lot of the discussion above will be relevant to suppliers of raw materials (usually the very end of the deep supply chain) and suppliers of transportation services. But these categories will be uniquely challenging, because — for instance — you can’t set up a solar microgrid and make mining, farming, or shipping instantly carbon neutral. The good news is there’s no shortage of creativity in thinking about how to tackle these challenges. More on this in a future post if supply chain fans demand it.
Another looming problem is the supply of clean energy. What happens if there’s a needle-moving event that pushes suppliers en masse towards clean energy? In the short run, there won’t be enough capacity to meet the demand. The good news is that this is the type of problem that markets are very good at solving.
Are there other obstacles to decarbonizing supply chains that are on your mind? Or solutions that you think are worth a look? If so, I would love to hear about them.