Are Current Approaches to Responsible Supply Chain Management Working?

Commentary, 12 August 2010

By Sune Skadegaard Thorsen, CEO of GLOBAL CSR

Sustainable or responsible supply chain management (RSCM) emerged in the 1990s as an important part of the corporate responsibility (or corporate social responsibility - CSR) discourse. Over the past two decades, leading corporations have increasingly recognised human rights risks in suppliers’ operations; sweat shops, child labour, forced labour, no living wage, discrimination, safety and health neglect and similar violations.

Lack of effective human rights governance in the home state of the suppliers, as well as stakeholder pressures on buyers to react, paved the way for RSCM as we observe it practised by corporations today.

Current research undertaken by GLOBAL CSR and the Copenhagen Business School (CBS) and supported by the Danish Ministry of Foreign Affairs suggests that despite greater attention to addressing supply chain challenges, existing approaches suffer from significant shortcomings and may indeed create a barrier to sustainable economic development. GLOBAL CSR is proposing a new model to address RSCM in a sustainable manner; what we call Responsible Supply Chain Management generation 3 (RSCM 3.0).

Responsible Supply Chain Management generation 1.0 (RSCM 1.0) – Individual Codes of Conduct

RSCM 1.0 remains the most widespread approach practiced by companies around the world. This approach involves a company or institution developing a code of conduct that sets out the demands its suppliers are expected to meet. To ensure compliance with the code of conduct, the company will often monitor and audit its suppliers.

Regular visits at suppliers’ premises by company employees trained to assess suppliers’ performance against code requirements has become common practice. In addition, some companies require external auditing by independent third party CSR auditors; either professional audit firms like KPMG, PWC, Deloitte and Ernst & Young, more specialized firms such as Bureau Veritas or by Non-Governmental Organizations (NGOs).

Corporations have leverage, economically and contractually, towards their suppliers; they can exert influence to minimize their risks. In effect, corporate practices with codes of conduct, monitoring and auditing systems build parallel systems, which substitute for lack of proper enforcement through state governance. These systems are being implemented with increased rigour where lack of state governance on human rights, environmental protection and anti-corruption is the highest.

A key challenge in relation to RSCM 1.0 approaches is the fact that suppliers are forced to meet the demands of many individual codes of conduct simultaneously. Although the codes are often very similar in content, the underlying monitoring and auditing standards tend to differ significantly. Demonstrating compliance with a growing number of individual codes requires additional capacity and extra costs for suppliers. In addition to traditional market denominators such as price, volume, delivery time, and quality, additional CSR requirements put a great deal of pressure on suppliers.

In particular, Small and Medium Sized Enterprises (SMEs) face the risk of being pushed out of global value chains, as they simply do not have the money and/or the human capacity to demonstrate compliance with the numerous standards. Often it is not possible for suppliers to implement all code requirements at the same time because of conflicting monitoring or auditing standards (e.g. one prescribes red emergency exits while others require yellow emergency exits). This overall situation has been termed “code mania”, and is not optimal for buyers or suppliers.

Research also indicates that the introduction of codes of conduct into the supply chain may not have the intended positive impacts. Permanently employed male workers experience some improvements, mainly in the area of ‘outcome’ rights (living wages, working hours, safety and health). However, the improvements are limited in the area of ‘process’ or ‘enabling’ rights (freedom of association and collective bargaining).

Where improvements are made, they generally only reach first tier suppliers. The approach therefore appears to fail in reaching the most disadvantaged groups of workers such as migrant workers, women, casual workers and workers employed by third-party labour contractors. [See Footnote 1]

When assessing the actual impact on the ground, improvements may be achieved; nevertheless, they tend to be temporary – limited to the buyer-supplier’s existing relationship – or even momentarily – while the monitoring or audit session is taking place. Although the impact may not be as positive as intended, buyer companies still invest massive resources in carrying out RSCM 1.0, particularly on monitoring and auditing.

For example, IKEA claimsii to employ 500 persons full time and Wal-Mart claimsiii to employ 200 persons to oversee and implement its own supply chain programs. Overall, it is quite apparent that RSCM 1.0 requires significant annual expenditures. Some or all costs for such programs are also frequently passed on from buyers to suppliers, further accelerating the exclusion of SMEs from international value chains.

Thus, it is important to establish whether the investments lead to comparable positive impact. Interestingly, the preliminary findings of our research indicate that companies don’t keep careful records of their RSCM related expenses. However, when we compare estimated expenses to actual achievements in improvements for sustainable development, we conclude that RSCM 1.0 is not representing a cost effective sustainable solution to challenges in supply chains.

Responsible Supply Chain Management generation 2.0 (RSCM 2.0) – Shared Codes of Conduct

RSCM 2.0 constitutes an attempt to address some of the pitfalls of the RSCM 1.0 approach. In RSCM 2.0, companies use a shared code of conduct (e.g. a code of conduct for an entire industry or a code established through a multi-stakeholder process) rather than individual codes. Examples of RSCM 2.0 approaches can be found in the Electronic Industry Code of Conduct (EICC), Business Social Compliance Initiative (BSCI), the Ethical Trading Initiative (ETI), Social Accountability 8000 (SA 8000), ILO’s Better Work initiative and the Fair Labour Association (FLA).

In addition to creating and using common codes, many RSCM 2.0 initiatives are shifting focus from monitoring compliance to building supplier capacity; most notable is the Business for Social Responsibility ‘Beyond Monitoring’ initiative. Often a shared “clearing house” is established to take care of monitoring or certification of suppliers and accreditation of auditors.

This approach provides some clear advantages when compared to RSCM 1.0. First, the problem of code-mania is reduced as suppliers primarily have to comply with a single code and its monitoring requirements. However, many suppliers still must contend with several RSCM 1.0 and RSCM 2.0 codes. Since the codes themselves do not differ much, the challenges for suppliers primarily relate to differences in monitoring or audit schemes and in this respect RSCM 2.0 schemes may often be far more elaborate; but overall still an improvement. Buyers also benefit through obtaining economies of scale resulting from sharing the costs and experiences of monitoring and auditing suppliers. Finally, the rising focus on building capacities in many RSCM 2.0 initiatives, rather than on strict “pass or fail” audits, has the potential for contributing to sustainable development to a higher degree than RSCM 1.0.

Despite these advantages, RSCM 2.0 carries a challenge to corporate risk management. RSCM 2.0 often becomes an arm’s-length exercise where the company criticized for supplier misconduct cannot answer the media or NGOs adequately since they do not have direct interaction or experience on these issues.

Another challenge for most RSCM 2.0 codes of conduct involves limiting themselves to first tier suppliersiv. The responsibility of the sub-suppliers to comply with the codes of conduct is placed on first tier suppliers only. Limiting the codes of conduct to first tier suppliers reduces the degree of risk management. Furthermore, SMEs continue to face the risk of exclusion because of the costs of certification and the rigorous and extensive nature of the underlying code standards.

An additional significant challenge facing both RSCM 1.0 and 2.0 models concerns lack of full coverage of human rights, including labour rights. The UN Special Representative on Business and Human Rights, Professor John Ruggie, explicitly points to the fact that corporate risks may appear in relation to all rights included in the International Bill of Human Rights. Thus, adequate risk management would entail that all human rights are included in the codes of conduct that suppliers are assessed against. However, most codes are restricted to address only seven or eight human rights; i.e. freedom of association, child labour, forced labour, non-discrimination, maximum working hours, minimum wages, degrading treatment and safe and healthy working conditions. In addition, the Special Representative’s ongoing work to set out key principles for human rights due diligence is becoming the international standard for all companies. If RSCM approaches do not fulfill these key principles they risk becoming obsolete.

Responsible Supply Chain Management generation 3.0 (RSCM 3.0) – addressing the pitfalls once and for all

The proposed RSCM 3.0 approach represents a shift in approach compared to RSCM 1.0 and 2.0. Whereas 1.0 and 2.0 are value chain focused in relation to the target of intervention, RSCM 3.0 is geographically focused. In other words, RSCM 1.0 and 2.0 approaches are vertical whereas RSCM 3.0 represents a horizontal partnership model.

RSCM 3.0 introduces a partnership approach, where the creation of partnerships between international buyers and primarily local authorities are the target group. International Development Agencies (IDA) would become key facilitators for the process, but only by invitation from the local authorities (State, Region or District). Depending on existing governance structures, local businesses, labour and employers associations, civil society and other stakeholders will be involved.

The vision of RSCM 3.0 is to build ‘CSR risk free sourcing and investment zones’ (TM) from which companies can source without the risk that their suppliers are involved in any kind of violations of internationally agreed standards such as those derived from the UN Global Compact principles. By having these ‘CSR risk free sourcing and investment zones’ (TM), companies would no longer need to spend resources on monitoring their suppliers and creating codes of conduct. Based on many years of experience working with key partners and other stakeholders on CSR and Public Governance all over the world, GLOBAL CSR has developed a process description for establishing pilots to demonstrate that the establishment of ‘CSR risk free sourcing investment zones’ (TM) that is both viable and realistic within a relatively limited timeframe.

A key difference between RSCM 1.0 and 2.0 and RSCM 3.0 is the inclusion of the state as a crucial partner. Including the state or local authorities acknowledges that the duty to protect against human rights violations involving business lies with governments, similar to international requirements on environmental protection and the eradication of corruption.

As opposed to RSCM 1.0 and 2.0, this approach thus addresses both the state duty to protect and the corporate responsibility to respect human rights as set out in the UN endorsed “Protect, Respect, Remedy” framework put forward by Special Representative Ruggie. The RSCM 3.0 approach avoids creating competing parallel structures to the traditional state-society relationship and, instead, enables the state to carry out its duty and enforce its legislation. Adequate legislation ensuring that international obligations are adhered to is already in place in most countries. However, challenges arise in relation to enforcement. Many governments in economically developing countries do not have the will or resources to build such capacity; but IDAs have for decades been engaged in and supported such work; however, only as part of government to government aid cooperation.

The establishment of ‘CSR risk free sourcing and investment zones’ (TM) requires the building of state capacity in order for local authorities to become capable of carrying out monitoring of business conduct in its area of jurisdiction. In addition to ensuring compliance with local regulations that become internationally compatible, such activity can be combined with building and enhancing authorities’ skills to continue buyers’ efforts on building suppliers’ capacity to improve performance.

Buyer companies have a great opportunity to motivate and create leverage with local state authorities since their willingness to source from, or invest in a specific geographical area has great economic importance locally. Thus, buyer companies’ role in RSCM 3.0 is primarily to motivate local authorities to commit, plan and execute the establishment of the “CSR risk free sourcing and investment zones” (TM). Where possible and appropriate buyer companies can also encourage their own suppliers and business associations to constructively participate in capacity development. The state-capacity building component directly feeds into the approach of many development agencies. Thus, IDAs have expressed a keen interest to provide financial as well as technical support to the development of ‘CSR risk free sourcing and investment zones’ (TM). In effect they are already financing such initiatives assisting in fulfilling conditionality under trade and development cooperation agreements. RSCM 3.0 answers one of the greatest challenges under the Paris Principles for development cooperation: creating ownership. Under RSCM 3.0, business interests function as a catalyst for such appreciation by the local authorities.

RSCM 3.0 has the potential to provide companies with a long-term and sustainable solution to CSR risk management in relation to suppliers’ conduct. The approach answers key challenges facing RSCM 1.0 and 2.0 approaches. In addition, the geographical focus answers the challenge that all companies face; that they are expected by stakeholders to address all tiers of suppliers in their efforts to ensure that basic standards are met; a ‘mission impossible’ when adopting RSCM 1.0 or 2.0 approaches.

Companies can also look forward to considerable cost savings by shifting to a RSCM 3.0 approach. Company expenditures will be limited to a share of the initial phase of a RSCM 3.0 project and will cease completely, if so desired, once capacity development financed by IDAs starts with the authorities. If a company wishes to maintain a stronger link to the project, it could choose to participate with in-kind contributions or the coverage of pre-defined costs during the implementation phase.

The terms RSCM 1.0, 2.0 and 3.0 might imply that the three approaches function stepwise. However, companies need not start by practicing RSCM 1.0 then upgrading to RSCM 2.0 and so forth. Furthermore, the terms 1.0, 2.0 and 3.0 do not indicate that RSCM 3.0 is the most difficult approach of the three. Actually, companies can start their work using a RSCM 3.0 approach, thereby avoiding the challenges connected with previous approaches.

However, shifting from RSCM 1.0 and 2.0 to RSCM 3.0 may pose a bigger challenge. Corporate management, already established systems, and professionals tasked with implementing those systems will likely resist changes. Equally important, the risks that previous systems tried to address still exist and call for effective action. Thus, change will not be made overnight. It is to be expected that companies will engage in a period of transition where traditional RSCM approaches are continued and gradually phased out, while capacities in relation to RSCM 3.0 are built up.

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