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net zero economy

Supply chain

Carbon accounting: learnings from the governance journey

Published 16 November 2023 in Supply chain • 6 min read

How companies understand their sustainability-related governance may hold the key to meeting climate goals and thriving in a net-zero economy.

The recent adoption of the European Sustainability Reporting Standards (ESRS) is a watershed moment in public policy efforts to address the challenge of climate change. The reporting obligations of the ESRS aim to provide normalized transparency to both companies’ full value-chain emissions and also to their efforts to meet the goals of the 2015 Paris Agreement. It is a recognition that commercial activities are at the heart of carbon emissions. The pivotal role of companies in the climate crisis and its solution – something that impacts us all – is apparent. This represents a daunting challenge. For this reason, now seems to be a good moment to reflect on the governance journey that companies have undergone.  

Supply chain in isolation 

The first sustainability goals devised by companies were very simple, They usually involved a top-line reduction in waste and carbon1 over a defined horizon. In this era, there was not yet a distinction between carbon avoidance and reduction, so most sustainability objectives called for activity-based reductions rather than absolute reductions. 

Importantly, these objectives were not enterprise objectives, they were supply chain objectives. For carbon in particular, the approach was facile in its thinking: emissions come from manufacturing and transportation, so the most effective way to lower emissions would be to challenge the supply chain through imposed objectives. Though simplistic, this siloed approach had its benefits at the outset. Not only did these efforts to consolidate shipments and find energy efficiencies in manufacturing often bear fruit, they also served as a useful prompt to improve operational savings. Indeed, these supply chain emissions are also responsible for the majority of overall greenhouse gas emissions from businesses – about 88% across sectors. 

But for many supply chains, the low-hanging fruit was quickly harvested, and gradually this simplified corporate model of carbon governance began to show signs of strain. Before the precipitous drop in renewable energy prices in the early 2010s, any progress would forcibly come through trade-offs: Fewer shipments would mean higher inventories or longer lead times for example, running directly contrary to the e-commerce-driven trend of more frequent, faster deliveries to online customers.

This period coincided with the rise of financialization, where companies began increasing the presence of controllers and audits, and return on investment (ROI) became the dominant way to adjudicate issues and support decision-making. In the absence of a widely accepted protocol for price discovery of carbon, the business benefits of reducing carbon emissions were undervalued or not considered at all in the dispassionate math of ROI.  

For supply chain managers, this placed them in a frustrating position. The era of making headway on their carbon objectives through efficiencies was ending. To continue demonstrating progress would require capital expenditures in solar, wind, geothermal, or other renewable energy sources but the cost framework would often not justify the investment on its own merits.  

One Chief Supply Chain Officer (CSCO) of a major consumer goods company, when deciding upon transitioning factories to renewable energy sources, informed factory managers that ‘renewable energy projects must make financial sense’ before being greenlit. As long as companies were not ready to pay for carbon, the options for supply chain managers to reach their carbon objectives dwindled. There was a newly formed tension between sustainability and finance. 

sustainability progressTo continue demonstrating progress would require capital expenditures in solar, wind, geothermal, or other renewable energy sources but the cost framework would often not justify the investment on its own merits

Adding to this tension was the realization that further carbon or waste reduction would require addressing business practices that were beyond the sphere of authority of the supply chain. For example, the relentless growth in SKU counts and shorter product lifecycles as marketing teams looked to further create niche market segments became a course of waste. Large production sizes, a result of financial pressures, created higher obsolete inventory levels for which the supply chain would be solely held to account.

An enterprise-wide approach 

The climate change crisis continued to develop, notwithstanding these internal corporate struggles to find a balanced governance approach. The introduction of the Non-Financial Reporting Directive (NFRD) in 2014 by the EU created a reporting obligation for companies to disclose, among other elements, information about sustainability. One of the knock-on impacts of the NFRD was to increase the role of the CFO in sustainability efforts, as the NFRD reporting was included in corporate annual reports. This helped initiate a gradual shift of sustainability objectives from being a supply-chain-only preoccupation to an enterprise-wide one. 

One group with a particular interest in the disclosure of such non-financial information was investors. When evaluating a company’s performance and, even more importantly, risk profile, investors started to become increasingly focused on climate-related metrics. In addition to the ability to reveal inefficiencies in supply chains, a company’s carbon data also spoke to the business’ exposure to transition, physical, or litigation risks. This trend also emerged among shareholders, with demands that companies disclose the risks of climate change. 

Another external force emerging in parallel was growing consumer awareness of the challenge of climate change. Just as with investors, consumers also began to bring carbon data into their purchase decisions, generating pressure on companies to be transparent in their carbon footprints and take action. To do otherwise might risk undermining their brand and consumer base. This trend is now spiraling further upwards as younger generations are showing themselves to be more eco-conscious and are aging into higher-spending demographics. With this, sustainability is not only no longer confined to the supply chain, but now also encroaching on the world of marketing. 

The two combined external forces of increased sustainability reporting requirements and elevated stakeholder interest are having tangible impacts on the governance models of major companies. Rather than simply applying pressure to CSCOs, or placing too much influence on CFOs, many companies have created the executive position of CSO – Chief Sustainability Officer. 

sustainability data
“Talking to business leaders, we see less and less of a distinction between the requirements for a company's sustainability initiatives and the requirements for a company's long-term success and resilience. As businesses mature, high-quality, high-frequency sustainability data becomes every bit as essential as accurate financial reporting. C-suite executives will evaluate carbon insights alongside financial performance data to identify new product, market, and investment opportunities.”
- Neil Ryland, CCO, Normative AB

A 2022 study by the consulting company PWC shed light on the growing trend. PWC looked in particular at all 40 companies that comprise the DAX stock exchange in Germany; each a large, major corporation. They found that 36 out of the 40 companies (90%) had a CSO in place. Eighteen of these CSOs either reported to the CEO or the CEO acted as CSO.  

Consistent with the narrative that this is a growing trend, PWC found that 25 of the 36 CSO positions have been created within the last three years, a clear recognition of the evolving importance given to sustainability by corporate actors and a sign that it is not solely a supply chain issue. Further to the point, PWC found that all but one of the companies on the DAX now has a multi-disciplinary sustainability board. This is a testament to the awareness companies now have that a truly sustainable business requires input, trade-offs, and buy-in from all functional areas to balance and address environmental impact, risk, mitigation options, ROI, and consumer sentiment.  

The right solutions might involve rethinking entrenched business models and challenging deeply held assumptions. When looking at the corporate governance journey they have taken in the last 20 years, companies now have the right fit-for-purpose structure to take the next steps. 

Authors

Ralf Seifert - IMD Professor

Ralf W. Seifert

Professor of Operations Management at IMD

Ralf W Seifert is Professor of Operations Management at IMD and co-author of The Digital Supply Chain Challenge: Breaking Through. He directs IMD’s Leading the Future Supply Chain (LFSC) program, which addresses both traditional supply chain strategy and implementation issues as well as digitalization trends and the impact of new technologies.

Richard Markoff

Richard Markoff

Supply chain researcher, consultant, coach and lecturer

Richard Markoff is a supply chain researcher, consultant, coach, and lecturer. He has worked in supply chain for L’Oréal for 22 years, in Canada, the US and France, spanning the entire value chain from manufacturing to customer collaboration. He is also Co-Founder and Operating Partner of the Venture Capital firm Innovobot.

alexander schmidt

Alexander Schmidt

Head of Science and Climate Research at Normative

Alexander Schmidt is Head of Science and Climate Research at Normative and a university lecturer. He previously worked as a consultant and entrepreneur in the fields of data science and artificial intelligence. He obtained his doctorate in economics after completing his studies in international business and East Asian studies in Germany, China, and Japan.

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