It’s Payback Time- Measuring ‘Value’ in Sustainable Supply Chain Procurement & Management

4 Jan

Over the holidays, a recent study was brought to my attention by Spend Matters Jason Busch (@spendmatters).  The report reminded me of the scene in the movie Jerry McGuire, where the sports agent coaches his client, and he shouts through the phone “Show me the Money!”.  Well, despite late 2010 surveys that suggested that companies may pull back sustainability efforts, I suggest that CFOs read this first before pulling the plug.

PwC, Insead and EcoVadis collaborated recently to construct a quantitative model to link Sustainable Procurement practices and positive economic impact. A link to the white paper download is here. The three companies went about asking the question: “Is Sustainable Procurement a true value creation initiative to be welcomed not only by customers but by shareholders and financial markets as well?” The quantitative model was created by the analysis of the three main drivers and their respective impacts on the company’s annual procurement spend, market cap and revenue. Their impact was then compared to the implementation cost of a Sustainable Procurement program.

Among the reports key findings:

  1. The payback from investing in risk reduction activities in the supply chain targeting the financial impact on “brand value from negative supplier practices (e.g., child labor, creating local pollution);economic cost of supply chain disruptions (e.g., noncompliance with environmental regulation,” etc. is eighty-five times the cost associated with the initial risk reduction investment.
  2. Additional revenue through innovation of eco-friendly products/services, price premium or income from recycling programs yielded a 58 percent payback.

Talk about showing the money!  Geesh, where do I sign up?!

The study found sustainability- driven cost reduction from energy reduction programs for instance, could fund the entire cost of a procurement initiative.  This would allow companies to benefit quickly from both risk management reduction and potential revenue growth opportunities.  The study also found that there were additional ‘value creation’ opportunities that could be realized if procurement departments collaborated more closely with the marketing and R&D departments upstream on the projects. In most cases, this requires a process modification to involve procurement experts in the design of new product and/or services.  Findings in three primary areas were covered in this report (cost reduction, risk reduction and revenue growth).  Key ‘value drivers’ for sustainable procurement and economic indicators are shown in the table below:

Cost Reduction

Reduced Internal Cost: In 2008, water conservation, energy efficiency, green building projects and other eco-friendly initiatives yielded Baxter International Inc. a total of US $11.9 million in environmental income, savings and cost avoidance.

Reduced Specifications- In 2007, Wal-Mart launched “CO2Scorecard” aimed at saving 0.6 million tons of CO2 and US $3.4 billion in costs through reduced packaging content.

Reduced Compliance Costs– The Waste Electrical and Electronic Equipment(WEEE) and Packaging taxes in the European Union paid by producers are essentially calculated based on weight and product category. However eco-design criteria are being taken into account in the calculation of these taxes (e.g., use of recycled raw materials in packaging). Cost reduction can be achieved through lighter and eco-designed products.

The study found that cost reductions per project represent on average 0.05% of the company’s total revenue, ranging from 0.005% to 0.36%- a small price to pay for conformity and enhance product revenue gains.  However, these cost reductions yielded a six times over payback for sustainable procurement initiatives.

Risk Reduction

Bad Barbie- In 2007, Mattel experienced a major crisis when a supplier used lead-contaminated paint on Mattel’s toys in addition to creating safety hazards with lead based magnets.  This fiasco caused the company to recall about 20 million products at a cost of over US $100 million. Stock price dropped 18 percent.    A big lesson learned was that Mattel’s brand reputation was significantly affected by events involving safety, environmental or social issues with poor supplier oversight and risk management. These events have also led to significant direct costs (recall of products, financial penalties) and/or indirect costs (decrease in market share, sales and market cap, product boycotts) for these companies.

Dirty Palms- As another example, the report showed that in 2006, Palm’s stock value dropped 14% in June 2006 due to suppliers not meeting the Restriction of Hazardous Substances (RoHS) directive.  This poor planning and oversight led Palm to withdraw the Treo 650 smart phone from the European market.

Overall, the study found an average 12% decrease in market capitalization after a supply chain disruption due to a sustainability issue.  Ouch.

Revenue Growth

The study found that enhanced opportunities for experiencing direct revenue growth area bit harder to quantify (due in part to so many external variables and market variations).  However, the companies did report that increases of to 0.01% to 2% of the company’s revenue could be realized, mainly due to linkages between enhanced brand’s reputation and implementation of sustainable practices in design, production, distribution and end-of-life management.

Green Procurement Strategies

The study noted the many challenges that procurement officers may have in effectively managing sustainable procurement challenges.  Particularly, upstream manufacturing of intermediate products can pose a challenge, but not necessarily close the door to change.

So when evaluating a best approach to green procurement, the report suggests that organizations consider first those “product categories that represent a high potential for cost reduction but that are not necessarily controlled by the procurement department such as energy, raw materials, chemicals used for production process, etc.”.  Other categories that can drive growth and reduce risk and that are controlled more closely by procurement might include purchasing of green energy, raw materials with a higher recycled content, etc/.

I have spoken before about how procurement staff can be the gatekeepers that can drive continuous improvement in environmental and corporate social responsibility up and down the product value chain. Here a few tips again on how to green the procurement value chain:

  1. Conduct a spend analysis and ID which product categories may have greatest environmental impact
  2. Engage  designers, production and transportation department staff and explore  the entire spectrum of the supply network costs and value chain of a  products life cycle.  Explore if the product, process or supplier is creating unnecessary wastes, risks or avoidable costs
  3. Identify alternative products to replace materials creating negative life cycle impacts
  4. Engage your suppliers and evaluate what steps they are taking to lower the environmental footprint of their products.
  5. Purchase products that disclose their environmental attributes (eco-labeling).
  6. Audit and engage suppliers to understand and more accurately evaluate their environmental performance. Collaboration and transparency with suppliers creates “reciprocal value creation” in the supply chain, where both suppliers and customers are better equipped and enabled to  recognize and quantify each other’s value contributions to a successful,  green supply chain.
  7. Work with suppliers to help them reduce environmental impacts through changes in product design and materials use.
  8. Engage in Product stewardship: Active management of all aspects of the product from raw materials to final disposal

So what’s the ‘bottom line’ on sustainable procurement?  The answer can be  lower costs, increased sales and revenue growth opportunities, enhanced  reputation and risk management, leading to increased market share.  These are all achievable targets that great, smart businesses should aspire to in 2011 and beyond.

Start making the business case- it’s payback time!

One Response to “It’s Payback Time- Measuring ‘Value’ in Sustainable Supply Chain Procurement & Management”

  1. garrett brothers January 5, 2011 at 8:36 pm #

    Another great article. I am seeing this idea more and more that green business practices are paying huge dividends. I feel that this trend is certainly going to continue in the short run and maintain as a cost savings avenue for the foreseeable future until it becomes just another standard operating practice. People see everything now a days so there is no hiding dirty practices anymore and in fact are willing to pay a premium for green products and services. I feel firms need to embrace these notions with open arms and start raking in the money as your blog certainly states.

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