Written

Hau Lee: A Surprising Formula for Improved Supply Chain Performance

Responsible supply chain practices are associated with lower operating costs and improved overall performance.

It was clear this week at the Stanford Responsible Supply Chains Conference that the responsibility of multinational firms to tackle social and environmental issues inevitably requires peering into the activities of their supply chains. New research by my colleague Professor Hau Lee and his team at the Stanford Value Chain Innovation Initiative shows that such efforts are well worth it from both ethical and economic perspectives. 

Their study finds that despite sometimes massive monitoring expenses, responsible supply chain practices are associated with lower operating costs and improved overall performance. Surprising? 

Environmental violations often result in costly lawsuits. Health and safety infractions lead to incidents such as fire or building collapse. Efforts to prevent these occurrences help eliminate supply-side disruptions and reduce the corresponding financial losses for the buyer in the process. Measures aimed at reducing waste, water, and energy use along the tiers of the supply chain can not only improve environmental performance, but produce cost savings that can be passed down to the buyer company.

Companies that reap the most benefits have adopted three counter-intuitive principles

Suppliers Are Business Partners

Each year, Walmart partners with 100 of its suppliers for its “Supplier Development Program” to improve factory working conditions and supplier management systems. Why? Because according to Lee’s research, the most effective results come from partnering, not from policing suppliers.

Walmart forms an internal consulting team to conduct a thorough analysis of each supplier’s social and environmental management systems and develops a customized program to fit the supplier’s business model. 

Suppliers have seen reduced worker turnover and injuries and increased worker satisfaction. Walmart continues to work closely with suppliers after the completion of the capacity building program to encourage continuous improvement. 

Textile manufacturer Welspun India, after developing a systematic approach for internal factory audits, reduced its energy consumption by 18 percent and also started harvesting rainwater from retention ponds to help with production needs.

Other demonstrated ways strengthening supplier capabilities can reduce operating costs for the buyer include reengineering product or process designs and investing in training and education for factory managers and supplier staff. Senior management involvement is found to be critical to the effectiveness of such efforts.

Carrots Are Better than Sticks

According to the study, when it comes to penalizing suppliers for code violations, issuing a warning followed by reducing the amount of business given to the supplier was found to be ineffective in reducing violations. 

This may suggest that it is challenging for low-performing suppliers to improve over time, or that the threat of reduced business is not sufficient to motivate suppliers to invest in improving performance. Indeed, the only type of penalty found to be correlated with reduced social and environmental violations was a warning followed by contract termination. And yet, fewer than 30 percent of participants in one major survey reported using this practice. 

On the other hand, the research revealed that creating a partnership relationship with suppliers and providing positive incentives for compliance is a surprisingly effective means of encouraging buy-in on responsible supply chain requirements.

When Starbucks began to require coffee growers to introduce responsible labor and environmental practices, it found that the desired changes would impose a significant financial burden on growers. The company therefore offered various levels of preferred supplier status for farmers, some of which included Starbucks offering a premium price for coffee beans.

By rewarding suppliers for responsible practices, Starbucks saw increased supplier retention, improved risk management, and increased visibility and control. In addition, it established its competitive advantage as a socially, environmentally, and ethically conscious coffee seller.

Competition Is Irrelevant

The Stanford report also revealed opportunities for collaborative practices and incentive programs that are currently underutilized. For example, participation in industry working groups to collectively share and develop responsible practices is associated with lower social and environmental violations, yet only 24 percent of Stanford survey participants reported doing this. In terms of building supplier capability, only 27 percent of Stanford survey participants reported training factory/supplier managers on monitoring and improving socially and environmentally responsible practices in their own upstream suppliers, a practice that was also found to be correlated with reduced social and environmental violations.

Responsibility in the Supply Chain Makes Economic Sense

Such findings clearly indicate that investment in social and environmental responsibility practices can result in increased business value. The research suggests that companies may do well to consider social and environmental responsibility practices not as a cost burden, but rather as an opportunity to reduce operating costs in addition to improving performance and enhancing a company’s public image.

The research is based on a comprehensive survey of 33 companies conducted by the Stanford Value Chain Innovation Initiative of Stanford GSB, as well as survey information from SCM World’s 2012 Chief Supply Chain Officer Report, which includes input from 334 companies.

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