From economic value to social and environmental values, global supply chains have a new bottom line.
The consumer societies constructed over the past 75 years in North America, Europe, and Asia are largely founded on the principle of making higher-quality goods more affordable for the average consumer. The endless drive to reduce costs by relocating production facilities has resulted in a globalized, vertically integrated, and highly specialized manufacturing model that benefits specific countries and regions. Willingly and consciously, we have created unbridled globalized supply chains that focus on maximizing value.
But this approach to global capitalism and highly mobile capital has increasingly come into question for several reasons: increased and changing security threats; geopolitical instability; and rising voter, consumer, and investor awareness of environmental, social, and governance (ESG) concerns. These and other considerations are forcing companies around the world to expand their strategic thinking, and to reorient their supply chains away from a straightforward concern over costs to one that satisfies a more complex business environment.
Governments, too, have become much more concerned about building supply chain resilience as they have confronted shortages of medical supplies, pharmaceutical products, critical minerals, and other elements that contribute to security. Companies now face a wider set of challenges when designing their supply chains, beset not only with reputational, political, economic, and commercial risks but also with a redefinition of their purpose.
An obsession with value is now accompanied by a need to focus on values.
The postwar model of international trade, focused on the reduction or elimination of both tariff and nontariff barriers, established the potential for an economic model in which comparative advantage and investment patterns were based not only on considerations of the finished product but also on the parts and processes along the value chain. The successes of first the General Agreement on Tariffs and Trade (GATT) and then the World Trade Organization (WTO), allowed for a vastly expanded global movement of finished goods and for a huge expansion of trade between firms and industries.
Production became increasingly fragmented, with most of the innovation happening at the operations level, and supply chains were therefore defined mainly around manufacturing efficiency. Beyond export facilitation, governments also focused on improving industrial and technological capacity, increasing efficiency and outsourcing processes.
A gradual awakening of concern over the environmental and social consequences of business activity has taken place over decades. In fact, the 1960s saw the first real awareness of corporate social responsibility, or CSR, with a focus on the impact of companies on the 3Ps—profit, people, and the planet.
From the creation of the GATT in 1947 to the terrorist attacks on the United States in September 2001, policymakers and business strategists in the US and Europe paid little attention to issues of national security and geopolitics. In part, this was because, in a bipolar world, the GATT aimed to foster trade between allied and friendly nations. Additionally, one of the liberal institutionalist assumptions underlying the GATT’s creation was that increased trade would lead to more peaceful international relations.
The success of the GATT and then the WTO as the world’s trade system created a policy and business environment in which questions of geopolitics and security faded into the background, particularly after the end of the Cold War. Fukuyama’s “End of History” was, of course, somewhat of a red herring, but the triumph of market-oriented democracies helped foster the belief that the profit motive would thrive regardless of political challenges. Other main factors driving the globalization of supply chains were China’s accession to the global trade system in 2000, the signing of NAFTA in 1994, the expansion of the European Union to include Central and Eastern European economies, and China’s overseas investments and growing imports of commodities from emerging markets.
In the 2000s, production became highly globalized and consumers benefited from uninterrupted and affordable access to goods and services. This trend was further aided by the liberalization of international capital flows and the ongoing significant differences in wage levels between developed and developing economies. As investors looked for the highest return on investment, cost reduction by any means possible–with an emphasis on cutting labor costs–became a priority in business strategies, and consequently in the design of supply chains.
However, as this model prospered, companies came to be seen as the primary causes of serious social and environmental consequences, and as a result, consumers and investors progressively shifted their focus to values, and the hidden costs of globalization.
The responsible business
The injection of values into supply chain thinking did not happen overnight. A gradual awakening of concern over the environmental and social consequences of business activity has taken place over decades. In fact, the 1960s saw the first real awareness of corporate social responsibility, or CSR, with a focus on the impact of companies on the 3Ps—profit, people, and the planet. This early formulation developed in different ways in different business cultures, with some countries focusing on the employment aspects of CSR, others on civic engagement, and some on producing safe and reliable products. Major scandals—such as the revelations about the use of child labor by sports shoe manufacturers, or toxic waste spills by chemical companies—have helped to raise awareness and have brought important remedial actions by the companies concerned.
Around the world, we have seen a growing focus on corporate philanthropy as a way of reassuring consumers and governments that businesses are responsible participants in the capitalist economic system, and that profits are not the only driver of corporate decisions.
For some companies, this idea was extended to a deeper definition of CSR, one that focused on the concept of the truly responsible enterprise, or TRE. A TRE sees itself as an integral part of human society, and recognizes environmental and social sustainability as the highest priority for corporate activity. A shift in language from shareholders to stakeholders accompanied this recognition of the “ecology of business” and the need to think about the impact that business decisions have on society and environment beyond simply its owners, employees, and clients.
This focus on diversifying the supply chain and reducing dependence on Asia—and specifically China—has continued as post-COVID recovery has gained momentum.
In the 21st century, the connection between supply chains and CSR has become more prominent, with growing concern from both consumers and investors. The discovery of horse DNA in ground beef products in UK supermarkets in 2013 brought a rude consumer awakening about the integrity of the food supply chain. More importantly, investors and consumers demanded that companies not only prioritize the sustainability and social impact of their immediate operations but also provide more transparency across their entire value chain, particularly of their suppliers located in developing regions, adding further complexity to the global supply chain planning process.
In time, consumers’ and investors' demands have shifted from CSR to ESG—environmental, social, and governance concerns. Whereas CSR was far from the core business of corporations and was mainly perceived as a “necessary” cost, ESG is progressively becoming an essential part of the value created by companies (The Big Idea: Creating Shared Value, M. Porter and M. Kramer, 2010). More effective resource use (energy, packaging, logistics) and better community integration are made possible by incorporating a greater understanding of societal and environmental impacts, thus decreasing overall costs. Additionally, new business opportunities are created by redefining productivity—and technology—across value chains, as well as rethinking products and markets regionally.
The prioritization of ESG concerns in investment decisions has indeed brought a premium to those companies that can demonstrate a strong record in this area. A 2016 EY report on sustainable supply chains noted that 88 percent of investors would reconsider or rule out investment if such risks were not addressed. It also noted that some companies now make buyers in each business unit “responsible for the ESG performance of their suppliers.” This provides a powerful incentive to suppliers to improve their ESG performance. A 2020 Boston Consulting Group article revealed that investors would pay an 11 percent premium for consumer packaged goods companies with the smallest environmental footprint. Those same investors would pay a 14 percent premium for steel companies and 12 percent for chemical companies with the lowest carbon intensity.
COVID-19 and the focus on resilience
The economic disruption caused by the COVID-19 pandemic further exposed the fragility of supply chains, in large part because of the interdependence of the global economy. As companies struggled to get hold of components and inputs originating from areas of the world stricken by COVID-19, transnational production platforms and vertically integrated manufacturing models came under severe stress. In the food sector, problems in the meatpacking industry caused knock on effects throughout the supply chain, bringing shortages and high inflation in the auto sector, a deficit of semiconductors left cars unfinished in factory lots and car buyers scrambling to find available vehicles, causing an inflationary effect in the used car and car rental sectors.
Here in the US, first the Trump and then the Biden administrations turned their attention to supply chain resilience. The Biden team conducted a 100-day review of the supply chains for pharmaceutical products, semiconductors, critical minerals, and electric vehicles. This was followed by recommendations to increase reshoring, near-shoring, and ally shoring. This focus on diversifying the supply chain and reducing dependence on Asia—and specifically China—has continued as post-COVID recovery has gained momentum.
In every vulnerable sector, the focus has been on building resilience through diversification, redundancy, reshoring, and technological innovation. Companies have invested heavily in closer manufacturing facilities and longer-term contracts to guarantee access. In the electric vehicle sector, some major producers have vertically integrated battery production rather than continue to depend on third-party suppliers. Long-term contracts with critical minerals suppliers have also been seen as a way to ensure reliable access to lithium and rare earth elements.
The US government has also concentrated legislative efforts and budgetary resources to overcome short- and long-term supply chain challenges. In the critical minerals sector, the Biden administration has used the Defense Production Act to provide funding for new mining projects, the Mineral Security Partnership to provide collaboration with allies and partners, and the Inflation Reduction Act to provide tax breaks and rules of origin incentives to push more funding into the production and processing of minerals needed for electric vehicles. The US semiconductor industry has received a massive boost from the CHIPS and Science Act of 2022, which provides $52 billion in new funding for semiconductor fabricators in the country. This is hugely significant not only for the chip industry but also for every sector that depends on semiconductors.
These US efforts have been mirrored in other parts of the world. Canada has recognized the huge opportunity in being part of the solution to US supply chain problems, the EU has similarly focused on critical minerals and semiconductors, and Asian economic powerhouses such as Japan and South Korea have invested heavily in incentivizing the reshoring of supply chains to their territories. Additionally, nations that produce critical minerals are eagerly eyeing the chance to sell directly to US-based processing and refining plants.
National security and geopolitics
The imperative to overcome supply chain disruptions has been intensified by recent geopolitical woes, most notably the Russian invasion of Ukraine. The immediate impact on Europe caused by natural gas and then oil supply disruptions was exacerbated by severe shortages of inert gases, critical minerals, and grain. The effects of these shortages were felt around the globe in the form of food inflation, dramatic spikes in energy prices, and the subsequent impact of higher transportation costs for most goods.
But the strategic importance of Russian aggression against Ukraine are being most closely observed halfway around the world. Vladimir Putin’s attempt to annex Ukraine raises the question of potential Chinese military actions against Taiwan, which would have a devastating impact on the global economy in the form of a disruption of advanced semiconductor manufacturing. The vulnerability of the US and Europe to a loss of Taiwanese chip production has now become unacceptable, and this was a major factor in convincing US and European lawmakers to pump public funds into incentives for new fabricator plants.
This is not the first time, of course, that national security concerns have been raised over supply chains. In the immediate aftermath of 9/11, the US Department of Homeland Security increased its vigilance over goods coming into the country to reduce terrorist threats. Trusted shipper programs were implemented, and billions were spent on new gamma ray technology at border crossings. During the Cold War, trade in advanced technologies with military applications was restricted through legislation such as the Missile Technology Control Regime to attempt to limit proliferation. In recent memory, rising tensions with China have brought more limits on trade, especially in advanced technologies.
Lessons from the past few years are clear: our supply chains can no longer be taken for granted. Our assumption of uninterrupted access to the goods we desire has ceased to hold true.
The US government has also begun to legislate against the use of forced labor in supply chains. The Uyghur Forced Labor Prevention Act of 2021 not only prohibits the importing of goods using forced labor in Xinjiang, it also gives significant funds to US Customs and Border Protection to investigate the goods that are suspected to have originated in Uyghur labor camps. The Uyghur law has created a major problem for companies that lack the technology and resources to make their supply chains fully transparent, with large fines for those that violate the act, willingly or unknowingly.
Squaring the circle between value and values
The incorporation of the values of sustainability, social impact, governance, resilience, national security, and geopolitics is now a central concern for supply chain managers and business strategists; however, this transition is taking place while businesses must still operate in a highly competitive environment. Shareholders continue to demand profit, most consumers demand both quality and lower prices, and many countries provide both direct and indirect support to their national champions.
This means that companies in both developed and developing countries must somehow find a balance between the need to integrate a broader set of values and the traditional corporate value, solely based on profit. They must satisfy more demanding investors and consumers at the same time as they comply with new government regulations and keep economic, societal, and environmental costs low. The high inflation that has marked 2022 is in part a reflection of the difficulty of achieving this compromise, and there are now frequent calls for pricing to reflect compliance with ESG principles and standards, as well as the prerogatives of security and geopolitics.
Some companies have turned to existing free trade agreements to resolve the dilemma. In North America, the United States–Mexico–Canada Agreement allows for the free movement of goods across the three economies, encouraging cross-border investment and an integrated manufacturing platform. This has long been essential for the competitiveness of the auto sector, and we are seeing moves toward a similar integration of critical minerals production and processing, as well as chip production. Under the auspices of the High-Level Economic Dialogue, the United States and Mexico recently created the Supply Chain Working Group, which focuses on the semiconductor supply chain. Mexico’s lower labor costs and more permissive regulatory environment provide a huge cost advantage, of course, but many companies and investors are concerned about social and environmental costs such as restricted access to clean energy, and problems with transparency and corruption.
Companies are also turning to technologies to increase transparency and information flows in supply chains. The use of blockchain, artificial intelligence, and other technologies shows great promise in reducing supply chain disruptions and facilitating compliance. If we get it right, we may be able to increase both security and efficiency, while at the same time making supply chains more sustainable.
To complicate matters further, companies are advised to plan their supply chains to satisfy not only the requirements of today’s investors and geopolitical tensions but, ideally, also those of 5 to 10 years in the future. If decoupling from China becomes a reality, if tensions with Russia are not calmed, and if pandemics become a regular feature of modern living, supply chains will need to adapt accordingly—by being shortened, and by factoring in resilience and values. Necessity may well be the mother of invention, and the growing demands of investors, consumers, and governments will fuel the ongoing transition to a broader corporate value generation and new supply chain thinking.
Lessons from the past few years are clear: our supply chains can no longer be taken for granted. Our assumption of uninterrupted access to the goods we desire has ceased to hold true.
Saskia Bonnefoi is partner and CEO of The Cluster Competitiveness Group. She is committed to putting sector-based public-private dialogue projects into action, which will have a substantial impact on the adoption of sustainable business models and fundamental adjustments to policy tools. She has created and carried out regional and national competitiveness programs in more than 25 countries. Duncan Wood, PhD, is the Woodrow Wilson Center’s vice president for strategy & new initiatives and senior advisor to its Mexico Institute. He is an internationally renowned specialist on North American politics, Mexico, and critical minerals policy. He regularly briefs the US Congress and leads the Wilson Center’s work on US supply chains.
Cover photo: Travel mania/Shutterstock.