The Impact of Environmental Legislation and Heightened Awareness on the Procurement World

Source: David Fertal, Ariba Supply Watch, Q3 2006

All of a sudden, green is everywhere.                               It’s in the organic food that we eat, the                               efficient buildings that we build, the hybrid                               cars that we drive, and the renewable energy that                               we consume. A decade ago, none of these products                               were well known, let alone commercially viable.                               Yet today, they are at the forefront of a growing                               environmental movement that aims to reduce many                               of the burdens that our progress has placed on                               our natural world.

                              Ariba has noticed a growing awareness of environmental                               issues in the markets that it serves. This article                               will address the underlying trends that are causing                               companies to incorporate these concerns into their                               everyday business decisions, and the changing                               role of procurement towards managing their supply                               chains to become more environmentally friendly                               and resource efficient. Buyers today must be aware                               of these green purchasing trends and look for                               ways to incorporate them into their business models.                               As a long-time Ariba customer recently commented:                               “If you’re not green, or looking at                               areas where your company can be green, then your                               long-term success will be in jeopardy.”

                              What is Driving Environmental                               Awareness in the Supply Chain?
                              There are a number of significant and long-term                               trends that are affecting companies and their                               supply chains today. Broad-reaching environmental                               regulations, growing consumer preference for “green”                               products, and sustained high prices for commodities                               are driving changes in business practices and                               supply chain management.

                              Increased Government Regulation
                              As a result of growing environmental concerns,                               governments are stepping in with increased regulations.                               More government regulations are forcing entire                               industries to address environmentally harmful                               business practices. On a global basis, 95 percent                               of companies comply with the legal requirements                               in their Environmental Policy Statements, whereas                               53 percent of companies exceed the legal requirements,                               and only 12 percent adhere to accepted best practices.

                              Historically, Europe tends to be more environmentally                               oriented and a leader from a regulatory point                               of view. RoHS, the European Union’s Restriction                               of Hazardous Substances directive that went into                               effect on July 1 of this year, is a good example                               of this. The directive, which prohibits the sale                               of electronics equipment that contains lead, chromium,                               mercury, and several other harmful substances,                               legally applies only to the 25 EU member states.                               However, due to the nature of global supply chains,                               the RoHS directive has had a ripple effect throughout                               the global economy, affecting almost all electronic                               goods producers, even if they don’t sell                               directly into the EU marketplace. While the health                               of many will benefit from this legislation by                               removing harmful substances from the environment,                               there has been a downside. Cost estimates for                               compliance have ranged from a low of two percent                               added to the cost of goods sold to a high of 10                               percent. Depending on market conditions, this                               has resulted in a direct drain on corporate profits                               for suppliers to the electronics industry.

                              In the United States, environmental leadership                               typically originates from the state of California,                               which is the sixth largest economy in the world.                               Recently, it passed landmark legislation that                               will reduce carbon dioxide and other greenhouse                               gas emissions from the state’s major power-producing                               industries by an estimated 25 percent by the year                               2020. More directly aimed at curbing the potential                               social and economic effects of global warming                               than RoHS, the legislation will allow companies                               to buy, sell, and trade emission credits as incentive                               to install new technologies or be forced to pay                               for the right to continue producing high emission                               levels. This market-based compliance mechanism                               is modeled after similar legislation in the EU.                               The bill also applies to any out-of-state utility                               that sells into the California market, broadening                               its impact throughout the supply chain.

                              Globally, more legislation is already being planned.                               China’s version of RoHS goes into effect                               next March, and it may restrict more substances                               and affect more of the supply chain than the EU                               legislation. It applies not only to manufacturers,                               but also to distributors, importers, and retailers                               of electronic goods. As of this writing, California                               has passed (and at least 20 other states are considering)                               similar legislation to RoHS for the U.S. marketplace.                               This appears to be just the beginning. Scheduled                               to go into effect in August 2007 is another EU                               directive called the Energy-using Products (EuP)                               law. Products that utilize energy will be required                               to meet energy efficiency standards during manufacture                               and end-use. Similar to the Energy Star seal for                               a product’s energy efficiency in the U.S.,                               the EuP law will measure energy efficiency during                               use but will also extend back into the manufacturing                               processes to measure the amount of energy used                               to process the raw materials into finished product.                               In this way, an entire energy profile will be                               available for consumers to consider when evaluating                               a product to purchase. And given the impact that                               RoHS has had on electronic goods producers, the                               EuP law will likely have similar implications                               for buyers today in how they manage their supply                               chains in the affected industries.

                              Consumers Prefer Green
                              At the same time as new legislation is hitting                               the market, consumers are shifting their preferences                               towards environmentally responsible brands. Recent                               polls in the U.K. and in the U.S. have shown that                               a growing majority of consumers prefer environmentally                               responsible brands from companies whose business                               practices are safe for the environment. As a result,                               many of these niche market “green” products                               have moved decisively into the mainstream. Most                               CEOs have taken note and now recognize that they                               risk damaging their corporate image if they ignore                               the environmental impacts of their products and                               business practices. The result—brands that                               promote “green” and “sustainability”                               are differentiating themselves in the marketplace                               from mainstream brands and are capitalizing on                               being “environmentally friendly”. This                               in turn is fueling the trend among many corporations                               towards a greater sense of corporate social responsibility.

                              Commodity Price Pressures
                              Another factor that continues to strongly influence                               buyers today is the volatility and sustained high                               prices of many commodities and raw materials.                               The underlying factors affecting the supply and                               demand of most commodity markets are larger scale                               and longer term in nature. On the demand side,                               the economies in countries like India and China                               show no signs of slowing down as their huge middle                               classes benefit from their growing prosperity.                               Conversely on the supply side, markets are burdened                               by the inherent risk associated with a large amount                               of a given commodity’s supply coming from                               a limited number of countries. Magnifying this                               situation are the political instabilities in some                               of these markets and the growing threat of terrorism.                               Copper and oil are good examples of this. Demand                               for these commodities continues to run at historically                               high levels, and an overwhelming percentage of                               the supply market is dominated by a small number                               of countries in potentially unstable regions.

                              High commodity prices normally help enable innovation.                               Companies can’t afford high prices for long                               periods of time and expect to stay profitable.                               To help reduce costs, companies will look for                               new technologies and alternatives to high-priced                               commodities. Oil, for example, has been at such                               high levels for so long that many previously expensive                               technologies are starting to make economic sense.                               Factor in a heightened awareness of the environment                               and a desire to more efficiently utilize our natural                               resources, and it provides a business opportunity                               for companies to capitalize on. New automobiles                               incorporating gas-electric hybrid technology and                               corn-based plastics are two examples that are                               gaining commercial acceptance. And given that                               less fossil fuel is being burned, fewer greenhouse                               gases are being emitted into the atmosphere, and                               a renewable and sustainable resource is being                               utilized, the consumer appeal for these products                               will be high.

                              So What are Companies Doing?
                              In order to cope with and indeed prosper under                               these growing pressures, leading companies are                               taking action to prepare for change and better                               manage their supply chains. They are realizing                               cost savings from alternative and recycled materials,                               reducing supply risk with continued regulatory                               compliance, and improving environmental performance                               through broad-based supply chain initiatives centered                               on collaboration and Design for the Environment                               initiatives.

                              The Benefits of Alternative and Sustainable                               Supplies
                              Although being environmentally friendly and compliant                               is often associated with higher costs that lead                               to higher prices for end users or lower profit                               margins for suppliers, some industries have been                               able to improve their environmental image and                               reduce costs at the same time. Three innovative                               examples that most of us see in the course of                               our everyday lives are outlined below:

1) Supermarkets in                               several European countries have gradually eliminated                               plastic bags from their outlets. As a substitute,                               they offer more robust reusable plastic bags and                               boxes to their customers for a symbolic fee. In                               this example, supermarkets gain from improving                               their image by helping to limit non-biodegradable                               waste, while at the same time they are lowering                               their overall operating costs.
                              2) By now, most of us have stayed at hotel chains                               that encourage customers to reuse their towels                               during their stay. On one hand, this reduces the                               impact on the environment by reducing the cleaning                               “liquids” and water used. At the same                               time, it reduces operating costs for the hotel                               chains by cutting laundry fees.
                              3) With oil prices recently spiking over $70 per                               barrel and still remaining at historically high                               levels, many companies are exploring alternatives                               to petrochemical-based plastics. As a result,                               usage of polyactic acid (or PLA) is on the rise                               in markets for plastic packaging. Marketed as                               an environmentally friendly plastic, it is made                               entirely from corn and is biodegradable. Although                               PLA plastics are not yet cheaper than petrochemical-based                               materials, continued investments to bring down                               unit costs will soon allow PLA plastics to challenge                               the market dominance of traditional polyethylene                               terephthalate (PET) or high-density polyethylene                               (HDPE) plastics in a variety of packaging applications.

In all of these examples,                               companies are appealing to their customers’                               environmental awareness and conscience while at                               the same time driving potential cost reductions                               in their operations. In a sense, they are reaching                               a business utopia—cutting costs, increasing                               customer satisfaction, and taking steps to improve                               the global environmental condition.

                              Regulatory Compliance
                              In order to avoid disruptions in the supply chain,                               buyers need to be aware of the environmental regulations                               in all of the markets in which it operates and                               understand how they relate to the capabilities                               of the supply base and their level of compliance.                               Depending on your supply chain, the scope of awareness                               may need to be global. In the electronics industry,                               many feared that RoHS would cause severe shortages                               in both compliant and non-compliant components                               as the July 1, 2006 effective date approached.                               Neither scenario has materialized yet, but buyers                               are still carefully monitoring market trends to                               ensure that they maintain steady supply inventory                               levels.

                              Another critical issue regarding compliance is                               the potential financial impact due to inventory                               obsolescence. Buyers can be exposed to inventory                               write-offs if there are large swings in price                               or demand for non-compliant components.

                              As new regulations go into effect, it will be                               increasingly important for buyers to keep track                               of their supply base compliance initiatives, to                               monitor their inventory levels and component lead                               times, and to consider alternative sources of                               supply if incumbent sources fail to meet regulatory                               compliance.

                              Incorporating the Environment at the Design                               Level
                              Though not a new concept, Design for the Environment                               (DfE) is taking on greater significance in helping                               to green the supply chain. In addition to incorporating                               design elements that minimize energy usage, toxic                               materials, and waste-generating production processes,                               DfE also helps enable the establishment of ‘closed                               loop’ supply chains by encouraging that products                               be designed for disassembly and recyclability.                               Products that are modular in design, that minimize                               the use of adhesives or other coatings, and that                               can be taken apart with common hand tools allow                               for efficient disassembly into core components                               and materials at the end of its useful life. These                               materials can then be recycled and reused into                               new or updated products, thereby reducing the                               harvest and consumption of virgin materials.

                              New Forms of Supply Chain Collaboration
                              To reduce costs and improve environmental performance,                               companies are joining industry groups or creating                               supply chain collaborations to adopt and support                               environmentally sound business processes that                               strengthen the entire supply chain. These joint                               efforts can dramatically increase benefits by                               ensuring that every member of the supply chain                               supports a common set of environmentally sound                               business practices.

                              Leading OEMs have implemented “Supplier Environmental                               Requirements” programs in response to regulations                               and a heightened sense of social responsibility.                               These programs take on a variety of forms, but                               they all have similar characteristics. Most programs                               are based on strong mission statements that are                               supported by the company’s top management,                               who have a clear understanding of the benefits                               of integrating the environment throughout the                               company’s business practices. Most realize                               that clearly communicating their environmental                               policies with their suppliers is only the beginning.                               These same OEMs understand that their roles are                               to educate, evaluate and monitor, as well as encourage                               and support their suppliers on environmental issues                               and compliance adoption. Furthermore, suppliers                               are being recognized for their efforts. Earlier                               this year, a major U.S. automaker issued its first                               ever “Environmental Excellence Award”,                               which goes to the supplier that best supports                               environmental improvement initiatives through                               leadership and adoption of best practices, including                               ISO14001 certification.

                              There are even collaborations involving the U.S.                               Government. Leading OEMs from the automotive,                               aerospace, healthcare, and pharmaceutical industries                               have partnered with the U.S. Environmental Protection                               Agency and the Department of Commerce to form                               the Green Suppliers Network. Members of the network                               share best practices on reducing their environmental                               impact while adding value across the supply chain.                               The goals are to continuously improve products                               and processes, increase energy efficiency, eliminate                               waste, and identify cost-savings opportunities                               through optimized resources and technologies.

Your Environmental Checklist
Cost continues to be a major driver and is really what buyers focus on the most. However, as new environmental regulations go into effect and as new materials and technologies become commercially available, the pressure will be high for companies to incorporate them into their business models to reduce their environmental footprint. In order to raise awareness and help prepare your company for new regulations and the adoption of best practices, buyers today should be focused on the following:

Stay abreast of environmental legislation and understand how they can impact your business and your supply chain. Legislative changes related to carbon emissions, waste generation and harmful materials are likely to accelerate in the coming years. As RoHS has shown, legislation in one part of the world will affect most everyone in the global economy. Being proactive in addressing these issues can help your company gain competitive advantage by being an early adopter.
Join industry groups to stay abreast of what others in your industry are doing and look to share best practices. These groups can help you generate ideas on how to identify new savings opportunities through environmental compliance.
Stay abreast of new materials and technologies that supply your company’s products. New materials and technologies normally have higher unit prices initially than traditional ones but may save money in other parts of your business due to reductions in energy consumption, increases in yields, or reductions in waste disposal costs. Utilize total cost of ownership analysis to accurately compare the costs of current with alternative materials.
Work with your engineering and design groups to look for ways to increase recycled content or alternative materials in your products. If an alternative material is from an environmentally safe and renewable source, maximize its use and promote its benefits throughout your organization. Many times, it’s as simple as asking for higher recycled content to be incorporated into designs or for alternative materials to be considered.
Market your environmental successes. As consumers continue to reward those products and brands that exhibit an environmentally friendly image, companies will have economic incentive to address those environmentally poor aspects of their businesses. Celebrate your successes and use them to gain market share from your competitors through effective environmental marketing.

Green Purchasing

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