February 1, 2023
This is the fourth in a series of The One Brief articles examining the impacts of climate change.
Supply chains around the world have been tested by a whole range of forces, such as geopolitical instability and the COVID-19 pandemic. Though some of these challenges may be temporary, there is one threat that is wide-reaching and growing in severity and relevance: climate change. The changing climate is linked to existing forces exacerbating supply chain disruption.
Ongoing environmental changes and natural disasters have already disrupted trade, prompting companies and governments to take a closer look at the resilience of supply chains. Building climate resilience can help businesses develop long-term solutions to future proof their business and increase their competitiveness. “The ‘just-in-time’ ability, as well as our long and dispersed global supply chains, are incredible when it comes to getting goods to market, but it can also leave supply chains quite vulnerable to interruption,” says William Bruce, global head of Climate Risk Consulting at Aon.
“Solving our climate crisis will involve rethinking not only the operational aspects of supply chains but also rethinking their role,” adds Stephanie Betts, head of alliances, coalitions and reporting for Aon’s Global Climate Execution Team. “We know that supply chains account for 90% of greenhouse gas emissions and are likely to be similarly linked to biodiversity loss, which impacts our raw materials availability. A further collapse of biodiversity will continue to have an impact on companies’ margins. Those companies that can get their arms around what’s happening in their supply chains now will certainly benefit from a competitive advantage and a resilience advantage, because the physical climate risk is not going away. It’s intensifying constantly.”
As extreme weather events increasingly threaten the production and delivery of goods, organizations are realizing that strengthening supply chains in response to climate change is essential. Companies evaluating climate risks in their supply chains will also need to consider transition risk, in the form of government regulations and new policies related to carbon reduction.
Improvements in supply chains will not only be driven by sustainability and compliance, but also increasingly driven by real life outcomes. “Supply chains are likely to transform faster than we expect as a result of rapidly changing expectations from stakeholders — shareholders, employees, governments and NGOS — and climate externalities directly affecting operations,” Betts says. “CFOs will look at their numbers and say, ‘This is now impacting our bottom line. We need to act differently. We need to rethink that portion of the supply chain.’”
The Risks Related to Climate Change
Businesses and governments are increasingly taking note of the urgency — and complications — in managing both physical and transition risks for supply chains.
Physical risk includes the acute and chronic risks related to climate change and events such as drought, wildfires and floods — which can take a toll on the production and transportation of goods. Issues encountered recently by Taiwan’s semiconductors are indicative of issues other countries will be facing. “Organizations that have geographically dispersed or complex supply chains are going to continue to feel the effects of those sorts of impacts,” Bruce says.
Transition risk focuses on the challenges and opportunities in an economy’s transition to low-carbon practices. “There’s going to be an increasing amount of policy and legal changes designed to catalyze transitioning to net-zero,” Bruce adds. “Consequently, supply chains will start to be impacted by that transition to a low-carbon economy as businesses favor lower carbon suppliers for their goods and services.”
Approaches for Climate Risk Management
Managing supply chain risk begins with identifying exposure. Bruce says that companies should consider incorporating climate risk exposure into procurement decisions. Identifying location-based risks, such as factories located in flood-prone areas, could prompt businesses to make changes to existing processes or relocate certain operations entirely. Exploring other options such as shortening supply chains, working with local suppliers or employing dual sourcing — which involves using two suppliers for the same product — could help to minimize climate-related business interruptions.
Larger companies can create sustainable supply chain practices by setting industry standards or maintaining climate-friendly criteria for their suppliers, resulting in a trickle-down effect in terms of supply chain reform. “Obviously there’s a cost associated with increasing the transparency of your supply chain, but I think once the bigger players start to do it, it becomes a lot harder for their competitors not to do it. Corporations requiring their supply chain to follow sustainable policies play a central role in transforming the supplier ecosystem through a trickle-down effect,” observes Betts.
Smaller suppliers are exploring what Betts calls “pre-competitive collaboration” by pooling risk and sharing information.
Technological innovations can also help companies, suppliers and insurers manage climate risks. “As insurers, better data allows us to assess risk more accurately, price cover differently and potentially lower the cost of insurance, accelerate the pace of change, and really support those companies through their transition. Availability of the right data is going to be a critical factor of progress,” explains Betts.
Planning with Nature in Mind
Resilient supply chains require planning on a local and global scale. Regulators as well as corporations will need to be mindful of the importance of nature and biosystems in supporting supply chains and environmental wellbeing. “Biodiversity links to water stewardship, which then links to food security,” Betts explains. “Whether it’s food and agriculture or even the energy transition, with less water most economic activities become constrained, and then impossible. Water scarcity and how we manage it is going to be one of the biggest drivers of capital allocation decisions.”
Reforms in Public and Private Sectors
Maintaining a dialogue between governments and companies will be critical in supporting a climate-resilient supply chain. “Everything has to work in sync,” Betts says. “We need governments to create the right set of incentives and to facilitate change. We need corporations to do the work: they’re the ones changing, they’re the ones redesigning their products or adjusting their pricing to reflect high costs.”
Increased levels of scrutiny around compliance with climate regulations may also lead to greater corporate accountability. “With increased scrutiny on corporate disclosures, and an appreciation of the importance of scope 3 emissions, pressure for organizations to proactively address risk in the supply chain will increase.,” Bruce says, noting these policies could curb so-called greenwashing as well.
Governments will also benefit from corporate insights, Betts adds, because companies are navigating the day-to-day challenges of conducting business while managing climate pressures. “We will need closer public and private sector collaboration,” Betts says. “The decisions that governments and regulators will make in the next five years will have such an impact on day-to-day outcomes for corporates and communities that governments can’t afford to disregard what industry is saying. That flow of information is going to be critical.”
To find out more about Aon’s insights for the supply chain, click here.
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