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ML Journal

ML Journal

The Sustainability Imperative: A Socially and Environmentally Responsible Future

As investors and regulators increase the pressure for greener, more ethical business practices, manufacturers look to get ahead of increasingly urgent demands.  

Over the past decade, public concern over corporate social and environmental impact has spiked and investors have responded by aligning with consumer priorities. Subsequently, manufacturers have made strides to adjust their business models and incorporate environmental, social, and governance strategies that benefit all stakeholders.

However, some manufacturers have yet to reimagine their processes, as federal and local regulations have not yet required they do so. Manufacturers that prioritize ESG strategies can protect brand reputation, mitigate risk, and improve capital access — all while doing their part to minimize climate risk and contribute to the communities where they operate. To achieve these goals, manufacturers should rely on a holistic approach to ESG that considers a number of variables and cross-industry practices.

Areas Influencing ESG
Strategies in Manufacturing

Depending on the type of manufacturing, associated processes have varying effects on social and environmental responsibility. Some practices have routinely fallen short of the mark and resulted in substantial waste, significant greenhouse gas emissions, inequitable working conditions, and other negative impacts.

Fortunately, manufacturers across all industry sectors are becoming increasingly aware of their social and environmental impact on the world, and they’re making changes to adjust priorities. In particular, manufacturers in the automotive and food sectors have made significant strides with initiatives that can lower carbon footprint, address challenges with forced labor, and more.

Despite the impact of COVID-19 on the automotive sector, companies have maintained steady growth in sales of electric vehicles — now projected to reach 58% of global passenger vehicle sales by 2040.1 EVs are also expected to account for 12% of fleet vehicles by 2030.2 Trucking companies are up against the need for a scaled charging infrastructure to support electric fleet efforts, but they’re continuing to support growth projections by finding opportunities to deploy electric tractor trailers along regional and last-mile routes and investing in long-range batteries. By offsetting the market share of gasoline-fueled vehicles, EVs have the potential to significantly reduce greenhouse gas emissions on the road.

Manufacturers that prioritize sustainability strategies can protect brand reputation, mitigate risk, and improve capital access.

In the food sector, rising priorities include reducing harmful chemicals in packaging and processing, reducing food waste, ensuring ethical labor practices, and mitigating environmental impacts. Food waste also produces methane — a greenhouse gas that’s 20 times more damaging to the environment than carbon dioxide.3 Food manufacturers are also examining the practices of companies at every stage of the supply chain, which helps ensure they’re not using forced labor or child labor, encourages fair trade, and can minimize ecological damage. For example, palm oil is found in many consumer products, but traditional sourcing is largely unsustainable and contributes to deforestation, pollution, and habitat loss for native species. Cocoa production can have similar effects. Food manufacturers can significantly curb these negative impacts by ensuring that sustainable practices are used throughout the process.

These larger trends go beyond the automotive and food sectors — manufacturers of all types are facing pressure to lower their carbon footprint, conduct business with ethical suppliers, and prove third-party companies are compliant with ESG standards and laws. Amid disparate reporting standards in the U.S. and increasing regulations in the EU, manufacturers have invested in supply chain technologies to help in many areas, including to track and trace raw materials, combat fraud, conduct third-party monitoring, assess workplace hazards, identify supply chain vulnerabilities, and more. These technologies help manufacturers mitigate risk and measure their social and environmental footprint — while also communicating these efforts to regulators, investors, and the public.

Many manufacturers have made their ESG commitments loud and clear. These include:

  • Net-zero carbon emissions by 20504
  • Evaluating opportunities with electric vehicles
  • Switching to renewable energy power sources in manufacturing processes
  • Implementing diversity, equity, and inclusion strategies and offering competitive wages
  • Retrofitting facilities to reduce environmental impact
  • Increasing investments in cybersecurity to protect operations against attacks and breaches

In order to reach these goals, manufacturers have to approach their ESG plans holistically and evaluate all areas that impact those initiatives, including criteria for capital access, stricter labor laws, Industry 4.0 acceleration, expanding regulations, and rising governance standards.

Sustainability and Capital Access

During the height of COVID-19, most investors and lenders sought to avoid the financial risks of manufacturers’ product shortages, increased transport costs, and trade tensions. As these challenges remain, investors and banks are continuing to analyze the industry with a critical eye. ESG scores are increasingly a factor in access to and cost of capital, as financial institutions evaluate the risks of lending to non-sustainable and unethical companies.

Leading manufacturers are protecting their supply chains from forced labor by investing in supply chain transparency solutions and continuously monitoring the practices of their suppliers.

However, reporting metrics and frameworks are disparate across practices for internal tracking and external disclosures. Investors recognize the importance of aligning with key stakeholders across business functions to develop industry-specific standards for ESG criteria. As a result, public companies are contending with disclosure pressures to report on their ESG compliance, incentivizing companies to share corporate data and form cross-functional teams to approach ESG holistically.

Private equity funds and lenders are also taking a closer look at ESG ratings. In fact, 94% of fund managers say incorporating ESG investment criteria into their investment strategies is a priority for their limited partners, according to BDO’s spring 2021 Private Capital Pulse Survey.5

As a result, it’s more important than ever that manufacturers ensure transparency and accuracy in their disclosures. Without standardized guidelines, investors must make decisions based on the data companies can provide. If standardized metrics aren’t available, manufacturers are at an increased risk of losing critical sources of capital. To navigate this risk, companies should invest in data tracking and analytics capabilities as they pursue ESG goals to support long-term impact.

Ensuring Fair, Equitable Labor Practices

Federal and local governments are looking to enforce more strict regulations around companies’ impact on social equity, introducing new pressures for manufacturers to improve fair labor standards, including workplace conditions, compensation, and DEI strategies.

For much of 2020, labor laws related to COVID-19 were unclear or underdeveloped, but the impacts of the pandemic were immediately clear. While essential workers continued to report to their jobs, the pandemic sent unemployment rates for nonessential staff to near-record highs.<sup>6</sup> Even after manufacturing companies temporarily paused operations and furloughed some staff members, COVID-19 still posed a threat to workers’ health. Manufacturers learned that getting their workforce back online would require more than allowing six feet between stations, and they began taking additional steps to ensure workplace safety.

Political leaders took steps as well. Since President Biden’s inauguration, American workers have seen a new Family and Medical Leave Act, an increase to minimum wages for federal contractors and private-sector employees, and federal support for unionization.

And the workplace safety conversation goes well beyond U.S. borders. Internationally, there is a web of labor laws and reporting requirements for supplier monitoring, including the Labor Value Content guidelines in the recent U.S.-Mexico-Canada Agreement, which requires a threshold of product content to be made by workers earning a higher minimum hourly wage. Furthermore, Section 307 of the Tariff Act of 1930 explicitly “prohibits U.S. imports of any product that was mined, produced, or manufactured wholly or in part by forced labor, including forced or indentured child labor.”

As the industry continues to see new policies around ethical labor emerge, it’s critical that companies take advantage of current opportunities to explore evolved compensation practices, worker safety needs, and DEI strategies. Leading manufacturers are going a step further in protecting their supply chains from forced labor by investing in supply chain transparency solutions, continuously monitoring the practices of their suppliers, and developing ethical labor standards for their own business and their partners.

Another step manufacturers can take to ensure ethical workplace conditions is to look at outsourcing with a critical eye. While outsourcing functions to third-party agencies can give manufacturers the opportunity to expand their service offerings, it can also increase their risk of engaging in unethical labor practices and falling short of compliance obligations. Industry 4.0 technologies can help manufacturers ensure the third parties they engage with are following ethical labor practices by providing real-time, data-backed insights on supply chain management and reporting.

The Role of Industry 4.0

Industry 4.0 also influences the adoption of ESG programs because of the benefits it offers through advanced, real-time data collection, tracking performance of ESG goals against key metrics, and automating reporting and disclosures. However, the industry is split between two types of manufacturers. Manufacturers who adopted Industry 4.0 strategies well ahead of the COVID-19 outbreak were well-poised to respond to the pandemic and the new challenges it introduced, including those around ESG requirements. On the other hand, manufacturers who are still using legacy technology are in a less advantageous position when it comes to tracking and reporting their ESG commitments.

For those who have yet to fully implement an Industry 4.0 strategy for sustainability, the competitive disadvantage will only grow over time.

 

According to BDO’s 2021 Industry 4.0 Survey, only 24% of manufacturers have fully implemented an Industry 4.0 strategy.<sup>7</sup> However, they’re already showing use cases that help achieve their ESG goals, including:

  • Blockchain: Blockchain is commonly known for its use with cryptocurrencies, but for manufacturers pursuing ESG strategies, there’s additional value to be unlocked. Blockchain can capture and share data across the supply chain in an immutable record, automate reporting, and improve traceability and origin tracking to measure environmental footprints, which is particularly useful for the food and lumber sectors.
  • Simulation and digital twins: By building simulations of their operations and testing changes virtually, manufacturers are better equipped to evaluate their carbon footprint and calculate associated carbon emissions based on a range of factors, such as the types of fuel used, their facilities, and more. Digital twins can also help manufacturers find efficiencies for resource usage and cut costs by removing redundancies.
  • IoT sensors: IoT sensors have been used to conduct predictive maintenance and optimize processes while enhancing production output. With this technology, manufacturers can better manage power use in facilities by having the sensors detect when to provide power and when to switch to a power-saving setting. Buildings contribute significantly to global carbon emissions, but by combining renewable energy sources with IoT sensors and other technologies, manufacturers can reduce their pollution and increase energy efficiency.
  • Dashboards: Manufacturers can leverage dashboards and integrate them with carbon capture technology to measure carbon impact, monitor energy usage, and determine how to respond. From a social and governance standpoint, dashboards can also identify and monitor vulnerabilities in operations and provide insights on customer and workforce management.

There is a wide range of technology solutions at manufacturers’ disposal as they pursue ESG implementation. Manufacturers that still rely on legacy technology should prioritize investing in digital solutions to support their ESG commitments. For those who have yet to fully implement an Industry 4.0 strategy, the competitive disadvantage will only grow over time.

Mounting Regulatory Pressures

Although consumer and investor pressures are currently outpacing regulatory policy, the Biden administration has committed to developing policies that will further ESG maturity in the U.S. Multinational companies should already be cognizant of regulatory policies in Europe and Asia, and they should consider the implications for their business if customers or suppliers are located in those regions. For example, sustainable investments have become a top priority for Europe’s asset management industry. In 2019, the EU rolled out its Sustainable Finance Disclosure Regulation, which aims to better define ESG metrics for end investors, allowing companies’ ratings to be compared more clearly. The regulation falls under the EU’s sustainable finance framework, which provides broad guidelines for sustainable investments.

In the U.S., manufacturers have already seen changes on the state and local levels. But they shouldn’t wait until federal policies are formally introduced, as the costs and risks associated with failing to support global ESG demand will weigh more heavily on the bottom line over time. To prepare, manufacturers can build standardized ESG models now with the help of variability analysis — including adjusting assembly line speed, motor efficiency, and overall social and environmental impact — and by maintaining adequate documentation for reporting disclosures.

The Need for Standard Governance

While ESG programs are spreading across industries, metrics and reporting frameworks remain disparate. As manufacturers are on the front line of business-to-business and business-to-consumer impacts, there’s a heightened need for standardized language and guidelines. Not only does this lack of standardization impede manufacturers’ ability to track the progress of their own ESG efforts and those of competitors, but it also makes new companies unsure of where and how to start. There are ESG ratings agencies that have developed algorithms and metrics to compare companies, but their methodologies differ vastly and sometimes tell contrasting stories of companies’ ESG performance, which limits the usefulness of ESG ratings for today’s reporting frameworks.

Beyond good business sense and being a responsible global steward, ESG strategies offer a plethora of opportunities for manufacturers

On the other hand, most ESG data is self-reported. Companies leverage the data they have on hand to attract investors and state and local government funds looking to make sustainable decisions with long-term value, but that data can lack transparency if companies are unable to disclose holistic reporting.

State and local fund managers are leaning into ESG investments, and regulations are following suit. In California, officials have released a policy requiring renewable and clean energy sources to “supply 100% of electric retail sales to customers by 2045,” according to the California Energy Commission.<sup>8</sup> And as the Biden administration continues to push a renewable energy agenda, more state and local governments will likely take similar steps. For those companies that haven’t prioritized socially and environmentally sustainable practices yet, the need for greater transparency to fuel capital access and new governance requirements on reporting ESG impact will be strong incentives to catch up to their sustainability-savvy peers.

An Evolved Manufacturing Landscape

Beyond good business sense and being a responsible global steward, ESG strategies offer a plethora of opportunities for manufacturers to incorporate enhanced and more formalized ESG standards as a part of their business improvement strategy and everyday operations. At the same time, it can help mitigate risks and reduce vulnerabilities associated with regulatory compliance and capital access. Going forward, manufacturers should take a holistic approach to ESG initiatives and leverage digital technologies that help support a sustainable business model of ethical labor and sourcing practices to bolster deeper community support. M

Footnotes:

1 https://www.forbes.com/sites/arielcohen/2020/10/26/plugging-into-the-future-the-electric-vehicle-market-outlook/?sh=1ccb14449812

2 https://www.greenbiz.com/article/8-electric-truck-and-van-companies-watch-2020

3 https://www.forbes.com/sites/quora/2018/07/18/what-environmental-problems-does-wasting-food-cause/?sh=6046d1462f7a

4 https://www.unpri.org/pri-blog/seven-major-companies-that-committed-to-net-zero-emissions-in-2020/6909.article

5 https://www.bdo.com/BDO/media/Report-PDFs/PE_Private-Capital-Pulse-Survey_Spring-2021_brochure_WEB.pdf

6 https://www.pewresearch.org/fact-tank/2020/06/11/unemployment-rose-higher-in-three-months-of-covid-19-than-it-did-in-two-years-of-the-great-recession/

7 https://www.bdo.com/BDO/media/Report-PDFs/Digital%20Transformation/2021-Industry-4-0-Survey_web.pdf

8 https://www.energy.ca.gov/news/2021-03/california-releases-report-charting-path-100-percent-clean-electricity

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