Supply chain social and environmental due diligence is changing — driven by a changing regulatory and enforcement environment in the United States, Europe and increasingly around the world. These regulatory changes, when added to cost pressure, market access, technology evolution, increasing customer and client expectations, the opportunity for product differentiation and the need for verifiable claims are creating a tipping point, where action, innovation and value will be found.
The future will bring increased experimentation, accountability and transparency, driven by five big evolutions
What do these changes add up to? They add up to an environment where knowing (or not knowing) the social and environmental aspects and impacts of your product and supply chain unlock risk — and opportunity.
The changing regulatory environment is being shaped by five big evolutions:
- Due diligence itself is becoming legally mandated; it must be risk-based, proportional, include responsibilities for both buyers and their supply chains, and include stakeholder engagement throughout the process; this is at the heart of the CSDDD and other regulations based on the UN Guiding Principles on Business and Human Rights as well as the OECD Guidelines for Multinational Enterprises on Responsible Business Conduct. Both social and environmental impacts are in scope of the due diligence requirements when the various legislation are considered as a whole.
- Due diligence must focus on ‘actual’ and ‘potential’ impacts. The focus on potential impacts means systems, processes and controls (to limit or avoid the risk) are increasingly important. It is no longer solely about reputational risk for the buyer; it is about actual and potential impacts on rightsholders.
- When forced labour regulation is added into the equation, risk areas up and down the value chain are pulled into scope. Forced labour regulation means that, if a component, raw material or part is made with forced labour, the final product can be subject to market access bans. Adding to this the EU Deforestation Regulation (EUDR) and Digital Product Passports (DPPs) means a core of traceability will increasingly sit behind the supply chain, and this data (whether for trade, carbon or claims purposes) becomes increasingly important and valuable — both for risk mitigation and value creation.
- As due diligence data links to CSRD and other reporting, transparency from and about the supply chain will continue to evolve. Transparency from supply chains is reported by the supply chain itself (inside out) and is going to be increasingly overlaid with transparency about supply chains (outside in) — be it from big data, AI pattern recognition, satellite and other data sources. Overlaying outside in and inside out transparency by regulators, civil society and, ultimately, consumers will drive accountability and the necessity for solid, verified data.
- Finally, when taking all of these factors together, the scope of due diligence — auditing across an entire value chain — will become a significant challenge even to the biggest of companies if they continue to rely on the processes and systems of today.
But these changes do not mean social and environmental due diligence is impossible. It just means due diligence has to evolve.
Change is going to be necessary for both buyers and suppliers. This need for transformation is not new — we have seen it before.
Let us think about quality — quality control, quality systems, quality processes and accountability. Anyone in manufacturing or supply chain will have heard of W. Edwards Deming. In the 1950s — in a manufacturing world focused on maximisation of output — Deming taught that most quality problems were the fault of management systems, not workers. He focused on systemic quality improvements, data and statistical analysis, and the need to move quality from the end-of-line inspection (or — shudder — at the receiving warehouse) and into corporate culture.
As various industries adopted and learned, quality control moved from inspections to building of quality systems marked by continuous improvement, systems thinking, and plan-do-check-act and root-cause-analysis-driven problem prevention. In short, from quality inspections to quality assurance embedded in manufacturing through lean manufacturing created by a mindset shift to recognise and eliminate waste. This change took decades, and all of the comments and criticisms we will hear about social and environmental due diligence were also present: Impossible! Too expensive! Radical! We cannot afford a focus on long-term quality over short-term profit! This is not how we do things!
And yet, can we imagine 1950s manufacturing succeeding in today’s world?
Social and environmental due diligence laws are formalising and echoing the evolution we saw in the changing approach to quality — but instead of addressing the hidden costs of poor quality (from customer returns to brand destruction and legal liability), they focus on the clear and apparent costs of externalities (carbon emissions, pollution, modern slavery and community impacts).
It is time for due diligence to move from the checklist audit to embedded systems, where innovation, experimentation, technology and most of all, mindset will win. The next decade is going to be interesting!