Where the Problems Are

To understand the situation and develop ideas for tackling it, we conducted a study of three supply networks. Each was headed by an MNC considered to be a “sustainability leader”—one in the automotive industry, one in electronics, and one in pharmaceuticals and consumer products. (For the specific selection criteria, see the “About the Research” sidebar.) We also studied a representative set of each MNC’s suppliers—a total of nine top-tier and 22 lower-tier suppliers, based variously in Mexico, China, Taiwan, and the United States. What we discovered was that many were violating the standards that the MNCs expected them to adhere to. The hoped-for cascade effect was seldom occurring.

About the Research

The pattern is worrisome. Remember, all those suppliers were connected to model firms that were working proactively to encourage sustainability. If exemplary MNCs are having trouble ensuring good practices among their lower-tier suppliers, then “regular” firms, in all likelihood, are faring even worse at this.

The problem, ironically, often starts with the MNCs themselves. They frequently place orders that exceed suppliers’ capacity or impose unrealistic deadlines, leading supplier factories to demand heavy overtime from their workers. When we asked a representative at one supplier why his company had violated a 60-hour workweek limit, he gave us a frank explanation: “We didn’t want to tell our customer that we can’t produce its products on time, because otherwise it’s going to try to find someone else that can. But our customer didn’t give us enough notice to hire enough skilled people to do the job.”

First-tier suppliers, for their part, rarely concern themselves with their own suppliers’ sustainability practices. That’s often because they’re struggling with sustainability issues themselves. The noncompliant company we cited above, for example, doesn’t try to enforce a strict 60-hour workweek limit with any of its suppliers. “We don’t comply with this requirement ourselves,” the representative told us, “so how could we ask our own suppliers to do so?”

For MNCs, there are special challenges in governing lower-tier suppliers. There’s often no direct contractual relationship, and a particular MNC’s business often doesn’t mean that much to the lower-tier supplier. If American and Japanese automakers rely heavily on a certain seat maker, for example, they can demand that it adhere to their sustainability standards. But that seat maker may have a hard time getting its suppliers to follow suit. Suppose it does business with a foam manufacturer that has many other big customers in the electronics, appliance, and health care industries—each of which has different sustainability standards. The foam manufacturer has little incentive to conform to the automakers’ sustainability requirements, because the automakers account for only a small fraction of its total business.

Furthermore, most lower-tier suppliers are not well known, so they receive relatively little attention and pressure from the media, NGOs, and other stakeholders. Even when they do attract attention (for sexual harassment problems, for example, or chronic overtime demands), we found that they do not feel the need to address the issues involved. They tend to act only when MNCs intervene.

Lower-tier suppliers are also the least equipped to handle sustainability requirements. They often do not have sustainability expertise or resources, and they may be unaware of accepted social and environmental practices and regulations. They are also frequently located in countries where such regulations are nonexistent, lax, or not enforced at all. And typically they don’t know much about the sustainability requirements imposed by MNCs—but even if they do, they have no incentive to comply. This may explain why most of the lower-tier suppliers in our study lacked programs to dispose of toxic waste and in fact had no environmental management program whatsoever.

MNCs, too, are handicapped by ignorance. They frequently don’t even know who their lower-tier suppliers are, let alone where they’re located or what capabilities they have (or don’t have). Many of the 22 lower-tier suppliers in our study are small or medium-size private firms that provide little information to the public—characteristics that, in effect, make them almost invisible. Several directors of the three MNCs we studied viewed this as a big problem. “The demon in this place,” one of them said, “is the [lower-tier] suppliers that I know the least about.” Another said, “I don’t have control over the ones that pose the highest risks, so I’m losing sleep over them.”

All these concerns mean that lower-tier suppliers are unquestionably the riskiest members of a supply network. If they have poor or dubious sustainability performance, then an MNC that does business with them can endanger its reputation and suffer profound repercussions—losing customers, being forced to find new suppliers, or having its supply chain disrupted. To reduce such risks, MNCs need to include both first-tier and lower-tier suppliers in their sustainability programs.

Best Practices

The three MNCs in our study have taken a number of steps to promote suppliers’ social and environmental responsibility:

• They have established long-term sustainability goals.
• They require first-tier suppliers to set their own long-term sustainability goals.
• They include lower-tier suppliers in the overall sustainability strategy.
• They task a point person on staff with extending the firm’s sustainability program to first- and lower-tier suppliers.

These are all beneficial measures that other companies should consider adopting. Firms can also borrow some of the specific strategies that our MNCs use to spread good practices throughout their supply networks. These fall into four broad categories:

Direct approach.

The MNCs we studied set and monitor social and environmental targets for their first-tier suppliers regarding second-tier suppliers. The automotive corporation, for instance, has a strong commitment to supplier diversity. It requires its first-tier suppliers to allocate 7% of their procurement spending to minority suppliers. Some first-tier suppliers were already meeting that target; others have made substantial changes to do so (for example, by changing performance criteria for their purchasing managers). The first-tier suppliers we interviewed noted that the MNC periodically checks to see if the target is being met and creates opportunities to help them network with minority lower-tier suppliers.

Managing Lower-Tier Supplier Sustainability

Additionally, the three MNCs work with their major suppliers to map the connections and interdependencies in their supply networks, including those at the lower-tier level. This allows them to identify potentially risky lower-tier suppliers and to work with the major suppliers to deploy customized risk-mitigation programs where

Indirect approach.

The MNCs we studied delegate elements of lower-tier-supplier sustainability management to their first-tier suppliers. This approach is effective because the MNCs are hands-on: They offer training to suppliers and provide some incentives for implementing sustainability practices. Most of the first-tier suppliers we interviewed told us that such training had led them to make substantial changes in their manufacturing processes and to begin asking their suppliers to adopt similar sustainability standards.

Photos © Edward Burtynsky, courtesy Howard Greenberg Gallery and Bryce Wolkowitz Gallery, New York / Nicholas Metivier Gallery, Toronto

The three MNCs have also created preferred-supplier programs aimed at fostering peer learning about sustainability. One corporation, for instance, invites its most socially and environmentally responsible suppliers to join an exclusive group that enables them to strengthen relationships with the MNC and exchange best sustainability practices with one another. Several of these suppliers have started to set their own sustainability requirements for the suppliers they use.

The MNCs we studied are all founding members of industry associations focused on developing sustainability standards, providing assessment tools, and offering training to first- and lower-tier suppliers. One notable association is the Responsible Business Alliance (RBA), whose members include Intel, HP, IBM, Dell, Philips, and Apple.

Collaborative initiatives have many benefits. They can increase efficiencies for suppliers, who can use a standardized self-assessment or audit to satisfy many customers and thus avoid duplication. These initiatives can also draw in more suppliers, because suppliers that have many customers with the same sustainability requirements tend to be more willing to participate. And collaboration can make sustainability initiatives more feasible, because industrywide training is subsidized by members.

Additionally, when MNCs help their first-tier suppliers become full members of an industry association, those suppliers must then comply with industry standards, which means they have to assess their own suppliers’ sustainability. The RBA, for example, requires its full members to conduct approved audits annually for at least 25% of their own high-risk facilities and 25% of their high-risk suppliers’ facilities. (Risk here is assessed along labor, health and safety, environmental, and ethical dimensions.)

Industry associations have a unique power over both first- and lower-tier suppliers, as most of their members are major players in their sectors. Consider the electronics maker Flex, a full member of the RBA and a first-tier supplier for many MNCs. A second-tier electronics supplier is unlikely to refuse a request from Flex for a compliance audit, because it knows that Flex itself has passed this audit and that most other top-tier electronics suppliers, to stay competitive, will probably start issuing similar audit requests.

Global approach.

The MNCs we studied make a point of collaborating with international organizations and NGOs that share their goals. For instance, all three corporations have joined the United Nations Global Compact, an international effort to promote corporate social responsibility. The three MNCs also participate in the Carbon Disclosure Project’s (CDP’s) Supply Chain Program, a global data-collection platform in which suppliers disclose information about their carbon emissions. Firms such as Microsoft, Johnson & Johnson, and Walmart use this platform to engage their suppliers in being transparent about their environmental impact. Several participating suppliers told us that as a result, they are now collecting previously unsolicited information and making investments to try to reduce their carbon footprints.