Everyone is so focused on the COVID-19 disruptions to the supply chain—and rightfully so—but what if there is something that could pose a greater threat to our supply chain? Climate change is making extreme weather events more frequent—and it could have a devastating impact on our supply chain.
Consider this example. Heavy rare earths production is concentrated in southeastern China, which is increasingly exposed to extreme rainfall. McKinsey finds heavy rare earth production in southeastern China will experience extreme precipitation events (defined as events that occurred historically with an annual probability of about 2%, corresponding to precipitation of about 170 millimeters per day in the relevant region) twice as often by 2030. Expert estimates and historical events indicate such rainfall events significantly increase the risk of landslides in the region.
Here is another concern. McKinsey suggests by 2040, a company using leading-edge chips (for example, with applications in memory, logic, communication, or optoelectronics) such as an automotive OEM (original equipment manufacturer), sourcing from geographies in Korea, Japan, Taiwan, or other hubs in the western Pacific, can expect that hurricanes sufficient to disrupt their suppliers will become two to four times more likely. Some of these disruptions may last for several months.
What if the impact from climate change could have a lasting impact for decades to come? Are we prepared for this future?
McKinsey suggests there are three drivers of near-term losses for suppliers that are hit by such events, potentially leading to losses of up to 200% of annual profit and 35% of revenues including:
- Physical damages to assets, including facilities, production equipment, and inventories
- Reduced sales, either because production is disrupted or because goods cannot be shipped to the market
- Higher costs in the reconstruction phase and after the plant is back in production, as market prices of labor, energy, and logistics may spike following a disaster
The combination of these impacts may also limit suppliers’ ability to quickly and efficiently restore production. Hypothetically McKinsey suggests downstream players could lose up to a third of annual revenue if supply is disrupted for an illustrative period of five months. Meanwhile, a well-prepared player may only lose about 5% of revenue in a similar event.
Let’s be clear, we have been talking about climate changes for years, and many struggle to understand the changes that have been happening in front of us and even behind the scenes, slowly, but ever so greatly. In fact, it is for this very reason, I have been saying for more than a decade we need to be looking closer at the supply chain, and not get hung up on the words that have caused so much distrust and confusion in what might be creating the generational differences in our discussions. In fact, if you take a closer look, you just might see the impacts are far greater in some areas than many can understand, and that is why we need to look to the supply chain and apply real data.
McKinsey suggests dual sourcing, increasing supplier resilience through due diligence and collaboration with suppliers on asset hardening; reducing losses, including insurance; best practice emergency procedures; and discounted cross-selling of substitute products to end consumers. Other options include building disaster-proof plants and raising inventory levels in order to continue production even if a supply chain is interrupted (for downstream players).
Resiliency in the supply chain is certainly one way to mitigate risk. Another is to address climate change head on, which is something I talk about quite a bit in my book, Sustainable in a Circular World.
Ironically, reducing emissions in the supply chain is one approach to help run the race to net zero. In most supply chains, the costs of getting to net zero (the state in which as much carbon is absorbed as is released into the atmosphere) are surprisingly low, according to BCG (Boston Consulting Group). Even full decarbonization would result in end consumer price increases of only 1% to 4% in the medium term—less than $1 on a $40 pair of jeans.
The challenge is many companies do not know the extent of the problem. While a manufacturer can calculate the greenhouse gas emissions from its own operations with a relatively high degree of confidence, getting a view on scope 3 emissions is complex.
BCG offers a nine suggestions for tackling supply chain emissions including: build a value chain emissions baseline and exchange data with suppliers; set ambitious reduction targets on scopes 1 to 3 and publicly report progress; redesign products for sustainability; design the value chain and sourcing strategy for sustainability; integrate emissions metrics in procurement; work with suppliers to address their emissions; engage in sector initiatives for best-practice sharing, certification, traceability, and policy advocacy; scale up buying groups to amplify demand-side commitments; and introduce a low-carbon governance to align internal incentives and empower your organization.
Now is the time. We need our supply chains to be more resilient and sustainable. If not, we might be sitting ducks waiting for the next disaster to strike—and the next supply chain disruption.
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