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Reputational Risks: Why Ethical Manufacturing is Vital to ESG progress

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Establishing a robust and impactful Environmental, Social, and Governance (ESG) framework that is aligned with business and sustainable goals is no easy feat. It is nuanced and requires diligence by all manufacturers. As an industry, manufacturers are tasked with integrating ESG principles into the fabric of their operations and digital supply chain with urgency due to the intensifying societal pressure on the industry to better manage its environmental footprint and social impact on workers.

Globally, the manufacturing industry has been reported by Gartner to be one of the largest producers of all global emissions, approximately 50 per cent combined with the transport sector. However, manufacturing has other various pitfalls beyond emissions to contend with, such as supply chain issues and human rights violations (see the alleged case against fast fashion giant Shien).

The apparel market, particularly fast fashion, including brands such as H&M, Zara, etc., is expected to continue to soar to a CAGR of over 3 per cent during 2022-2027. The growth can be attributed primarily to the cost-of-living increases and inflation, but a production increase in this sector will indeed affect environmental goals, such as reducing fashion waste. Already, there are 5.2 million tonnes of textile waste in the European Union yearly. The fashion industry is only one segment of manufacturing, but it reflects the ESG challenges the industry as a whole is facing: more stringent regulatory governance and shifting consumer attitudes.

To avoid risks or ESG-related breaches, leaders must first understand the role ethical manufacturing plays in achieving business goals and then make appropriate decisions to uphold ESG commitments.

What constitutes ethical and sustainable manufacturing?

To safeguard against ESG violations, ethics should factor in heavily into any sustainability framework and definition of business goals to avoid risks and any costly regulatory infractions. Manufacturers should include special attention into a wide range of principles and priorities, including social or fair labour practices (i.e. providing safe working conditions, fair wages, workers’ rights), environmental sustainability (i.e. cutting waste, reducing carbon footprint, using sustainable materials), and safeguarding that operations are ESG-friendly.

According to the United States Environmental Protection Agency (EPA), “sustainable manufacturing is the creation of manufactured products through economically-sound processes that minimise negative environmental impacts while conserving energy and natural resources.” Further, the EPA suggests that when sustainable manufacturing is activated, other areas of manufacturing benefit, such as improved worker, community, and product safety, which aligns with the concept known as the 3 P’s.

The 3 P’s and their manufacturing significance

As its originator, John Elkington, suggests, the triple bottom line is a measure of success that should added to the DNA of company frameworks. The philosophy of the ‘3 P’s‘ can also easily be applied to manufacturing to ensure ESG goals are met because, at their core, they align with ESG principles. The 3 P’s consist of:

1) Prosperity – relates to income, profits and cash flow but ultimately, is connected to whether a company is financially performing well.

2) People – relates to social impacts and examples of this could include fair wages, healthy working conditions, and fair treatment of staff.

3) Planet – relates to environmental responsibility and a commitment to sustainable practices.

As Forbes suggests, “sustainability in manufacturing is not just about meeting a set of global targets or checking off a list of best practices” but includes a commitment to “embedding the ethos of the ‘3 P’s’” into business goals.

What are the consequences of poor ESG governance?

Regardless of a manufacturer’s phase in its own ESG journey, failure to act to improve sustainable priorities can have a substantial fiscal impact. Moody’s Analytics in “The Business Impact of ESG Performance” found that moderate or serious sustainability events could trigger a loss as high as a 7.5% stock market decline in a given year period.

Additionally, manufacturing companies could be penalised for a broad array of ESG breaches inclusive of offences related to human rights, greenwashing, and regulatory offences related to carbon footprints. An example of an American company found guilty of excess pollution is the American Truck engine maker Cummins Inc, which will be penalised an eye-watering USD $1.675 billion fine. Stateside, the instances of ESG fines are increasing according to former Securities and Exchange Commission (SEC) leader, Kurt Gottschall, now a partner at law firm Haynes Boone. He says that “penalties will be higher” primarily due to the new direction of the SEC leadership.

Beyond penalties, there is also the court of public opinion, which can be almost as damaging if trust is lost between customer and business. Due to this rising awareness, manufacturers must prioritise ESG priorities for the overall well-being of the business.

The Evolution of Consumer Awareness

If ESG is not upheld as a key manufacturing pillar, challenges will arise, but what are the most common ethical dilemmas in manufacturing? Loss of consumer trust, stakeholder scrutiny, bad publicity, and a decrease in investing can all stem from poor ESG frameworks, and reputational risks elevated through the lens of the consumer have become a highly problematic challenge that can ruin a company’s reputation quickly and irrevocably.

To better understand consumer priorities, the recent 2023 Global Reputation Monitor report uncovered the top three consumer ESG concerns in terms of the consumer-packaged goods industry:

1) Environmentally friendly packaging (33 per cent).

2) Decreasing carbon emissions associated with the operations of a business (28 per cent).

3) Improving safety of products was critical (26 per cent).

Interestingly, however, global market researcher IPSOS suggested in a report that “shoppers are most likely to be motivated first by what’s best for themselves, then their immediate world, and finally by the planet more generally.” Sustainability is at the top of consumers’ minds, but as the rise of fast fashion highlights, consumers will go with the more affordable option because it meets their immediate needs. In contrast, sustainability can be less critical for some consumers.

Due to various reasons, it is clear that the consumer appetite for buying more sustainability-friendly products has changed and mainly for the better.

Why have consumers changed their sustainability demands?

According to the Harvard Business Review (HBR), there are three factors that have led to a significant shift in customer consumption patterns where sustainability is considered a requirement for purchase:

1) By building customer trust, this eventually translates into buying behaviour, followed by business outcomes.

2) Sustainability has the capacity to encourage trust, which impacts the younger generations the most.

3) This segment of the population should be observed as a critical piece of the economy as in the U.S, because as HBR asserts, they will soon have “most of the purchasing power” in the country.

Beyond consumer ESG appetites, manufacturers must continue to advance their sustainable goals for the health of their business and not just for the consumer but also to avoid penalties and reputational loss.

Safeguarding against ethical and reputational risks

According to Faye Skelton, Head of Policy, Make UK and Huw Howells, Managing Director of Manufacturing and Industrials, Lloyds, a recent report by her organisation uncovered that there has been a significant increase of 48 per cent of manufacturers who now have key performance indicators (KPIs), which “is huge” but she asserts the industry still has a lot of ground to cover.

“The 48% increase in the number of manufacturers that have targets or KPIs is a great statistic and really good news. However, it should be tempered by the fact that only around half of firms have the resources to meet the required conditions.”

“In addition, three quarters of manufacturers that are building ESG requirements into their procurement strategies; again this is fantastic news, but four in ten manufacturers are not aware of how their suppliers are performing in these conditions. So, it’s great on one hand, but there is more work to do,” she said.

The future of ethical manufacturing

Manufacturers must be savvy and agile to meet ESG expectations and future-prof their operations, but first, they must understand their vulnerabilities and embrace the tenets of ethical manufacturing. An analytics platform, such as XIRI-Analytics, can empower and support manufacturers with knowledge and data-driven insights.

XIRI-Analytics is a dynamic solution that works seamlessly with the Smart Industry Readiness Index (SIRI) and the Consumer Sustainability Industry Readiness Index (COSIRI) to aid manufacturers in making informed decisions, thus leading to an enhancement of transformation processes related to ESG guidelines and digital transformation.

With innovative solutions like these and a thorough understanding of areas of improvement, manufacturers can remain competitive and address their most pressing sustainable-focused business goals, unlocking effective planning and resource allocation.

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