Supply Chain Compliance: Addressing the Elephant in the Room

by Derek Newberry*

If events like Apple’s Foxconn debacle teach us anything, it is that even reputable companies with strong supplier codes of conduct can face serious compliance issues where regulatory mechanisms are lacking.  I reflected on this recently when leafing through the summary report from last year’s Wharton Initiative for Global Environmental Leadership (Wharton IGEL) Conference “Greening the Supply Chain”.  While I enjoyed reading about the participants’ experiences in sustainability management, I was struck by the short shrift they paid to the all-important question of compliance, despite acknowledging that when it comes to producing tangible results, this really is the “elephant in the room”.

Indeed, ensuring that suppliers adhere to social and environmental criteria and comply with applicable legislation is a thorny problem in settings where the boundaries of corporate responsibility are unclear and enforcement can be costly and onerous.  This is doubly true in production chains characterized by numerous small suppliers and sparse governmental regulations, as is the case in much of the global agricultural sector.  How can we create regulatory mechanisms that enable these sustainability programs to look as good in practice as they do on paper?

I will focus here on legal compliance in particular since this is often the biggest hurdle to meeting supplier certification criteria, especially in countries where social and environmental legislation is already fairly strict. Through my research with sustainability managers at biofuel companies in Brazil, I have found that one critical barrier to achieving compliance is in the way supplier sustainability programs are conceived and implemented in isolation from pre-existing regulatory networks. I argue for a more holistic approach in which companies work collaboratively with local authorities and NGOs in the regions where their suppliers operate, leveraging their collective resources to provide the surveillance and support necessary to foster compliance along the production chain.

To give a sense of how this might work, I will describe the particular sustainability challenge in the rural region of Brazil where I conducted my dissertation fieldwork and then describe how an “ecosystem of compliance” approach could work in similar situations.

A View From the Ground: Brazilian Biofuels

The image issues faced by the biofuels sector are by now well known; almost as soon as these alternative energies were heralded by policymakers as solutions to climate change and energy security concerns, they came under attack by NGOs and academics who claimed that diverting massive amounts of crops toward energy production could accelerate deforestation.

This negative image is of particular concern in Brazil, where a well-established sugarcane ethanol industry makes this country the world’s second largest producer of biofuels after the U.S. Many of Brazil’s sugarcane companies have recently begun implementing sustainable production certifications to demonstrate to potential investors and buyers abroad that they do not pose a serious risk to the environment or to the communities where they operate.

These companies do not own much land, rather they tend to either rent space from local farmers to plant sugarcane or they buy it directly from producers. A single refinery could have contracts with hundreds of farms that are renting land from the company or supplying it with cane; the farms themselves could be as large as 10,000 hectares or as small as 20.  This causes major challenges for effective supply chain sustainability management, as I discovered from my case study of a refinery doing business with sugarcane farmers that routinely violate legal conservation spaces.

The Supplier Challenge: Cattle in the Conservation Area

I conducted ethnographic research in a rural, agricultural region of Brazil that I will call Nova Terra to ensure the confidentiality of the corporation and people I studied.  Nova Terra had almost no sugarcane production until the mid-2000s, when a large multinational ethanol and sugar company built a refinery in the area to tap into projected demand for biofuel exports.  In the years since, sugarcane production has boomed as local landowners have begun transitioning away from cattle and other crops to take advantage of the relatively high returns from cane.

One of the most pressing environmental challenges posed by these numerous suppliers is their violation of Brazil’s national forest code, which requires that every rural property maintain a preserved conservation area, the size of which depends on the type of biome, the presence and size of rivers and other geographic factors. These conservation spaces are poorly enforced in the region, and farmers tend to use them for productive purposes, especially raising cattle. The biofuel MNC, let’s call it BioCana, entered into a situation where a majority of its potential sugarcane suppliers are not in compliance with federal environmental legislation. BioCana has begun implementing a range of sustainable production standards in order to improve its public image and more effectively capitalize on external markets for green energy, but getting suppliers to comply with the forest code is a daunting problem.

The cost of paying third-party auditors to adequately monitor tens of thousands of hectares of farm land and hundreds of suppliers would be substantial for the refinery to take on, and as outsiders, these auditors lack the local knowledge that is often necessary to target the worst offenders. At the same time, a push to reforest and maintain conservation spaces places new burdens on farmers. The costs for the hundreds of small farmers in Terra Nova could be so burdensome as to compel them to sell their land, creating an undesirable choice for BioCana between losing suppliers or contributing to growing land concentration, which is already a major concern in Brazil.  How can we meaningfully enforce legal compliance among cane farmers in a way that is viable for both BioCana and its suppliers?

Creating an Ecosystem of Compliance

The problem is in the way supply chain sustainability programs tend to be designed and implemented in a social vacuum, ignoring existing regulatory actors and resources in the regions where suppliers operate. By narrowly defining these programs as tools of corporate governance, in isolation from the mechanisms of public governance at the state and local level, they miss opportunities to leverage a greater pool of enforcement resources. A better approach would be to work with local partners to create the right balance of positive and negative incentives that ensures supplier compliance. Creating an ecosystem of compliance is a three-pronged strategy:

1. Leverage multiple sources of assistance for suppliers. Getting larger farmers in Nova Terra to reforest their legal reserves and gain certification is mainly a function of pressure and relationship building.  For the region’s numerous small and medium sugarcane suppliers however, the costs associated with gaining compliance are often prohibitive.  Since reversing deforestation is a crucial public good, BioCana could work with the state government to set up a fund that would provide need-based financial and technical assistance toward reforesting and maintaining conservation lands.  This joint fund could also help with the auditing costs associated with certification.

2. Tap extended enforcement networks to improve regulatory oversight. As important as the carrot of assistance is the stick of rigorous enforcement to ensure suppliers comply with environmental law. The auditors BioCana hires can only reach a limited sample of the company’s many suppliers and as outsiders they lack in-depth knowledge of the area that would help them locate the worst offenders.  Local officials and union leaders know the region and its farmers well, but have limited funds to adequately patrol and check in on sugarcane farmers. BioCana could tap into these local networks to boost overall enforcement in the region.  This would mean coordinating visits with auditors and regulators to prevent overlap and also maintaining open lines of communication to report violators.  Working with local partners in this way would make the most of limited enforcement resources and leverage local knowledge to create significant efficiency gains in how Nova Terra’s suppliers are regulated.

3. Utilize local social capital to improve supplier relations. Creating a culture of compliance also hinges on developing strong relationships of trust with local farmers. In fact, I found in my research that one of the reasons sugarcane farmers use their conservation spaces to raise cattle is that they perceive BioCana to be a risky partner.  The large company is relatively new to a region of small producers, and farmers tend to see cattle as a hedging mechanism against their sugarcane crops, should the company leave the region or go bankrupt.  Changing this risk perception will depend upon BioCana reaching out to farmers on their terms – for example, organizing barbeques and community lunches is an important means by which these farmers develop and maintain their social networks.  BioCana does some limited outreach of this nature, but generally only with its few large producers.  The company could work through the local producers associations to increase participation with smaller farmers as well.

Local Context is Critical for Effective Supplier Compliance. In Nova Terra, as in many other rural regions with numerous small producers, supply chain sustainability programs fall short because they become one enforcement mechanism among others that operate from a limited funding and knowledge base.  This leads to a situation in which government, NGOs, and companies monitor suppliers in overlapping and inefficient ways.   Supply chain sustainability strategies should be designed and implemented with local context in mind, enabling managers to combine efforts with these actors to optimize the overall resources available to create a culture of environmental compliance.  This ecosystem approach would help ensure that suppliers actually follow the laws and environmental criteria they are supposed to adhere to on paper.  It would provide them with support in the process to keep them in operation and improve overall relationships between government, civil society groups, and businesses.  Globalized businesses are already used to the idea that they have to adapt their brands to local contexts in order to be successful abroad.  By thinking about supply chain sustainability in the same way – as a system that has to be adapted to local regulatory networks rather than imposed uniformly from above – companies can enable these programs to work as well in practice as they do in theory.

*Derek is a researcher and consultant specializing in organizational change, stakeholder relations, and sustainable enterprise.  He is currently a Ph.D. candidate in anthropology at the University of Pennsylvania, where he is writing his dissertation on the barriers faced by biofuel companies that are adopting sustainable management practices.

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