Red Flags and Risk Management: How to Manage Suppliers in the ESG Age

Supplier relationships are a little like romantic relationships. Suppliers and their customers are mutually dependent, and supplier pitfalls can significantly disrupt business activities. With more corporations around the world addressing Scope 3 (supply chain) in their ESG strategies, many are asking: “Should I continue working with an underperforming supplier, or look for a new one?”

Red Flags: Signs It’s Time to End a Supplier Relationship

As with any relationship, our partners don’t always meet our expectations, and it can be difficult to know whether to let a supplier mistake slide or to take action immediately. It’s helpful to think of supplier pitfalls as belonging to one of two categories, which can help you decide on the best course of action.

Quick Splits

Some supplier issues are serious and can put your firm’s corporate reputation at risk. These include problems such as:

• Labor malpractices and human rights violations
• Negative environmental impact, including climate-related controversies or general environmental malpractice
• Governance-related issues, such as corruption and bribery

“If you have a supplier that violates a fundamental expectation of your supplier code of conduct or applicable laws, then it’s time for a quick split,” says Josh Mellinger, ESG board member and strategic advisor for reThink Purpose.

The best way to approach this conversation is to stick closely to the contract breach and use the documentation in your contract or service-level agreement to back you up. As long as you can line up a new vendor quickly, or rely on existing vendors, a quick split from a controversial supplier is often the best decision you can make from a liability perspective.

Phase Outs

Not all supplier relationships end because of flagrant code or legal violations. Less public supplier pitfalls can still lead to financial or supply-related disruptions. These pitfalls include:

• Inconsistency in communication, delivery, and quality
• Lack of transparency around pricing and practices
• Failure to meet promises or expectations
• Performance issues, or performance that seems to stall

These kinds of problems often warrant a discussion with the supplier, and a second chance for it to redeem itself, before you sever ties. If you do need to end the relationship, these kinds of concerns warrant a different kind of breakup.

“If you have a supplier that is unable to provide transparent performance information, is not improving, or has mitigation plans that are the same over a long period of time, then they may not have the capabilities to achieve success,” Mellinger says. “It’s time for a phase out, where new competition can be used to address challenges.” A phase out gives your firm time to perform due diligence on new suppliers and carefully plan out the transition.

How to Assess Risk and Monitor Supplier Performance

Supplier performance should be monitored regularly and through a standardized format. This helps supply chain managers predict and prevent supply disruptions, ESG-related risks and controversies, and performance issues that can impact your firm. This kind of monitoring is often referred to as supplier performance management and can involve practices such as:

Supplier Scorecards

Supplier scorecards are an effective way to keep track of supplier performance. Scorecards typically set and measure KPIs, which can include metrics such as:

• Delivery times
• Lead times
• Quality
• Cost
• Responsiveness

Scorecards also keep track of a supplier’s:

• Financial standing
• Business processes
• Operational performance
• Legal and contractual compliance
• Total cost and yearly price changes

Evaluation Tools

Just as comprehensive supplier monitoring looks at multiple metrics, your supplier evaluation should employ multiple methods for assessing performance. Where possible, conduct site visits to see a supplier’s operations and facilities in person. At the same time, consider using questionnaires, certifications, third-party reviews, independent ratings, and regular phone calls to keep abreast of supplier activities.

What to Do When It’s Time to End Things

It’s not always easy to decide whether a supplier deserves a second chance, but even if you continue to work with a supplier who has disappointed you, it’s wise to look at your options and perhaps even begin to onboard alternative suppliers as a form of risk management.

If the time does come for the ‘breakup’ conversation, sharing the news via phone is one way to soften the impact. It’s also important to take responsibility for your own role in the relationship not working out. Unless you’re dealing with a major scandal, it’s possible your firm also contributed to the relationship problems in some way, such as not communicating expectations or priorities clearly.

Whatever the reason for the breakup, and no matter whether you opt for a quick split or a phase out, it’s always best to keep things polite and professional, and leave doors open for the future.