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Widening the Sustainability Circle

As more regulators and investors seek more action on climate change, more businesses are measuring Scope 2 and 3 effects of their operations beyond their corporate walls. That requires superior supply chain data.

By Christine Susanne Müller, James Sullivan, Fawn Fitter | 13 min read

The list of companies publicly committing to greater sustainability effects grew in 2021 to include one of the world’s biggest brands. General Motors, the world’s sixth-largest automaker, announced that it aims to achieve net zero carbon emissions by 2040, a full decade sooner than the Paris Agreement’s 2050 target.  

 

GM intends to roll out 30 all-electric models by 2025 as an interim step toward making its line of light vehicles entirely battery-powered by 2035, which would eliminate 75% of the company’s carbon footprint. However, its sustainable business strategy doesn’t stop at its own four walls. From planning to buy only 100% renewable energy to power its facilities to helping suppliers measure and reduce their own greenhouse gas emissions, GM is extending its decarbonization plans across its entire value chain. 

 

The fuel for GM’s action is both familiar and increasingly urgent, even as geopolitical and economic tensions threaten to slow global progress to address climate change. Scientists warn that the planet is heating up faster and more intensely than previously predicted. Investors are responding by upping their demands for companies to combine profitability with sustainability. At the same time, regulatory bodies such as the European Union (EU) Commission are proposing ambitious regulations that would obligate large companies to identify, prevent, and minimize adverse effects to people and the environment–  not just within their own operations, but also in companies with which they regularly do business. 

 

The demands for sustainable business action may come from different directions, but they have a common effect: enterprises that can gain visibility into their upstream and downstream value chains will be better positioned to respond. Those with the data necessary to take meaningful actions – and exert influence on their broader business ecosystems – will be better able to shape their own futures. Those actions begin with assessing the true extent of their results. 

 

This article will help you understand what’s changing and how to keep up. 

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Regulators, investors drive attention to sustainability accounting 

In 2022, the World Economic Forum’s (WEF) Davos conference focused on how climate change is affecting economies and industries worldwide, and how business and government can work together to drive progress. “The world remains on course for unsustainable production and consumption patterns, according to data on climate change, pollution and biodiversity,” noted an accompanying white paper on supply chain sustainability. The authors also pointed out that business has a crucial role to play in averting that dire outcome. 

 

As the WEF points out, more than half of global GDP comes from trade, and 70% of that occurs through global value chains. That means making supply chains more sustainable is crucial to the performance and resilience of the world economy. Events that have disrupted global supply chains throughout 2021 and 2022, such as ongoing waves of COVID-19 and Russia’s attack on Ukraine, have demonstrated many places and ways in which supply chains can break. They’ve also shown that supply chains are only as good as the ability to share current, trustworthy data about critical goods and suppliers across organizations and industry sectors. Without this data, they cannot mitigate risks tied to key environmental, social, and governance issues, including not just climate change but also corruption, tax avoidance, human rights, modern slavery, and more. 

 

The regulatory energy associated with sustainability has grown significantly since 2020. At that time, Japan issued a guidance for companies to perform sustainability reviews throughout their value chains based on international standards from the Organisation for Economic Co-operation and Development. 

 

There is also growing consensus among regulatory and industry bodies to categorize the origins of greenhouse gas emissions that industry produces in three circles that radiate outward from a company itself. Scope 1 includes emissions that originate from company-controlled sources. Scope 2 covers emissions created by generating the energy a company purchases to run its operations. Scope 3, where much of the carbon is produced, covers emissions created by third parties in the company’s value chain, such as upstream vendors and suppliers and downstream customers and users. Scope 3 is also the most challenging to calculate. (For more examples, see “Regulatory Momentum.”) 

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  • In December 2021, trade ministers from 71 developed and developing countries in the World Trade Organization issued a statement committing their countries to compiling effective methodologies and sustainability standards to promote sustainable supply chains. 
  • In February 2022, the EU Commission proposed a directive on corporate sustainability reviews. The directive obligates large firms to identify, prevent, and minimize adverse effects throughout their own operations, their subsidiaries’ operations, and value chain operations carried out by companies with which they have persistent direct or indirect business relationships. 
  • In March 2022, the EU agreed on a Carbon Border Adjustment Mechanism (CBAM) imposing a carbon price on imports in the cement, aluminum, fertilizer, electric energy production, iron, and steel sectors. 
  • Also in March 2022, the U.S. Securities and Exchange Commission (SEC) proposed rules that would require U.S.-listed companies to report on climate-related risks to their businesses. Those companies were also required to add climate-related metrics to their financial statements; and disclose their Scope 1 and Scope 2 greenhouse gas emissions, as well as Scope 3 emissions if the company has set targets for them. 
  • In August 2022, the United States passed the Inflation Reduction Act, which includes $369 billion in climate and energy provisions. The law will reduce the country’s greenhouse gas emissions by as much as 42% by 2030, according to estimates from Rhodium Group. The law includes tax breaks for energy companies to add renewable sources to the power grid, and incentives for industrial companies to cut their carbon footprint, Vox reports

As regulators turn their attention to sustainability, the investment world is watching closely. Understandably, skeptics have expressed doubt about whether making a business more sustainable boosts profitability. As The New York Times has reported, they question whether it’s desirable or even feasible to incorporate sustainability into corporate reporting and point out that a single global standard for doing so has yet to be developed. However, as Harvard Business Review has noted, many experts are working on ways to better tie it to corporate financial accounting. The issue is especially urgent in emerging markets, according to EY. These locales are the main manufacturing locations for the top global 500 companies and therefore need to take the necessary steps to attract and retain foreign investors. 

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When business value surfaces through financial reporting and other effects 

Reporting on sustainability is not intended to supersede other standards or measurements of business value. It’s meant to increase visibility into business operations – something investors are responding to with enthusiasm. According to the Global Sustainable Investment Alliance, sustainable and responsible investment across the United States, Canada, Japan, Australasia, and Europe grew 15% from 2018 to 2020. It now accounts for US$35.3 trillion in assets under management – or more than one-third (36%) of all professionally managed assets in those regions. 

 

Similarly, the Sustainable Investments Institute says that support for social and environmental proposals rose in 2020 and 2021, Reuters has reported. At the shareholder meetings of U.S. companies alone, support – which was at 21% in 2017 – rose to 27% in 2020 and to 32% in 2021. 

 

The combined pressure from regulators and investors continues to spur companies’ efforts to act. As of August 2021, almost one-third of Europe’s largest publicly traded companies had committed to target dates for reducing their Scope 1, 2, and 3 carbon emissions to net zero by 2050, according to Accenture. These 303 companies, which represent industries ranging from finance and real estate to utilities and mining, are responsible for more than two-thirds of greenhouse gases emitted by the 1,022 largest companies on the European stock exchanges. 

Reporting on sustainability is not intended to supersede other standards or measurements of business value. It’s meant to increase visibility into business operations – something investors are responding to with enthusiasm. 

Companies are also increasingly realizing they need corporate targets to benchmark their progress toward sustainability and greater circularity

 

For example, in May 2022, the New York state legislature began discussing a proposed law called the Fashion Sustainability and Social Accountability Act. It would be the first law in the United States to impose explicit sustainability requirements on large retailers and manufacturers in the fashion industry. It would require them to disclose information deep into their supply chain about how they prioritize risks, what actions they take to mitigate these risks, and metrics on implementation and results of mitigation measures. All of these steps would require a clothing manufacturer to gather and report on more data at every step of the value chain. Ultimately, though, it would help an industry notorious for human rights violations and generating waste to do better at protecting workers and maximizing the value of raw materials by reusing them through resale, recycling, and upcycling. 

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New tools to catalog emissions across the value chain

Most business leaders understand the need to identify and cut emissions. Now they have to generate the momentum to do what needs to be done, and to continue expanding their efforts throughout the value chain. 

 

In a nutshell, that means collecting more and better data, reporting on it to show regulators and investors that their demands are being met, and acting on it to manage effects deeper into the value chain. It also requires companies to see regulations not as a hindrance to performance, but as a guide to developing effective data-driven approaches to sustainability. For example, companies in the UK that produce or import plastic packaging made of less than 30% recycled materials must now pay a tax on each ton of that packaging. That creates a powerful incentive for companies to seek out suppliers who can verify that they use recycled materials. It also puts additional pressure on companies to ensure the data they report to government tax authorities is accurate and auditable. 

 

A company can’t report and act on data it doesn’t have. 

Most business leaders understand the need to identify and cut emissions. Now they have to generate the momentum to do what needs to be done, and to continue expanding their efforts throughout the value chain. 

With the current emphasis on limiting carbon emissions, companies that want to drive compliance and inform decision-making need to act quickly to gather more data about greenhouse gas emissions in particular. Scope 1 emissions (from sources a company controls, such as corporate vehicles or factory furnaces) typically account for the smallest percentage of a company’s total emissions. Scope 2 emissions from generating the power a company uses make up more of a company’s carbon footprint, and data from utility companies makes it possible to calculate them and find ways to mitigate them. 

 

To understand its true environmental impact, though, a company needs data about its Scope 3 emissions – that is, all other emissions across its value chain, from vendors and their suppliers upstream to customers and end users downstream. Between 2021 and 2022, technology has evolved to include more sophisticated and granular tools for Scope 3 emissions data. 

 

The efforts to address this challenge continue. The promising avenues companies are exploring include the following: 

 

AI and machine learning applications. It’s now possible to push data from upstream suppliers into operational systems that use AI and machine learning. These systems answer complex questions, such as which suppliers of which types of packaging will deliver the optimal combination of cost and sustainability for shipping a specific product. 

 

Advanced materials data. Companies also have access to more and better data to help them manage their product footprints. They can now gather detailed information about the materials they’re using, where those materials are sourced, and how they’re disposed of at end of life. They can track a wide range of supplier-specific factors to decide with whom to do business and how to avoid high-risk geographic areas and materials. And they can now add carbon data to the information they exchange within business networks to improve forecasting and identify risks. 

 

Companies that use these technologies to gather sustainability data across the supply chain can now use it to estimate or even calculate 50% to 80% of their Scope 3 emissions. These emissions are often greater than the emissions generated by a company’s operations. 

 

For example, a company that worked with SAP and its business partner Consilio.io to measure its Scope 3 emissions in 2021 found that the largest proportion was generated by employees’ use of non-fleet vehicles such as taxis and car services, air travel, and transit. This helped the company implement steps to reduce these emissions and demonstrate why those changes were both necessary and effective – which motivated its employees to do even more to shrink their carbon output. 

 

Financial applications for carbon budgets. Companies also need tools to define, standardize, and consolidate the data they gather and integrate it into the financial systems that translate it into dollars and the analytics systems that drive insight. This enables them to steer business strategy in a more sustainable direction and to facilitate compliance with overlapping and intersecting regulations across industries and geographic regions. 

 

For example, in addition to letting enterprises map their existing carbon footprint, emissions management tools now let them create carbon budgets and trigger workflows in operational systems to keep the company within that budget. 

 

Product life cycle systems to evaluate sustainability scenarios. A company might also integrate data about sustainability into its product life cycle management (PLM) system to explore different design variants for a product and its packaging, based on relevant regulations to determine a product’s true cost to produce. Accounting for regional costs such as a plastic or packaging tax, which retail channels will and won’t carry the product, and where it can and can’t be sold, will help the manufacturer decide whether the product fits into the company’s carbon budget and its strategy. 

 

Procurement systems that reward emissions reductions. A business could also cut its Scope 3 emissions by combining externally validated data, information from its procurement network, and details on supplier financing to develop incentives such as faster payment terms for the vendors in its supply chain that are working to reduce their own emissions. 

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Even if it’s not perfect yet: 

Learn how businesses are using their sustainability data now.

Don’t coast, accelerate

No one ever said that making enterprises more sustainable would be simple – but it’s not so difficult as to be impossible. Even though there’s still a long way to go, companies in a variety of industries are already collecting and reporting on data about their Scope 3 emissions so they can use that information to reduce their emissions-related risk. 

 

In 2021, Kraft Heinz issued a verified Scope 3 emissions statement for 2020, making it a standout in the food industry. That’s a sector that significantly lags other industries in translating emissions reduction goals into action, according to a report by Ceres, a nonprofit promoting more sustainable business practices. Yale University calculated that Scope 3 emissions represented approximately 57% of its total emissions, creating a meaningful benchmark against which to set reduction targets. And Unilever released a Climate Transition Action Plan, noting that despite the challenges and complexities of gathering data about other organizations to calculate its own Scope 3 emissions, it has “chosen not to wait for every issue to be resolved and for every term to be defined.” Instead, it decided to adapt its plans as value chain emissions data improves, and terminology about carbon neutrality becomes more standardized and formalized. 

 

Organizations already know what needs to be done. Measuring and quantifying environmental effects at ever-expanding scope helps them cut emissions and increase sustainability – and not just because more regulatory bodies are issuing complex rules about it. By calculating and reporting on the full extent of their environmental effects, they’re also able to identify more ways to act on climate change at a time when taking action is more urgent than ever. 

 

Editors’ note: Read more from SAP Insights about how sustainability affects competitivenessfinancial planning and analysisaccountinghow to develop a talent for sustainability, and how a number of enterprises make sustainability central to their business model.

Meet the Authors

Christine Susanne Müller
Director Global Sustainability Transformation and Change Management | SAP

James Sullivan
Global Head of Product Management, Sustainability | SAP

Fawn Fitter
Independent Writer | Business and Technology

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