Organizations are facing heightened expectations from reputation-conscious investors, conscientious consumers, and empowered employees to prioritize the  S in ESG – the social factors that affect supply chain operations as part of an overall environmental, social, and governance (ESG) framework.

For years, these social factors have been a secondary consideration to other governance priorities. Environmental concerns have encouraged organizations to reduce their carbon footprints and ensure greater supply chain transparency, relegating the social factors to play “the poor sister” to its attention-seeking siblings, according to Peter McAllister, executive director of the Ethical Trading Initiative, an alliance of trade unions, non-governmental organizations (NGOs), and companies dedicated to ending the abuse of human rights at work. But that dynamic is changing fast, as public scrutiny of the ethical implications of supply chains intensifies and the financial fallout of violations, such as slave labor and discriminatory hiring practices, grows.

While the situation continues to evolve, executives managing social factors point to several challenges and opportunities. Consider the risk of scrutiny from outsiders on the working conditions of a far-flung supply chain. Public perceptions about a company can affect its reputation – even if the company is not contractually responsible for, say, working conditions at a supplier’s factory.

Another challenge: regulations proliferating in different jurisdictions around the world mean there are no uniform standards for social goals. That makes it difficult to measure conditions and report progress.

If this all sounds like one difficulty layered atop another, think about it this way: corporate leaders in cybersecurity have been dealing with hard-to-quantify systemic risks for years and have worked out ways to mitigate them. In the same way, the S in ESG calls for companies to invest time and resources to reduce the chance of experiencing the worst. That means deeper vetting of all levels of suppliers. It means calling on experts with domain knowledge of local markets. And it means establishing clear responsibilities for legal and regulatory compliance.

When reputational risk knocks

The risk of a reputational problem can creep up on a company.

Consider the United Kingdom’s online fashion retailer Boohoo, for example. In July 2020, the nonprofit organization Labour Behind the Label released a report revealing widespread labor abuse in some of the factories where Boohoo products are manufactured. With allegations including wage theft, poor working conditions, and a high risk of COVID-19 infections and fatalities, the report called on the company to provide greater visibility into its supply chains.

Within a day of the allegations going public, Boohoo shares dropped by 23%, knocking £1.1 billion off the company’s stock market value, the Guardian reported. “It was nearly catastrophic to the business,” says McAllister.

Since then, Boohoo has said it has taken steps to improve supply chain governance, including forensically monitoring suppliers and its financial records and appointing independent directors to its board to oversee supply chain compliance, as reported by Drapers, a fashion industry publication.

By failing to meet consumer expectations for safe working conditions, diversity, consumer data privacy, and fair compensation, organizations put their market share – and hence their bottom line – at risk.

Consumer sentiment can also be a factor; shoppers say they take notice of the treatment of laborers who work in an organization’s supply chain. For example, according to a 2019 survey from the international human rights group Walk Free Foundation, 66% of U.S. consumers would switch brands if they knew human trafficking or forced labor was used to create the products.

By failing to meet consumer expectations for safe working conditions, diversity, consumer data privacy, and fair compensation, organizations put their market share – and hence their bottom line – at risk. These risks are likely to multiply as transparency in supply chains increases and media and industry watchdogs double down on their efforts to expose organizations that fail to maintain socially conscious and inclusive supply chains.

Regulators pushing for due diligence on social factors

While scrutiny of social factors is on the rise, many enterprises find it challenging to review their operations. A 2023 corporate human rights benchmarking study by the World Benchmarking Alliance found that while one-third of companies expect their suppliers to respect human rights, only 11% follow through by working with suppliers on reducing human rights risks such as child labor, forced labor, and living wage violations. And just 2% assess how many people are affected by these issues in their supply chains and report progress.

Experts point out that regulators are paying attention and that time is running out to bridge the gap between aspiration and action, even for companies with strong human rights commitments.

“Regulations are accelerating, and due diligence and disclosure are the main themes,” says David Simon, a partner with international law firm Foley & Lardner.

Both the United States and the European Union either have adopted or are in the process of adopting real enforcement mechanisms to protect against the importation of goods made using forced labor. For example, in June 2022, the U.S. introduced the Uyghur Forced Labor Prevention Act, which “deems all goods mined, produced, or manufactured in the Xinjiang Uyghur Autonomous Region in China” to be produced by forced labor and therefore prohibited from being imported into the United States.

Similarly, a new Norwegian law, the Transparency Act, requires companies to make sure human rights and decent working conditions are respected in their supply chains and operations. The law is unique in that its due diligence requirements apply to a company’s entire supply chain. The act also requires companies to respond to information requests about how they would address any adverse effects on human rights and decent working conditions.

Other initiatives to encourage responsible corporate behavior are the Corporate Sustainability Due Diligence Directive, a proposed European Union law that would require companies to report on the effect that their operations and business relationships have on human rights and the environment; the UN Guiding Principles for Business and Human Rights; the OECD (Organisation for Economic Co-operation and Development) Due Diligence Guidance for Responsible Business Conduct; and Germany’s Supply Chain Due Diligence Act, which imposes severe penalties on companies that fail to comply with environmental and human rights standards in their supply chains.

Compliance risk factors: monitoring supply chains, guarding reputations

No company sets out to source its supplies using child labor or partners who host exploitative workplaces. But policing all the links in a global supply chain has challenges, not the least of which is defining the S in ESG. Some organizations see it as falling under the umbrella of a company’s diversity, equity, and inclusion (DEI) mandate: How do you treat your workers? Are you paying fair wages? Are you treating employees with respect and providing them with flexibility?

These questions are clear, but the answers are not always straightforward.

For one thing, human rights are defined differently around the world. “There are fairly clear lines around forced labor and child labor,” says Simon. “However, it gets a lot fuzzier with respect to things like working conditions, reasonable wages, unionization, and freedom of speech for workers.”

Another consideration: complex supply chains make it tough to monitor all the factories, warehouses, and other spaces of a company’s global partners – including entities for which they’re not directly responsible.

“Supply chains are long,” says Simon. “How far back does your obligation go? Everybody is wrestling with this.”

Another risk factor: when something goes wrong, public sentiment can fixate on large companies that are linked to negative events. Public perception can further blur the lines of responsibility when it comes to ensuring socially responsible supply chain practices.

“Supply chains are long. How far back does your obligation go? Everybody is wrestling with this.”

– David Simon, Partner at Foley & Lardner

Just ask Fabienne de Blois, an associate director at S-RM, a global intelligence and cybersecurity consultancy that helps businesses address the environmental and human rights effects of their operations. De Blois points to Bangladesh’s Rana Plaza tragedy as an example of how public opinion can shape a company’s human rights practices. In April 2013, a structural failure caused the eight-story commercial building, which housed five garment factories, to collapse, resulting in the death of more than 1,000 workers.

“There was no contractual obligation by any of the ultimate beneficiaries of the labor in that factory to secure workers’ health and safety because the factory was independently owned,” says de Blois. “Yet the fact that the factory contained workers who were assembling pieces with direct instructions from large fashion brands became part of public consciousness.”

Less than one month after the disaster, nearly 200 companies, along with factories and trade unions, signed the groundbreaking agreement Accord on Fire and Building Safety in Bangladesh, which promotes workplace safety through independent safety inspections, training programs, and a complaints mechanism for workers. An international organization also was formed to promote health and safety in the garment industry worldwide.

Given the complexity of modern supply chains and the power of public sentiment, such fallout and the response show how social issues that are far from headquarters can develop into risks to manage – not unlike financial, cybersecurity, and operational risks. Adding another layer of complexity is the growing concern among companies of the results their actions may have on suppliers’ employees and communities at large. Fortunately, there are ways to manage these risks, including vetting a supply chain’s adherence to global human rights standards, teaming up with the right partners, and creating a strong organizational structure around compliance and risk management.

Vet your supply chain, including those in far-flung locations.

Prioritizing the S in ESG requires understanding a given supply chain and assessing its human rights risks. For example, says Simon, components sourced and manufactured in high-risk regions – such as Pakistan, which has some of the worst forms of child labor despite efforts to improve conditions, according to U.S. labor officials – require organizations to carefully vet suppliers for compliance with global human rights standards.

But proper vetting extends beyond geographical boundaries to the entire supply chain. “A business shouldn’t just look inward,” says de Blois. “It should look at its whole value chain – its contractors’ contractors and its suppliers’ suppliers. They all matter with regard to human rights.”

"A business shouldn’t just look inward. It should look at its whole value chain – its contractors’ contractors and its suppliers’ suppliers. They all matter with regard to human rights."

– Fabienne de Blois, Associate Director at S-RM

It’s a challenging task that academia, private industry, and government agencies are addressing with a diverse array of tools. For example, a research team at North Carolina State University hopes to simplify supply chain compliance monitoring with an Ethical Apparel Index (EAI) – a framework that organizations can use to identify signs of forced labor and slavery in factories as well as violations of living wages, building safety, and housing conditions.

According to the research team’s Web site, the EAI summarizes such social indicators and communicates benchmarks to consumers and supply chain stakeholders. The framework is being tested on apparel supply chains through partnerships with a variety of brands, retailers, and factory owners around the world.

Intergovernmental agencies also are consolidating efforts to mitigate human rights abuses in business operations and global supply chains. Case in point: in 2011, the United Nations Human Rights Council endorsed the UN Guiding Principles on Business and Human Rights. The guiding principles are the global standard for responsible business conduct – a blueprint by which companies can assess their compliance. By following the principles and addressing potential human rights abuses in supply chains, companies can decrease the risk of lawsuits and increase trust among investors and customers.

Gather partners with the right expertise in local markets.

Despite the proliferation of auditing and self-assessment tools, measuring the social aspects of an organization’s supply chain may call for the expertise of a third party with a presence in the field. “You may need to find partners who can help you understand, in context, what you need to know about your supply chain,” says McAllister of the Ethical Trading Initiative. “You may need to localize the conversation. Audits don’t always lend themselves to simply plugging in a data set. There’s footwork required.”

McAllister points to India’s caste system as one example of the contextual understanding required to satisfy the S in ESG. Although poorly understood by global companies sourcing from South Asia, caste discrimination can lead to slavery, child labor, and exploitation of workers in certain geographical segments throughout the supply chain, he says.

Third-party organizations can offer guidance on how to contextualize these regional issues and improve the working conditions of people throughout the supply chain by “bringing together people who are not easy bedfellows like NGOs, trade unions, and companies that have different perspectives on human rights issues,” says McAllister.

Establish clear legal and compliance responsibilities and assigned roles.

Building the proper organizational structure around a socially responsible supply chain is key to achieving long-term compliance and minimizing risk. This is especially true for global organizations that must work with suppliers to identify risks across regions with varying rules and regulations. For this reason, says Simon, many companies “are pairing legal and compliance departments with procurement to identify high-risk suppliers.”

While cross-functional collaboration can bolster risk management, the C-suite also plays a pivotal role in ensuring that the necessary time and resources are allocated to auditing the supply chain, putting remedial processes in place, and staying on top of new human rights regulations.

“You need a champion in the organization who has the ear of a board member who will say, ‘Let’s not wait it out. Let’s not play Russian roulette with our reputation. Let’s look at our global supply chain, talk to people, and find out what risks we are exposed to and what we can do about it,’” says McAllister. “Because, with few exceptions, most large companies with wide supply chains will be exposed to risk.”

Managing risk, however, is only as effective as an organization’s initiatives to manage public perception. Just as greenwashing that misleads people about a company’s environmental bona fides can erode consumer trust, social washing – the practice of companies promoting themselves as more socially responsible than they are – can lead to reputational damage, consumer mistrust, and legal penalties.

“We see social washing allegations all the time, so a business’s ability to convey a clear, concise, and transparent message with regard to its social strategy and the impact of any initiatives within its supply chain, or internally within the business, is really important,” says de Blois. “A business doesn’t want to find itself called out.”

Nor does any company want to be called out for employing underage workers, creating unsafe work conditions, or not paying a living wage. Yet detection is an increasing possibility as regulatory bodies, media outlets, consumers, and industry watchdogs keep close watch on the labor practices that fuel today’s supply chains. As a result, organizations must look deeply into their supply chains and manage the risks within. Fortunately, an increasing number of technology tools are emerging that promise not only to drive collaboration, resilience, and transparency among organizations and their suppliers but also to help organizations meet their environmental and social goals.