Does Your Supply Chain Risk Management Strategy Hold Water?

Does Your Supply Chain Risk Management Strategy Hold Water?

The rising cost of water and the threat of shortages will force more companies to develop water-efficient supply chains.

Companies have come a long way in their ability to manage supply chain risk, but they urgently need to step-up their efforts in one key area: the threats posed by water scarcity.

The Carbon Disclosure Project’s (CDP) 2016 Annual Report of Corporate Water Disclosure, published in November 2016, provides a wake-up call. A total of 607 of the world’s largest global companies submitted data about their efforts to manage and govern freshwater resources — the largest response in the report’s seven-year history.

Disclosing companies reported $14 billion in water-related impacts this year, a five-fold increase from 2015. Impacts include financial obligations to address groundwater pollution, capital costs to build power plants to replace declining sources of hydropower, and water conservation efforts in the face of drought. [[info from pp.14-15 in PDF]] Over a quarter of companies have experienced detrimental impacts from water this year, and they expect more than half of the 4, 416 water risks identified to materialize over the next six years.

Yet the report’s year-on-year disclosures show that companies are not moving fast enough to responsibly manage water, says CDP. Performance has not improved since last year on key metrics such as tracking water usage and assessing related risks. These failings will surely become more glaring as climate change and increasing demand for this precious resource create more shortages and quality issues.

The humanitarian implications are paramount. However, from a corporate viewpoint, increasingly stressed water resources represent a major threat to the integrity of global supply chains. Mitigating or eliminating these risks will require action on multiple fronts. There are three responses that are especially important for organizations to take: change public perceptions of water usage, measure what matters, and expect rising water prices.

Materials such as platinum are perceived as highly valuable, subject to price volatility, and worthy of careful management. The same isn’t true of water — but should be. Water’s deceptive abundance and low cost in many countries does not promote responsible management within companies.

It’s true that many companies have dedicated substantial resources to improving the management of water resources. Some address the challenge from an external perspective, because they identify most water use as occurring outside of their immediate operations. In the beer industry, for example, water consumption is concentrated in the agricultural supply chain. There also are programs that address the management of water in internal, direct operations that have achieved some success. For example, in 2015 the multi-national manufacturer Unilever abstracted 19 million fewer cubic meters of water than it did in 2008 — a reduction of 37%. The company has reduced its water consumption even though its global footprint has grown.

Efficiency programs like these are essential and will continue, but still represent low-hanging fruit. These programs tend to be the most cost-efficient options that are relatively easy to justify. Those that require greater investment, or where the payback is harder to justify, are likely to be pushed to the back of the queue.

It’s important to engender a holistic view of this scarce resource. Many businesses can’t do without water –– when supplies are restricted or unavailable production slows or comes to a halt — so there needs to be a rethink of how water is valued within these corporations. Water’s “true” value includes the production and supply chain costs associated with supply failures and quality issues at the plant level. It also encompasses the social costs incurred when communities are water stressed, the ecological price exacted when supplies are depleted, and the infrastructure investments needed to maintain supplies. In other words, water’s true value reflects how it is evaluated by various stakeholders.

Managers are very familiar with the need to measure what matters. Still, measurements of water usage are often inadequate because they do not provide the kind of data necessary to avoid business disruption based on water scarcity.

While many companies are developing metrics based on intensity of use (quantity of water used per product) as well as total consumption across their production facilities, there is a need for metrics based on local context, or context-based metrics. These metrics gauge other factors that constrain the availability of water, such as the percentage of the resource that is renewable and regional variations in supply.

Factors that affect pricing are also important. In most places, the price of municipally supplied water does not reflect the availability of the resource. This runs counter to the laws of supply and demand. In many places where there is less water the price is frequently low to a point where the commodity is almost free. Studies show that water costs for manufacturing facilities range from “negligible” to less than 1% of total production costs.

As water becomes increasingly scarce, companies can expect water’s pricing structures to follow the market dynamics that govern other commodities. This will have a significant impact on the way supply chains are designed, built, and managed. The trend is analogous to the pricing of energy. A couple of decades ago when energy costs were very low, supply chains were predicated on the availability of low-cost, abundant energy. That changed when prices increased and improving environmental sustainability became an important corporate goal. A similar trend might be underway in the water domain, as energy managers, and sometimes environmental health and safety managers, are increasingly taking on responsibility for water management as an additional task.

Managing water needs to become a more important part of supply chain risk management strategies. Some companies are starting to move in this direction, but much more work is needed, including further research on the risks associated with supply failures.

The MIT Center for Transportation and Logistics and Unilever recently completed a joint project to create a framework to calculate combined business disruption cost, frequency, and impacts of water-related disruption for a total value at risk that can be used by 260+ global manufacturing sites. This framework, together with informed metrics, can help companies plan for price hikes and serious disruptions and justify the cost of action to stakeholders –– both inside and outside of the business.

Ultimately, water shortages and seemingly inevitable price rises will force companies to change the way they perceive and measure this critical resource. Starting the journey now will enable enterprises to avoid extremely costly supply chain disruptions, and reap reputational rewards.

This article was written by Alexis Bateman, Director of the MIT Responsible Supply Chain Lab, and first appeared in Sloan Management Review. For more information contact the author at: hickmana@mit.edu

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