Visibility is Key to Managing CSR Risks in Indirect Spend, EcoVadis Says (Part 3)

Indirect spend often gets overlooked by businesses because the outcomes from buying those goods and services are not the company’s core product, which relies on direct spend. But the potential for lost money and increased risk is so great that businesses must find a way to manage indirect spend.

Millions of dollars go to a business’ suppliers of office products, IT equipment and supporting services such as utilities, travel, freelancers, consultants, janitors, legal counsel, marketing and outsourced services. And those suppliers often aren’t managed as closely as core suppliers, opening up companies to hidden risks that can harm production, undercut ethics and compliance, as well as damage a brand’s reputation with consumers.

To find out more about how these problems are being solved, we asked for insights from EcoVadis, a specialist that rates companies’ efforts in corporate social responsibility (CSR) and sustainability and which is adding the capability to map a customer’s supply chain risks.

“The broad reach of indirect spend, coupled with a lack of visibility creates risk, so the key to gaining visibility and managing this risk is to prioritize indirect spend management within an organization and start assessing indirect supplier performance in a formalized way,” said EcoVadis, a risk mitigation provider that offers business sustainability ratings and intelligence.

EcoVadis joined us for a Q&A to explore the next steps to figure out how to identify weak points, prioritize areas to defend against and create a plan for mitigating risks.

Spend Matters: On the issue of CSR, why has indirect spend, as a category, not received as much interest as direct spend?

EcoVadis: Direct spend receives more attention for three top reasons:

  • Amount spent: Proportionately, direct spend is greater than indirect (currently, indirect spend accounts for around 27% of total spend, though that amount is increasing). When looking at dollars out the door, it’s a higher figure, so procurement teams naturally pay more attention.
  • Visibility: Direct materials/categories go into the product that produces revenue, and thus get much higher visibility in the organization, from the product team that wants to ensure quality, the marketing team wants to be assured it meets brand and positioning requirements, to the finance team monitoring margins. This is less often the case for indirect categories. Current procurement processes, as well as spend analysis and procurement suite technologies are good at tracking direct spend supplier contracts, capacity and performance. They were not designed for indirect spend management.
  • Control: Since direct materials are part of production, they are usually controlled in an ERP system with high precision on specification and quality. This level of scrutiny and precision is then imposed on the purchasing process. Sustainability can easily be added and tracked as just another attribute. However, indirect spend does not enjoy this level of scrutiny or ERP tracking, thus it must be added on afterward. Also, since most direct spend originates in ERP/production planning, and passes directly to procurement, there is control over the process from start to finish, whereas with indirect spend, origination of contracts or orders is fragmented across many other departments or teams, putting it outside of procurement’s

How does indirect spend’s level of risk compare to that of direct spend?

From a sustainability and CSR perspective, indirect spend can pose just as much risk as direct spend, or more because indirect spend is harder to get under control and can cause significant reputational damage and undermine larger initiatives. Corruption and other ethical violations are just as likely to crop up in indirect spend categories, which when uncovered can not only turn into a scandal but threatens leadership and can turn into significant bottom-line penalties.

What are the challenges of managing all of this indirect spend?

Traditional supplier auditing and tracking tools aren’t designed for indirect spend suppliers. While each organization will have different degrees of challenges when getting indirect spend under control, the top barriers usually come down to two areas:

  • Lack of awareness and prioritization: Since most organizations are focused on direct spend, there is often a lack of awareness around the impact and risk of indirect spend. While we’re seeing a change in this trend, with more companies realizing the potential threats from indirect categories — particularly related to sustainability initiatives — without clear direction and prioritization of indirect spend management, it will still be a major barrier to success. Additionally, since much of indirect spend is dealt with on a business unit or department level, there may be internal confusion over who owns what, making it that much more difficult to wrangle.
  • Lack of resources: Lack of awareness and prioritization results in less than adequate resources to manage indirect spend. Because of its lack of visibility and complexity, managing indirect spend requires dedicated staff time and expertise as well as different tools and technology to be effective. Also, since indirect is often seen as less important compared to direct spend in the eyes of leadership, it often doesn’t get the same level of investment until something negative happens.

How does EcoVadis address tail spend?

EcoVadis’ sustainability intelligence suite, which comprises our core ratings platform as well as risk-spend mapping services, provides deep sustainability and CSR intelligence across the broadest possible spectrum of suppliers. It covers over 190 spend categories — including both direct and indirect, over 155 countries, and all sizes from very small (under 25 employees) up to the very largest suppliers. Risk mapping and EcoVadis Scorecard results can help arm procurement teams with the rationale to entice their colleagues to observe contracts they’ve negotiated with suppliers who have been vetted (meaning assessed — or at least screened) on these sustainability issues. This would help the purchase requester to know that if they buy outside the system, they may be risking a purchase from a supplier who has poor environmental practices, or is a risk of child or forced labor, etc. that will put their brand at risk. Also, the EcoVadis API allows for integration of ratings and scorecards into purchasing tools making it even easier for purchasers to choose better and lower risk suppliers from both a cost and sustainability standpoint (or to request that the supplier they wish to use undergo an assessment).

Do organizations have sufficient data to make good decisions on which suppliers to use?

Many companies lack the data — or more importantly they lack information or indicators — that buyers can use to make decisions in a timely way. Typically when a customer first comes to us, they have some kind of supplier questionnaire or survey in place, collecting answers in a spreadsheet, but are finding it useless or of little value for many reasons. They may lack the resources to chase down suppliers and scale up to any meaningful amount of their supply base. They may have inadequate coverage of enough categories, or countries and languages, and they don’t trust self-reported data and don’t have the expertise or resources to validate any of the responses or digest it into something like an indicator that buyers can use.

Are ethical and compliance risks also vulnerabilities for businesses?

Yes, absolutely. Ethics are constantly taking center stage, and brands caught with practices or processes deemed unethical or irresponsible are paying the price in reputational damage and hits to their bottom line. We recently published a study on the state of corruption in the supply chain, based on data from a subset of 20,000 assessments, and it shows there’s a surprising amount of room for improvement.

On the compliance side, of course regulatory compliance issues are crucially important for businesses, and staying on top of current, changing and potential impacts of legislation is vital to supply chain risk management.

Reputational risks seem commonly linked to direct materials like conflict gold, but the indirect area faces issues like modern slavery. How can businesses gain visibility and manage those problems?

Reputational risks can come from anywhere. Today, consumers are demanding more transparency and proven CSR measures from the brands they do business with, and the workforce is demanding demonstrated commitment to sustainability initiatives from the organizations they work for. This means that any sort of corporate behavior that is deemed unethical or irresponsible can cause significant damage. Modern slavery can exist in practically any category and is always a serious problem, but we’ve also seen corruption issues in indirect categories like hiding bribes in corporate travel expenses or environmental concerns within packaging or real estate categories.

By fostering greater collaboration between procurement teams, risk leaders and business unit teams to identify indirect spend and unite everyone toward the mission of visibility, organizations will be well on their way to better indirect spend management.

How can companies identify their weak spots and create strategies to mitigate risks as they arise?

As with any risk management strategy, identifying and assessing sustainability and CSR risks throughout a supply chain relies on visibility and collaboration between buyer organizations and their suppliers. Using a proven, transparent assessment and scoring methodology that focuses on improvement and innovation to drive growth will create a more resilient supply chain, able to weather risks as they arise. Additionally, investing in technology to support supply chain risk mapping and supplier screening are critical in today’s landscape of economic and political uncertainty.

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