'Ecoflation' Set to Rattle Supply Chains

Increasing pressure on natural resources will mean higher costs along corporate supply chains. Only firms that incorporate environmental sustainability into their business practices will be well-positioned to meet the challenges ahead.

After climbing rapidly for two years, prices on commodities such as oil and wheat have declined since the financial crisis hit, yet upward price pressures on these goods look likely to resume in the long-term. Approximately 60 percent of the planet’s ecosystem services are degraded or currently being used unsustainably. Climate change will further degrade these ecosystems. In addition, population growth and increased levels of consumption in India and China will further stress our planet’s finite resources.

A new report by WRI and A.T. Kearney indicates that these environmental trends and their consequences could have even wider ramifications for businesses in the coming years. According to the study, Rattling Supply Chains: The Effect of Environmental Trends on the Fast Moving Consumer Goods Industry, businesses in the fast-moving consumer goods (FMCG) industry could see earnings fall by 13-31 percent by 2013 and 19-47 percent in earnings in 2018 if they do not implement sustainable strategies throughout their supply chains.

These pressures will affect firms in an array of industries, particularly companies that depend on natural resources to produce consumer goods.

The "Ecoflation Scenario"

As natural resources become scarcer and sustainability issues become more pressing, environmental costs will increasingly be borne by private firms. These increased costs will lead to ecological-inflation--or "ecoflation"---that is not currently priced into economic transactions. Under this "ecoflation scenario," corporate supply chains will soon have to internalize costs society currently bears.

WRI and A.T. Kearney based this scenario on several assumptions about major environmental trends and the subsequent policy actions taken. The study predicts the future drivers of increased environmental costs will be:

• Climate Change Policy. The United States implements a comprehensive climate-change policy, which spurs international cooperation and results in a global price for greenhouse-gas emissions.
• Water Scarcity. Climate change causes more drought and water scarcity throughout major agricultural regions and leads to increased production costs and declining yields.
• Deforestation. Consumer products companies in the United States and the European Union voluntarily agree to source all wood and fiber from sustainability-certified forests, and to increase the use of recycled fiber for all paper packaging and products.
• Biofuels. Major biofuel-producing countries retreat from existing mandates and apply sustainability requirements to all relevant government policies.

The study analyzed how these drivers might affect prices on selected commodities like oil, natural gas, electricity, cereals and grains, soy, sugar, palm oil, and timber. As stated above, firms could see their earned reduced 13-31% by 2013 if increased costs cannot be passed onto consumers.

The results offer tangible examples of how environmental costs might impact the value chain, especially for food, beverages, and other fast-moving consumer goods that are usually produced in large quantities.

The Case Of Cereal

Cereals and grains, which are the direct ingredients of many food and beverage products, face long-term supply constraints and price increases.

The report finds a 6-13 percent increase in cereal commodity prices due to these pressures. Cereal prices are susceptible to upward pressure from climate change policy and growing water scarcity, but may be reduced if certain biofuel policy changes reduce ethanol demand.

The following chart shows how policy changes will impact price (click the chart to enlarge):

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Solutions

Even though the earnings at risk for the selected sample are significant, Rattling the Supply Chains finds that companies have the capacity to develop solutions, and then transform their operations to mitigate risk and take advantage of growth opportunities.

Companies can take the following actions to address the emerging environmental risks to their supply chains:

1. Understand the environmental impacts and dependencies: Examine how cost drivers are exposed to emerging environmental trends and, when possible, seek substitutes with lower environmental impacts.

2. Take an inventory of current initiatives: Learn what the company, its suppliers, and its partners already are doing through the value chain.

3. Prioritize: Rank environmental issues and opportunities according to their current and future potential impact on costs, revenues, and reputation.

4. Chart a new course: Make sustainability principles part of an action plan by including externalities in the decision-making process and establishing the principal performance indicators.

WRI and A.T. Kearney believe that in order to adapt to these challenges, companies will need to implement real structural changes, such as product innovation and restructured value chains, which will affect both the companies and millions of existing and new consumers.

Successful firms will be those companies that anticipate the implications of a changing landscape, collaborate with suppliers and other stakeholders, and make environmental sustainability one of their core business principles.