How mutinationals can avoid supply chain scandals

The collapse of the Rana Plaza building in Bangladesh remains one of the biggest supply chain scandals ever to hit multinational companies.

The disaster in April 2013 killed 1,134 people and maimed more than 2,500 others. Many were workers in five clothing factories that served well-known high street retailers.

As a result, the tragedy became a symbol of the fashion industry’s failure to ensure high standards across its growing supply chains, causing long-term reputational damage and having a significant impact on sales.

However, the issue of environmental, social, and governance (ESG) scandals in global supply chains is not confined to the fashion industry.

Many pharmaceutical companies rely on generic drug shipments from India, where suppliers have been involved in water quality scandals.

Child labour and modern slavery remain risks across a range of products and countries.

Quality issues – such as a recent contaminated eye drop scandal involving Global Pharma Healthcare in India and affecting consumers in the US – have also raised governance concerns.

Supply chains and reputational risk

As globalisation continues, supply chains are becoming ever more complex. While this complexity can improve cost efficiency and innovation, it also makes it more difficult to manage those supply chains effectively and maintain ESG standards.

On top of this, scrutiny of firms’ sustainability credentials is increasing, driven by consumers, investors, and (in most cases) governments.

As the issue gains attention, multinationals are increasingly seeking solutions to rising ESG supply chain risks. According to our research, one solution to these ESG risks may be to increase ‘small-worldness’ in multinational supply chains.

This involves a network where companies are closely connected – in the same way as individuals in a close-knit village – enabling better oversight, sharing of information, and enforcement of social and environmental norms.

Our findings show that small world networks are key to improving control for multinational firms, making it easier to monitor and regulate supplier behaviour and ensure more ethical supply chains to reduce the ESG risks involved.

A company’s level of ‘connectedness’ is key to a successful small-world approach.

The better connected a company is, the better placed it is to identify potential ESG issues and tackle them.

A 'small world' approach to global networks

When all buyers and suppliers in an industry know each other well, news of questionable behaviour can spread quickly throughout the neighbourhood – similar to the way that news travels around a village.

Negative news does not normally come directly from the guilty party, but spreads indirectly through that network. So, a company planning to buy from a new supplier should seek information about them from other companies that already have connections to the supplier – as well as from the supplier itself.

Companies can then either avoid risky suppliers or work together to control the behaviour of the supplier – delivering a form of social or network-based governance, while overcoming some of the limitations inherent in their contractual terms.

However, multinationals must be careful to avoid collusion when finding out about a supplier, maintaining a delicate balance between competing with fellow firms and ensuring high ESG standards in the supply chain.

On the other side of the equation is the degree of separation between the buyer and the supplier. A small-world approach would involve reducing this to as few intermediaries as possible.

Companies with high levels of small-worldness have relatively few degrees of separation between them, and so fewer steps to suppliers.

Our research showed US companies averaged around four to five degrees of separation – those below this level have relatively high small-worldness.

Bringing these two factors together, the density of a buyer and supplier’s connections (numerator), over the number of steps between firms (denominator) gives a single measure for small-worldness.

Increasing the connection density of suppliers

Ideally, firms should aim for a large number of connections between companies in their network, and few degrees of separation from their suppliers.

When firms have a high connection density and a low degree of separation, it resembles an environment where we typically say, “Yeah, I know them, it’s a small world!”

Our research recommends three distinct approaches to increase connection density

1. Create direct relations with tier-two suppliers, ie those firms supplying parts to their suppliers

2. Promote connections between suppliers

3. When selecting new suppliers, choose one that already has connections with their customers or existing suppliers, so the network density is increased.

The number of companies in the supply chain can also be cut, but this must be balanced against the operational advantages of involving a great number of companies.

Multinationals can reduce the impact of degrees of separation by creating supply chain ties with firms that have high levels of connectivity themselves.

In practice, multinational employees need to keep their ear to the ground and maintain close connections with others in their industry.

How firms can be better connected

Employees must go out and meet people, including competitors and potential suppliers. Good relationships with those involved means a smoother flow of information.

Procurement managers should attend networking events or create their own to make connections stronger. For example, German pharma giant Bayer has regular annual events to invite suppliers and make awards.

Information flow is enhanced when people know each other and meet in person more frequently.

A broader relationship between companies can also improve connections.

For example, if they develop a product together, connections are extended between one firm’s engineering team and the other’s research and development department, while marketing departments interact, as well as sales and procurement.

The best-connected buyers and suppliers have multiple layers of connection.

Many retailers in the US and Europe did not know how bad conditions were at the Rana Plaza factory because their orders were placed through multiple layers of subcontracting, involving sourcing agents and local producers around the world.

The intermediaries were able to quickly allocate production, which individual retailers (or suppliers) could not do as efficiently, but they also separated buyers from suppliers.

A small-world approach can reduce this separation by improving communication and co-ordination among companies involved, while maintaining the advantages of global supply chains.

After the event, many companies decided not to source from Bangladesh, but they were steadily drawn back by the country’s production advantages.

To remove the risk of a similar event happening again, they check conditions closely and require companies to meet safety standards – with a smaller-world network structure facilitating more stringent oversight.

Further reading:

Why firms need to start measuring Scope 3 emissions in their supply chains

The 10 questions successful leaders use to spot the scandal before it happens

Why big firms are rarely toppled by scandals

Four steps to prevent professional misconduct

Sangho Chae is Associate Professor of Operations Management at Warwick Business School. He teaches Supply Chain Management on our undergraduate programmes.

Learn to lead with renewed purpose, resilience, and adaptability with the WBS Executive Leadership programme at our stunning Warwick Campus.

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