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ESG for SMEs: future proofing supply chains

Author: ICAEW Insights

Published: 08 Sep 2023

The impacts that environmental, social and governance issues can have on supply chains is stark, but if SMEs don’t comply with new ESG rules they could also risk their entire business.

In the UK, and many other parts of the world, the dearth of food and non-food items on supermarket shelves starting in 2020 right up to today has become the visual representation of supply chain disruption.

This is just one example of how climate change is impacting everyone, particularly small businesses. Supply chain challenges are now costing the UK economy over £12bn a year in lost revenue, according to a study from TMX Global. That could accelerate if SMEs fail to address and mitigate environmental, social and governance (ESG) issues in their supply chains.

According to EY’s 2023 Global Private Equity Survey, less than half of mid-size and smaller companies said they were knowledgeable on all the proposed or enacted regulations that could impact their organisations. Small and mid-size companies will need to address this shortcoming to be able to interpret and respond to new regulations and avoid running afoul of regulators. 

Dr Peter Ellington, Associate Professor in Accounting at the University of East Anglia and CEO of Triple Bottom Line Accounting firm, which carries out client net zero assessments, says: “It’s starting to happen. It’s a trickle at the moment. It’s an ‘S’ curve where we’re at the start. We’re in the foothills but then you get a rapid adoption of sustainability accounting and understanding of supply chain greenhouse gas emissions.”

All companies irrespective of size within supply chains must reduce their carbon emissions so that larger companies comply with rules around Scope 3. Scope 3 covers indirect greenhouse gas (GHG) emissions within a supply chain of an organisation’s main operations. 

For many organisations, the largest part of their carbon footprint falls within Scope 3. Although these emissions are outside their direct control, they remain the responsibility of large companies.

“The main pressure on SMEs will come from their large customers and suppliers who have made public ESG and net zero commitments,” says Eduardo Tugendhat, Managing Partner for Inclusive Growth and Nature at global impact company Palladium. 

Tugendhat points to the apparel industry, where large retailers and brands are ensuring that the companies to which they outsource comply with child labour and other ESG standards. 

“While the initial focus was on the Tier 1 suppliers, these now also must take responsibility for smaller-scale subcontractors. Complying with the standards imposed by large companies is expensive for SMEs, although once they do so they will be more competitive in the market,” Tugendhat says.

On the flipside, one way big business could improve its ‘S’ credentials in the ESG is to pay smaller suppliers on time. Late payments to smaller suppliers is a massive problem in the UK. 

Our recent ESG paper argues that adding late payment metrics into ESG reporting could drive a sea change in corporate behaviour and hold big businesses to account. Small and larger businesses alike could make far more accurate risk assessments of partnerships, unlocking a healthier, more transparent supply chain,” says Alex Von Schirmeister, Managing Director UK & EMEA at Xero.

How to respond to ESG risks

Unless SMEs begin to address the ESG risks in their supply chains, they could risk losing contracts or government grants. The public sector is already leveraging its procurement power to change ESG behaviours. 

For example, FX Plus, which carries out procurement for Falmouth University and the University of Exeter, set a 50% target to reduce its Scope 3 emissions by 2030. In its latest tendering process, 20% of its scoring is now allocated to carbon reduction and social values. If its suppliers don’t meet the requirements they will likely lose their contracts.

A vital first step for business owners is to map out their supply chains, listing all suppliers and then working backwards, analysing each supplier’s risk in the wide range of ESG risk categories.

Not all ESG risks will affect all companies, which is why there is no one-size-fits all approach. Company owners could also consider the United Nations 17 Sustainable Development Goals (SDGs) and choose some that directly impact their own company.

In the UK, some businesses are already applying ESG in their strategy, while others are woefully underprepared. Tugendhat says: “This really varies by country and sector and the extent to which SMEs feel obligated to conform to more exacting ESG standards.”

He says the best situations involve programmes initiated by governments and/or large companies to partner closely with clusters of SMEs in support of their modernisation.

“For example, the automotive industry has largely evolved from one of constant greater cost pressure on Tier 1, 2 and 3 suppliers, to one where there is now a greater degree of collaboration to ensure that the overall supply chain is more competitive and able to meet social and climate objectives,” Tugendhat says.

Sustainability advisers and online tools can help businesses to start looking at these challenges. Whichever option business owners choose, it’s vital to start now. Many cloud accounting packages such as FreeAgent, QuickBooks and Xero offer add-ons that calculate carbon estimates.

“It’s a natural place for accountants because they know their clients and their clients’ cost base. Accountants have to do the business plans with the clients to justify whether they can afford some of these changes. It's naturally in the accountants’ remit to do net zero plans,” Ellington says.

SMEs are often fast-growing and will need to adjust and recalculate their carbon footprint as they grow. They should make adjustments for carbon intensity to make the numbers comparable over time.

“One of the key measures is cross-departmental collaboration and improved communication between finance and procurement teams, and operations,” says Tony Hague, CEO of manufacturing outsourcing specialists PP Control & Automation. “Having clear sight through data analysis of patterns, trends and anomalies in the supply chain will help SMEs get ahead of potential disruptions, and accountants are ideally placed to manage this kind of data and make sense of it.”

Many business owners feel overwhelmed by the quantity of ESG information. If their accountants can offer direction by way of an ESG plan that provides small but clear steps to take then incremental change will follow. But it needs to come soon or more bankruptcies may follow.

Climate for SMEs

Climate change is affecting businesses of all sizes. ICAEW is aiming to cut through the noise by providing tools and resources for small to medium sized businesses to build resilient business models and get to grips with ESG.

Support for SMEs on getting to grips with the impacts of climate change and ESG.
More support for SMEs on ESG

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