Encouraging responsible sourcing in our supply chains

We may all want our products to be sourced responsibly but mathematical modelling suggests firms need low-cost ways to signal their credentials, and more of us taking notice

Dr Lusheng Shao, University of Melbourne

Dr Lusheng Shao

Published 9 February 2022

One of the consequences of globalisation is firms increasingly seeking low-cost sources of products anywhere they can find them across the globe.

For example, today 95 per cent of textile and apparel products used around the world are imported from another country, with low-wage China and Southeast Asia being the leading exporters.

Globalisation has meant suppliers can scour the world seeking the lowest cost goods and services, but this can come at a devastating high social and/or environmental price. Getty Images

However, many suppliers offer cheap prices by cutting corners and engaging in irresponsible practices, like using forced labour, exploiting poor working conditions, and using hazardous substances and conflict minerals – minerals sourced from politically unstable areas where the proceeds go toward financing armed conflict.

It is estimated that 16 million people were subject to forced or slave labour conditions in the private economy in 2016. The United Nations Human Rights Council estimated that over 2.78 million workers globally die each year from unsafe or unhealthy work conditions.

The impact of these practices is socially and environmentally devastating. A notorious example is the collapse of the Rana Plaza textiles building in Bangladesh in 2013, which killed 1,134 workers and injured 2,500 others. In response to such tragic events, consumers are increasingly concerned about whether, and the extent to which sourcing practices are responsible.

There is evidence that some consumers have started to vote with their wallets to actively choose the companies they support and the practices they endorse.

A Nielsen survey from 2014 found that 55 per cent of global respondents were willing to pay extra for products and services from firms “committed to positive social impact”. In 2016 an Oxfam survey found that over 89 per cent of Australians “were willing to pay a little more for clothes to ensure garment workers had safe and decent working conditions”.

Globally, firms are revisiting their sourcing practices to ensure responsible behaviours across their supply chains. But it can be difficult for firms to make it obvious to consumers when they are sourcing responsibly. As a result, firms sourcing responsibly may not be rewarded by consumers, either by market preference or willingness to pay higher prices.

The site today where the Rana Plaza building once stood before it collapsed in 2013, killing 1,134 workers, is a reminder of the terrible consequences of irresponsible sourcing. Picture: Getty Images

The success then of efforts to make global sourcing of products and services more responsible partly depends on firms seeking ways to better communicate their sourcing practices to consumers.

In my research with colleagues Professor Jennifer Ryan at the University of Nebraska-Lincoln and Professor Daewon Sun at the University of Notre Dame in Indiana, we have developed a signalling game mathematical model to study a firm’s decision on responsible sourcing in circumstances where any move to responsible sourcing isn’t transparent to consumers.

A signalling game is a type of theoretical model on behaviour in which the party with private information uses some ‘signal’ (like a higher price or the offer of a warranty) to persuade the other party who doesn’t have the information (like a consumer) that the product or service offered is high quality.

We considered two communication mechanisms that are most relevant in responsible sourcing. First, the firm may use a higher selling price to signal its sourcing practices, given that responsible sourcing costs more and consumers can be expected to associate a higher price with a greater quality overall, including sourcing.

Alternatively, a firm may directly and voluntarily disclose its supplier information to consumers in a credible manner that can be verified by the consumers.

We found that, due to information asymmetry, a firm that sources from a more responsible supplier may need to distort its price upward to signal its responsible sourcing action. This, however, leads to reduced demand and decreased profit. As a result, the firm may prefer to source from a less responsible supplier.

When it comes to encouraging responsible sourcing, consumers have an important role to play. Picture: Getty Images

However, if supplier disclosure is an option, the firm will choose to source responsibly when the disclosure cost is small and the proportion of socially conscious consumers is large.

Regulations have been put in place to mandate certain firms to report their specific actions to eradicate slavery and human trafficking. Examples include the California Transparency in Supply Chains Act, the UK Modern Slavery Act, and the Modern Slavery Act in Australia.

However, these regulations don’t cover small and medium-sized enterprises (SMEs). In addition, the firms are only required to report in their annual statements, so it is difficult for consumers to verify the information reported and compare that information between different firms.

Some third parties provide independent monitoring and verification of social responsibility that can be signalled with labels on the packaging, or through the use of technologies that promote transparency. These include tracking and sensing technology, as well as Blockchain technology that creates a digital ledger of activity.

But not every firm can afford these third-party verification regimes, especially small to medium-sized enterprises. If we are to better encourage responsible sourcing we need to reduce the disclosure costs so that firms can easily demonstrate their credentials to consumers.

In this regard, government and non-profit organisations (NGOs) can create repositories or clearinghouses for supplier information. These one-stop shops allow consumers to better understand each firm’s sourcing practice.

Victoria has an ethical supplier register for clothing and protective equipment. Picture: Getty Images

One example is the Victorian Government’s ethical supplier register, which lists local suppliers of corporate clothing, uniforms, workwear and personal protective equipment.

Governments could also provide partial funding support for third-party certification or labelling services to reduce the cost burden on the firms, which ultimately helps to make the firms’ sourcing practices more transparent to consumers.

Consumers have a role to play too. Academic research on how much customers are actually willing to pay for social responsibility has been mixed. An analysis of previous research revealed that consumers were willing to pay a higher premium for non-durable goods (like paper towels) but not such a higher premium on durable goods (like furniture) that tend to already be more expensive.

Consumers also appear willing to pay a larger premium for socially responsible sourcing that benefits people compared to responsible sourcing that benefits animals or the environment.

Our research shows that increasing the pool of socially conscious consumers or the premium they are willing to pay can help promote responsible sourcing, but this is less effective when the sourcing decisions are not transparent.

The focus then needs to be on governments and NGOs offering more education about the importance of socially conscious consumption and reducing the cost to firms of making responsible sourcing more transparent.

Banner: Getty Images

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