Multinational companies have been successfully developing their supply chain for decades to improve their financial bottom line. However, as concerns about global warming grew, supply chains of multinational companies have been pointed out as being one of the major sources of carbon emissions. The World Economic Forum estimated in 2009 that the sector of the logistics and transport sector contributes to 5.5% of the global emissions.
As more regulations and taxes are put in place to limit the environmental impact of industrial activity, companies may also buy carbon credits in order to offset part of their carbon emissions. A carbon credit is a generic term for any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or the equivalent amount of a different greenhouse gas (tCO2e) (Climate change glossary 2010).
These environmental constraints therefore are giving rise to a new type of costs prompting corporations to account for this dimension when planning their production.
At GenLots, we decided to evaluate if we could factor in such environmental costs in our model and project what the impact on the Total Cost of Ownership would be with optimal ordering strategies.
In this article, we will start by taking a generic look at environmental costs accounting and pricing methods, followed by a discussion on the challenges standing in the way of a wider scale adoption of these parameters; finally, we will consider what influence GenLots could bring there with a concrete example. If you are interested in the details of the methods used, please consider the separate article here.
Before diving in, we would like to thank our former master thesis intern, Andrés Engels for conducting the experiment as part of his research at GenLots, gathering information about carbon pricing and accounting, estimating clients’ readiness, and directing the analysis.
1. Carbon emissions and supply chain
Supply chains are responsible for a large portion of global carbon emissions. Fuel and electricity consumed during transport, maintenance and handling of goods result in high CO2e emissions being released into the atmosphere. This is why companies must account for them and keep track of their activities to report their environmental impact, but how do they perform this analysis?
1. How are supply-chain-induced CO2 emissions assessed?
When talking about carbon emissions, we refer to the amount of carbon dioxide (CO2) emissions associated with all the activities of a person or other entity. When it comes to supply chain, it encompasses direct emissions, such as those that result from fossil-fuel combustion in manufacturing, heating, and transportation, as well as indirect emissions, required to produce the electricity associated with goods and services consumed.
Along this article, we will often mention the term CO2e (e for equivalent) which is a common unit of measure used to compare the emissions from various greenhouse gases on the basis of their global-warming potential (GWP), by converting amounts of other gases to the equivalent amount of carbon dioxide with the same global warming potential.
Over the past decades, multinational corporations have begun looking at emissions resulting from their own operations such as on-site gas consumption. To measure the environmental impact they have, companies go through the process of carbon accounting which refers to the processes to measure the amount of carbon emissions emitted by an entity. By multiplying the resulting mass of CO2e mass obtained by the internal carbon price, we obtain the environmental costs linked to one operation.
According to the definition of The World Bank, the carbon price is an instrument that captures the external costs of greenhouse gas (GHG) emissions, such as methane, nitrous oxide, or chlorofluorocarbons (CFCs) – the costs of emissions that the public pays for, such as damage to crops, health care costs from heatwaves and droughts, and loss of property from flooding and sea-level rise – and ties them to their sources through a price, usually in the form of a price on the carbon dioxide (CO2) emitted. The concept of carbon footprint often referred to in this context, also often includes the emissions of other greenhouse gases.
Companies have started to try to optimize those costs directly linked to their operations but a large amount of indirect emissions are also related to these companies and are not consistently considered.
2. Emissions’ scopes when doing carbon accounting
The Greenhouse Gas Protocol has established a “comprehensive global standardized framework to measure and manage greenhouse gas (GHG) emissions” across the private and public sectors (Greenhouse Gas Protocol, 2020). It identifies three different categories of GHG emissions based on whether these emissions result from the direct or indirect activities of an organization.
- Scope 1 emissions are all direct emissions from the activities of an organization or under their control. Including fuel combustion on-site such as gas boilers, fleet vehicles, and air-conditioning leaks.
- Scope 2 emissions correspond to indirect emissions from electricity purchased and used by the organization. Emissions are created during the production of the energy and eventually used by the organization.
- Scope 3 emissions regroup all other indirect emissions from activities of the organization, occurring from sources that they do not own or control. These are usually the greatest share of the carbon footprint, covering emissions associated with business travel, procurement, waste, and water.
All in all, carbon emissions are well defined, there are some established methods to account for them and attribute a price to them. What one may ask is, what is the problem?
2. Why are carbon emissions accounting and pricing more complicated than it seems?
As we have seen with carbon accounting emissions scopes and carbon pricing definitions, it may seem like carbon emission costs are well defined for use by large industrial corporations. However, it is not completely the case.
1. Lack of clarity around carbon accounting and pricing
Firstly, for carbon pricing, it is normally enforced through a carbon tax or an Emissions Trading System (ETS) however there is no consensus or unified price across countries, ETS, industry or company for one tonne of CO2e emissions. Many companies use the carbon price they face in mandatory initiatives as a basis for their internal carbon price. Some companies adopt a range of carbon prices internally to take into account different prices across jurisdictions and/or to factor in future increases in mandatory carbon prices.
According to the World Bank, as of April 2020, 61 carbon pricing initiatives taking the form of a carbon tax or an Emissions Trading System have been implemented or are scheduled for implementation. Across these initiatives, prices range from as low as US$0.07/tCO2e in Poland to as high as US$119.43/tCO2e in Sweden, with the bulk of carbon prices set between US$5 and US$25 (The World Bank, 2020).
Secondly, scope 1 emissions are relatively straightforward to account for, as they happen under the control of corporations; however, scope 3 represents the majority of emissions as transportation and other supply chain related activities are often taken care of by suppliers or third-party logistics providers (3PLs). Even though raw material ordering decisions from the production company impact the emissions, those are accounted in the suppliers “CO2” balance sheet. This creates an agency problem which is tricky to resolve with today’s methods, meaning that it is extremely difficult to keep track of all emissions linked to one company as the lack of specific and granular carbon accounting logistics data is one of the most critical factors.
2. Improvements in data readiness
Interesting to know that initiatives in terms of software-based solutions are on the way. SAP recently announced to be working with multiple leading companies to launch a new program called Climate 21 to help them understand, monitor and optimize the carbon emissions related to the supply chain. For the moment, there is no information on when this new development will be available for clients but it shows that more data will become available for companies making it possible to imagine further optimization possibilities.
It seems challenging to impute all environmental costs related to one entity only and correctly price them accordingly. With all those limits, how is GenLots able to help?
3. Carbon emissions and order planning optimization
1. How to integrate carbon emission costs in order planning
As each step of the value chain process is responsible for a certain amount of carbon emissions, a portion of the environmental impact can be traced back to inbound material purchasing. For example, if a material is purchased from a supplier, fuel and electricity are consumed during transportation and for warehousing.
If we are effectively able to estimate the mass of carbon emissions emitted there, then it becomes easy to integrate carbon accounting as a cost parameter constraint in our algorithm using the Total Cost of Ownership (TCO) equation. What is needed at that stage is the corresponding carbon price to apply
- Transportation emissions will be associated with the order costs
- Warehousing emissions will be associated with the inventory holding costs
As inbound materials purchasing experts, our question was: even though it is interesting to keep track of emissions related to these segments of supply chain activity, can it achieve a meaningful impact on the bottom line and weigh sufficiently to guide strategic decision?
We have looked at transport and warehousing emissions in detail and the different methodologies are explained in a separate article.
2. How can order planning help?
Every order planning decision involves trading off between cost factors, and accounting for carbon emissions on this level could become relevant to support supply chain strategic decisions like:
- Producing in plant A or plant B
- Using transportation provider A or B
- Using transportation mode A or B
- Consolidating orders A and B in the same truck
We are looking right now at how we can decrease the number of shipments through increased payload or how we can connect our inbound and outbound flows.
Antoine de Saint-Affrique, CEO Barry Callebault, Forever Chocolate Progress Report 2019/20
As an illustration of this, carbon emissions could encourage a planner to consolidate two orders into one to only have once a full truck instead of two half-full trucks.
Leveraging this model, companies could deduce the threshold carbon price resulting in an alteration of business decisions. That would also be a way to rationalize the environmental efforts made by corporations. As there is no consensus for carbon pricing, setting an undervalued carbon price, spending time and resources accounting for carbon emissions would lead to inefficient efforts to try to change the negative impact multinational companies can have on the environment.
We did the experiment and tried to integrate environmental cost in one real-life example we faced. Details about what methods are available and used can be found here.
- The standard order cost is set at $900
- The standard carrying rate is set at 16.5%
- Using $5, $25 and $100 for carbon pricing
- Average order size: 42’308 kg = 42.31 tonnes
We tested four different transportation scenarios:
- Shanghai to Geneva by plane
- Shanghai to Geneva by ship
- Aubonne to Vevey by truck
- Aubonne to Vevey by refrigerated truck
We used two different warehousing scenarios:
- Ambient temperature
a) Transportation Costs
MODE OF TRANSPORT
|GHG Plane (tCO2e)||310.483||–||–||–|
|GHG Ship (tCO2e)||–||4.320||–||–|
|GHG Truck (tCO2e)||0.098*||1.200||0.180||0.150|
|GHG TOTAL (tCO2e)||310.581||5.520||0.180||0.150|
|Carbon Price||Order cost change|
*We have truck emissions also for plane transport as the goods must be transported from the airport to the warehouse.
We observed that the mass of the order makes a very large difference in determining whether the GHG emissions will influence the TCO or not. In the case of air freight, GHG emissions were consistently 50 times greater than those resulting from shipping, despite the fact that nearly twice as much distance was covered by ship in the case of a trip from Shanghai to Geneva. At a carbon price of $5/tCO2e, the $1,553 cost of air freighting emissions already represented nearly 200% of the original order cost of $900.
In the case of shipping, larger carbon prices would be necessary to influence the TCO, while in the case of trucking long distances and heavy materials are the only way influencing the TCO. Having a refrigerated truck only resulted in an approximately 20% increase in GHG emissions in comparison to a truck under normal conditions.
As you can see, for transportation costs, it is difficult to really make a difference unless air shipping is considered, or trucking distances are very large or a high carbon price is used. In some cases however, base parameters used by GenLots to compute the optimal order plan are sufficiently impacted to change the results.
b) Warehousing Costs
The example material selected has the following properties:
- Products per $100: 35.21
- Current carrying cost: 16,50%
|Warehouse Scenario||Emission Emission factor||GHG Emissions per $100 (tCO2e)||Carrying cost change|
The GHG emissions per $100 (tCO2e) are computed according to the estimates of GHG Emissions for logistics sites in Europe from Fraunhofer IML study (Dobers & Rüdiger, 2019). By dividing $100 by the material price we obtain the number of products per $100, in this case, $35.21. Multiplying this number by the emission factor corresponding to the warehouse scenario and then converting it to tonnes we obtain the GHG emissions per $100 in tCO2e. We then add this cost to the carrying cost percentage giving us the carrying rate including carbon emissions.
In the end, transport emissions are only relevant when air freight can be avoided or when orders can be consolidated into fewer trucks. Air freight is often used when a material is needed in a hurry. Setting the right safety stocks and a good S&OP process would help to avoid such situations and are therefore the biggest lever to reduce emissions at the moment.
Emissions resulting from warehousing activities are not relevant in this experiment but we can assume that more data is needed to draw deeper conclusions.
As supply chain is responsible for large amounts of carbon emissions, new regulations and measures have been set up to regulate associated environmental costs.
However, if the methods of carbon accounting and pricing have been well established, their systematic use isn’t. There is still a clear lack of consensus and standards around those concepts, making it difficult to integrate them in cost reduction strategies. Progress is needed to unify regulations and pricing as well as developing data collection to correctly account for the real mass of CO2e emissions resulting from companies’ own activities and networks. Scope 3 emissions such as waste, water, travel make up the bulk of supply chain emissions. Their accountability is difficut as they are induced by production companies, but recorded by suppliers or third-party logistics providers.
For the planning of inbound material orders, associated emission costs could be factored in through GenLots. Using concrete examples, it appears that the influence is not clear: a high carbon price is needed to really make a difference on transport emissions. Warehousing environmental costs have a next to no impact on the decision-making processes; still, considering them is important as companies will need to report them and some particular storage conditions could increase the related emission factor.
There are actions companies can take to reduce emissions, the highest impact according to our studies are consolidating shipments, avoiding air freight and scrap. Which can be done through improved planning and setting service-level related parameters correctly.
We are only at the very beginnings of seeing emissions measures being considered for business decisions. Awareness grows and software solutions emerge, progressively easing data tracking and processing to effectively integrate those costs.
If your company is considering integrating environmental costs and accounting for order planning, please reach out to us.
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