Risk Assessment with Regard to Sustainability

If business people discuss about risk assessments, it becomes clear that most of their arguments are based on financial matters. This was confirmed by Knox & Maklan (2004), who highlighted in their case study that “in most of our respondent companies, risk is managed separately by the finance department and is not fully integrated with CSR. Each respondent confirmed that finance undertakes formal risk assessment and that neither the process nor the management actions arising from it are managed within the CSR function” (Knox & Maklan, 2004). In this sense, Porter & Kramer (2011) clearly emphasised that an enterprise needs to worry about non-financial risks too. A company’s value is not only counted in pecuniary terms but also in more intangible assets, such as the company’s reputation or how it implemented the CSR issues. Thomas (2006) explained that non-financial risk assessments may force managers to incorporate diverse uncertainty factors into their decision making processes. In the same logic, Porter (1985) and Porter & van der Linde (1995), explain that such a company can improve its overall competitiveness through the consideration of societal matters.

Morhardt et al. (2002) elucidated the importance for companies to get involved with non- financial risk management while accepting sustainability being based on its three inherent pillars. Their arguments were, beyond others, compliance with the regulatory requirements which may become stricter in future, the compliance with the industry environmental codes, or the promotion of stakeholder relations. In addition, they accentuated the benefits resulting from adhering to societal norms, and the competitive advantages constituting the consequences from the enterprises’ external perceived environmental endeavours. The non-financial management may consequently serve as a base to handle environmental and societal risks. Effectively, it may be used to assess eventual impacts during the execution of the processes. In addition, it may assist companies to benefit from new occasions when identifying eventual non-financial risks, leading to enhanced sustainability and profitability (Bernstein, 1996; Porter, 1985). According to Carter & Jennings (2004), irresponsible supplier behaviour of any kind can be transmitted to the buying company, causing negative advertisement, as well as reputational damage and statutory obligations. In fact, Cousins et al. (2004) and Russo & Fouts (1997) identified several damage potential of unfavourable sustainability incidents, as for instance commitments for damage, non-compliance fines, negative media exposure, pressure group imminences, or the loss of corporate reputation.

Nowadays, sustainability becomes more and more connected to the SCRM discourse.

Most of these works, as for example Campbell & Scott (2013), Christopher et al (2011) and Matten (1995), bear on the environmental pillar, neglecting the societal issues. On the other hand, Anderson (2006) for example, assembled chemically harmful substances, decreasing ecosystem services, boycott risks, and social justice risks and classified them into the category of sustainability risks. Since we defined sustainability being based on the Triple Bottom Line (TBL) and on the time factor, we cannot agree on this classification. In our point of view, the chemically harmful substances are a matter of the environmental or the working environment pillar, depending on the substances’ related risks. The decreasing ecosystem services needs to be rated as an environmental risk, whereas the boycott risks can either be allocated to the economical, or the ethical issues matters, depending once again on the type of risk analysed.

The social justice risks belong clearly to the ethical pillar. In short, we consider that the different risks cannot be allocated in one only category.

Companies usually have tools to deal in an effective way with most of the traditional financial risks in a business operation (Bischoff, 2008). For this reason, Wong (2014) highlighted the significance in developing environmental and social risk management so that corporate sustainability may be increased. In his article, he highlighted the fact that environmental and social concerns are usually viewed as intangible enigma which needs to be articulated and managed in an accurate manner to reach the goal of corporate sustainability. In addition, just like Porter (1985), Porter and Van der Linde (1995), or Morhardt et al. (2002), the need of a systematic and strategic non-financial risk management system needed to achieve the overarching goal of improving the company’s overall competitiveness by moving closer to sustainable development, has been discussed in Wong’s (2014) paper. He also admitted that risk assessment in sustainability matters has become extremely complex and needs to balance several conditions, perspectives, and variables across an enterprise. The author argues that “integrating environmental and social risks is critical to the effective management of a company’s real risks, and to improved resource allocation for enhancing corporate sustainability. This demands the quantification of environmental and social risks in an atypical manner” (Wong, 2014).While we admit this statement, we do not agree on the idea that this quantification would require to identify, measure, and monetise the risks just as traditional ones, i.e. commodity prices and credit risks, as suggested by Wong (2014).

According to Yilmaz & Flouris (2010), the companies will not be able to determine the time frames or the anticipations for managing sustainability, but shareholders, federal and state agencies, and consumers will promote its evolution. In their point of view, sustainability is not to be seen as a reactive response to environmental or regulatory threats. They therefore developed the Enterprise Sustainability Risk Management framework, based on the TBL concept. They indicate that this framework can protect, create, and enhance business value through measurement and management of sustainability threats and opportunities, as well as helping businesses to effectively respond to the growing expectancy of the corporate stakeholders via the guidance to managers on how to set up a holistic and systematic sustainability risk management process. The process needs to generate the risk indicators, sources, and objectives and must report the systems needed to ensure effective handling of sustainability risks and enhanced overall organisational performance and values. Their Enterprise Sustainability Risk Management Framework is depicted in Figure 48.

Figure 48 – Enterprise Sustainability Risk Management Framework by (Yilmaz & Flouris, 2010)

Yilmaz and Flouris (2010) proclaim that integrating sustainability considerations into existing systems and processes would be the most effective way to embed sustainability into corporate business, unlike creating new systems and processes. We agree on their statement, revealing that “Current sustainability risks are considerably different from old risks. For this reason, more holistic and enterprise-wide approach needs to managing corporate sustainability risks” (Yilmaz & Flouris, 2010). In addition, they suggest “to go beyond compliance and legal liabilities, businesses have to integrate risk management based philosophy and culture into core business functions of the company” (Yilmaz & Flouris, 2010). We consent to their idea that sustainability management will only be achieved if managers recognise the resulting values. For this reason, cultural change within the business needs to be attained, so that sustainability management based benefits may be provided.

Even though this model takes into account the three pillars of sustainability, we criticise that it is, nevertheless, only taking into account the financial perspective. Indeed, the given formula:

is only related to the monetary costs but neglects the non-financial risks which may occur.

As stated before, we consider that a risk may occur in various forms, i.e. financial and non- financial.

Foerstl et al. (2010) also used the term sustainability in the sense of the TBL and also discussed the competitive advantage companies could gain through the correct use of the CSR concept within the purchasing and supply management. They analysed how companies address the challenge of meeting their beneficiaries’ sustainability requirements in an efficient manner,

Financial Performance

– Risk Cost (Environmental Performance) 𝑇𝐵𝐿 =

– Risk Costs (Societal Justice)

sustainability risk assessment and the consequent supplier selection and development, which helps to successfully handle a sustainable portfolio of suppliers. In addition, they suggest that there are two types of positive performance outcomes resulting from sustainable purchasing supplier management, namely (1) a more profound mitigation of corporate reputational risk, and (2) increased operational performance. They assessed the probability of occurrence of a negative incident related to sustainability on a selection of only four indicators, scilicet (1) physical properties of the supplied product, (2) the related product process, (3) the supplier’s geographic position, and (4) the supplier’s past performance records. The assessment of those KPIs has mainly been carried out on a qualitative basis. In a next step, depending on the kind of the element analysed or service procured, the assessment KPIs have been assigned different weights. We regret that Foerstl et al. (2010) did not give more detailed information about the indicators assessment and weightings. One of their conclusions given is that external responsiveness positively affects sustainability risk identification, assessment and alleviation strategies, which on the other hand, positively affect risk and operational performance. However, we agree on their accentuation, declaring that their findings may be particularly appropriate to the chemical industry. Furthermore, they criticise that “one may doubt whether the purchasing volume is a reliable indicator to approximate corporate reputational damage caused if suppliers do not adhere to sustainability standards” (Foerstl et al., 2010). We agree on Foerstl et al.’s (2010) suggestion that further research should be elaborated and tested in order to find out whether the sustainability risk assessment method presented in their work is valuable in different industry sectors.

Another model which has been elaborated recently is the Risk, Resilience, and Resource Management (TripleRM) Sustainability Model introduced by Krishnaswamy (2015). The TripleRM sustainability model is based on the FMEA and the Sustainability Framework for Risk Analysis models, expanding these concepts by including resiliency and resource management. The TripleRM Sustainability Model’s goals are threefold: It intends (1) to help identifying, assessing and mitigating the risk of failure of infrastructure systems, (2) to prioritise projects via a comparative analysis of quantified ex-ante and ex- post risk applications of relieving sustainable solutions, and (3) to help distributing the resources – and all this in regard to the TBL. However, the model is also based on strong assumptions stating that first, corrective measures will always help to reduce the risks, second, preventive actions on a particular system will always help to reduce the risk, and third, that any remedial measure will never impact any other system in an negative way.

In other words, the hypothesis state that every action taken will always have a positive impact on the referred system, and that there is no interaction between the different systems. We cannot agree on those premises, knowing that the sustainability issues are strongly interrelated.

In summary, we agree with Yilmaz and Flouris’ (2010) declaring that: “Integration and a holistic approach are the key concepts for both a successful business and sustainability”. Even though the sustainability matters gain in importance, the monetary issues still prevail. Nevertheless, we consider that an enterprise’s overall performance, hence the pecuniary as well as the nonmonetary one, may be enhanced if sustainability risks are mitigated. In addition, we remain convinced that today’s needs will deepen and consequently alter over time. The logical consequence is that the risks will also change due to the different sustainability systems’ evaluations. For this reason, companies must

render the risk calculation model too simplistic. To set up such a model, we need to analyse existing risk assessment methodologies, and to assembly them in a pertinent way.

Managers need to be aware of the fact that risks can appear in many different forms. It is precisely for this reason that they cannot assess and evaluate every potential risk but need to prioritise them. In addition, most indicators used to measure the SC’s performance are interrelated, which may entail risks which cannot be identified at the first glance. To address this issue, companies classify the potential risks and try to analyse them in terms of categories.

In this work, we will adopt the idea of classifying the different risks, but adjudged the Customers’ classification being inadequate for our purpose of investigating the risks in terms of sustainability. This will be explained in detail in section 3.4.2.

There is a myriad of methodologies accepted of how a risk needs to be evaluated and classified, but there no panacea to be used to assess every possible risk. The methodologies aimed to quantify and assess specific risks depend not only on the latter’s type but also on the data the company has access to, to provide the required calculations. Those data may be hard to monitor because of the risk matters’ level of abstraction.