1 PROFIT OR PROVENANCE OR BOTH? By Rear Admiral Chris Parry CBE Statement of intent Companies and institutions are familiar with the frailties and risks inherent in supply chains, whether caused by natural disasters or by the organizational or business failures of suppliers. But until recently, companies and their customers demonstrated a marked indifference to their supply chains, preferring to seek assurance about delivery, on time and to price, rather than about the ways and means by which they were obtained. This paper examines why it is not enough for firms to determine the provenance of the companies and institutional entities with whom they are dealing; they also need to establish the credentials and provenance of the people in the chain.
2 About the author Chris Parry spent 35 years in the Royal Navy as a Seaman and as a Fleet Air Arm officer during which he commanded HMS GLOUCESTER, the Maritime Warfare Centre and HMS FEARLESS. Along with regular operational tours in Northern Ireland, the Gulf and the Falklands, he was mentioned in despatches during the Falklands War and received the 1983 Prince Philip Helicopter Rescue Award from the Guild of Air Pilots and Air Navigators. From 2001, as a Commodore, he was Director Operational Capability in the Ministry of Defence and then, from , commanded the UK s Amphibious Task Group. As a Rear Admiral from 2005, he formed the Development, Concepts and Doctrine Centre (DCDC) and spent 3 years as its Director General. Here, he led and supervised the complete revision of all Armed Forces thinking and operation practices to reflect modern and emerging strategic conditions. In the Ministry of Defence and in the academic world, he has written extensively on strategic, policy and transformational issues and contributed to all Defence options, cost studies and reviews since He is the former Chair of the UK s Marine Management Organisation. Nowadays, he works as a non-executive director, consultant, writer and lecturer, specializing in briefing major institutions, leading companies and banks about strategic forecasting, leadership and risk, as well as on security and geopolitical themes. He is a Fellow of the Royal United Services Institute, the International Institute for Strategic Studies and the Chartered Management Institute and is a member of the Institute of Directors and the policy board of the Oxford Research Group. He is also President of a Rugby League team. 2 Profit or provenance or both? MAY 2013
3 CONTENTS INTRODUCTION... 4 PROVENANCE... 4 THE FINANCIAL SECTOR... 5 THE WAY AHEAD... 5 SOME LESSONS... 6 FINALLY Profit or provenance or both? MAY 2013
4 INTRODUCTION Companies and institutions are familiar with the frailties and risks inherent in supply chains, whether caused by natural disasters, such as that which overwhelmed the Fukushima nuclear plant in March 2011, or by the organizational or business failures of suppliers. The commercial fall-out from the Fukushima event (leading to substantial loss of profit for several major companies) exposed the complex, tenuous and opaque links that made up the chains between producers, manufacturers and consumers. Similarly, the discovery of horsemeat in processed food advertised as beef-based products on sale in Europe prompted widespread public outrage and a major forensic and procedural examination of the sources of products and their subsequent route to market. In both cases, the opaqueness of supply and transactional chains concealed not only systemic and operational risks, but also the considerable potential for reputational damage, brand erosion and loss of market share. Until recently, companies and their customers demonstrated a marked indifference to their supply chains, preferring to seek assurance about delivery, on time and to price, rather than about the ways and means by which they were obtained. In the face of aggressive cost-cutting and price differentiation, very few questions were asked about the origins and supply paths of their commodities and goods, or about the risks and lack of accountability inherent in increasingly depersonalized and remote transactions. PROVENANCE Owing to a succession of high-profile scandals, the complex, hidden interrelationships that form the global trading system are no longer simply theoretical models. Unless they already have full transparency, companies are obliged, more than ever, to consider where products in their supply and transactional chains originate and to identify and evaluate the various intermediaries through which products and services pass. End-users now need to establish and track the provenance of commodities, components and other goods and services if they are to earn consumer trust, meet regulatory requirements and demonstrate social responsibility. The urgency and importance of this requirement to achieve end-to-end transparency are heightened by aggressive media attention and the real-time dissemination of information through social media and the internet. Recently, several high profile brands have found to their reputational cost the penalties associated with failure to examine the ethical and environmental credentials of their suppliers and their suppliers suppliers, even though they might rightly have suspected that their customers were largely indifferent to these concerns at the point of purchase. The need to deal with the issue of provenance does not relate simply to internal mechanisms and culture, but also to vigilance with regard to externalities. The widespread counterfeiting of products, such as clothing, fashion items, aircraft and motor components and electronic goods, as well as the adulteration of seemingly legitimate products, poses difficult reputational and competitive challenges for leading brands and their suppliers. Despite the fact that few people can tell the difference between a fake Rolex watch or a counterfeit Moschino handbag and the legitimate items, safety, authenticity and provenance in the real products are important to consumers. The difference between a genuine and counterfeit, low-quality aircraft component 4 Profit or provenance or both? MAY 2013
5 is, however, significant. The illicit trade in diamonds and other precious materials through criminal and irregular channels and acquired from sources that are considered politically (rogue regimes) or ethically (child labor or exploitative conditions) compromised, adds to the problems of major companies sourcing their components through diffuse supply chains. THE FINANCIAL SECTOR The opaqueness, complexity and existence of illicit activity associated with product supply chains are paralleled in the financial world and are characterized by the roles of agency capitalism, a host of complicated algorithmdriven derivatives and money-laundering. In order to restore confidence and trust, cash, credit and other financial assets need to assert their end-to-end provenance in the face of tightening regulatory control and public expectations after the systemic collapse in trust after the financial crash of Since then, it has been apparent that a generalized reputation for cavalier risk-taking and sharp practice, coupled with an inability to identify the precise points of failure, affects the ability of banks and financial institutions not only to regain public trust, but also to secure talented individuals, attract investment and appear as reliable, legitimate business partners. This stems in part from a continuing impression of smoke and mirrors in the hinterland of financial services. Both governments and the public have become wary with regard to the provenance, transparency and origins of financial products, investment vehicles and cash flows. They are suspicious that those in financial institutions and trading positions do not fully understand the complexities and risks of their supply and transactional chains and doubt that there is sufficient knowledge of the precise ownership or provenance of the assets under management. Governments and regulators, in particular, are demanding a high level of visibility and accountability in their attempts to counter money-laundering, tax evasion, corruption and bribery. Under both the US Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act, it is now essential that institutions bring their supply chains and transactional networks, as far as commercial confidentiality will allow, into their traditional compliance programs. THE WAY AHEAD These factors mean that companies and institutions will in future be held to account and penalized for the faults and failures of their suppliers and partners in the transactional chain. Ignorance, willful or otherwise, is no longer a legitimate or credible excuse, either in the commercial or financial sectors. It is becoming increasingly straightforward to label, validate and track commodities, produce and consumer goods. Technology allows sophisticated electronic tagging, identification and assurance mechanisms throughout the journey from origin to customer, sustaining an unbroken chain of provenance. Another solution involves keeping the supply chain as simple as possible. Morrisons, the UK supermarket group, sources most of its own-label meat in the UK and processes it at its own network of slaughterhouses; it consequently fared well during the horsemeat scandal. Similarly, private banks are more easily able to assure themselves of the origins and purposes of the assets with which they deal and are readily compliant, and, nowadays, regarded as such. These methods are at first glance less applicable to the more complex service and 5 Profit or provenance or both? MAY 2013
6 investment sectors, where assurance and trust rely so much more on the provenance of people, the human elements in the chain. Nevertheless, even for more complicated supply and transactional chains, modern communications and internet technologies have massively improved the volume and immediate accessibility of information flows, with comprehensive data bases and analytical tools allowing progressively greater visibility of commercial interdependencies, transfer points and personal interconnections. In this way, recognizing the competitive and reputational advantage to be gained, major conglomerates are making a virtue out of declaring not only their suppliers, but also the networks that branch out to their suppliers suppliers, to ensure legal, safety and ethical compliance across the whole supply chain. The UK Bribery Act Consultation Guidance is explicit and relevant here. It highlights due diligence of transactional networks as a key component of its anti-bribery and anticorruption best practices a commercial organization needs to have, due diligence policies and procedures which cover all parties to a business relationship, including the organization s supply chain, agents and intermediaries, all forms of joint venture and similar relationships and all markets in which the commercial organization does business. This guidance confirms that it is not enough for firms to determine the provenance of the companies and institutional entities with whom they are dealing; they also need to establish the credentials and provenance of the people in the chain. Risk assessments would have to include whether individuals or other organizations involved in key decisions and transactions had a reputation for bribery and whether anyone associated with them is being investigated, prosecuted, or has been convicted or debarred for illicit practices. Consideration would also be needed about the risks associated with politically exposed persons where the proposed business relationship involves, or is linked to, a prominent public office holder or person of influence. SOME LESSONS Some important lessons are apparent from the succession of supply and transactional chain failures in recent years. Firstly, it is essential to gain assurance about the key people in the transactional chain, at least those in a position to affect the integrity of the process, or the provenance of a product. It is not sufficient to rely on remote testing, selfassessment or check-lists. Secondly, it is doubtful whether simple adherence to and compliance with - the law will in future be sufficient to secure reputational advantage in relation to the supply of goods or services or in providing assurance about partnerships and assets. There is increasing public intolerance of practices that are technically legal, but not considered socially and ethically - legitimate by the average man and woman on the street. This aspect has a critical importance for a company s brand and reputation in a globalized, interconnected market-place, where social media allows peer groups and communities of interest to share views and pillory behaviors. Transactions and business practices will need to be seen to be legitimate and reasonable, not just at the point of delivery, but as an expression of corporate culture. Thirdly, trust is generally most justified in those areas where people and institutions have something to lose rather than something to gain an aspect has significant implications about how risk is identified and assessed in complex supply and business chains. 6 Profit or provenance or both? MAY 2013
7 FINALLY There is a significant body of analytical and anecdotal evidence to show that those companies and institutions which take active measures to ensure the integrity and provenance of their products and services will be rewarded in terms of competitive and reputational advantage. When this philosophy extends to their wider business or transactional community, companies and institutions are likely to derive substantial competitive advantage and reputational resilience, at a time when most companies would consider the improvement of supply and transactional chain integrity as just another overhead. Those who can demonstrate a culture and commitment that go beyond compliance are likely to thrive. It must be accepted that no control mechanism or regulation is a guarantee against malpractice and the ingenuity of people to discover ways to beat the system. As a former Speaker of the US House of Representatives, Thomas B Reed, said in 1886, One of the greatest delusions in the world is the hope that the evils in this world are to be cured by legislation. In the end, as we have seen, possession of an assured, secure supply or transactional chain is the product of corporate responsibility, constant vigilance and culture. 7 Profit or provenance or both? MAY 2013
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