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Supply Chain Act: Importance & implementation for purchasing
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What is the Supply Chain Act?
The Supply Chain Act, officially known as the "Lieferkettensorgfaltspflichtengesetz" (LkSG), is a German law that obliges companies to comply with due diligence obligations to protect human rights and environmental standards along their entire supply chain. It aims to prevent human rights violations such as child labor, forced labor or discrimination as well as environmental damage caused by the business activities of German companies and their global suppliers.
Contents
Core elements of the Supply Chain Act
The Supply Chain Act is based on several core elements that companies must establish and demonstrate:
1. risk management
Companies must set up an appropriate and effective risk management system to identify and assess human rights and environmental risks in their supply chain. This includes implementing clear lines of responsibility, for example by appointing a human rights officer.
2. risk analysis
Affected companies are obliged to carry out a regular risk analysis in order to identify human rights and environmental risks in their own business activities and those of their direct and indirect suppliers. The analysis must be carried out at least once a year and on an ad hoc basis.
3. preventive measures
Based on the risk analysis, companies must implement appropriate preventive measures to avoid or minimize identified risks. These include, among other things, the establishment of a declaration of principles on respect for human rights, the development of suitable procurement strategies and the integration of human rights aspects into supplier contracts.
4. remedial measures
If breaches or risks are identified, appropriate remedial action must be taken immediately to end or minimize them. Depending on the severity of the breach, this can range from demands for rectification to the termination of business relationships.
5. complaints procedure
Companies must set up an effective complaints procedure that enables those affected to report risks or violations. The procedure must be accessible, transparent and fair for those potentially affected.
6. documentation and reporting obligations
Affected companies must document their due diligence obligations and publish an annual report on the fulfillment of these obligations6. The report must be made publicly available on the company website no later than four months after the end of the financial year for a period of seven years.
Effects on procurement
The Supply Chain Act has far-reaching implications for the procurement function in companies, as purchasing plays a key role in implementing and complying with the legal requirements at the interface with suppliers:
Realignment of supplier management
Purchasing must fundamentally revise its supplier management in order to systematically record and assess human rights and environmental risks. This includes
- The implementation of extended supplier evaluation systems that take social and environmental criteria into account in addition to economic criteria
- The development and implementation of supplier audits to verify compliance with human rights and environmental standards
- Regular monitoring of high-risk suppliers and regions
Adaptation of contracts and purchasing conditions
Existing supplier contracts must be reviewed and adapted to integrate human rights and environmental aspects. This includes:
- The inclusion of human rights and environmental clauses in supplier contracts
- Establishing codes of conduct for suppliers
- The definition of sanction mechanisms for violations
Reassessment of procurement strategies
Traditional procurement strategies, which are mainly focused on costs and efficiency, need to be expanded to include sustainability aspects. This can mean
- Diversification of the supplier base to minimize risk
- The development of local procurement structures for better control
- The integration of human rights and environmental risks in make-or-buy decisions
Increased complexity and resource requirements
The implementation of the Supply Chain Act leads to increased complexity in purchasing and requires additional resources:
- Need for specialized professionals with expertise in human rights and environmental issues
- Need for training and further education for purchasing staff
- Additional time and financial expenditure for risk analyses and monitoring measures
Affectedness as a supplier
Companies that are not directly covered by the Supply Chain Act may also be affected as suppliers:
Direct vs. indirect suppliers
The law distinguishes between direct suppliers (direct contractual partners) and indirect suppliers (all other links in the supply chain). Stricter due diligence obligations apply to direct suppliers than to indirect suppliers, which is why the status of the supplier in relation to the obligated company is decisive.
Requirements for suppliers
As a supplier to a company affected by the Supply Chain Act, you may be subject to the following requirements:
- Implementation of self-assessments on compliance with human rights and environmental standards
- Documentation and proof of own due diligence processes
- Participation in audits and control procedures of the customer
- Passing on requirements to your own suppliers
Cascade effect through the supply chain
A key effect of the Supply Chain Act is the so-called cascade effect, in which due diligence obligations are passed on through the entire supply chain. This means that even small and medium-sized companies that are not directly affected by the law must indirectly fulfill the requirements as suppliers.
Sanctions and enforcement
Violations of the Supply Chain Act can result in considerable sanctions:
- Finesand financial consequences:Violations of the due diligence obligations can be punished with fines of up to 500,000 euros. For companies with an annual turnover of more than 400 million euros, the fine can even amount to up to 2 percent of global annual turnover.
- Exclusion from public contracts: Companies that violate the Supply Chain Act can be excluded from the award of public contracts for a period of up to three years. In view of the considerable volume of public contracts, this can lead to significant economic losses.
- Monitoring by BAFA: The Federal Office of Economics and Export Control (BAFA) is responsible for monitoring and enforcing the Supply Chain Act. BAFA can carry out inspections, request documents and, if necessary, issue orders to ensure compliance with the legal requirements.
Example: Implementation of risk-based supplier management
A medium-sized company in the electronics industry with 1,200 employees had to implement the requirements of the Supply Chain Act by January 1, 2024. The company sources components from more than 300 direct suppliers from 27 countries, including high-risk regions such as parts of Asia and Africa.
Purchasing developed a three-stage risk-based supplier management system:
- Risk categorization: All suppliers were classified into three risk categories based on country risks (based on the Human Rights Risk Index) and product-specific risks (e.g. use of critical raw materials): high, medium and low. The analysis showed that 15% of suppliers fell into the high risk category, 35% into the medium risk category and 50% into the low risk category.
- Differentiated measures: Different measures were implemented depending on the risk category:
- High-risk suppliers: Mandatory on-site audits, monthly monitoring, mandatory training courses
- Medium risk: Annual self-assessments, random audits, training courses
- Low risk: Standardized codes of conduct, self-declarations
- Continuous improvement: Specific improvement plans were agreed with all high-risk suppliers. Implementation was monitored through quarterly reviews. The business relationship with two suppliers who did not show sufficient improvement despite repeated requests was terminated following a structured escalation process.
The quantitative results after one year:
- 100% of high-risk suppliers were audited
- 78% of the identified risks were successfully addressed
- The average compliance rate rose from 68% to 87%
- The implementation costs amounted to around EUR 350,000, mainly for additional staff, training and audits
Digitalization in supply chain monitoring
The implementation of the Supply Chain Act presents companies with considerable operational challenges that can hardly be overcome without the use of digital technologies:
Need for digital solutions
The complexity of modern global supply chains with hundreds or thousands of suppliers makes manual monitoring and risk assessment almost impossible. Digital systems enable the efficient collection, analysis and documentation of the necessary data and help to reduce the high administrative workload.
Integrated SRM systems
Modern supplier relationship management (SRM) systems can be extended to meet the specific requirements of the Supply Chain Act:
- Integration of human rights and environmental criteria in supplier assessments
- Automated risk assessments based on country, product and supplier data
- Workflow management for audits, corrective measures and escalation processes
- Central documentation of all due diligence processes to fulfill the obligation to provide evidence
Blockchain and traceability
Innovative technologies such as blockchain can revolutionize transparency and traceability in complex supply chains:
- Seamless documentation of all links in the supply chain right back to the source
- Forgery-proof proof of origin and production conditions
- Smart contracts for automated verification of compliance requirements
AI-supported risk analysis
Artificial intelligence and machine learning can support the identification and assessment of risks:
- Automatic evaluation of large amounts of data from various sources
- Recognition of risk patterns and trends
- Forecast of potential future risks
The challenges of digitalization
The digitalization of supply chain monitoring also brings its own challenges:
- High investment costs, especially for medium-sized companies
- Necessity of integration into existing IT landscapes
- Data protection and data security requirements, especially for international supply chains
- Dependence on data quality and availability from suppliers
Outlook: EU Supply Chain Directive
The Corporate Sustainability Due Diligence Directive (CSDDD) was developed at European level in parallel to the German Supply Chain Act. This EU Supply Chain Directive is expected to be transposed into national law within two years of its final adoption and could supplement or amend the German Supply Chain Act.
The EU directive goes beyond German law in several respects:
- Extension to companies with 500 employees and net sales of more than 150 million euros
- Later additionally to companies with 250 employees and a net turnover of more than 40 million euros
- Inclusion of not only direct, but also indirect suppliers
- Consideration of the use and disposal of products
For purchasing departments, this means that they should already be looking at the potential requirements of the EU directive in order to be able to make appropriate adjustments at an early stage.
Conclusion
The Supply Chain Act marks a paradigm shift in corporate responsibility and poses far-reaching challenges for procurement, but also offers opportunities for a more sustainable and resilient procurement strategy. The systematic integration of human rights and environmental aspects into supplier management requires considerable adjustments to procurement processes, structures and systems, but leads to more transparent and responsible supply chains in the long term. Companies that act proactively and tackle the necessary transformations at an early stage can not only minimize legal risks, but also generate competitive advantages and contribute to sustainable development. It is therefore advisable for procurement managers to see the Supply Chain Act not primarily as a regulatory burden, but as a strategic opportunity to redesign their procurement organization and to provide the appropriate resources for successful implementation.
