Supply Chain Act – What SMEs need to consider in 2024

The introduction of the Supply Chain Act (Lieferkettensorgfaltspflichtengesetz, LKSG)¹ by the German government marks a crucial step towards sustainable business practices, having an impact particularly on small and medium-sized enterprises (SMEs) involved in complex supply chains. SMEs are now confronted with the task of navigating these new regulations, as larger companies – bound by legal obligations to maintain ethically sound supply chains – often exert pressure on smaller enterprises. 

In this article, we'll explore the Supply Chain Act, its significance for SMEs, and practical steps to fulfill obligations. Despite the complex German terminology, navigating your company through this process can be simple and straightforward.

What to expect in this article 

As of January 1, 2024, the Supply Chain Act has conferred responsibility upon German companies with a workforce of at least 1,000 employees. Why? High standards in the areas of sustainability, social issues and corporate governance (also known as ESG – Environmental, social, and corporate governance) are becoming increasingly relevant – both for the public and for the political sphere. This is why the observance of human rights² (e.g. regarding forced labor, child labor or unfair wages) and environmental protection in global supply chains are required. This means that companies must not only adapt and update their compliance, purchasing, and contractual practices but also proactively implement measures to enhance overall sustainability and environmental awareness.

The Supply Chain Act obliges companies based in Germany to comply with human rights, social and environmental standards along their supply chains. Ideally, it should ensure that goods produced abroad meet domestic manufacturing standards. It applies directly to companies with 1,000 employees or more, placing a heightened focus on sustainability and responsibility in global supply chains – with mandatory annual reports.

If SMEs are involved in such supply chains as suppliers, corresponding evidence must also be provided to not jeopardize business partnerships: this applies to their own business practices, the actions of any contractual partners and those of other (indirect) suppliers. Sustainable decisions and approaches are therefore becoming more relevant, even though the official legal obligation is not yet in effect. Without specialist knowledge and available internal resources, the Supply Chain Act is a major challenge, but one that cannot be postponed. After all, the aim is to remain competitive. 

Companies with 1,000 employees or more are directly affected if they source products from abroad or are themselves active in the international market. The law covers all sectors and places a clear focus on sustainable action in global supply chains. It also indirectly impacts SMEs with fewer than 1,000 employees, especially if they collaborate with larger partners obligated to provide evidence.

To ensure that they meet the requirements of the Supply Chain Act, companies should identify and assess risk factors in supply chains and place the avoidance of these factors at the top of their agenda. Companies with global supply chains are guided by methods such as KYS (Know Your Supplier), derived from the compliance field for industrial and export companies.

KYS is a comprehensive process in which the entire supply chain is analyzed to uncover weaknesses. The tools included in KYS can be used to ensure the integrity of suppliers or to prove your own reliability. Of course, these processes require high internal resources, which are hardly feasible for smaller companies. To get started, it is advisable for SMEs to define their own standards first and pursue them consistently with the available capacities. Companies often focus on the following points:    

• Create transparency: A comprehensive and precise analysis of their own supply chain makes it possible to identify potential risks and violations at an early stage.

• Establish principles: By defining own principles and approaches, company standards are clear.

• Implement risk management: To identify, prevent and mitigate potential human rights violations and environmental damage, it is important to define clear guidelines and to identify, assess and ultimately prioritize how potential vulnerabilities are handled. 

• Establish a grievance procedure: For critical incidents, the parties involved need to know which channels are used to file complaints. It is advisable to adhere to a transparent process and to involve and train all stakeholders.

• Regular reporting: Accurate documentation of all measures and regular reporting are crucial to demonstrate compliance with the standards. These must be submitted to the Federal Office of Economics and Export Control (BAFA) no later than four months after the end of the financial year.³ 

• Obtain evidence: When entering a contract, there is a legal basis to require certificates regarding business practices. However, no direct basis is established for such requests at a later stage. The timing component becomes pivotal in business partnerships, particularly in the pursuit of maintaining ethical and sustainable supply chains.

• Strengthen cooperation: Continuous exchange with suppliers, partners and stakeholders helps to develop sustainable solutions together.

Whether you are part of a global supply chain as a supplier or must ensure that you procure your resources in compliance with the Supply Chain Act: in addition to looking to the past, it is imperative to focus on the future to remain competitive. This starts with your own premises, as that is where decisions with long-term impact can be made. Ideally, these decisions should also keep companies a step ahead regarding potential compliance issues. 

Do the following questions ring a bell: “What can I do to improve my direct impact on the environment? Where does the energy that is used every day come from? How do my employees get to work? Do I need to save energy to reduce emissions? Is my vehicle fleet resource-intensive?”  

The answers to these questions may not necessarily be covered in one sentence. But making sustainable decisions, such as transitioning to solar energy, not only aligns with the Supply Chain Act but also offers long-term benefits. Companies can minimize investment risks through partnerships, ensuring a seamless transition to green electricity. There are even different solar concepts available, e.g. rental models and more. However, many companies are embracing the energy transition not only because of regulatory pressure or business partnership requirements, but also because switching to green electricity offers other benefits – in addition to reducing emissions. 

Coming back to the questions posed earlier, the answer can be summarized as follows: With electricity from your own roof, you improve your environmental footprint and don't have to save energy to become more sustainable. Even if, according to a PwC study, 76% of SMEs regard saving energy as the most important goal of a sustainable strategy⁴, you can genuinely avoid this cumbersome detour; it's unnecessary. The source of your energy does matter. 

Once companies have embarked on the energy transition, additional solutions can be seamlessly integrated for even more benefits: With charging infrastructure, companies can not only encourage employees to travel between work and home in a climate-neutral way, but also refuel fleets with zero emissions. If you think the infrastructure through to the end, you end up with an additional electricity storage system that, when used smartly, provides even greater cost efficiency, e.g. when storing electricity that was purchased at a cheaper price.

The Supply Chain Act provides important impulses to drive companies forward. When companies rely on renewable energies, they reduce their energy costs in the long term and become more independent. They also strengthen their position as an environmentally friendly company. This creates trust among customers, business partners, investors and current and future employees.   

Visible “green” signs that have a real impact in terms of sustainability set a high benchmark for all business practices and serve the supply chain law - whether SMEs are part of a global supply chain as a supplier or must officially guarantee standards along their own value chain. For fast-growing SMEs, such measures also pay off in terms of preparation.

In conclusion, the mentioned measures within the article present both challenges and opportunities for SMEs striving to establish themselves as sustainable players. The measures are not easy to implement, but they have many positive side effects that will prepare companies for the future and make them more competitive. 

Making future-oriented decisions in terms of sustainability and environmental awareness, such as the integration of photovoltaics, is both an ecological and an economic way of meeting the requirements. Through transparency, close cooperation and exchange, and accurate reporting, SMEs can not only ensure compliance with the Supply Chain Act, but also strengthen corporate awareness from different perspectives.

As a solar service provider with an international value chain, we uphold our due diligence obligations to meticulously assess and transparently disclose our supply chain practices. This involves maintaining a continuous and close exchange with our partner companies and the collection and verification of evidence. Aligned with our ESG Policy and Code of Conduct, we proactively communicate our corporate principles, expecting suppliers to prove compliance with official certificates. We address any violations and risks through established grievance procedures to ensure that all crucial information reaches us. Through a thorough examination of this information, we derive further measures and react accordingly.