ESG Reporting

The top 3 challenges of the German Supply Chain Act (LkSG) and how to overcome them

Dec. 6, 2023

The German Supply Chain Due Diligence Act (also known as the German Supply Chain Act or LkSG) is in force. Since January 1, 2023, companies based in Germany with more than 3,000 employees must report in accordance with the LkSG. And thus, pay attention to compliance with human rights and environmental due diligence obligations in their global supply chains.

We review the first year of practical implementation of the LkSG: what insights have we gained? We have compiled the top 3 challenges for companies affected by the LkSG. In addition, we offer you possible solutions to tackle these challenges.

Would you like an overview of all the important facts, figures, and deadlines for the LkSG? Read more in our insight article The German Supply Chain Act (LkSG) defines corporate due diligence obligations.

Challenge 1: Ensuring data availability and transparency

Challenge 1 in detail

There is no doubt about one thing: The huge amount of data that affected companies have to process for reporting in accordance with the LkSG is a headache. At the same time, the transparency of their own supply chain is one of the greatest difficulties for these companies. This is not surprising, as a study conducted by the BME (Bundesverband Materialwirtschaft, Einkauf und Logistik e.V.) in 2022 found that more than 60% of the German companies surveyed have difficulties obtaining accurate and reliable data on their supply chain activities.

According to the IHK (Chamber of Industry and Commerce) Düsseldorf, around a third of a sample of companies subject to reporting requirements lack information on indirect suppliers (the suppliers of their own suppliers). And it is precisely this information that is needed to fulfill the requirements of the LkSG with regard to indirect suppliers.

In addition, often, there is a lack of standardized data formats and reporting procedures between the various suppliers. As a result, companies are often confronted with a variety of data types that hinder the comparability and analysis of the information collected.

Possible solutions to ensure data availability and transparency

Companies, including those that will only fall within the scope of the LkSG in the near future, should start processing all supplier data for the purpose of analyzing and assessing individual supply chain risks as soon as possible. Firstly, it is important to identify the relevant data sources along the entire supply chain. Some data points have particularly high priority for compliance with the standards under the LkSG – for example, supplier information, environmental indicators, working conditions, but also external data from certification bodies or international organizations. Secondly, it is important to develop and introduce clear guidelines and processes for data collection. Standardizing these processes ensures consistent data collection.

The integration of digital tools – such as ESG reporting software – can also be helpful. In particular, it will hardly be possible to cope with the enormous volume of data that needs to be processed to achieve the necessary transparency under the LkSG without the early implementation of suitable software solutions. By automating data collection, organizations can minimize errors and ensure real-time data availability.

Challenge 2: Mapping complex supplier structures

Challenge 2 in detail

The diversity of actors in supply chains, from raw material producers to various intermediate suppliers, complicates the task of seamlessly tracking production conditions and environmental impacts.

This applies, in particular, to companies with complex international supply chains that cover several countries and regions. A particular challenge arises for companies in resource-intensive industries, such as electronics, textiles, and automotive production. In these sectors, supply chains are usually particularly widely branched and globally distributed.

Ultimately, the complex structures also affect German SMEs. According to the German Association of Small and Medium-Sized Enterprises, 99.5% of all companies in Germany are small and medium-sized enterprises (SMEs). This gives them a traditionally important role in the value chain of large companies and means that they are affected by the effects of the German Supply Chain Act to a large extent, especially indirectly as suppliers.

Possible solutions to map complex supplier structures

Prevention is better than cure. By implementing strict supplier qualification processes, future suppliers can be checked for compliance with environmental and human rights standards before collaboration begins. In addition, conducting training for suppliers could ensure that they understand and are able to meet the requirements.

A software solution can also help with this challenge. It provides a platform for mapping complex organizational and product structures, creating synergies, and providing a central overview of all supplier data. However, be aware that the tool must be able to map different entities and product levels worldwide in order to offer real added value.

A further solution that is complex to implement but addresses the core of the problem is to reduce complex supply chain relationships and the associated opacity. This could be achieved, for example, by working with local producers or with suppliers who already communicate their environmental and human rights standards transparently.

Challenge 3: Mastering a change of perspective in risk management

Challenge 3 in detail

Another key aspect: The LkSG introduces a fundamental change of perspective on risk management. Traditional risk management focuses on identifying, assessing, and managing risks that have a direct impact on the company itself – whether financial, operational, or in other areas.

The LkSG, by contrast, requires companies to broaden their focus from the mere consideration of risks to the company's business success. In addition, they should adopt a human and environmental rights perspective that focuses on the impact of the company's activities on the environment and the affected stakeholders. These include, for example, employees along the supply chain. The LkSG thus emphasizes the need for a holistic view of risks that goes beyond the immediate boundaries of the company and includes socio-ecological responsibility.

Once again, this poses a particular challenge for internationally operating companies in Germany.

It starts with the identification of risks in various departments and subsidiaries. One of the most common problems in practice is incomplete risk identification. In many cases, a joint analysis of different subsidiaries reveals that risks reported by one subsidiary would also have been relevant for the other subsidiaries.

Possible solutions to master a change of perspective in risk management

Therefore, it is advisable to implement an integrated risk management system. This allows all recorded risks to be shared across all subsidiaries and departments. Only in this way, a holistic perception of risk within the entire company is possible. And only then, potential risks that may be relevant across different areas of the company can be identified and assessed.

Plus, the introduction of standardized risk assessment methods that take into account both financial and socio-ecological aspects is equally important. This ensures that risks are assessed consistently and comprehensively, regardless of the department or subsidiary. A central coordination point for risk management, which monitors and coordinates the activities of various departments and subsidiaries, could also be helpful: This guarantees that relevant information about risks is actually shared and taken into account at the company level.

One year of LkSG in practice – summary and outlook

The analysis reveals three key challenges in the first year of practical implementation of the LkSG. But it doesn't stop there. Affected companies also need to master other tasks, such as the implementation of a complaints procedure and the expansion of due diligence obligations under the forthcoming EU Supply Chain Directive.

In addition, indirect suppliers have so far only been affected by the due diligence obligations if a company has concrete indications of possible human rights violations or breaches of environmental regulations. However, developments regarding the EU's draft directive indicate that the due diligence obligations could also be generally extended to indirect suppliers. In view of these possible changes, indirect suppliers should already be included in the risk analysis, which means an additional data volume for companies.

The use of software-based processes can support companies that are subject to the legal obligation not only in data processing and continuous documentation, but also in fulfilling the auditing and reporting obligations under the new law. In the future, these obligations must be fulfilled at least once a year, but possibly also on an ad hoc basis (e.g. following information via the complaints system).

Envoria's all-in-one ESG software is ready to support you in fulfilling your due diligence obligations. With Envoria's new supply chain software module, you can assess your suppliers according to human rights and environmental aspects – in accordance with the German Supply Chain Act (LkSG). Evaluate all supplier information in one single location. Identify, understand, and monitor your risks and manage confirmed complaints globally.

The German Supply Chain Act (LkSG) defines corporate due diligence obligations

Read more

German supply chain law in effect since January 1, 2023

Read more

German Supply Chain Act (LkSG): The importance of risk analysis incl. practical tips

Read more