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On trial: the Supply Chain Due Diligence Act in Germany and its effects on car suppliers

Munich, July 2023

On trial: the Supply Chain Due Diligence Act in Germany and its effects on car suppliers

Munich, July 2023
T

he industry has been critical of the new law, but it will give German companies an opportunity to get ahead of EU competitors who will also soon face more stringent ESG requirements

Germany’s Supply Chain Due Diligence Act (SDDA) came into force on 1 January 2023 as part of the government’s ambition to ensure that businesses comply with human rights and employment legislation, as well as environmental standards. In addition, the government hopes the SDDA will highlight Germany’s leading role in Europe on these issues and provide the opportunity to create more transparent, robust supply chains in the long term. Suppliers in the car industry will be a critical test of the law’s impact and the ability of companies to overcome the administrative challenges. However, suppliers would prefer more specific guidance about how to comply with the law’s requirements.

The SDDA will be introduced in stages. In the first instance, it will apply to companies which have their headquarters or a branch office in Germany and employ more than 3,000 people in the country. This includes about 60 car suppliers. From 2024 onward, the threshold will be reduced to 1,000 employees, covering a total of about 140 car suppliers in Germany.

Defined duties of care will apply to the company and its direct suppliers, and in specific cases to indirect suppliers. This will involve carrying out regular risk assessments relating to human rights and environmental standards, from the identification of risks to mitigating measures. Substantial fines of up to €500,000 or 2% of annual revenue can be imposed in cases of infringement.  

Suppliers see the SDDA as an administrative headache

For some years now, car manufacturers (OEMs) have required suppliers to meet a range of conditions regarding human and employee rights and environmental standards, and show proof of compliance. The SDDA increases the administrative and reporting burden for suppliers. In the months before the Act came into force, departments such as sales, purchasing, human resources and sustainability were preoccupied with implementing its requirements.

For suppliers, the following challenges are particularly demanding:  

  • Higher staff costs: Several full-time employees, and sometimes more, are usually required to perform the required due diligence and ensure compliance with the law, depending on the company’s size and the complexity of its supply chain.
  • Vague scope of required risk assessments: In theory, all suppliers of direct and indirect product groups and materials must be included in risk assessments, given the ambiguous way in which the law has been drafted. For medium-sized German suppliers, this means between 10,000 and 15,000 sub-suppliers fall within the law’s scope; for large, established suppliers it could be almost double that number.

  • Inadequate information: Both external and internal data need to be consulted to identify the relevant suppliers’ risk profiles for human and employee rights and environmental standards. However, such data tends to be incomplete and fragmented, and therefore of limited use. Adding to the problem, many suppliers currently provide external information in the form of risk indices. So, the selection of suitable and reliable indices is made according to their best guess without legal requirements.

  • Challenging worldwide implications: German suppliers with global supply chains often encounter difficulties when performing due diligence and selecting risk indices in foreign jurisdictions. The physical distances involved can be significant, while there are also different working practices and cultures to contend with.

  • Uncertainty about the right risk-assessment and compliance tools: Tools can assist with implementation and compliance with regulatory requirements. However, these tools do not currently feature end-to-end coverage of all due diligence areas, from risk assessments to documentation of countermeasures and tracking of their effectiveness. Digital tools are rarely used, with risk assessments carried out manually, as far as possible, because most suppliers want to avoid a fragmented system landscape. However, the result is increased expenditure and a higher error rate.

Pressure from suppliers for more specific legal requirements

Although many German car industry suppliers are well on the way to implementing the SDDA, these challenges mean they continue to take a critical view of the law’s requirements. Their administrative costs have risen sharply, adding to the compliance costs already imposed on them as suppliers to OEMs, whose requirements are in some cases even more extensive than the conditions set by the SDDA.  

The effectiveness of the law is also questionable, because it involves a duty of effort rather than a duty of success. The SDDA does not make clear to suppliers which specific measures should be taken in a risk situation, when to implement them and what consequences to expect. Suppliers would prefer the introduction of industry-specific standardization to reduce their administrative costs. This would include recommended actions and requirements for the risk indices to be used for the identification of country and industry risks during the assessments.

Suppliers want standard questionnaires to reduce the large number of questions in differing formats and to simplify the collection of important information along the global supply chain. If the SDDA were made more specific, the industry would be able to minimize the scope for different interpretations of the law’s requirements – for example, by clarifying the definition of suppliers to be assessed to ensure that full due diligence is conducted along the supply chain relevant to the car industry.  

The SDDA weakens small and innovative suppliers

There are two main reasons for differing perceptions among car suppliers about the Act’s costs and benefits: the company’s size and profitability, and the complexity of its value chain. The SDDA’s impact in terms of higher costs is felt most by small and medium-sized suppliers operating innovative and often complex value chains. According to one study, the cost of compliance with the SDDA in the supplier industry lies between 0.5% and 1% of annual profits.

Range of costs for compliance with SDDA

Source: Berylls Strategy Advisors 

Larger suppliers of course incur higher costs to comply with the SDDA, but the law’s impact on smaller suppliers’ profits is greater. Unlike large suppliers, they have to follow new risk and compliance structures or even start again from scratch. Their expenses are mainly made up of direct and indirect staff costs and the cost of hiring external service providers which support them in meeting the terms of the Act.

Electric car batteries carry the highest SDDA-related risk

Experience has shown that the highest risks regarding observance of environmental, social and governance (ESG) standards are found at the start of the supply chain. Consider, for example, the high-voltage electric car battery:

  • 75% of all cobalt is extracted in the Democratic Republic of the Congo (DRC), which has major problems concerning child labor, safety at work and water pollution.

  • Two-thirds of all graphite is extracted in China, where there are considerable risks because of the chemicals used, in addition to human rights issues.

  • Aluminum should also be evaluated critically, because the bauxite needed for extraction is often associated with environmental pollution, illegal deforestation and child labor.

 

Overall, it is striking that the components of a BEV which currently involve the greatest innovation – the battery, E/E system and electromotor – have a particularly high SDDA risk profile. This is principally because critical raw materials such as rare earths, cobalt, silicon and aluminum are processed to make them. From a sustainability perspective, the law is therefore being introduced at the right time to ensure observance of ESG standards along the BEV supply chain. This in turn will help promote more sustainable development of E-mobility and boost consumer confidence in the car industry’s sustainability performance.  

Comparative SDDA risks of car components
(in %)

Source: Berylls Strategy Advisors 

The SDDA is an opportunity for suppliers, despite their criticism of the additional costs

German suppliers were already under margin pressure before the SDDA and are now burdened by extra compliance costs. In this environment, it is hardly surprising that many companies are critical of the new law, which has increased their insecurity, especially given the potentially steep penalties for failing to comply. So far, suppliers are often only meeting the minimum standard for compliance with the SDDA, instead of using the law to create additional value.

Yet in the long term, the German supplier industry stands to gain from the establishment of more sustainable and ethical supply chains. Consistent implementation of the SDDA will build valuable expertise across the industry, enabling suppliers to recognize potential risks early enough to take effective action. This in turn will help them to improve their resilience, efficiency and competitiveness.  

The automotive industry is already working on standardized solutions such as Catena-X for data exchange along the entire global supply chain, while in an industry consortium funded by the German Ministry of Economics, OEMs, suppliers and digital companies are working on the first open data ecosystem. This should help harmonize the data networks of all companies in the automotive supply chain (from tier-n to recycler) through standardized, simple and secure data exchange according to the Gaia-X standard, and enable suppliers to perform ESG risk analyses with less effort.

A comparable EU-wide law is expected to be introduced after 2025 with the SDDA as the blueprint. German suppliers have the opportunity to enjoy preferential treatment over European competitors when bidding for contracts in the region as they assume responsibility along the whole supply chain for improving human and employee rights and raising environmental standards, in line with the SDDA. In the end, employees, customers and investors will reward ethical and sustainable action in the future – and that includes creating ESG-compliant supply chains.

Authors
Dr. Alexander Timmer

Partner

Lars Behr

Senior Consultant

Fabian Dinescu

Senior Consultant

Daniel Willenbrink

Senior Venture Associate

Felix Günther

Consultant

Dr. Alexander Timmer

Dr. Alexander Timmer (1981) joined Berylls by AlixPartners (formerly Berylls Strategy Advisors), an international strategy consultancy specializing in the automotive industry, as a partner in May 2021. He is an expert in market entry and growth strategies, M&A and can look back on many years of experience in the operations environment. Dr. Alexander Timmer has been advising automotive manufacturers and suppliers in a global context since 2012. He has in-depth expert knowledge in the areas of portfolio planning, development and production. His other areas of expertise include digitalization and the complex of topics surrounding electromobility.
Prior to joining Berylls Strategy Advisors, he worked for Booz & Company and PwC Strategy&, among others, as a member of the management team in North America, Asia and Europe.
After studying mechanical engineering at RWTH Aachen University and Chalmers University in Gothenburg, he earned his doctorate in manufacturing technologies at the Machine Tool Laboratory of RWTH Aachen University.

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