The push for more sustainable supply chains has largely centered on premiums: consumers want to know how their food and fiber is produced and will reward transparency by paying higher prices. These higher prices are meant to translate to incentives across the supply chain and provide a pathway to scaling more sustainable supply chains.
Unfortunately, this narrative glosses over the inherent tension between premiums based on differentiation and scalable solutions for sustainability.
Differentiation is the foundation for the idea that consumers will pay sustainability premiums. At first glance it makes sense: if a product is “better” than an otherwise comparable alternative or the status quo, consumers will pay more.
The challenge is that differentiation is inversely related to scale of adoption. Almost by definition, the more adoption there is of a particular sustainability claim, practice, or standard, the less differentiated, and valuable, it becomes in the market. This comes down to the basic dynamics of supply and demand: with more supply of the “differentiated” product on the market, the prices that can be earned for it will fall.
Our team saw this recently during a deep dive into Australia’s cotton industry. Cotton growers have been encouraged to attain Better Cotton Initiative (BCI) certification to earn premiums for their cotton. However, the premiums attainable for BCI certified bales have gone down over time as adoption of BCI has grown around the world. According to industry numbers, nearly 20% of Australia’s cotton planting in 2019 was BCI certified and in 2020 23% of global cotton production was BCI certified. Anecdotally, we heard from Australian cotton growers that BCI certification earns at best $2–5 extra per bale today, whereas it previously earned up to $8 extra per bale. This represents a decline of anywhere between 38% and 75% in a matter of 5 or 6 years.
If the promise of premiums is the central narrative used to convince supply chains to adopt sustainable practices, we are setting ourselves up for sore disappointment. Indeed, many cotton growers expressed that the BCI premiums available today don’t stack up against the costs of obtaining certification. This could help explain why only ~50 out of Australia’s 1500 cotton growers are BCI certified.
An alternative to scaling standardized sustainability claims might be for individual producers or brands to market their own “flavor” of sustainability to differentiate from competitors and command higher prices on that basis. For this to be feasible, however, some degree of scale is required. If consumers are interested in purchasing goods associated with specific claims or production practices, the supply chain needs to maintain a chain of custody for both information layers (i.e., evidence of the claim) and physical products themselves (i.e., the physical product that is associated with the claim).
In the case of cotton, for example, products that meet a certain sustainability specification–say carbon neutral cotton–would need to be kept separate from “conventional” cotton at every stage of the supply chain. Maintaining physical separation between the carbon neutral and conventional product at the gins where raw cotton is processed, at mills where cotton is spun into yarn, and during manufacturing when yarn is sewn into final goods would be costly and complicated. Without sufficient volumes of carbon neutral cotton flowing through the system or vertical integration, it’s unlikely that the economics of handling carbon neutral cotton separately would stack up at each stage along the supply chain. And of course, if brands are competing on a large number of bespoke sustainability claims, the number of segregated pathways that need to be maintained in the supply chain would balloon and amplify the problem.
Selling sustainability to farming industries on the promise of premiums is convenient, but it is simplistic and won’t deliver the scale of action we so urgently need.
We must acknowledge the elephant in the room: supply chains are going to have to adopt sustainable practices and demonstrate transparency or risk losing market access. As concerns around sustainability grow, not just from consumers, but from investors, financial institutions, and governments too, sustainability considerations will be a “must have.” Adoption of the Task Force for Climate-Related Financial Disclosure (TCFD) recommendations and other climate commitments by private organizations and governments alike are early signals that this shift is already underway. Though perhaps less palatable than premiums, these disclosure pressures and requirements actually provide a path to achieving impact at scale.
Industry organizations and agribusinesses can’t keep encouraging the adoption of sustainable practices and related technologies by promising growers that they will be paid more for their good behavior. More nuanced and holistic design of incentives will be required to support the transition to more sustainable and transparent supply chains.. Sooner or later, we’re going to find that stakeholders who resist change won’t have a seat at the table, let alone be in any position to ask for a treat.
Tenacious Ventures Management Pty Ltd (CAR 001275760), Tenacious Ventures Management Partnership, LP (CAR 001298484), Tenacious Ventures Fund II Management Partnership, LP (CAR 001298483), and Tenacious Ventures Fund II Staple Co Pty Ltd (CAR 001298487) are Corporate Authorised Representatives of Sandford Capital Pty Ltd (ABN 82 600 590 887), Australian Financial Services Licence No 461981, and are authorised to provide advisory and dealing in connection with investments to wholesale clients only.