How Can the EU Achieve Deforestation-Free Supply Chains?

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Deforestation, which accounts for roughly 25% of global greenhouse-gas emissions, is primarily driven by commodity production for global markets

ФОТО: Depositphotos/vladvitek

Legislation recently enacted by the European Union aims to curb deforestation by banning the import of commodities and products linked to it. The measure represents an important step forward, but gaps in critical data are set to undermine its effectiveness.

The new law requires companies to provide a due diligence report detailing the «country of production», «geographic coordinates … of all the plots of land where the relevant commodities and products were produced», the «time range of production», and «verifiable information that the relevant commodities and products are deforestation-free». In other words, companies must prove that their supply chains are deforestation-free.

While the new regulation seeks to ensure that companies collect accurate traceability data on the geographic origins of commodities known to be part of their supply chains, it lacks the necessary specificity to prevent companies from merely identifying a range of possible origins instead of actual sources. This ambiguity jeopardizes the legislation’s potential.

The EU seeks to regulate trade in several commodities, most of which are produced by smallholder farms. These include roughly 40% of the world’s palm fruit85% of its rubber, and 80% of the global production of cocoa and coffee beans. Because these goods often exchange hands via «informal» supply chains and are neither taxed nor regulated before they reach a formal factory, there are no digital records of the transactions between smallholder farms and factories. Consequently, companies face significant challenges tracing these commodities to their origins.

Companies trying to improve traceability often first identify formal factories within their supply chain that source from smallholder farmers, and then work with service providers that «search” for smallholder farmers within a certain radius of the factory, «mapping» the outlines of their plots into a digital format. But, because the mapping often stops once the estimated volume produced by the mapped farms aligns with the capacity of the identified formal factory, it overlooks the possibility that other farms are also contributing to that factory’s supply.

The prevailing method of supply-chain mapping in supply chains with smallholder farms thus results in a set of potential origins rather than actual sources. Companies incur a compliance cost that neither provides commercial value nor adheres to the spirit of the EU regulation.

For starters, commodities produced on recently deforested land may still enter the supply chain. Surveyors are less likely to map farms associated with recent deforestation, as farmers who engage in illegal practices are unlikely to agree to have their land mapped. This skews the dataset toward deforestation-free farms. Given that commodities are typically produced in contiguous areas teeming with buyers and suppliers and characterized by a lack of loyalty, companies simply cannot know whether they are buying from farms that have been mapped.

Likewise, if some mapped farms are not free of deforestation, companies must refuse supplies from them. But that proves to be an impossible task, as companies are unable to determine which delivered batches originate from which farm.

Lastly, the prevailing method of supply-chain mapping fails to generate data-driven insights that could potentially improve companies’ sourcing processes. But despite its limited commercial value and low likelihood to accomplish the objectives of the EU regulation, companies might adopt it simply to ensure compliance at the most basic level and avoid the costs associated with segregating their supply chains into EU-compliant and non-compliant flows.

To reduce the EU’s contribution to deforestation, the new regulation must mandate that companies collect transaction-level data linking commodities to their geographical origins. In other words, the EU should require a record of a company’s transactions with each of its suppliers. These suppliers, in turn, must maintain a record of their own transactions, all the way back to the original source.

Smallholder farmers and intermediaries currently lack the incentives and digital tools needed to achieve this level of traceability. In contrast, formal factories and buyers are required to collect transaction-level data in a digital format due to their tax obligations. Many companies also use this data to generate business value that extends beyond mere compliance. For example, the analysis of transaction-level data provides data-based insights into which suppliers are most reliable and enables optimized inventory management and demand forecasting.

To obtain transaction-level information on informal supply chains, smallholder farmers and intermediaries need digital tools that enable them to streamline supply-chain management and be more profitable. For this reason, my partners and I founded PemPem, which develops supply-chain management tools for smallholder farmers and enables real-time traceability from farm to factory. We began with the smallholder palm oil industry in Indonesia, providing farmers with a mobile application that collects commodity-price data from all buyers within a specific geographic region. Using data-driven algorithms, the platform can determine the best possible price for a certain commodity; smallholder farmers can then accept the offered price and facilitate a transaction.

PemPem’s algorithms match «bundles» of smallholder farms with transport services that collect and deliver the goods to designated buyers. Because they are orchestrated through a mobile app, these exchanges are automatically recorded, generating transaction-level records from farm to factory. Farmers benefit from securing the best possible price, buyers can better match supply with demand, and intermediaries can optimize vehicle capacity and delivery routes. This approach has been embraced by technology startups such as Aruna and Fishlog, both in the seafood industry, and BanQu, which helps cassava farmers maintain transaction-level records and ensure sustainable sourcing practices.

The emergence of this new generation of digital solutions should allay concerns that obtaining transaction-level records could have a negative effect on smallholder farmers. By adopting a more commercial approach to meeting traceability targets and embracing emerging technologies tailored to their needs, farmers could adapt to deforestation-free supply chains while benefiting from increased efficiency, thereby better positioning the EU regulation to accomplish its goal.

Joann de Zegher, a professor at the MIT Sloan School of Management, is Co-Founder and CEO of PemPem, which creates management tools for smallholder commodity supply chains.

© Project Syndicate 1995-2023 

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