Conflict Minerals - Another Supply Chain Challenge

1Eight Power Moves

Conflict Minerals: Yet Another Supply Chain ChallengeAs lawmakers target conflict minerals, companies could face significant costs to comply. The focus is on four metals extracted from the war-torn Democratic Republic of Congo and adjoining countries.

2Conflict Minerals: Yet Another Supply Chain Challenge

Manufacturers will face significant raw material cost pressures as lawmakers target conflict minerals. The legislators' current focus is on the war-torn Democratic Republic of Congo (DRC) and adjoining countries.

In the recent past, the supply of and demand for raw materials forced manufacturers to cope with radical market-price fluctuations for commodities such as iron ore and steel; as they formulated successful market strategies, the impact of commodity price spikes became manageable. More recently, procurement professionals have been tested by the scarcity of rare earth metals such as scandium, yttrium, and cer. China, which has the world's largest known deposits of these metals, has exacerbated the challenge by enacting stringent export caps. Again, manufacturers adjusted their strategies and are managing their predicament.

Now on the horizon is a new federal regulation to require companies that make products using certain minerals to disclose whether their supply comes from or near the Democratic Republic of Congo, where mining revenue has funded violent military groups. When this regulation passes, companies with global supply chains will face the daunting task of adapting once again.

Recent Developments in U.S. LegislationMany institutions—including the United Nations, the U.S. Department of State, the European Union (EU), and numerous nongovernmental organizations (NGOs)—have closely studied the issue of conflict minerals and the militia groups in the DRC region that have taken over their mining and sale. The peak of international focus came with the inclusion of Section 1502 into the Dodd-Frank Wall Street Reform and Consumer Protection Act, a federal statute signed into law on July 21, 2010. Subsequently, the U.S. Congress charged the Securities and Exchange Commission (SEC) with its implementation. On December 23, 2010, the SEC proposed a rule that would, if adopted, require publicly traded companies to conduct certified audits, submit an annual report as part of their disclosure requirements, and disclose that information online, thus incurring enormous compliance costs.

Companies using certain minerals will have to disclose whether their supply comes from or near the DRC.Regulators are now struggling to create a rule for companies that use conflict minerals while also avoiding a compliance nightmare for manufacturers with complex supply chains. While the SEC has postponed the deadline several times, a final ruling seems imminent. Many believe the regulation will be costly and difficult to put into practice. Although most companies affected support the ultimate goal of the pending regulation, many are calling for phase-in periods and allowances for the use of smaller amounts of the minerals without disclosure.

In its proposed rule, the SEC defines four minerals as conflict minerals—cassiterite, the chief ore to produce tin; columbite-tantalite, the ore from which tantalum is extracted; wolframite, an important source of tungsten; and gold. The rule would require companies to disclose their use of conflict minerals that originated in the DRC or an adjoining country. The term “adjoining country” is defined as a country that shares an internationally recognized border with the DRC,


which includes Sudan, Uganda, Rwanda, Burundi, Tanzania, Zambia, Angola, Congo Republic, and Central Africa Republic. In 2009, the DRC countries made up 32 percent of global tantalum mine production, 4 percent of global tin mine production, and 1 percent of both tungsten and gold mine production (see figure 1).

Applicability: A Trickle-Down EffectSection 1502 is applicable to U.S. domestic and foreign issuers, or companies that are required to report to the SEC. These entities are directly affected if conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured. The SEC conservatively estimates that this ruling will affect about 1,200 issuers. However, an indirect effect resonates throughout the supply chain as companies ask their suppliers to look into their sourcing practices for conflict minerals. Current estimates indicate 700,000 to 900,000 businesses would be subject to some degree of supply chain traceability effort.

Compliance costs would certainly be high. Although the SEC pinpoints implementation costs at around $70 million, other estimates predict total compliance costs to be somewhere between $5 billion and $7 billion for issuers and their associated suppliers. In one way or another, a wide range of industries use conflict minerals—from automotive and aerospace to jewelry and leisure (see figure 2 on page 4). The picture becomes even more complex at the product level. Although found in very small quantities, conflict minerals can be used in products as diverse as cell phones, laptops, canned food, automobiles, golf clubs, and wedding rings.

Global production

32.4%Ta Tantalite (Columbite)

4.0%Sn Tin (Cassiterite)

0.7%Au Gold

1.4%W Tungsten (Wolframite)

Source: A.T. Kearney analysis

Figure 1 Democratic Republic of Congo and adjoining countries

DemocraticRepublicof Congo

AngolaZambia

Tanzania

Sudan

Central AfricaRepublic

Uganda

Congo RepublicRwandaBurundi


A Complex and Twisted Supply ChainThe complexity of conflict minerals becomes apparent when looking at a communications company as an example. The company would need to sift through 35 manufacturers, 60 to 80 parts suppliers, more than 1,000 commodity parts suppliers, and an unknown number of distributors to get to all of its sources. Because only very small quantities of conflict minerals are typically integrated into any given product, traceability is even more difficult. For example, a 2 kilogram (4.5 pound) laptop contains 10 grams of tin, 0.6 grams of tantalum, 0.3 grams of gold, and 0.0009 grams of tungsten. Smelters, where metals of diverse origins come together to be processed, have been identified as the crucial traceability point. Fortunately, the number of smelters within the overall supply network is still manageable (see figure 3).

Ta Tantalite (Columbite)

Sn Tin (Cassiterite)

Au Gold

W Tungsten (Wolframite)


Figure 2A wide range of industries use conflict minerals

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Figure 3Smelters are the critical point of supply chain traceability

Mine Tradinghouse Smelter Refiner

Critical pointfor supply chain

traceability

Manu-facturer Customer

Number of players


Electronics and automotive companies are on the forefront of this issue and are trying to anticipate the exact configuration of conflict minerals regulation. They have been implementing supply chain traceability systems such as conflict-free smelter validation programs, risk assessment programs, and contractual requirements. Engaging downstream suppliers both voluntarily and through contractual measures is essential to supply chain transparency.

Supply Chain Traceability in Other IndustriesSimilar cases in other industries reveal how best to deal with the conflict minerals supply chain. Food and hazardous goods industries are no strangers to traceability, which has also found its way into clothing and forestry industries as environmental sustainability has become increas-ingly important to consumers and businesses alike.

In the early 2000s, the food industry enacted supply chain traceability systems in the wake of several food safety and health crises. Chemical companies and supermarket chains imple-mented traceability systems that allow consumers to trace the origins of particular products through the entire supply chain using their smart phones. Many food companies are using radio frequency identification (RFID) technology to track food from its point of origin to its retail outlet.1 An RFID track-and-trace system can be used not only to track the location of food as it moves through the supply chain from the grower to the grocer, but also to provide vital information about environmental fluctuations in temperature, humidity, and light.

The struggle is to create a rule for companies that use conflict materials while avoiding a compliance nightmare for manufacturers with complex supply chains.The supply chain for hazardous goods mandates an even more sophisticated system because of the danger to public health and safety. This technology enables real-time tracking on the product level, and parameters for humidity and temperature can be checked while the materials are en route. For conflict minerals, these systems allow for boundary alerts that prevent the materials from crossing certain geographical boundaries.

Even without explicit regulatory provisions, some businesses have introduced supply chain tracking systems to promote their products’ sustainability and eco-friendliness. A New Zealand-based company and maker of merino clothing engages its customers by allowing them to see the source of its products online, thus fostering consumer involvement.

Lessons from the Scarcity of Rare Earth Metals The shortage of rare earth metals last year prompted suppliers to adapt their strategies. Some of the lessons learned can serve as forward-looking guidelines for avoiding conflict minerals.

1 The RFID uses microchip tags that respond to radio waves. Unlike traditional barcodes, RFID tags, also called smart labels, do not require a line of sight to relay information. Instead, information is accessed by simply placing the tag within range of an RFID radio transmitter.


Suppliers have tried to reduce demand by shifting to alternative technology, new manufac-turing techniques, or other materials. This has made companies less dependent and less vulnerable. They have also intensified recycling of these materials, a strategy that is of particular interest for conflict minerals because recycled materials lack the connection to DRC violence.

Finally, severe Chinese restrictions that have limited the export of rare earth metals since 2009 have made the situation worse. Suppliers reacted by investing in extraction capabilities outside of China, thus becoming less dependent on volatile Chinese export policies. Shifting demand and involvement in other regions where conflict minerals are also mined is another possible solution, especially for gold, tin, and tungsten, for which DRC production constitutes less than 5 percent of the global volume.

A Process for Supply Chain TraceabilityAs supply chain transparency becomes a legal requirement, a structured three-pronged approach can help companies not only adapt to the immediate affect of regulatory require-ments, but also better understand the longer-term social and environmental affects of the products they make as well as the impact on competitive advantage (see figure 4). Our approach takes place in three phases:

Phase 1. Create transparency

Phase 2. Develop a traceability strategy

Phase 3. Comply with regulations

Create transparency. Companies must understand the regulatory and compliance require-ments that arise within a network of associated suppliers. In other words, what information is required by associated suppliers or regulatory provisions? Next, an internal identification of

Figure 4Three phases in supply chain traceability


Develop a traceability strategy

Strengthen supply chain traceability systems

Establish a conflict-free smeltervalidation program

Evaluate possible conflict-free manufacturing techniques andtechnology

Design and implement acomprehensive risk managementprogram

Comply with regulations

Identify conflict-free sources andestablish conflict-free supplier base

Report supply due diligence (andpublish online)

Carry out independent third-party audit

Create transparency

Evaluate degree of compliancerequirements

Assess risk of conflict mineralinvolvement on a product level

Assess risk of conflict mineralinvolvement in the supply chain


the risks associated with conflict minerals must be followed by identifying those same risks downstream in the supply chain so that a company can fathom the potential scope of the issue.

Develop a traceability strategy. Strategies must be developed and implemented for supply chain traceability systems and validated conflict-free smelters. The breadth and depth of these programs depend on the risks identified in Phase 1. Vertical integration of systems along such a supply chain is tricky but potentially necessary. Compatibility is crucial in this roll-out phase. Industry associations including the Association Connecting Electronics Industries (IPC) have taken a lead in coordinating it. This specifically relates to reconciling different IT systems and proposing unified standards. At the same time, companies should identify and evaluate potential alternative manufacturing techniques and technology that would make them less dependent on conflict materials. Weighing all possible options, a comprehensive strategy should be designed and implemented to adequately respond to the risks identified in Phase 1.

Comply with regulations. In the third and final phase, the transition to a conflict-free supplier base is initiated. This could mean making use of recycled materials or shifting demand to other conflict-free sources. Finally, compliance requirements regarding due diligence and disclosure are followed according to the assessment of Phase 1. This can range from mere information requirements and associated suppliers all the way to conducting a full audit with all disclosure requirements.

Outlook: Adapting, Once AgainThe SEC has not yet issued a final rule, but a decision is imminent. Therefore, it is of utmost importance for supply chain managers to prepare accordingly. Thorough preparation and anticipation will have an immediate impact on efficiency. The general direction of the issue is manifested in the SEC’s proposed rule from 2010. Once implemented in the United States, a global roll out is likely as institutions such as the EU follow suit. The potential challenges for supply chain traceability include complexity, small quantities, and lack of transparency, as outlined above. Given the pressure of NGOs and other organizations, corporate social responsi-bility and consumer awareness are additional challenges, which is why some companies have made conflict minerals a priority. Meeting all of these challenges will be important—for, as other industries have shown, supply chain traceability is here to stay and will be instrumental in helping companies capture an enduring growth advantage.

Authors

Christian Schuh, partner, Vienna [email protected]

Michael Strohmer, principal, Vienna [email protected]

The authors wish to thank Nino Mori for his valuable help in writing this paper.

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Conflict Minerals - Another Supply Chain Challenge