Environmental performance contracts, accelerating the supply chains green transition

Thanks to the city of Lille and CDC Biodiversité for sharing their experiences.

Geopolitical or health crises, extreme weather events, violation of fundamental human rights… So many elements that weaken supply chains and lead to a strengthening of regulations on the responsibility of the first contractor. French and European laws relating to the duty of vigilance, for example, make companies responsible for their upstream supply chains and accountable to take effective measures to prevent environment and human and labor rights abuses.

However, faced with the complexity of supply chains of many industries, composed of many suppliers and subcontractors, whose geographical locations are not always known and, in the absence, (with a few exceptions) of case law, companies face the difficulty of engaging suppliers beyond their direct (“tier 1”) suppliers.

While dialogue with tier 1 suppliers remains a prerequisite ([#4 Traceability] The pressing need for supplier dialogue in the transformation of supply chains (deloitte.com)), it seems essential to find more systematic means of guaranteeing environmental and social performance of all tiers suppliers. Environmental performance clauses linked to the price, included in any contract with a direct supplier, could constitute an adequate response to this operational difficulty.

What is an environmental performance contract?

Performance contracts have developed with the rise of what is called the “service economy”, the principle of which is to monetize the use value of a good rather than the good itself. The advent of companies based on the sharing of goods such as AirBnb, Uber, Blablacar or, more simply, laundromats, testifies to the interest of these consumption patterns - despite their social balance sometimes disputed because of the precariousness of the workers status.

In this context, performance contracts make it possible to reduce the need for material production: the supplier of a good has an interest in maximizing its lifespan (by fighting against planned obsolescence) rather than producing or buying again.

The environmental performance contract commits the supplier to improving in particular carbon, energy, biodiversity, water (…) footprint of its product, as well as its quality or delivery time. The supplier's remuneration is then directly indexed to the environmental performance achieved, in relation to objectives previously determined between the parties. The supplier thus limits the waste, extraction and use of material resources and reduces the greenhouse gas emissions linked to its production.

• In the public sector, the energy market integrated the use of these contracts into current practices very early on, moving from the sale of energy to the sale of energy performance, thanks to the creation by the European Union in 2006 of “CPE” (Energy Performance Contracts) regulated by the State.
• Another example: the environmental performance contract concluded between the city of New York and Veolia¹ in 2012 aimed to improve the management and maintenance performance of the city's public water and sanitation services, while reducing operating costs and preserving local jobs. Using this 4-year performance contract, the city of New York aimed to save $100 to $200 million per year on management and maintenance costs that presented a budget of 1.2 billion dollars. Veolia's compensation was calculated according to the performance savings achieved.
• In waste management, the urban area of Montauban concluded an environmental performance contract with Suez² in 2021 which partially remunerates the company, no longer according to the quantity of waste treated but according to the achievement of waste reduction objectives and the improvement of employment and integration rates in the region thanks to partnerships between local players in the social and solidarity economy and Suez. After 11 months of implementation, the volume of bulky waste collected has been reduced by 31%, 17% for green waste, 7% for household waste and 5% for the selective collection of packaging.
  Article 35 of the French Climate and Resilience law introduced in 2021 the obligation for buyers and authorities to include environmental clauses in public contracts and to retain at least one selection criterion based on the environmental characteristics of the offer. Thus, an offer may be deemed more or less relevant depending on its environmental impact, beyond the sole factors of price, quality and delivery times taken into account so far. In its report of February 15, 2022³ on the application of public procurement regulations, the Economic Observatory of Public Procurement in France estimates that 18.6% of public procurement included an environmental clause in 2019.
• The private sector has been able to turn these contracts into competitive advantages in calls for tenders. When Michelin, in its Effifuel⁴ offer launched in 2013, sells transport companies a performance commitment on the reduction of fuel consumption rather than tires, it makes every effort to produce the most resistant tires possible and improve the efficiency of client itineraries. In two years, this offer covered 2 million tires in Europe and the first contracts enabled savings of 1.5 liters per 100 km over one year.

How does the environmental performance contract work?

The environmental performance contract is based on an obligation of environmental or social result of the service provider or supplier, linked to the price clause. Four steps are key success factors in the implementation of this type of contract.

1. Define the purpose of the supplier social or environmental results obligation by prioritizing the impacts on which the environmental or social performance clause will focus: transparency/traceability, eco-design, carbon footprint of the product and/or transport, biodiversity footprint of the production site, job creation, development of worker protection, etc.

2. Determine the method of remuneration for the environmental or social performance of the supplier. Several levels of ambition are possible between the supplier and its client:

• The payment of a penalty encourages the supplier to achieve its objectives so as not to lose part of its remuneration;
• The payment of a bonus makes it possible to reward the achievement of objectives;
• Sharing the environmental or social cost avoided between the first contractor and the supplier makes both parties to the contract more responsible by encouraging them to work hand in hand to achieve the objectives;
• The release of part of the payment of the price upon achievement of the objectives is certainly the most ambitious modality because it places ESG issues at the heart of the supplier contractual obligations. In the examples studied with our clients, 10% of the price is released when the objectives are achieved.

3. Define the objectives, qualitative or quantitative, but assessable, of the supplier in its commitments.

4. Specify the performance evaluation system: time frame, KPIs, measurement tools and data recovery process... Supplier reporting must therefore also become a contractual obligation because it makes it possible to determine whether she/he has fulfilled its social or environmental performance obligations and, if necessary, to anticipate progress plans.

Why can the environmental performance contract become a lever for transforming supply chains and applying the law on the Duty of Vigilance, with all tier suppliers?

Whether for its carbon impact, its biodiversity footprint, its waste management or its social responsibility, the tier 1 supplier results often depend on that of its own suppliers.

By having a price-related performance environmental or social obligation carried by the tier 1 supplier, we play the contractual "domino effect" by encouraging her/him to transfer the same obligation to tier 2 and so on…

The implementation of environmental and social performance contracts therefore appears to be an insufficient but fundamental tool to engage, by a domino effect, all ranks of suppliers in the transformation of their practices.

Conclusion
 

The English expression "Scope 3" refers to the requirement to calculate and reduce the carbon footprint linked to an organization's supply and distribution chains, a requirement usually transmitted by companies to their direct suppliers.

However, today, the elements that weaken these chains are varied, evolving and go far beyond the first tier of suppliers: difficulties in the supply of raw materials, regulatory requirements for decarbonization, legal and social consequences of the footprint of production sites, human and labor rights violations in supply chains…

Anticipating and responding to the risks associated with this "expanded Scope 3" are now strategic needs for companies.

The real challenge for Chief Procurement Officers lies in the implementation, right down to raw material suppliers, of the sustainable purchasing strategies that have flourished in recent years and their operational anchoring in the day-to-day work of purchasing.

To do this, changing the decision-making processes (carbon price integrated into purchases), supplier dialogue or contracting (criteria for selecting suppliers and environmental and social performance contract) is essential.

Testimonials and sharing of good practices

Performance contracts are also applied to the market for cleaning public spaces and collecting household waste, with the aim of reducing water consumption and social reintegration of workers. The benefits are not only environmental. «Well-being at work, measured monthly thanks to the absenteeism rate, has progressed, absenteeism is now less than 5% ».

In 2023, the metropolis of Lille5 also signed a performance contract with Veolia, committing the service provider to implement effective water saving actions within the metropolis. The contract includes a financial penalty for the supplier if the savings objectives are not achieved. Thus, beyond the contracted volumes, Véolia will see its purchase price of water from the city's production management multiplied by more than two.

With the objective of ecological enhancement and the creation of social ties, CDC Biodiversité has carried out, in consultation with the residents, several operations for the development and management of outdoor spaces (catering, development of flowery meadows, shared gardens, pedagogical rock …), within a budgetary framework defined beforehand with the lessor.

The objectives are measured on the basis of ecological KPIs, to measure the evolution of biodiversity, social KPIs, to assess the satisfaction and awareness of users and economic KPIs, to monitor the evolution of expenditure directly and indirectly linked to the outdoor spaces. A few years later, this project is a «social and ecological success» which has made it possible «to increase the potential for hosting birds and insects» and is the result of «the co-design, with the residents, of common objectives responding to daily problems, for example with regard to shared gardens or cleanliness areas». This tool is now deployed with owners and managers of outdoor spaces in urban and peri-urban areas, such as tertiary business parks or logistics platforms.

¹ Business Wire, Veolia Eau signe un contrat de partenariat avec la Ville de New York pour l’optimisation de ses services publics d’eau et d’assainissement, April 2012

² Suez,  Réduction des déchets : 1ers résultats positifs du contrat de performance pionnier entre Le Grand Montauban Communauté d’Agglomération et Suez, December 2022

³ Ministère de l’économie, des finances et de la relance, Rapport à la commission européenne relatif à l’application de la réglementation en matière de marchés publics pour la période 2017-2019, February 2022

⁴ Les Echos, Michelin accélère dans les services et l’innovation, February 2015

⁵ Métropole de Lille, La MEL adopte une politique de l’eau inédite en Europe, May 2023