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Sustainability Benefits: A Corporate Perspective

True North has shifted. There is a valuable opportunity to capture here, and if businesses don’t adjust their bearings, they will become lost and left behind.

Denis Noonan

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The opportunity of a lifetime 

Sustainability… It’s the topic of the decade, maybe even the century! We hear about it in all of our personal and social environments, and it seems to be aggressively penetrating every aspect of business and finance. But are Sustainability and ESG really here to stay? Is this a full paradigm shift, or just another passing trend? For businesses, is it just another regulatory challenge, or is it a true opportunity? How business leaders decide to answer this question will have huge impact on their company’s market position and longevity.

Hopefully you are reading between the lines here and see that the answer to these questions is quite obvious. True North has shifted. There is a valuable opportunity to capture here, and if businesses don’t adjust their bearings, they will become lost and left behind. Even if businesses are not convinced about sustainability, basic business management fundamentals make a strong case for integrating ESG and Sustainability into business models across all sectors. This article highlights the benefits corporates can realise by strategically and proactively integrating Sustainability into all aspects of their business.

The Challenges are Obvious

The concept of Sustainability has been present for decades, long before Responsible Investing and Corporate Social Responsibility became popular. But it has taken hold of the mainstream as a result of global environmental and social awareness made possible by quantifiable environmental and climate data and tangible social impacts. The Kyoto Protocol and the Paris Agreement are good examples of how socially connected individuals and a multitude of influential stakeholders can result in a critical mass of the world placing a higher priority on ESG, and this has led to the Sustainability Paradigm Shift.

The increased demand for sustainability, coming from the consumer, social, investor and several other perspectives puts a wide range of burdens on companies. Processes, systems, resource management all need to be re-engineered to reduce pollution, replace non-renewable resources with renewables, improve waste management, gain control of supply chains, improve employee safety and well-being, improve relations with local communities, ensure that no adverse damage is caused to the local environment, the list goes on. And when a company makes these changes, how do they demonstrate to stakeholders that what has been done actually achieves the expected sustainability goals the company set to achieve? How did they know those goals were materially important or even relevant? How can stakeholders validate a company’s claims of sustainability and impact? 

Then there is the ‘big picture’ challenge: different stakeholders from different jurisdictions, cultures and experiential backgrounds have different ideas of what should be considered as sustainable. This challenge is underscored by the plethora of sustainability associations and frameworks that have set up to define, manage and improve sustainability. Regulation is starting to be introduced to standardise sustainability definitions and quantifiable criteria. Europe was the first to introduce regulation with the NFRD, Taxonomy and SFDR. China, Singapore and the UK, along with several other countries, will soon follow. Even within a single regulatory jurisdiction like the EU, different perspectives exist and it takes time to find feasible, manageable, practical solutions. So while the convergence of taxonomies and frameworks will eventually be achieved as a result of collaborative efforts like the International Platform for Sustainable Finance (IPSF), the Comprehensive Corporate Reporting System and the Corporate Reporting Dialogue (CRD), a lack of clarity on what Sustainability really means and how it can be measured will remain for the foreseeable future.

But don’t be daunted by the required effort and uncertainty that comes with Sustainability. Another word to describe this situation is commonly referred to as ‘Change’ and change is something we have managed since the beginning of time. Business fundamentals teach us to manage risk, identify opportunity and implement change accordingly to maintain or create a competitive advantage. In other words, change creates opportunity. This is nothing new and it’s exactly what the Sustainability Paradigm Shift is creating. It’s up to each company: adapt and thrive or stagnate.

Realising the Opportunities created by Sustainability

The objective of this article is to create awareness of the benefits corporates can realise by ‘integrating Sustainability’ into all aspects of their business. Sustainability is not about reinventing or replacing a business model, but rather about incorporating ESG factors into strategy, policy and operations that already exist. So when it comes to addressing challenges like uncertainty and regulation, the effort and cost should be considered in the context of the strategic development that is required for the company to remain competitive, not as a compliance burden.

It’s also important to accept that global best practices for business management have changed. Creating shareholder value is out of style and creating stakeholder value is the status quo. More specifically, in the early days of responsible investing, the choice between the value creation and social responsibility was thought to be mutually exclusive. Today, there is clear evidence that companies which incorporate ESG factors into their strategy and policies, and thereby create value for a wide range of stakeholders, outperform companies that do not. They maintain their value better during down turns and crisis periods, they are more likely to capture value from innovation and they ultimately have higher alpha. So why does integrating ESG into a business model create value?

The Basics

Well let’s start with basic principles. We can all agree that companies are always looking for ways to improve efficiency, optimise staff productivity, reduce costs and produce better products. This is commonly achieved in ways that benefit the shareholder but which deliver no benefit, or even negative benefit, to other stakeholders. Examples include cutting cost by reducing wages and employee benefits, increasing production efficiency with negative impacts on worker safety as well as the environment and improving product longevity by using non-cyclable, non-renewable materials. Process automation to improve efficiency and quality can also lead to job loss that unintentionally impacts a higher proportion of jobs held by minorities. By integrating ESG into the strategy and policy, the business decisions that are made to achieve the initial commercial goals like cost reduction and efficiency improvements will consider additional factors that are important to a wider range of stakeholders. What is most interesting is that the integration of these ESG factors into the decision making process can achieve the same goals of traditional business management ‘best practices’ while simultaneously creating additional financial and financial value. Here are just a couple of examples:

  • Last mile delivery costs account for more than 53% of total delivery costs. With the volume of online shopping continuing to increase, this will have a significant impact on company cost structures in the future. IKEA has seen this as on line sales have increased by 50% and is now 10% of total sales. Realising that last mile delivery will not only impact cost, but also traffic congestion and air pollution, ESG is a significant component in their delivery strategy where Ikea plan to optimise delivery efficiency and achieve zero emission delivery methods in all 30 global markets by 2025.
  • To reduce production cost, H&M modifies pattern cutting to minimise the amount of material used in the production process and minimise waste. In addition, the material waste that is produced is recycled directly by H&M to produce sweatshirts from repurposed waste fabric. So not only is cost reduced, but the net impact on the environment is a reduction of 1.5 tonnes of cotton waste per year, as well as a reduction in the use of natural resources to produce the clothes.
  • To reduce electricity use and reduce carbon emissions a company invests in technology and upgrades operational systems to use less electricity. Electricity use and carbon emissions are reduced. In addition: lower energy use enables the company to use a higher percentage of wind and solar energy thereby reducing dependency on non-renewable energy resources and reducing carbon emissions in the supply chain as well as reducing production cost by using less electricity.

In each example, ESG factors are highlighted to demonstrate that additional value is added to the standard commercial objective by addressing the larger scope of a company’s impact. Integrating ESG into basic business principles does not require a degree in quantum physics. It just requires that a few more variables are included in the business planning and decision making process.

And while maintaining safety levels for staff or reducing the use of non-renewable materials may not be directly correlated to a defined strategic objective, they do have a positive externality which certainly adds value to all stakeholders.

The Intangibles

In the examples above, the ‘additional value’ created by including ESG factors can be quantified. But there are several other positive externalities and intangibles that are achieved from incorporating ESG factors into basic business practices that may not be directly quantified. For example, incorporating worker safety into the enhancement of an operational process may actually increase cost, detracting from the objective to reduce production cost. The choice to increase wages, or not to decrease wages during a crisis, will also have a negative impact on bottom line profitability. But the positive impact on employee satisfaction from both cases could improve staff retention and attract more qualified applicants. This would lead to improvement of the overall staff experience level and capabilities, positively impacting productivity and quality of service in the long term.

The biggest positive externality related to incorporating ESG factors into a corporation’s management process is reputation. A positive reputation can increase financial and social capital as well as market share and profit, and ESG factors can have a significant impact on achieving this. In addition to increased employee satisfaction, discussed above, community engagement, protection of cultural heritage, impacts on gender equality, as well as actions to improve environmental and climate conditions are examples of how integrating ESG into existing policy and process contributes to a strong reputation. But reputational value can only be realised if the intent is clearly defined, truly embedded in action and if the impact is quantified and communicated. This requires a long term perspective and commitment as it takes time for a reputation to be established but only seconds for it to be lost.

Augmenting the foundation for value creation

In the new economy where sustainability is a high priority and companies need to deliver value to all stakeholders, two fundamental management components benefit significantly from the integration of ESG factors. We explained above that the companies that incorporate ESG retain their value relative to non-sustainable oriented peers in times of crisis and perform better in normal markets. Risk management and innovation, the ability to assess and validate new opportunities, are the two primary ingredients for this above average performance.

The reason for this is that companies which incorporate ESG factors into core policies, and specifically into these two management processes, incorporate a wider spectrum of materially important variables into critical business decisions that were not previously considered. Incorporation of ESG into risk management means that the corporate jet gets sold, off-site management meetings in Bali are discontinued and funds are redirected to invest in flood control systems for factories located in flood zones or in energy efficient cooling systems for production facilities in areas now prone to frequent heat waves. Companies that integrate ESG into risk management also use a longer term risk horizon, accepting that climate change may not have a negative impact tomorrow, but that there is a high probability a damaging environmental event will occur in the next 5 to 10 years. The incorporation of ESG risk factors and the long term risk horizon improves a company’s risk rating and the investor’s perception of stability, both contributing to a ‘sustainable company’s ’ ability to hold its value relative to peers in times of crisis.

Similarly, companies that incorporate ESG factors into their product development, process improvement and innovation strategies excel because they consider more areas where value can be created and use more data points to validate the feasibility and value an opportunity can add. If the definition of value is extended from simply producing more with less cost to accepting a proposal to produce the same amount for the same cost, but with less pollution, a decision can be taken to create value that benefits a broader range of stakeholders that would not have been taken in the old economy. As a result, sustainable companies are more open to, and therefore faster, at identifying, validating and implementing innovative change because they see how value can be created in more ways.

The key to impactful sustainability integration — The EU Taxonomy

Integrating sustainability into the core strategic and management processes of a company is not a simple task and needs to considered as an ongoing, evolving process, much like the introduction and creation of generally accepted sustainability frameworks has been. As the first legislative sustainability framework, the EU Taxonomy provides a foundation of definitions and measurements for distinct economic activities. Based on this foundation, companies can credibly and quantifiably assess their proprietary business models to identify where the largest opportunities exist for integrating sustainability to achieve ESG and financial benefit.

Using standardised, activity specific sustainability KPIs prescribed by the Taxonomy enables companies to integrate sustainability factors into strategy, investment and commercial decision making. New business opportunities can be assessed with both financial and non-financial factors. The standardised ESG factors also means that companies can both measure and manage continuous improvement of sustainability objectives, as well as improve transparency in communication to stakeholders. This mitigates the risk of greenwashing and significantly improves overall brand and company reputation. 

Important benefits realised by a sustainable company

So what does all this really mean? As a company CEO, what changes am I going to see to my bottom line when I integrate ESG into the core framework of my company? Most of the benefits have already been mentioned, but we know that CEOs like to see everything summarised in one place (we just left it to the end to ensure that they would read the detail).

  • Higher share price — lower risk, proven innovation success, continuous quantifiable impact on environmental and social factors and the resulting reputational value create investor demand.
  • Lower cost of funding — the flip side of the higher share price, for all the same reasons, lenders see a better risk profile, leading to reduced borrowing rates.
  • Increased, stable sales volumes — a brand & reputation that is aligned with clients’ demand for supplier sustainability and with building high customer loyalty and satisfaction both attracts and retains clients.
  • Cost and efficiency improvements — employee retention, process and system innovation, waste and energy reduction, supply chain efficiency and sustainability alignment, community support, better relations with regional regulators and local legislators are some of the main ESG impacts that will reduce operational and administration resource requirements.

Measure and Disclose ESG Impact

By now it should be clear that there are multiple benefits to corporations that strategically and proactively integrate Sustainability across their business. The key to achieving these benefits is for a company to demonstrate that they have successfully transformed their ESG vision and intention into tangible, measurable impact. And verification of the impact from an external source always helps. Demonstrating that there is a process in place to continually monitor, manage and prioritise continuous improvement of ESG impacts is also important. Companies will optimise the value they gain from their ESG vision and actions through transparency. ESG transparency is what Stakeholders demand. 

A closing note: Notice we did not talk about reputational risk anywhere in this article. It is important to emphasise the importance of starting from the top down and incorporating the ESG factors that are most material for an individual company. A company that worries about reputational risk is integrating ESG for the wrong reasons and will not realise the larger benefits. A company that integrates ESG because of the positive benefits it will bring to all stakeholders, in addition to the company’s bottom line, will benefit from a strong reputation as a result of their actions and will be much better positioned for new opportunities that will drive success.


 

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