Today the vast majority of companies cite climate change as a significant priority and pledges for carbon neutrality are mushrooming both at the industry and company level.
But take a look at these facts: in 2016, 90% of executives saw sustainability as necessary, but only 60% of companies had a sustainability strategy, and only 25% had developed a clear business case for their sustainability efforts.
Five years later, of companies committed to carbon neutrality, how many have a clear business case? Without one, their well-meant ambitions will flounder. With one, sustainability is transformed from an earnest but unfocused exercise in corporate social responsibility to business momentum.
Think about your own boardroom: when sustainability initiatives yield extra profits, the trade-off between doing well and doing good disappears, and management, financial sponsors and customers will happily join forces to push the sustainability agenda. These forces are deeply rooted in the DNA of any market system, and are even required by companies as part of meeting their fiduciary duties to shareholders. When sustainability yields profits, capitalism’s formidable forces are unleashed, and sustainability can scale.
Beyond profits, the business case is also key for investors as it provides a credible picture of how a company’s sustainability strategy has added to performance, and therefore boosts not only the bottom line but also the share price and valuation.
What constitutes a robust business case in today’s environment? We believe that it must be three-fold: direct “accounting” impacts hitting the Profits & Losses head on; indirect impacts on the company’s performance; and transformational impacts ensuring that the company remains “future-proof”.
Sustainable companies benefit from a higher brand value. A stronger brand is perceived positively by investors
On the revenue side, sustainable companies can boost revenue through premium pricing and access to new customer segments at all ends of the income spectrum. Environmentally and socially aware consumers, inclusive of emerging customer demographics such as LOHAS (Lifestyles of Health and Sustainability) are typically willing to pay 15 to 30% more to sustainable companies (depending on the product type) and are also 64% more likely to recommend sustainable companies to friends. Serving Bottom-of-Pyramid (BOP) consumers with dedicated products and services can also increase volume. Commercial results for companies taking action can be stunning: Unilever, a leading fast-moving consumer goods company, announced in June, 2019, that its purpose-led Sustainable Living Brands were growing 69% faster than the rest of the business and delivered 75% of the company’s growth.
On the cost side, operational efficiencies, or reductions in energy use or waste, have a direct benefit for the bottom line. Walmart, for example, aimed to double its logistics efficiency between 2005 and 2015. The end of 2014 saw fuel efficiency improved by approximately 87% compared to the 2005 baseline. This resulted in 15,000 metric tons of avoided CO2 emissions and savings of nearly $11 million.
It’s important to note that regulators increasingly ask companies to pay for their externalities (“negative impacts on the environment or society”), and what used to be in the sphere of risks now directly enters the P&L. As a result, airlines, for example, must factor in the cost of their CO2 emissions, at a value of about 30 to 50 euros ($36.50 to $60.90) per ton in 2021 to date. Accounting for these externalities strengthens the business case, as sustainable initiatives reduce these recurring costs.
Based on costs and benefits, profit–maximizing companies will allocate resources optimally and implement profitable sustainability initiatives.
But not so fast: if sustainability initiatives directly and immediately pay off, what is all the fuss about? Why aren’t companies doing them anyway?
The truth is that direct impacts on the bottom line are often not sufficient to generate a positive business case (this consensus is supported by a strong body of evidence dating back to the 1980s). For a positive business case, indirect impacts need to enter into play.
‘Companies with social capital gained through a track record of honest sustainability leadership are much more likely to be forgiven by customers
One of them is employee value proposition. A sustainable vision and mission can galvanize your workforce, boosting engagement at work by 1.4x and satisfaction at work by 1.7x. This directly boosts productivity, reduces costly employee churn and helps in attracting talents, in particular millennials and Generation Z.
Sustainable companies also benefit from a higher brand value. Beyond employees and customers, strong brands are also positively perceived by investors, creating intangible capital often translated into higher share prices.
Additionally, transparent, sustainable practices across all operations can shield companies from scandals. Companies with “social capital” gained through a track record of honest sustainability leadership are much more likely to be forgiven by customers. As recognized by leaders in the investor community (for example, think of the 2021 letter to CEOs from Larry Fink, CEO and Chairman of BlackRock), the line between sustainability risk and financial risk is gradually disappearing as companies become exposed to the scrutiny of civil society: if negative externalities are not directly paid through regulation, they will be paid in the form of increased risk of sustainability scandals.
Finally, using sustainability as a lens for innovation helps a company to remain relevant in the long term, by properly accounting for emerging risks and opportunities that will become financially material one day. Umicore, global leader in the circular economy space, transformed from traditional mining to urban mining: instead of extracting resources from the ground, the company today sources materials from used IT equipment. The interesting part of this transformation is its timing: launched in the early 2000s, 10 years before the circular economy megatrend began to materialize.
The challenge of indirect impacts is that they are, by nature, difficult to quantify and will thus tend to be overlooked or discounted. And this partly explains why companies struggle to identify and sell positive business cases for sustainability to their management and boards.
One thing is clear: the world is moving at a much quicker pace, and stakeholder expectations on sustainability are no exception. More than ever, firms must continuously adapt. The rules of the game are constantly evolving, with full transparency becoming the norm, often enforced by regulation (The European Union’s strengthening of the rules of Directive 2014/95/EU on non-financial reporting and the roll out of its EU Taxonomy Regulation 2020/852/EU are cases in point). Competitive peer pressure also plays a significant role, with companies being jostled towards sustainability.
The biggest shift, however, is in Environmental, Social and Governance (ESG) reporting. Five leading standard-setters together with the World Economic Forum (WEF) are working towards universal metrics and methodologies to report all material societal impacts under the umbrella concept of ESG (the Climate Disclosure Standards Board, the Global Reporting Initiative, the International Integrated Reporting Council and the Sustainability Accounting Standards Board).
Standardized metrics will mean companies will no longer be able to cherry-pick the impacts and externalities they wish to share. Invariably this shift will move sustainability from being a soft concept to one with clearly defined edges and very little wriggle room.
Already, financial analysts are equipped with tools that compare sustainability performance across industries, or over a timeframe, and immediately reward or sanction sustainability performance. Moreover, technologies offer sophisticated algorithms that track complex ESG data to report a company’s true performance. With such scrutiny on the near horizon, a business’s material risks could change considerably in a very short space of time.
But will this be enough? The ability of the economic system to self-regulate through ESG is questioned by heavyweights in the financial system. Tariq Fancy, former Chief Investment Officer for sustainability at BlackRock, has poked holes in the very concept of ESG and highlighted the critical role of regulation to reach societal objectives as poised by the Sustainable Development Goals (SDGs) or the Paris agreement.
And the 2020 progress report on the UN SDGs (recognized as the universal framework for sustainability) goes in the same direction, as it warned that the world is off track to achieve most of these goals.
Combine this with the election of US President Joe Biden and his prominent sustainability agenda, and we believe that today’s rules of the game are far from set in stone, and that regulation is poised to play an increasingly prominent role.
As a result, companies need to remain agile, ready to adjust continuously in the face of a complex, high-paced environment. And this has concrete, deep implications for business operations, as companies now must prevent rigidification of capabilities, keep internal movement from the outside-in, legitimize exploration, marshal energies, all while ensuring a long-term vision and consistency.
A clear business case accounting for direct and indirect impacts is a must-have for companies if they want to avoid becoming obsolete. But this is not enough: the sustainability megatrend, from its complexity, unpredictability, speed and far-reaching business implications, could be the ultimate test for corporate agility. Survivors, chin up, should take advantage of the scars left from the sustainability megatrend for future disruptions.
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