Every company operates in an environmental, social and governance (ESG) context. It is therefore clear that a strong ESG offering can create corporate value. But let’s take a brief look at the individual elements of ESG:
- The E stands for “Environment,” the environmental criteria, includes the energy a company takes in and the waste it emits, the resources it requires, and the consequences that result. Last but not least, the E includes carbon emissions and climate change. So every company consumes energy and resources, affects the environment and is affected by it.
- S stands for social criteria and is concerned with a company’s relationships and the reputation it has with people and institutions in the communities in which it operates. “S” includes labor relations and diversity and inclusion. Every company operates within a broader, diverse society.
- G for governance, is the internal system of practices, controls and procedures that a company uses to make effective decisions, comply with the law and meet the needs of external stakeholders. Every company, which is itself a legal creation, needs governance.
The individual elements are interwoven and, for example, social criteria overlap with environmental criteria and governance when companies aim to comply with environmental laws and broader sustainability concerns. Our focus is primarily on environmental and social criteria, but as any executive knows, governance can never be hermetically separated. Indeed, good governance requires mastering not only the letter of laws, but also their spirit – such as identifying violations before they occur, or ensuring transparency and dialogue with regulators, rather than formalistically filing a report and letting the results speak for themselves.
But do you pursue such goals merely to look good, or does it also enhance a company’s success?
Revenue growth
Strong ESG performance helps companies enter new markets and expand into existing ones. When regulators trust companies, they are more likely to grant them the access, permits and licenses that open up new growth opportunities. ESG can also influence consumer preference. McKinsey research has shown that customers are willing to pay a premium for green behavior. Although there are customers who refuse to pay even one percent more, the study revealed that more than 70 percent of consumers surveyed across purchases in various industries – including B2B markets – said they would pay five percent more for a green product if it met the same performance standards as the alternative.
That actually pays off. When Unilever developed Sunlight, a brand of dishwashing detergent that uses much less water than its other brands, sales of Sunlight and other Unilever water-saving products outpaced category growth by more than 20 percent in a number of water-scarce markets. And Finland’s Neste, founded more than 70 years ago as a traditional oil refining company, now generates more than two-thirds of its profits from renewable fuels and sustainability-related products.
Cost reduction
ESG can significantly reduce costs. Among other benefits, effective implementation of ESG can reduce operating costs (e.g., feedstock costs and the actual cost of water or carbon). As with each of the five links to ESG value creation, the first step to realizing value begins with recognizing the opportunity. Take 3M, which has long understood that proactively managing environmental risks creates competitive advantage. The company has saved $2.2 billion since launching its pollution prevention program back in 1975. This has been done by reformulating products, improving manufacturing processes, redesigning production facilities, and recycling and reusing production waste. FedEx, for its part, has set a goal of converting its entire fleet of 35,000 vehicles to electric or hybrid engines; so far, 20 percent have been converted, which has already reduced fuel consumption by more than 190 million liters.
Less regulatory and legal Intervention
A stronger external ESG promise can give companies greater strategic freedom and reduce regulatory pressure. Indeed, in many cases across sectors and regions, we have seen that a strong ESG position helps reduce the risk of adverse government action for companies. It can also win government support. Of course, the impact of regulation varies by industry. In pharmaceuticals and healthcare, about 25 to 30 percent of profits are at stake. In banking, where regulations on capital requirements, “too big to fail,” and consumer protection are so important, typically 50 to 60 percent of value is at stake. In the automotive, aerospace, defense and technology sectors, where government subsidies (among other forms of intervention) are widespread, the value at stake can also reach 60 percent.
Higher employee satisfaction and productivity
A strong ESG profile can help companies attract and retain good employees, increase employee motivation by instilling a sense of purpose, and increase overall productivity. Employee satisfaction correlates positively with shareholder returns. Alex Edmans of London Business School, for example, found that companies that made Fortune’s list of “100 Best Companies to Work For” had 2.3 to 3.8 percent higher stock returns per year over a period of more than 25 years. In addition, it has long been known that employees who not only have a sense of satisfaction, but also a sense of connectedness, perform better. Positive social impact correlates with higher job satisfaction – when companies “give back,” employees respond with enthusiasm.
Recent studies have also shown that positive social impact correlates with higher job satisfaction, and field experiments suggest that employees appreciate it when companies “engage. Just as a sense of higher purpose can inspire employees to perform better, a weaker ESG offering can drag productivity down. The most glaring examples are strikes, work stoppages and other labor actions within the company.
And it’s worth looking at productivity constraints outside the company, such as in the supply chain. A good example is General Mills, which defines its ESG principles “from farm to fork to landfill.” And Mars is looking for ways to create what the company calls a “win-win-win” for the company, its suppliers and the environment. For example, Mars has developed model farms that not only introduce new technological innovations to farmers in its supply chains, but also improve farmers’ access to financing so they are able to retain a financial stake in these initiatives.
Optimizing investments and assets
A strong ESG position can increase investment returns by investing capital in more promising and sustainable options (e.g., renewable energy, waste reduction, and emissions control). Proper consideration of investment returns requires starting from the right baseline. When it comes to ESG, doing nothing is usually an eroding line, not a straight line. Being forward-thinking impacts the bottom line, and going with sustainability creates new opportunities to increase investment returns.
The rules of the game are shifting: regulatory responses to emissions are likely to impact energy costs and could particularly affect the balance sheets of carbon-intensive industries. And bans or restrictions on things like single-use plastics or diesel cars in inner cities will impose new constraints on many companies, many of which may have some catching up to do. One way to stay ahead of the future is to consider repurposing assets now – for example, converting redundant office space into higher-demand uses such as apartments or daycare centers, a trend we are beginning to see in revitalized cities.
Take China, for example: the country’s need to address air pollution is expected to create more than $3 trillion in investment opportunities by 2030, ranging from air quality monitoring to indoor air purification to cement manufacturing.
How can we support you?
Leading change and inspiring employees is our passion. We are happy to lend our experience and knowledge to your project and look forward to working with you to design and implement an ESG strategy – for you and all your stakeholders.