Companies Need To Take A Clean Sheet Approach To ESG

ESG has long been viewed through a compliance and risk management lens, rather than a strategic priority. Over the last several years though, we’ve seen a shift – many top executives have begun to make significant commitments, with the early focus  around emissions. There’s a greater demand from society and investors to elevate ESG performance beyond compliance and risk management, but CEOs are struggling to gauge both the extent and timing of these commitments.

Early winners are already emerging among larger, established companies who’ve started looking at ESG more strategically. Unilever is a standout example, saying that brands that have been integrated into their Sustainable Living Plan grow 30% faster than those that have not. Danone is moving towards becoming a B Corp by 2025, with 45% of its global sales covered by B Corp certification. It’s a much slower go in the industrial sectors, but Dow is a standout.

And while public equity markets have yet to consistently price in broad ESG performance – be it positive or negative – we expect this to change within the next few years. We’ve seen how the markets have acted with first-movers before in other industrial sectors. Climate change is a great example. In mining, markets devalued any company significantly exposed to thermal coal even while global demand was steady or rising. In oil and gas, the markets are devaluing both those companies that have announced major transition strategies, such as BP and Shell, and those that have not, such as Exxon – while driving higher values for much smaller renewables producers. For example, NextEra Energy, as of February 2021, has a market cap nearly twice that of BP, despite having one-tenth of the revenue.

The markets will act. It’s a question of when, not if. Companies need to be prepared.

A mindset shift using a clean sheet approach

Thus far, the three approaches we’ve seen companies take have been:

• This too shall pass: continuing to treat ESG as purely compliance and risk management
• Repackage and repurpose: reframing existing compliance- and risk management-focused initiatives to a more strategic wrapper
• A clean sheet approach: rethinking ESG and integrating it into their overall business strategy

Companies simply can’t afford to take anything but a clean sheet approach to ESG, because there’s a mindset shift that ESG should also be an opportunity for competitive differentiation. Investors are playing a huge role in pressuring companies, particularly long-term shareholders and sovereign wealth funds. Societal demands have also moved upstream – end-use consumers are pressuring the companies they buy from, which in turn are moving through their supply chains, all the way to raw materials suppliers.

In order to meet the demands and adapt to this new mentality, ESG must be part of the corporate DNA, and not just relegated to the sustainability team and focused on compliance and risk management. ESG must be able to develop competitive differentiation to help win the market.

The sustainability- or ESG-centric businesses that have already figured this out are one thing. But how do the large incumbent, asset-intensive industries – in other words, not the AllBirds, Patagonia or Whole Foods of the world – actually achieve this?

Unilever and Dow, as mentioned above, give us a glimpse into what’s possible by starting fresh.

• Apply a “value capture” mindset: When ESG’s treated with a mindset of creating value rather than just compliance, regulatory and reporting requirements go from the standard to the bare minimum.

• Intentionally include ESG in core strategy development: It should be part of what differentiates you.

• Integrate ESG into every process, product and service of the company: It doesn’t just live within the Sustainability Department; it has major implications for the entire business, and should be applied as such, with the Sustainability team becoming the stewards.

Stop neglecting the “S”

When people say “ESG,” they’re often thinking only of climate change and emissions – that’s where the most attention and funding has gone. Other environmental issues have taken a backseat, but even more alarmingly, so have social issues. The “S” in ESG must be as important as the “E,” and there’s tremendous opportunity for companies that employ this kind of thinking.

Social inequalities are a critical focus for the primary industries powering many Western-focused companies and economies. More often than not, industries like mining and agriculture are developed around remote communities, including indigenous groups. In an era of such low trust, it’s especially important that companies developing these natural resources become true partners with these communities, helping to develop their social, economic, and environmental prosperity. Companies must act as catalysts for long-term prosperity, instead of just mining/growing a resource and leaving the region behind.

To ensure social issues are just as prioritized as the environmental ones, companies must:

– Engage local stakeholders: Involve local stakeholders, including the communities, in strategic conversations, and take a principles-based approach to goal-setting. That way, broader goals and principles can be adapted for each unique situation, with input from the communities they impact. The nonprofit Development Partner Institute is actively bringing together the major mining companies of the world with local and indigenous communities. Hershey’s responsible sourcing program for cocoa across West Africa is another great example.

– Consider broad market and geographic conditions before mapping out your just transition: Companies have often leaned on their Foundations as the sole vehicle for social purpose. With ESG now integrated into the core business strategy, the Foundation cannot be the sole pathway to address social issues.

– Utilize SDGs to make ESG part of the corporate culture: This mindset shift has a critical organizational change element to it. SDGs, a universally understood and accepted definition of the underlying components of ESG, offer an important new organizing framework that enables companies to think differently and identify what initiatives align to the relevant SDGs and can create value for the business.

Companies must pursue ESG beyond compliance and risk management, in order to capitalize on this transformational moment and create value and competitive differentiation. This bold aspiration requires new strategies and approaches, as we’ve outlined here. While it’s most certainly a challenge, leaders who tackle this head-on will see improved financial and stock performance; improved access to debt; lower cost of capital; and greater transparency, trust and brand value with all stakeholders.