Top Ten Things Every Organization Should Ask About the “E” in “ESG”
Yvette Leung and Brian Patrick Green
Yvette Leung, a 2021-22 Environmental Ethics Fellow, and Brian Green, director, technology ethics, both at the Markkula Center for Applied Ethics. Views are their own.
In 2006, the UN-backed Principles for Responsible Investment (PRI) was created to target successful investments in environmentally conscious companies. It consisted of roughly 63 investment firms with nearly $6.5 trillion in assets under management. By 2018, the number of assets under management had risen to $81.7 trillion, with more than half of global asset owners implementing and considering ESG issues as part of their investment decisions . Over the past several years, the Environment, Social, and Governance (ESG) sector has grown rapidly and gained immense amounts of traction. The growing demand for ESG is related to the added benefits and promising returns that companies can receive when they align themselves with ESG values. The environmental component of ESG has become a focal point because it can lead to more sustainable products, improved environmental practices, and the preservation of the Earth. In order for companies to obtain these ESG benefits, organizations should consider the different steps to successfully implement ESG targets into their overall company strategy. This article offers a “top ten list” of things organizations should prioritize when thinking about the “E” in ESG.
1. How to create a strong sustainability plan
A strong sustainability plan can enable companies to enter new markets and industry sectors. Prioritizing specific environmental issues that are of value to consumers can promote top-line growth, which helps companies generate more revenue or gross sales. Since expenses are not factored into gross revenue, firms may be concerned by the increased production costs of green products. However, the benefit of having top-line growth outweighs the short-term debt the company may incur from sourcing more sustainable and quality resources. When Unilever created Sunlight, a dishwashing liquid brand that uses less water than other brands, Sunlight outpaced category growth by more than 20 percent in a number of water-scarce markets . Although the expenses of a green product such as Sunlight are higher than a non-green competitor, customers are willing to pay more for a green product. By curating a strong sustainability plan and setting forth concrete environmental goals, firms are able to prioritize the creation of eco-friendly products, which positively impacts revenue growth and profitability in the long run.
2. Shifting the narrative from a short term to a long term approach
A recurring theme with the ESG sector is that a short-term approach or ‘short-termism’ conflicts with the overall goal of ESG. In this case, short-termism specifically refers to the pressure for companies to show continuous growth in profits and to outperform quarterly earnings. Due to current culture and financial structure, these financial practices have led the financial markets to promote short-term thinking. It can be difficult for ESG to survive in an environment that promotes short-termism because making real change towards tackling ESG issues may take long periods of time. For example, a company that struggles with major environmental issues and neglects to work on these problems will see long term consequences that go beyond the upcoming quarter.
As just one example of how ESG is influencing corporations towards more long-term thinking, companies are already beginning to transform the ways in which quarterly calls are conducted. All too often, companies were and are driven by short-term sell-side analysts and would cave to the pressure of these interests. But now, ESG has initiated significant change because corporations are including progress on specific long-term ESG targets during earnings calls. To continue this momentum, companies should include ESG targets in their long-term strategy and find ways to communicate crucial ESG related information to investors rather than just financial metrics.
3. Reducing water consumption and going water positive
High water consumption is one of the greatest challenges firms face. There is a greater demand to be “water positive,” which refers to generating more clean water than they use, by making water-intensive products and processes more efficient and replenishing areas in which the company has consumed the water resources. The overconsumption of water has led to a significant increase in shortages throughout the world. The UN has predicted nearly a “40% shortfall in freshwater resources by 2030” . Therefore, firms have set targets to replenish more water than the amount used in a company’s operations. An example of this is PepsiCo creating a water positive plan for replenishing more than 100% of water used at all high-water risk facilities by 2030. PepsiCo has already worked towards meeting these targets by implementing incremental changes throughout the firm and their third-party facilities. More specifically, Pepsi’s Mexican brand Sabrita worked with a franchise bottler and figured out a way to recycle the water used in ingredient processing. Sabrita and the franchise bottler were able to treat the ingredient processing water and make it drinkable, as well as usable in different food plants to wash potatoes. The company was able to reduce freshwater consumption by 50%. While not yet water positive, Pepsi continues to look for alternative ways to reduce water consumption and plans to collaborate with more firms to reinvent their current operations systems .
4. Reducing carbon footprint and going carbon negative
Reducing carbon footprint is another critical element when thinking about the “E” in ESG. Utilizing carbon negative technology can be an integral part of managing a company's supply chain and sustainability efforts. Some multinational companies are focusing on ways to reduce their carbon footprint in hopes of one day becoming entirely carbon negative. Corporations such as Starbucks have committed to reducing their carbon footprint by reconstructing their operations and supply chains. Starbucks continues to transition to clean energy through onsite solar and implemented new innovative renewable energy investments. In 2021, the company completed the installation of their 1-megawatt solar array at the Starbucks Carson Valley Roasting Plant and Distribution Center. This center is one of the largest for supplying Starbucks products domestically and internationally, and provides a third of the Roasting Plant and Distribution Center’s electricity annually . Additionally, Starbucks is starting to scale electric fleets throughout the company. Overall, Starbucks is one of the examples of how companies are searching for ways to renovate their current supply chain and daily operations by enforcing cleaner methods to solve their challenges of producing high amounts of carbon footprint.
5. Why companies should consider localizing their supply chain
Locally diversifying a firm’s supply chain can help alleviate environmental concerns. Although corporations are integrating climate change into their operational strategies, many U.S. companies ignore the indirect emissions through their supply chains. According to McKinsey & Company, 75-90% of emissions that consumer good companies produce in their supply chains come from emissions beyond their direct control . Apple corporation has run afoul to this exact issue: Morgan Stanley analysts have been tracking air quality reports in Chinese cities that indicate an increase in polluted air quality due to production of the iPhone 12 . The air quality data tracks for specific elements such as nitrogen dioxide levels and have found a significant increase in the atmosphere that coincides with the mass production of the iPhone 12. Excessive nitrogen dioxide in the air can form acid rain, decrease crop yields, and can be dangerous for health. Additionally, the Intergovernmental Panel on Climate Change (IPCC) issued a report of which 90 climate scientists from 40 countries concluded that if there is no collective action to limit global warming to 1.5 degrees Celsius by 2040 then there will be severe consequences on the natural systems of the planet. Examples of these consequences include extreme droughts, devastating wildfires, massive floods, deadly hurricanes, and famines throughout the world . While perhaps not always the most cost efficient solution, localizing supply chains to decrease greenhouse gas emissions is a more ethical solution.
6. Ethical sourcing & utilizing renewable material
Ethical sourcing for a company's materials is vital in order to maintain a sustainability focused company. A great example is the new and upcoming footwear company Allbirds. The company was launched in 2016 with the mission to reverse climate change. The firm ethically sources their materials such as wool “...from sheep farmers that engage in regenerative agricultural practices” . Allbirds has also pledged to source 100% of its wool from sustainable farmers by 2025. Furthermore, Allbirds uses renewable and responsibly grown sugarcane for the development of their shoe-sole material. Overall, Allbirds is said to have maintained a negative carbon footprint by their use of renewable sugarcane and the low carbon intensity feedstock . More corporations should invest in ethical sourcing and dedicate their efforts towards renewable resources.
7. How corporations could effectively allocate their resources
Evaluating how and where a firm’s resources are being utilized can significantly help reduce operating costs and promote sustainability. These expenses could include the cost of water, raw materials, and other natural resources that the organization relies on to operate efficiently. Understanding certain areas of the firm where operating expenses are abnormally high (or an abundance of waste is being produced) will help the firm pinpoint specific operational issues and ways in which the company's efficiency (and financials) are dragging. According to McKinsey, reducing resource costs can improve operating profits by as much as 60% , showcasing how a company’s resource allocation and financial performance work in tandem. Once these target issues are discovered, the firm can move forward by making certain adjustments, such as improving their manufacturing process, redesigning equipment, reformulating products, or figuring out ways to reuse and recycle waste. Puma published data on their water intake and carbon emitted through theirits supply chain, which helped them identify ways to reduce water, energy, and fuel consumption by 60% . Another great example is FedEx, which was able to overcome challenges with high fuel consumption in their 35,000-vehicle fleet. FedEx decided to convert 20% of its vehicles to electric or hybrid engines, thus becoming more sustainable and saving fuel costs. As of 2020, Fedex has met this 20% goal, which has reduced fuel consumption by more than 50 million gallons . By 2040, FedEx hopes to have converted all their parcel pickup and delivery fleet to zero-emission electric vehicles. Puma and FedEx are just two examples of how large corporations can actively implement sustainable practices that efficiently utilize their resources in order to improve operating profits.
8. Targeting ‘materiality’ issues & implementing the SASB Materiality Map
Materiality issues are industry-specific issues that companies should consider when making business decisions because they yield higher profits by increasing efficiency. Companies prioritizing materiality issues often outperform those that don't. For example, FedEx’s incorporation of hybrid and electric vehicles into their fleet helped them combat high gasoline consumption and saved them expenses on major operational costs. In fact, electric vehicles are $60 cheaper per month to drive than gasoline ones, which illustrates the advantages of directing attention towards materiality issues . A greater concentration towards material ESG issues can positively impact the firm’s financial performance compared to those which have an unclear commitment to sustainability.
The Sustainability Accounting Standards Board (SASB) has defined materiality issues amongst all 77 industries. These material ESG targets vary. For example, material issues for companies in food retail and distribution include greenhouse gas emissions, energy management, access and affordability, fair labor practices, and fair marketing . For the coal operations industry, some of the relevant materiality issues would be GHG emissions, water & wastewater management, waste & hazardous materials management, and other ecological impacts. The value of using the SASB materiality map is that it helps organizations focus on material ESG issues that directly impact the firm’s performance. An example would be greenhouse gas emissions, which are certainly material issues for an electric utility company but less so for a financial services firm. Since ESG standards are not regulated by the government, the SASB materiality map provides guidance for companies to properly assess whether or not certain ESG issues are addressed in the firm.
9. Why companies should incorporate SDGs into their external report
The United Nations Sustainable Development Goals (SDGs) lays out a strong framework for organizations to utilize and assess when evaluating their impact on the environment and the society as a whole. The SDGs are made up of 17 goals that the UN had identified as necessary to taking actionable steps towards a more sustainable future . Under the 17 goals, there are 169 specific targets that are set out to be accomplished by 2030. The SDGs enable companies to integrate sustainability issues into their reporting cycles and communicate with employees, investors, and customers of the company’s commitments to tackling these SDGs targets. Specifically, issues involving the “E” component of ESG, the SDG framework offers environmental analyses as parts of goals 6, 7, and 11-15 . Although there are no regulated corporate reporting systems for the SDGs, companies should still consider incorporating the SDGs and other frameworks such as the SASB materiality map in order to disclose crucial information that is important to institutional investors. Moreover, third party ESG raters rely on the quality and quantity of ESG corporate disclosure; complying with the SDGs targets could easily have a positive impact on a corporation’s third-party ESG ratings, and these improved ratings could help lead to inclusion in ESG index funds.
10. Why companies should have an external report
ESG external reporting is a way for corporations to effectively communicate with investors and the public on their business strategy and mission. Publicly displaying ESG related issues the company is facing are important for both the corporation and its investors. There are many examples of how there is a positive relationship between a corporation’s prioritizations towards ESG materiality issues and superior financial outcomes . Corporations that demonstrate a proactive and long-term approach to tackling difficult environmental issues illustrate how the company mitigates risks and has a strong sustainability plan. Furthermore, ESG transparency enables firms to build a strong relationship with their customers and gain customer loyalty. It tells the consumer that the company is aiming towards a sustainable approach that values first the planet, then people, and lastly profit. Additionally, ESG external reports are important metrics for the public to see and consider when investing in the company or purchasing products from them. Overall, it holds companies accountable for their actions and long-term impact on the planet.
ESG has become the focal point for many corporations, investors, and consumers. The growing demand for a more sustainable and ethical approach to business operations has driven the ESG sector. Companies have started to take notice of the financial benefits and future returns they receive when tackling their industry specific ESG issues. Although it may take a while for corporations to realize immediate gains, firms need to remember that ESG is a long-term process. Therefore, firms should focus on curating a solid sustainability plan that prioritizes clean and renewable approaches. As well as, setting forth specific targets on how expenses can be reduced through more efficient uses of natural resources, water, raw materials, water consumption, and carbon emission. If a firm is unclear on what industry specific ESG issue it faces, the company can use resources such as SASB Materiality Map or the SDGs in order to distinguish the sustainable issues they should prioritize. Once a clear and concise plan is in place, corporations should communicate with the public on how they are actively addressing their ESG targets through external reports. If a firm is able to follow these steps, then the company should be able to obtain additional financial benefits while also leaving a positive impact on our planet.
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