It is easy to take a cynical approach to the drivers of big business.
Over recent years you cannot move for business trying to show us it has a conscience. We care. It is hard to say this is anything other than a great move but how deeply does a business really value its values beyond profit? I mean, do we really believe they have a higher purpose, a mission that drives them to a higher standard. Can they really make us believe as employees, customers, investors, and stakeholders that we are all part of something bigger?
As the pandemic stripped business bare, I became less cynical.
It has been tough for many and the future is far from certain. What is becoming clear is that some businesses will come out of this in a position of strength, if not stronger. We are in the midst of a global experiment in mass behavioural change and its accelerating. The beneficiaries are those that can enable this. Enter the tech industry, digitalisation, and our brave new net zero future - well only partly. It also appears that having a conscience, caring, and looking after each other is good for all business. Organisations who measure their success against a broader measure than financial performance are attracting increasing amounts of attention from the kings of capitalism themselves – private equity & fund management. Enter the rise of ESG and the sustainability agenda.
Why focus on Sustainability
ESG or Environmental, Social & Corporate Governance is nothing new. It measures business performance against a set of metrics for carbon emissions, labour rights, gender equality & management practices. If it started as a thesis; what is good for society is good for business, then it has been proven in the real world of a pandemic. Resilience (tick), employee wellbeing / productivity (tick), customer engagement (tick) & innovation (tick). Want to withstand another global systemic shock? …. (tick)
The UN were ahead of their time when they created the “Who Cares Wins” conference in 2005. Never has it come into a starker reality than through this pandemic. We have seen fear and uncertainty engulf our markets, industries, workers, families and loved ones. The importance of purpose and sustainable business is now mainstream.
Ethisphere, an institute that measures ethical business practices, drew up its annual list of the world’s most ethical businesses and found that their share price had on average outperformed a benchmark index of comparable large companies by 13.5% over the preceding five years.
We have had time to reflect on this with our clients over the past 6 months. Those operating with ESG principles embedded into their being are clearly benefitting from a ‘sustainability dividend’. Here are 5 overriding reasons we’ve seen why a focus on sustainability is good for business:
2020 has overwhelmingly shown that those companies with sustainability woven into the fabric of their operation have outperformed those that don’t. Because their operations are built on sustainable practices, with raw materials coming from sustainable sources and a governance structure that promotes environmental awareness, they are far more resilient in times of existential threat.
Sustainable sourcing systems are typically built around circular economy principles of recycling and sustainable production of raw material. Irrespective of a pandemic or economic crisis, these companies and their eco system of suppliers and service providers remain strong during these periods of time.
With resilience, brings the opportunity for sustainable, long term growth – which in turn attracts investors and with that brings more capital to grow the company even more. It becomes a vicious cycle of success.
Sustainability drives efficiency. Invention and innovation are born out of restriction and constraint. Net-zero targets create the restriction and constraint to drive innovation in operational efficiency. Digitalisation has been a great example of this. It has helped those firms with ESG invest in R&D, automation, and people to become leaner and more profitable.
Being sustainable is hard. It requires a ruthless focus on operational efficiency to cope with the constraints and restrictions that an ESG ‘gold’ standard requires. But because of this, they become very good at continuous improvement and experimentation. They also haver higher rates of success in innovation to reality as the innovation and new ideas become the greatest driver for profitability.
Oxford University and Arabesque Partners conducted a meta-study entitled "From the stockholder to the stakeholder" involving detailed analysis from more than 200 different sources. This study confirmed that there is a conclusive correlation between good business practices in sustainability and economic profitability. To put this in perspective – this study was conducted in 2015! This isn’t a “new thing” or a “fad”. It is simply good business!
The first part of the study explored this principle from a strategic business management perspective. The results were remarkable: 88% of the 200 sources reviewed found that companies with solid sustainability practices have better operational performance, ultimately resulting in cash flows (see exhibit 1 below). In the second part, 80% of the sources reviewed showed that prudent sustainability practices have a positive influence on returns on investment.
Exhibit 1: Sustainability practices and business results
3. Shareholder value
The success of companies with ESG and sustainable business practices has not gone unnoticed. Those with money want to make more money and they want to do it responsibly and sustainably. They don’t like surprises and shareholders that play in the arena of companies with poor ESG practices invariably get bitten. Shareholders see that companies with strong sustainability practices also have more predictable and resilient income streams. They have stronger ecosystems of partners and suppliers and have faster creation and adoption of innovation to drive operational performance. More importantly, Shareholders, particularly PE and VC firms, have seen those companies with strong governance and green credentials will deliver them a greater multiplier when it comes to realising their investments.
While ESG has its critics and challenges, it has undoubtedly made an impact. PwC’s Private Equity Responsible Investment Survey 2019, a survey of private equity (PE) firms and their LP investors, reveals a trove of eye-opening results by respondents that illustrate a shift in thinking among LPs. A few notable findings from the report include:
- 79 percent of respondents have adopted a responsible investment policy
- 81 percent report ESG matters to their boards at least once a year
- 91 percent of respondents have already adopted or are currently developing a responsible investment or ESG policy*
*Intalinks.com article: “ESG Can Give Private Equity Firms a Competitive Advantage Among Socially Conscious Limited Partners” 3 Sept 2019.
4. Lower Regulatory Risk
Sustainability commits an organisation to meeting higher operational standards reducing the shocks from regulatory changes. ESG frameworks require an organisation to invest in and adhere to more robust and stronger policies and governance. It requires an organisation to deeply examine the impact of their actions on the environment, the people it impacts and the employees.
EY recently wrote about the importance ESG plays in mitigating regulatory requirements and keeping ahead of the regulatory change curve. “Regulatory pressure continues to intensify. The European Union continued to expedite the implementation of the EU Taxonomy, Disclosure Regulation and Benchmark Regulation as well as enhancements of all financial market regulations and directives during the COVID-19 pandemic.
The EU Recovery Funds that are proposed to restore the COVID-19-affected EU economy are designed with an emphasis on long-term projects that meet specific climate and energy plan criteria. Significantly, some 25% of the €750bn will be allocated to the EU climate action program, adding additional pressure to the implementation of the sustainable finance regulations.
ESG practices typically keep 1-2 steps ahead of regulators – as it invariably eschews in a new, more comprehensive approach to how and what companies require themselves to do. As a result, when the regulators finally catch up with the expectations and needs of the stakeholders they are there to protect i.e. customers and those that use and consume the products and services these companies create; those companies with robust governance underpinned by sustainability principles are invariably already complying or very near to it. The impact of a new regulation becomes negligible.
5. Employer Branding
Potential employees are attracted to the higher purpose of sustainably managed organisations. These were in no particular order, but we were surprised how many clients rated this as their top driver for promoting sustainability within their organisations.
Talent is a key driver of financial performance. Our next generation of top talent are looking for employers who align with their values. If they aren’t, then they will go somewhere else – or better still, they will create the platform themselves!
Speaking to a client of ours about the subject, they said (prior to lockdown) you could be in a room full of potential graduate recruits who either work for the company or are thinking about it, historically they always asked, ‘how do I get your job?’ and now they say: ‘why would I want a job with you and your company?, 'what are the values of this business?, 'what are you doing about climate change?', 'why is there so much plastic?’. Millennial focus is critical. Every organization says its people are the most important asset and that they will struggle to recruit if they operate by a set of values that don’t subscribe to how people think and what they want.
The next generation also applies to the upcoming generational transfer of wealth. This new generation of investors will drive the change in investment expectation. One thing is for sure, they are not going to have a tolerance for some of the ways that we have been choosing to do business. Their expectation is much more of a purpose driven organization.
Whilst it is easy to talk about this as a next generation or Millennial generation phenomena, we are also seeing evidence that the parents of that generation, who are now on the cusp of being the leaders of our corporate village are also more aware of and just as concerned about the impact they have with their jobs and the organisations they represent.
All of this adds up to organisations that have purpose, environmental, social, inclusive and diverse cultures, sustainable working practices to truly marry a life/work balance for all and rock solid corporate governance will be the winners for the continual ‘war for the best talent’.
The pandemic has brought a realisation that things need to change and presents a unique opportunity to make it happen. What is truly exciting is that those heavy industries that were marginalised by the green agenda have been empowered to be the change themselves. The business case is proven and now it’s everybody’s business.
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6 Group partners with clients to help design their organisational structures - typically as a component of other initiatives e.g. transformational changes, wider organisational redesigns and leadership assessment & development programmes.
If you’d like to discuss any of your objectives with us, please get in touch:
- +44 (0)161 926 4320