Business Update n. 1
Strategy, sustainability and the role of the investment community
Welcome to our monthly business update n. 1
I’ve attended some inspiring conferences recently, like the World Business Forum, which counted Prof. Michael Porter among its speakers, and I feel inspired to dedicate this first monthly update to strategy. I really believe that nowadays strategy cannot be seen as separate from sustainability and Environmental, Social and Governance (ESG) practices. As such, in this first review I will present my latest reflections on corporate responsibility, strategy, shared value and their financial implications.
Things have changed considerably since the 2030 Agenda for Sustainable Development was adopted by all United Nations Member States in 2015 - let’s see how.
In recent years, a growing number of companies have adopted and implemented a broad range of sustainability practices, provoking debates about the nature of sustainability and its long-term implications for organizations.
According to Ioannis Ioannou (London Business School) and George Serafeim (Harvard Business School), authors of the study Yes, Sustainability Can Be a Strategy, sustainability practices can be classified into two distinct groups:
Common practices: may be a necessary condition for survival, but cannot be a sufficient condition for building a competitive advantage. An example of this is a company’s adoption of waste management practices to improve cost efficiency while improving their sustainable footprint. Even if those practices can help the company optimize its operations, they can easily be copied and therefore adopting them will not help the company establish a competitive advantage. The adoption of common sustainability practices is not associated with return on capital, but it is positively associated with market valuation multiples.
Strategic practices: generate a competitive advantage and therefore, result in above-average performance (i.e. doing well by doing good), giving companies the opportunity to occupy an unexploited or underexploited position by developing a unique and difficult-to-imitate strategy. The adoption of strategic sustainability practices is significantly and positively associated with both Return On Capital and market valuation multiples.
The detailed outcomes of this recent study are reported below:
Indicatively, 93% of the largest 250 companies in the world issue a corporate sustainability report and, 78% of them already include and/or integrate sustainability information in their (audited) annual financial reports (KPMG, 2017).
Sustainability practices significantly impact a company’s relationships with its material stakeholders, including customers, employees, investment analysts, and the broader investment community.
Even if some sustainability activities are simply becoming best practices and are thus considered a necessity, some companies are creating real strategic advantages by adopting sustainability measures their competitors can’t easily replicate.
Within most industries, sustainability practices converge over time, meaning that an increasingly similar set of sustainability practices are adopted, raising the possibility that they are becoming common practices and as such, are less likely to serve as a strategic differentiator and more likely to be a strategic necessity.
(Yes, Sustainability Can Be a Strategy. I. Ioannou and G. Serafeim, Harvard Business Review, Feb. 2019).
Increasingly, financial and ESG considerations are being perceived as two sides of the same coin.
Is an ESG agenda still a ‘nice to have’?
Is sustainability just a commitment to have something to show on a company’s website or sustainability report?
The answer is no. But this answer also leads me to another question: How can sustainability be incorporated into a company’s strategic actions?
Investor and shareholder pressure might be the answer; let’s see how.
According to the article The Investor Revolution, investors and pension funds are already considering the environmental and social impact of their portfolios and companies need to adjust their way of operating, managing, and communicating their impact performance.
In 2018, 1,715 investment companies representing $81.7 trillion in Assets Under Management (AUM) had signed the UN-backed Principles for Responsible Investment (PRI) (63 in 2006).
The reasons for this shift are the following:
The investment industry is highly concentrated and big investments firms cannot let the planet fail.
Firms with a better ESG record than their peers achieve better financial results.
The demand for ESG investment options is high and growing.
Shareholder activism is on the rise in financial markets and ESG is increasingly becoming a focus of these interventions.
The major barriers to sustainable investing are that most of the sustainability reporting put forth by companies is aimed not at investors but at other stakeholders, such as NGOs, and the quality of ESG data is not perfect, though it is improving rapidly.
The article revealed 5 recommended actions that companies should take to prepare for sustainable investing:
1- Publish a Statement of Purpose.
2-Engage with shareholders through company reports to demonstrate that the company is practicing ‘integrated thinking’ by changing its orientation from short-term financial results to long-term value creation.
3-Increase middle management involvement
When appropriate, executives should include middle managers in conversations with investors. Top management should evaluate and reward middle managers on both financial and ESG performance, and with a longer-term perspective than simply quarterly or annually.
4- Invest in internal systems for ESG performance information
5- Improve measuring and reporting
Wrapping up, ESG practices are directly associated with higher profits and investors are interested in companies with a strong commitment/purpose and a positive ESG impact. Having said that, do you believe that businesses committed to sustainable practices are really having a positive impact? What businesses really are sustainable? Can every industry become more sustainable and align with the SDGs? How could cigarettes or oil and gas companies be sustainable and aligned with the SDGs without radically changing their strategies?
A recent study reveals that four years after the publication of the United Nations’ 17 Sustainable Development Goals (SDGs) there is no evidence that companies are advancing serious solutions regarding global societal and environmental issues. The majority of them are showing a certain amount of commitment but no real impact can be reported.
Achieving the SDGs presents a huge business opportunity, but even if corporations are aware of this, the commitment appears to be merely cosmetic: existing Corporate Social Responsibility (CSR) initiatives are simply relabeled with the relevant goals and very few companies are doing anything new or different to advance these goals. We all know that the private sector can mobilize much more resources than the public sector can, but those resources can be used for ESG purpose only through the development and deployment of a new strategy based on shared value, finding business opportunities, and maximizing the competitive value of solving social problems (Creating Shared Value, Harvard Business Review)
I’ve selected the following actions among those presented by the authors of the study to transform commitments into actions and impact:
Choose fewer and more specific goals.
Focus on the most promising business opportunities. The larger and more profitable the opportunity, the faster new products and services can scale up to advance the goals. This means that the SDGs must move out of the CSR department and into corporate strategy and operations. CEOs must set the agenda and task relevant business units with implementation.
Require accountability for and verification of all corporate claims. The UN must hold companies accountable for their commitments and, equally important, for sidestepping inconvenient goals or claiming to work on goals that their fundamental business model undercuts.
Facilitate partnerships. The UN, its agencies, and CEO coalitions must actively organize multi-sector coalitions to work together toward each of the goals, as contemplated by SDG 17.
As stated by Porter in 1996, strategy is not operational effectiveness. Operational effectiveness can be imitated while a differentiation (sustainable) strategy is harder to imitate and drives competitive advantage.
Do you need our help?
Brite is a consulting firm supporting businesses in the areas of strategy, marketing and sustainability, because we believe these three elements cannot be seen separately. We help small and medium businesses as well as corporations define and clarify:
What they sell (products and services) and how they drive value for their clients, society and the environment (shared value).
How they do it
Their operations and how they align with the UN Sustainable Development Goals
What they say
Their marketing and communication strategy, and how they engage with different stakeholders
Director at Britetrend