Social And Global Issues

ESG Reports Aren’t a Replacement for Real

Sustainability
by

 Tensie Whelan
July 27, 2022
Yaroslav Danylchenko/Stocksy

Summary.

Many corporate leaders are growing frustrated that their ESG efforts are not
being rewarded in capital markets. But that’s because they are focusing on
reporting more than on doing sustainability. Can companies embed sustainability
and make it a source of competitive advantage? Yes, but only if they make it
part of strategy. To do that they should undertake SWOT analyses through a
sustainability lens, look specifically for material ESG issues that are resulting in
risks and opportunities for the company, and then undertake and track return on
sustainable investment, setting benchmarks and tracking financial performance
over time.

Corporate leaders face conflicting signals on the need for environmental, social, and
governance reporting. A predictable backlash against ESG investing has arrived, with
right wing politicians attacking ESG investors for promoting what they see as a “woke”
agenda, and the SEC cracking down on “ESG-washing” by asset managers.

While more scrutiny of ESG claims is needed, corporate leaders and investors who focus
solely on ESG disclosure are missing the point. ESG disclosure uses process-oriented
output measures, such as whether a company has a policy on chemical management.
These metrics, while necessarily broad, do not track performance. There’s a big
difference between a company that has a chemicals management policy, and one that
has a bio-based dye that reduces waste and water use (and cost) and creates new sales
opportunities.

There is a growing consensus that ESG issues are material to corporate resiliency and
competitiveness today. In fact, our research on the return on sustainability investment
(ROSI), as reported in HBR, has demonstrated that embedding sustainability core to
business strategy can create a competitive moat for business leaders by driving
operational efficiency, innovation, employee engagement, supply-chain resilience, risk
mitigation, improved sales, and other strategic business benefits.

However, just as with any business activity, competitive advantage through

sustainability comes from good strategy, culture, KPIs, and execution. Reporting metrics
are the last step, not the first. So how does a company avoid the ESG disclosure morass
and develop a robust sustainability strategy that improves the bottom line?

Every company’s strategic planning and work plans are different, but there are some
useful tools and approaches to embedding sustainability for competitive advantage.

Step 1: Identify material ESG issues and associated stakeholder

perspectives.

Broadening the planning lens to include incorporation of material ESG issues for your
industry is the first step. Looking at existing standards, such as those from the
Sustainability Accounting Standards Board (SASB) or the Global Reporting Initiative
(GRI), will provide initial insights. For example, SASB will tell you that if you run a
consumer packaged goods (CPG) industry, climate, water, and labor practices are
amongst 10 material topics that need to be managed. Critical stakeholders such as
employees, investors, customers, regulators and civil society should also be consulted as
their insights may help identify priorities that business leaders may otherwise ignore.
The business assessment and the stakeholder assessment can be combined into
a materiality matrix, which helps prioritize topics that that are important to both
stakeholders and the business and potentially lead to competitive advantage. For
example, a materiality matrix in CPG may identify food safety as a material ESG issue,
but one that is table stakes for all. It may also identify water stewardship as a material
risk, where companies who reduce their water use will be less likely to experience water-
related production disruptions or regulatory or consumer backlash.

Step 2: Undertake Strategic Analyses Through an ESG Lens

With the materiality matrix in hand, a sustainability-oriented PESTLE (Political,

Economic, Social, Technological, Legal, and Environmental) analysis and then a SWOT
(Strengths, Weaknesses, Opportunities, Threats) analysis may be helpful next steps.

The PESTLE analysis helps with understanding ESG trends related to your material
issues. For example, how might the changing legal framework regarding greenhouse gas
emissions affect your business? What type of blockchain technologies for managing
sustainable supply chains might help improve supply-chain resiliency and performance?
What type of political regimes in supplier regions might affect supply volatility, ethical
challenges, corporate reputation? There are consultants and NGOs who actively monitor
these trends and could provide essential insights.

The SWOT analysis will help you assess how well you are currently positioned to
manage these material ESG issues and trends across your business units. As you assess
your strengths and weaknesses, for example, you may find that you have already
developed a sustainable supply-chain network, but your marketing team has failed to
capitalize on it. As you look across the industry to identify opportunities and threats
posed by material ESG issues, you may note that all your competitors have made
commitments to phasing out plastic packaging and that you are a laggard, or that you
are one of the few with a compelling carbon labelled offering, but it is still niche and
others could rapidly overtake you. This analysis should help you identify where you
should focus your efforts.

Step 3: Get granular with how to tackle business risks and

opportunities in your business planning.

For example, if water use is a big challenge for your business, you’ll need to understand
where those risks are in your supply chain and explore potential solutions. You’ll need
to define the future state you’d like to achieve and how to get there. If you use a lot of
water in manufacturing facilities located in regions with water quantity and quality
issues, extreme weather events related to climate change, as well as poorly managed
water withdrawals that threaten local water supplies, then you will need to explore
strategies such as watershed conservation and technologies and procedures that reduce
your own water footprint.
Then, define goals and key performance indicators (KPIs): How much water reduction
is needed, how much is feasible, and what is your action plan? You’ll need to understand
your current water-use performance, benchmark against competitors, explore
technologies that can reduce water use, and reach out to key stakeholders, such as
NGOs, community groups and regulators working on water in your operating regions.

As mentioned earlier, most reporting and disclosure standards have process-based

KPIs. To improve competitive advantage, companies need to develop outcome and
impact-based KPIs (which they can later map to the reporting metrics). For example,
let’s say a company aims to improve diversity and inclusion. It may hire a chief diversity
officer, which is an input; publish a diversity, equity and inclusion policy, which is an
output; and train 50 people in diversity and inclusion, also an output. The outcomes are
what results from these inputs — e.g. 20% managers of color or 100% pay equity.
Assessing the impact of those outcomes will require the company to determine what
state is necessary to achieve for it to be diverse and inclusive and drive better results for
the company such as increased productivity and creativity. Organizational ESG KPIs
should tie back to the business strategy and provide accountability for executive
leadership as well as the rank and file.

Build these ESG goals and strategies into your core business strategy. Using water in
your factories, as an example, you likely have overall goals related to the high-quality
functioning of those factories, related to operational costs, quality of goods produced,
capital investments planned, etc. Improving those factories’ performance on water
becomes part of your overall goals associated with manufacturing. Investing in better
water management can reduce costs (less water in, less waste out, less likely factory
shutdowns due to lack of water) and improve performance (better community
reputation and relationship with regulators, etc).

Step 4: Build a governance structure focused on ESG.

Change is hard. As with any transformational process — and sustainability is

transformational — the culture, the governance, and incentives must be aligned to be
successful. A first step is organization-wide ESG KPIs, signed off on by the board,
supported by executive leadership, and included in staff work plans and compensation.

From a governance perspective, board leadership in the form of a sustainability

committee, an executive-level cross-divisional sustainability committee, and
management-level cross-divisional committees will be essential to delivering against the
plans as most ESG issues are cross-divisional.

A chief sustainability officer, ideally reporting to the CEO, with authority as well as
responsibility (usually they have a lot of the latter and none of the former) can help
coordination across the company and support business unit efforts through functioning
as a center of ESG excellence with access to the latest thinking, technologies, and tools.
The CSO can work with HR and the executive leadership team to build a sustainability
culture across the company, including training, sustainability committee, and
ambassador roles as part of accelerated development. Conventional HR techniques can
be used to embed sustainability into the purpose and culture of the company, which is
likely to have the added benefit of improving employee recruitment, retention and
productivity. The CSO will also work closely with finance, procurement, brand managers
and the other key business units to support them in meeting the organizational ESG
KPIs.

Step 5. Understand and track the return on sustainability

investment (ROSI).

Businesses that don’t manage the bottom line well don’t stay in business. Why, then,
are most companies not tracking the return on their sustainability investments? In
order to improve decision-making and build competitive advantage, corporate leaders
must begin to track the financial returns, intangible (e.g. risk mitigation, employee
engagement) as well as tangible (e.g. operational efficiency, sales) associated with their
embedded sustainability strategy. One major shortcoming, for example, is that the
CFO’s office does not track avoided costs (e.g. savings from used automotive
components in new cars or factories not being shut down due to lack of water). That
means assessing the potential benefits using a model, such as NYU Stern’s open
source ROSI, developing benchmarks, and tracking financial performance over time.
This should improve the analysis of projected ROI related to ESG-related capital
investments, and make it easier to meet internal hurdle rates. In working with apparel
company Eileen Fisher and spice company McCormick, for example, we identified
$1.8M and $6M respectively in terms of benefits related to circular practices and
sustainable sourcing.

B2C brands with sustainable offerings will be rewarded by consumers, and B2B brands
can help companies deliver sustainable goods and services. Working with IRI, a market
research firm that collects all bar-code data for consumer packaged goods (CPG) sales in
the U.S., we found that sustainability marketed products delivered 32% of the growth in
CPG in 2021 while enjoying 30% premiums on average. We also discovered that half of
all new CPG products in 2021 had some type of sustainability attribute (e.g. plant-based
cleaners, sustainable soups). In response to these trends, most CPG companies,
including Unilever, Nestle, General Mills, PepsiCo, and Coca-Cola are making
significant investments in improving the sustainability and nutritional value of their
products.

...

Sustainability is the new digitalization but with even more impact on competitiveness.
Take climate change: Fees are being charged for carbon emissions, investors are asking
for assessment of climate risks and penalizing companies with high carbon exposures,
energy price volatility is increasing the cost of goods sold, and companies and
consumers are looking to reward carbon positive companies and products. In 2021, for
example, carbon-labeled consumer packaged goods represented $3.7B in sales, two
years after introduction!
Companies who want to win in their markets will be more likely to realize that dream if
they embed sustainability core to business strategy, manage implementation and ESG
KPIs well, and track the returns on their sustainability investment. Audited reporting to
globally recognized disclosure standards will be the icing on the cake.

Editor’s Note: This piece was updated for clarity on 7/27/2022 with a small change to
the “Step 1” subhead.

 TW
Tensie Whelan is a clinical professor of business and society and the director of the
NYU Stern Center for Sustainable Business, and she sits on the advisory boards of
Arabesque and Inherent Group.

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