- A strong ESG proposition makes financial sense and enhances shared value.
- Companies that rely on government contracts, having a comprehensive ESG proposition, places them in good stead.
- Studies conducted by McKinsey have shown that customers are willing to pay more to go green.
Doing good is good business.
A closer look at the benefits of environmental, social and governance (ESG) stewardship and the potential risks.
Who can forget the oil spill in the Gulf of Mexico in 2010?
BP, the company responsible for the oil spill had an explosion at one of its facilities that gushed out vast amounts of crude oil into the ocean. According to National Geographic, “It was the biggest oil spill ever in US waters and remains one of the worst environmental disasters in world history. Eleven rig workers lost their lives. So did untold millions of marine mammals, sea turtles, birds, and fish. While the world watched, helpless, oil gushed into one of the planet’s most biodiverse marine habitats for 87 long days.”
The effects of this spill can still be seen to this day. Many species, such as deep-sea coral, common loons, and spotted sea trout are still struggling, their populations lower than before. By contrast, a few Gulf inhabitants have shown a robust recovery—among them, menhaden fish and the brown pelican, Louisiana’s state bird. While long-term damage estimates vary, a new study published in the Canadian Journal of Fisheries and Aquatic Sciences determined that the oil spill could have an $8.7 billion impact on the economy of the Gulf of Mexico including losses in revenue, profit, wages, and close to 22,000 jobs.
This was an ESG failure of epic proportions and highlights the importance of sustainability going forward. Corporate executives and entrepreneurs will ignore this at their own risk and at the risk of the reputations of the corporations and businesses they represent.
As the effects and hazards of global warming and climate change become more apparent corporations and businesses in general in southern Africa cannot remain in the paradigm of old which is to view ESG as a mere box-ticking exercise. ESG provides a compelling case and it makes financial sense. Going forward after COP26 it will be a considerable and material risk for business entities regardless of size to ignore the environment, its relationships with various stakeholders and governance issues.
A strong ESG proposition makes financial sense and enhances shared value through five ways which are:
- Facilitation of top-line growth in revenue
- Cost reduction
- Reducing the scope and likelihood of regulatory and legal intervention
- Optimizing employee productivity
- Optimizing investment and capital expenditure
These potential benefits should be the focus of executives and entrepreneurs alike when handling ESG considerations.
Growing the topline
A strong ESG proposition will enable a company to gain access to new markets and grow existing ones. As was reported in another article, “Doing Good is Good Business” certain aluminium producers were able to increase the margins on their products by eliminating carbon from their products and selling it to customers who are demanding more of that product.
For companies that rely on government contracts, having a comprehensive ESG proposition places them in good stead to receive increased business from governments of nations that are becoming more climate and green conscious.
According to leading business consultants when governing authorities trust corporate actors, they are more likely to award them the access, approvals, and licenses that afford fresh opportunities for growth. In the United States, a private-public partnership for a massive infrastructure project was undertaken in Long Beach, California and for-profit companies were selected to participate in the PPP based on screening results of their ESG credentials. This shows that going forward into the future companies with superior ESG and sustainability performance will see their efforts pay off through increased business from the creation and development of green products and services. This is most visible from companies operating in the mining sector. Companies perceived to have a beneficial social impact found it easier to extract resources and had higher valuations in comparison with those companies with lower social capital.
Going forward ESG will drive more and more customer preference. Studies conducted by McKinsey have shown that customers are willing to pay more to go green. The premiums for green products were found to vary between 1 to 5 per cent depending on the good or service whether it is automotive or electronic. Companies and businesses based in Africa should therefore start investing immediately in the development of green products and services.
The payoffs are real. When Unilever developed Sunlight, a brand of dishwashing liquid that used much less water than its other brands, sales of Sunlight and Unilever’s other water-saving products proceeded to outpace category growth by more than 20 per cent in a number of water-scarce markets. And Finland’s Neste, founded as a traditional petroleum-refining company more than 70 years ago, now generates more than two-thirds of its profits from renewable fuels and sustainability-related products.
Executing ESG effectively can mitigate rising costs in the form of raw materials, water and/or carbon. 3M the US technology firm and widely regarded as proactive when it comes to sustainability matters is said to have saved as much as US$2.2 billion since it introduced its initiative which it called “prevention of pollution pays” (3Ps) in 1975 which prevented pollution upfront by reformulating products, improving manufacturing processes, redesigning equipment, and recycling and reusing waste from production. FedEx has set an ambitious goal to convert its entire 35,000-vehicle fleet to electric or hybrid engines; to date, 20 per cent have been converted, which has already reduced fuel consumption by more than 50 million gallons according to Witold J. Henisz, “The costs and benefits of calculating the net present value of corporate diplomacy,” Field Actions Science Reports, 2016, Special Issue 14.
Reduced Legal & Regulatory intervention
There is greater strategic freedom to be had from strong execution of ESG and this eases government and regulatory pressure. Adverse government action against a business or government action to support a business depends in whole or in part on the execution of its ESG proposition. This is because a substantial portion of the profit generated by businesses is always at stake from government intervention. Regulation naturally depends on the sector. For pharmaceuticals and healthcare, the profits at stake are about 25 to 30 per cent. In banking, where provisions on capital requirements are, “too big to fail” and consumer protection is so critical the value at stake is typically 50 to 60 per cent.
In countries that are highly litigious like the US, companies in areas that are sensitive to legal and regulatory pressure must set aside a portion of their earnings to a fund described as a litigation reserve. The idea is that should the company get entangled in legal and regulatory matters and is either sanctioned or penalized for any wrongdoing on its part it will have the financial wherewithal to settle its legal and regulatory obligations. The financial implication of this is obvious in the event of a sanction or a penalty. What is not poignantly obvious is that when a company provides funds to its litigation reserve it takes from the profits which would otherwise be attributable to shareholders. This form of risk management through prudent curtails the ability of firms to enhance the financial welfare of their shareholders.
Companies that are at risk of regulatory sanction and legal pressure tend to be alcoholic beverages and cigarette manufactures as well as banks. They are also companies that cannot afford to engage meaningfully in ESG activities. When they develop proper ESG initiatives they will reduce the risk of regulatory and legal pressure which will free up cash resources in a literal sense.
A compelling and effective ESG proposition can help attract and retain quality talent, enhance employee motivation by instilling a sense of purpose, and increase productivity overall. Employee satisfaction is positively correlated with shareholder returns as shown by Alex Edmans, “Does the stock market fully value intangibles? Employee satisfaction and equity prices,” Journal of Financial Economics, September 2011, Volume 101, Number 3, pp. 621–40, sciencedirect.com. Just as a sense of higher purpose can inspire your employees to perform better, a weaker ESG proposition can drag productivity down. The most glaring examples are strikes, worker slowdowns, and other labour actions within your organization.
Further studies on employee productivity show that “…employees with a sense not just of satisfaction but also of connection perform better. The stronger an employee’s perception of impact on the beneficiaries of their work, the greater the employee’s motivation to act in a “prosocial” way.” Positive social impact enjoys a strong positive relationship with job satisfaction to the extent that when companies give back the resultant effect is that employees react with enthusiasm.
Investment & asset optimization
This is another financial wonder which can be delivered by a strong enough ESG proposition—by allocating capital to more promising and more sustainable opportunities, for example, renewables, waste reduction, and scrubbers.
It can also help companies avoid stranded investments that may not pay off because of longer-term environmental issues. Going forward companies that rely on energy-intensive facilities will find them increasingly expensive in terms of conducting business. While the investments required to update the operations of most companies may be substantial, choosing to wait it out can be the most expensive option of all.
Regulatory responses to emissions will likely affect energy costs and could especially affect balance sheets in carbon-intense industries. Bans or limitations on such things as single-use plastics or diesel-fueled cars in city centres will introduce new constraints on multiple businesses, many of which could find themselves having to catch up. One way to get ahead of the futures curve is to consider repurposing assets immediately and urgently.