The Quest to Redefine Business Success Through Sustainability
As investors and consumers seek out more socially and environmentally responsible companies and businesses learn to account for their impacts on people and the planet, all are seeking precise ways to express what sustainability looks like in data and dollars.
The next time you stop for a latte at your local Starbucks, you might notice more non-dairy options like soy, almond, oat, and coconut milks on the menu. Delicious as they are, their presence isn’t entirely a response to customer demand. As part of an initiative to cut its environmental impacts in half by 2030, the global coffee giant recently began to track and report on greenhouse gas emissions across its operations. In the process, it discovered that dairy products are its single largest source of CO2, accounting for more than one-fifth of its carbon footprint. So as it brews up future business strategies, Starbucks is now mixing in a greater emphasis on plant-based alternatives.
Companies need to track and report on various aspects of business performance in granular detail, both for compliance purposes and to guide strategic decision-making. In the past, that reporting focused predominantly on financial metrics. However, as today’s regulators, investors, and consumers become increasingly concerned about societal and environmental well-being, companies are looking for ways to incorporate sustainability metrics into their business reporting.
Some companies are already reporting on supply chain transparency, carbon footprints, and other environmental, social, and governance (ESG) issues of their own accord. These moves are partly due to investor and consumer demand, but they are also a way to make a virtue of necessity as more regulatory bodies begin to require companies to report on how they’re advancing positive ESG impacts and mitigating negative ones. Business groups and academia are providing further motivation by exploring ways to express sustainability metrics in financial terms.
The ultimate goal of this more holistic approach to reporting is to get companies to take their environmental and social impacts into account with every business decision throughout the value chain so that they can stay within the planetary boundaries and social foundations that support civilization itself. One key way to encourage them to adopt this mindset is to help them connect the dots between increasing attention to ESG impacts and improving business performance. But we’re not there yet.
Unlike financial reporting, we have no universally agreed-upon standards for ESG metrics and key performance indicators (KPIs), so organizations have no baselines or benchmarks with which to turn reporting into meaningful action. It’s one thing to commit your company to measuring its carbon footprint and cutting it in half by the end of the decade. It’s another thing to determine whether that 50% reduction is enough to contribute meaningfully to keeping global warming below the 1.5°C threshold that the scientific community says is necessary to avoid climate catastrophe.
It’s harder still to gauge a company’s progress toward that science-based target against that of other companies. And since even the record drops in carbon emissions during the global COVID-19 pandemic are turning into a recovery rebound expected to push emissions to a new high, meaningful action can’t wait. If companies hope to fend off environmental and societal crises that could threaten their survival, they need to push toward making more holistic reporting possible so that they can begin steering their strategies in a new direction quickly and effectively.
Broadening the view of business
The same global economy that has delivered tremendous financial growth and value has also created massive negative impacts, such as forcing governments to starve public services like education and transportation to support ever-growing needs for waste disposal, accelerating the global climate emergency, and degrading the natural systems that support human life. As the world wakes up to the realization that it’s impossible to continue “business as usual,” creating value for shareholders will no longer be enough for a company to be considered worthy of existing.
To remain relevant and accepted, companies will have to be willing to take responsibility and action for mitigating their negative impacts and increasing their positive impacts. And to be effective at doing that, they will need to measure those impacts and compare them to both what other companies are doing and what needs to be done. That calls for an accounting framework that is actionable, scalable, and standardized across organizations so that stakeholders, including investors, employees, local communities, and governmental bodies, can understand, communicate, and make decisions about sustainability consistently over time.
Two factors are driving interest in such a framework, says Neil Stewart, director of corporate outreach for the Sustainability Accounting Standards Board (SASB): business leaders want greater transparency into all kinds of KPIs to benchmark and improve performance, while investors are demanding details about ESG issues to inform their investment decisions.
The challenge of holistic reporting
Investors are eagerly seeking out sustainable companies. In 2020, investors poured US$27.4 billion into U.S.-based exchange-traded funds focused on ESG, doubling the size of this niche, according to FactSet data cited by The Wall Street Journal. Even so, it’s not always clear what’s guiding investors’ choices since there are no agreed-upon standards for reporting on ESG issues that enable companies to indicate how sustainable they are or in what ways.
That leaves companies struggling to determine the true social and environmental costs of their businesses. Financial measurements alone don’t reflect those costs, so they aren’t generally incorporated into performance reports. The exception is when there’s an actual fee involved, such as measuring and reporting greenhouse gas emissions to comply with regulations in 40 countries worldwide that impose a carbon tax based on each ton of CO2 that a business emits within the relevant geographic area.
To take on the challenge of expanding corporate reporting to include sustainability metrics, some of the world’s leading universities have embedded sustainability initiatives into their finance, economics, and/or accounting departments.
In the United States alone, Harvard Business School’s Impact-Weighted Accounts Project is developing a way to assign monetary value to ESG impacts, as is the Center for Sustainable Business at New York University’s Stern School of Business, which has created a methodology to prove the financial ROI of sustainability efforts. The Yale Initiative on Sustainable Finance at the Yale Center for Business and the Environment is exploring how investors can better integrate ESG factors into investment decisions, while the Aggregate Confusion Project at the Massachusetts Institute of Technology’s Sloan School of Management is focused on improving the quality of ESG measurements in the financial sector.
In the UK, the Cambridge Institute for Sustainability Leadership promotes and directs capital to sustainable business models. The Oxford Sustainable Finance Programme is responsible for the key concept of “climate-related stranded assets,” that is, assets that have unexpectedly or prematurely lost value or become liabilities due to environment-related factors. The Imperial College Business School in London has partnered with Singapore Management University to set up the Singapore Green Finance Centre to drive sustainable investing in Asia. And interest continues to spread worldwide. Each of these institutions is among the 27 research universities across North America, Europe, and the Asia-Pacific region that make up the Global Research Alliance for Sustainable Finance and Investment.
Organizations outside of academia are also working on the challenge, including Value Balancing Alliance (VBA), a group of 21 multinational companies developing metrics for measuring and comparing the value of contributions made by businesses to society, the economy, and the environment. In 2020, VBA ran a pilot program across 11 companies in seven industries that focused on supply chains and operations, testing specific indicators and translating nonfinancial metrics like environmental and social impacts into comparable financial terms. The May 2021 report on the results shows that the VBA methodology can be used successfully to compare the long-term value contribution of companies.
“Investors have started actively bringing up ESG issues and sustainability, which is a dramatic advance from five or six years ago,” says Sonja Haut, head of strategic measurement and materiality at the Swiss pharmaceutical company Novartis, a founding member of VBA. “Now we need to standardize valuation around impacts so we can articulate to investors the value we bring to society. What we’ve learned so far is that impact valuation is relevant and compelling as a way of looking at an individual company, that it can be scaled, and that it makes sense across different geographies. Now we need to understand how well we’re doing, how we’re performing against peers, and how to benefit more from our insights.”
While this work is in process, though, most companies are still trying to determine what to measure, never mind how to act on that data beyond sharing it for the sake of transparency. “Many companies are pumping out hundreds of pages of disclosures but not yet changing their strategy to align their business with ESG factors,” says Stewart. “That’s the next step.”
Connecting sustainability metrics to performance
A handful of companies have taken the next step by developing internal ESG metrics to monitor their own progress. Andrew Winston, coauthor of the sustainability strategy book Green to Gold: How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage, offers the examples of consumer goods giant Unilever, which announced in 2020 that it would report on the carbon footprints of all of its suppliers, and luxury fashion holding company Kering, which is using impact reporting to increase transparency into the sourcing of key materials. However, Winston points out that there’s no easy way for these companies to compare their sustainability against each other’s.
To be fair, financial metrics also fall short in this regard. “Companies can play with what cash means on their balance sheets,” Winston notes. “A retailer doesn’t use the same metrics as a mining company. So it’s not realistic to expect the metrics to be perfect.”
Still, everyone agrees on what cash is, and there are several established requirements for reporting on it. That isn’t necessarily true for ESG metrics. The Greenhouse Gas Protocol is the world’s most widely used standard for accounting and reporting of greenhouse gas emissions, describing in detail how they can and should be measured along the value chain. But it isn’t mandatory. Companies can opt to use it in whole or in part or to use other industry benchmarks. And as a result, even if a company uses the best technology currently available to measure its greenhouse gas emissions in detail, it is still likely to have gaps in its ability to assess how its CO2 output compares to its peers or to the progress necessary to reduce global emissions.
There’s also the question of how to assign significance to things that are measured. It’s possible to measure the concentration of CO2 in the atmosphere. But to determine the true meaning of that metric, it’s necessary to trace the “impact pathway” by which higher levels of CO2 increase global temperatures, which make sea levels rise, and subsequently force people to abandon homes on the shoreline. Only then can you assign a monetary value, or the “social cost,” to the damage caused by putting one ton of CO2 into the atmosphere.
That barely scratches the surface. We’re used to the idea of measuring and reducing carbon emissions, but there are other things that need to be measured to capture the true holistic costs of doing business, and we don’t know how to do that. Companies have yet to adopt potential science-based KPIs that would establish targets for managing water use, protecting biodiversity, or eliminating manufacturing waste. And if we don’t know what our targets are, we have no context for taking action. “You could cut your company’s water use by 20%, but that isn’t a relevant benchmark if your facility is in a watershed where you need to cut your water use by 80% to prevent drought conditions,” Winston explains.
This, too, increases the urgency of the push to establish globally accepted standards.
Making strides toward standards
As of 2016, there were around 400 sustainability reporting instruments in 64 countries. Only 65% of them were mandatory, and those applied predominantly to state-owned or publicly traded companies, particularly larger ones. For example, the UK requires publicly traded companies to report annually on greenhouse gas emissions as well as specific requirements for diversity and human rights, and India’s Securities and Exchange Board requires the top 100 publicly traded companies in that country to produce annual Business Responsibility Reports. Another notable example is the European Union (EU)’s Directive on Disclosure of Non-Financial and Diversity, which requires certain businesses to report on material environmental, social, and employee-related matters, including corruption and human rights performance.
The EU is also developing a taxonomy of corporate activities with detailed specifications that a company must meet before it can position itself or its products as “sustainable.” At a time when rising investor demand for socially and environmentally conscious products and services makes it tempting for companies to indulge in “greenwashing,” this regulation is intended to keep false claims of sustainability out of the financial markets. Instead, it will direct investors to companies that can credibly verify that they meet the EU taxonomy’s standards.
Other organizations are also developing standards with an eye toward widespread adoption. The Task Force on Climate-Related Financial Disclosures, comprised of 31 members from across the G20 nations and created by the global Financial Stability Board to improve and increase reporting on climate-related financial information, has developed recommendations. So have the Global Reporting Initiative (GRI), an organization whose widely used ESG standards cover topics such as human rights and waste disposal, and the Sustainability Consortium, a nonprofit helping the consumer goods industry create more transparent, sustainable supply chains.
Another noteworthy player is SASB, which was founded in 2011 and released its first set of standards in 2014, with an update at the end of 2018. SASB winnowed down which disclosure topics and metrics are most critical in 77 different industries, such as appliance manufacturing and marine transportation, to identify the subset of ESG issues most material to financial performance in each specific industry. However, the SASB standards do not look in the opposite direction: how the company’s actions impact the environment and society.
The proliferation of and enthusiasm for ESG reporting standards and frameworks are promising, but as Haut points out, “having lots of standards that no one can agree on is essentially the same as having no standards at all.” Smart organizations recognize that the global economy requires a global approach for consistency across jurisdictions, and they are watching as one continues to emerge.
In 2020, consolidation among standard-setting bodies and framework providers began to accelerate. SASB and the International Integrated Reporting Council (IIRC) announced their plans to merge to create the Value Reporting Foundation. The “Big Five” organizations for sustainability and integrated reporting – SASB, IIRC, CDP Worldwide (previously the Carbon Disclosure Project), the Climate Disclosure Standards Board, and the GRI – created a joint coalition to unify standards. The World Economic Forum’s International Business Council has proposed a common, core set of metrics and recommended disclosures for its members to align their reporting on ESG matters, and its Stakeholder Capitalism Metrics project has announced that it will work to align its performance measurement and reporting metrics with those of VBA.
In March 2021, the 200-plus companies comprising the World Business Council for Sustainable Development declared in a vision statement for 2050 that companies should work with governments to push for standardization and regulation. And looking ahead, the European Financial Reporting Advisory Group and the global International Financial Reporting Standards (IFRS) Foundation are also tackling the challenge. The IFRS Foundation’s Sustainability Standards Board has the potential to become a global “center of gravity” for the effort.
As with other regulations, the goal is to require companies to report on their actions and provide them with goals and benchmarks. Eventually, we may see penalties for noncompliance to ensure both a level playing field and a more sustainable world. After all, it’s hard to run a profitable business with a prospective customer base that’s struggling to survive famine, floods, heat waves, disease, and other negative environmental and societal impacts.
Navigating by the data
Stewart acknowledges that many companies aren’t yet at the point where they can draw a line between more holistic reporting and more sustainable business strategy around operations and risk management, for example. As he puts it, there’s still a gap between potential and use, and that gap may still take some time to close.
Winston is more blunt about the challenge that many companies face. “The holy grail has always been to have such complete and robust measurements of energy use and carbon footprint that you can easily allocate it to each individual customer and product and make changes accordingly,” he says. “But we’re not close to that, even though it’s felt for years like it’s about to be here. It’s shocking to me how many companies don’t even have a very good handle on their energy use and are asking their different facilities to input utility bills on a spreadsheet!”
On the other hand, some sophisticated companies already understand that sustainability goals and financial goals are inextricably linked. “They know it doesn’t have to pay off immediately,” Winston says. “You make investments and do research and development and, instead of reporting on quarterly performance, you write one complete story that captures long-term value.”
The more data a company has about its social and environmental footprint, he adds, the more it can use that data to achieve goals about shrinking and greening the footprint of each individual product or service throughout its lifecycle. In the process, the data will also reveal information about sources and suppliers that will help the company optimize its supply chain, achieve better outcomes, and share best practices that result in systematic change.
Digitalization is critical to helping companies manage their data around ESG impacts. Companies already rely on digital technologies to process vast amounts of enterprise and supply chain data, automate key actions, and generate real-time insights. These same technologies also drive compliance reporting and make it possible to embed insights and decision-making into core business processes, seamlessly weaving together operations, analytics, and strategic planning. More integrated reporting won’t force companies to reinvent the wheel; it will just require them to incorporate more types and sources of information into the data-driven processes they already use.
Winston predicts that Unilever’s decision to start gathering and publishing carbon footprint data from all of its suppliers will do more than just identify areas where they can reduce their own CO2 emissions. By providing that information to consumers, Unilever enables them to make their own sustainability-driven choices about which products to buy to reduce their own energy consumption – for example, by choosing detergent that works well with smaller amounts of cooler water.
Another example is Kering, the holding company that owns some of the world’s best-known fashion brands. Several of these brands, such as Gucci, Balenciaga, and Bottega Veneta, are famed for their leather goods, but producing leather is an extremely resource-intensive process that includes raising the source animals and processing their hides. Impact reporting is helping Kering identify ways to increase sustainability throughout its supply chain without diluting its brands’ reputations for impeccable quality.
As a pharmaceutical company, Novartis had metrics to report on its environmental impact but little way of indicating the positive social impacts of the medicines it produces. Working with health economists, the company developed a framework, tested it in two countries, and then scaled it company-wide. Haut says it’s now part of the company’s regular disclosures, both at the corporate level and among country-specific leadership teams, who use it for insights, stakeholder engagements, and initiatives for providing services to underserved communities.
Novartis has also begun to measure and report on the social impact of employee pay, including how many jobs the company creates, where, and what kind; the quality of the jobs; and how the company’s salaries and wages contribute to gross domestic product, both globally and in the specific countries where it does business.
“Impact valuation has a transformative power in giving people a different appreciation of what value can be,” Haut says. “[At] Novartis, we haven’t yet been able to correlate our impact data with our productivity, but we’ve had instances where more integrated reporting has persuaded external stakeholders to let us get or keep access to a market, so we’re definitely seeing use cases emerge.”
The point of including ESG metrics in business reporting isn’t just to gather more data for its own sake or even for regulatory compliance. When you have data, you can identify what you’re doing wrong – or right – to improve company performance. Once we’ve arrived at the end of the arduous journey to build a standardized reporting framework, there’s no need to keep refining every KPI down to its component aspects. Instead, that’s a sign that it’s time to ask every company in the world to report on that agreed-upon KPI and begin building benchmarks that drive comparisons and action.
The VBA pilot project suggests what it’s going to take to make that leap. First, internal stakeholders from the C-suite down need to be convinced that reporting on sustainability is as important as reporting on profit and loss. Second, those stakeholders and managers need to play an active role in determining how to analyze the resulting data to inform decisions. And finally, business users need to understand the data so that they can spot the insights that matter and that will make a difference to performance.
Investors and customers are becoming increasingly vigorous in demanding that business take action on key sustainability issues. To satisfy them, companies will have no choice but to report en masse on social and environmental impacts and announce what they plan to do about them. That will require them to coordinate on these steps:
- Agreeing on metrics
- Determining how to capture them
- Taking measurements
- Understanding whether the data is relevant
- Using the data to generate insights
- Using those insights to drive the decision-making process
Following these steps may not pay off immediately, but, as Stewart points out, they will in the long term. More holistic reporting that incorporates ESG metrics will help companies identify risks, like the inability to access necessary resources because of climate change, and it will help them spot opportunities, like creating jobs and demand for products in an underserved community.
“Sustainability risks are material to value,” he says. “By managing them over the long term, you improve performance by reducing the costs of resources and operations, minimizing poor outcomes, improving efficiency, and increasing resilience.”
Transparency triggers actions, and right now, companies don’t have the transparency to make informed decisions and act on them. But by allowing them to connect their actions to broader goals rather than mere profit, they can be good employers, good neighbors, and good global citizens who are supporting the transition to a more just and less polluted world. And that will be good for everyone.