Sunday Brunch: Moving from ESG to competitive advantage
If we want companies to become more sustainable, we need to focus on the financial impacts of the transition. And we need to make the imperative for change clear - not just from society, but from governments and regulators.
One of my frustrations is that we don't work hard enough to link sustainability to business strategy and long term financial value creation. My pitch is simple. If we continue to primarily focus on the societal and moral arguments for improved sustainability, then we make it easy for companies and governments to fob us off.
How do they do this. By focusing on long term targets that have no real meaning or that they are not really committed to delivering. Or by creating rules that have so many loopholes they are effectively meaningless as triggers for action.
Yes, we have made some good progress, especially in transport and electricity generation, but let's be honest. It's not enough.
Which is why a recent report from the Cambridge Institute for Sustainability Leadership entitled 'Survival of the Fittest: From ESG to Competitive Sustainability' is so important. The report authors argue that we need to "revisit the fundamentals of business and sustainability".
What do I think we could we do better? Two things. First, more of a focus on sustainability as a long term financial value creator. If it makes financial sense to companies they are much more likely to act (rather than just promise). And second, establish regulations that are aligned with the incentives (both carrots & sticks), giving companies visibility on the speed and scope of the changes that they need to respond to.
Survival of the fittest.
What is the Cambridge Institute for Sustainability Leadership report arguing? At its most simple it's that:
"It is time to revisit the fundamentals of business and sustainability. Despite decades of corporate commitments and innovation, the massive flow of capital into clean technologies, and the significant and growing body of evidence of the economic benefits of swift action, the sustainability crisis is deepening. Business is failing to keep pace with the scale of the problem and trends on climate and nature continue to head in the wrong direction."
So, what could we do differently? I learnt three simple rules as an investor. And I think all three apply to how we encourage business to become more sustainable, not because it's the right thing to do, but because it makes good business sense.
Rule 1 - every business model, however successful, reaches an end. There will be a time when the current business model no longer works and it stops delivering financial value. We can all think of the big examples - Nokia, Kodak, Blockbuster. These are not exceptions, it happens to every company. It's just sometimes the failure is very public.
One of the main jobs of the board of directors is to anticipate and prepare for this. To have a plan B. If they fail in this they have neglected their fiduciary duty.
The reality is that the sustainability transitions are going to happen. Maybe next year, maybe they will take longer. But they will happen. And the longer that we as a society take to recognise this and prepare, the more rapid the change will end up being.
And when the transitions happen they will create material risks and opportunities for many companies. The impact will differ by sector. It will be different for VW than it will be for Anglo American or ENEL. This means there is no simple general rule as to how industries should prepare. We will need company by company analysis.
Rule 1 means every business should be preparing for the sustainability transitions. And by preparing I mean taking real actions. Shareholders should be ensuring that this happens in a meaningful way, and where it isn't happening , hold boards to account.
And it means that NGO's and society should be encouraging governments and regulators to set clear transition plans. Because this helps companies see the direction of travel. Open ended big picture aims do not help. Detailed plans do.
And make sure that they stick to the plans, constant change just creates uncertainty. And gives those who like the status quo a reason to do nothing.
This can work, but we need to stick at it.
Rule 2 - it's better to start preparing now than to wait. Most good companies got to be good by constant improvements and fine tuning of their business models. Learning by doing. This takes time. Rather than trying to do everything at once, take smaller steps and build toward the end objective. This massively reduces the risk of failure.
Because trying to do a big bang change normally ends in disaster. Companies have deep seated operational cultures. Changing them is harder than you think.
Rule 2 means that even if the impact of the transition is years away, start now. If you don't, and your competitors do, then you will be at a massive disadvantage when the change happens. Waiting can create a crisis.
Rule 3 - show the financial imperative for change. This one might seem obvious but it's scary how often it's missed. If you explain to shareholders how the new strategy creates long term financial value, they are much more likely to support the change, even if it involves more investment now (for future benefits).
If you have carried out the steps above, then you have already anticipated and prepared for the change, and started early on your new strategy. And you have prepared your investors ....they know what is coming.
So when you set out the details of the plan, and the investments needed, the financial logic is clear.
Take Microsoft. Nobody said to them 'ignore the cloud, just keep doing what you have always done'. Yes, they pumped a lot of investment into the new strategy, but the driver of the change was well understood, and the long term financial benefits were clear.
It can be the same for sustainability. Explain how the transitions will impact the company, including how they can be benefits. And start early, explain where you want to be in 2030 and what you will do between now and then to get there. And set out clear financial metrics and targets.
One last thought
Change can happen faster than we think. It might be comfortable to argue that either the change will not happen or that 'we have years to prepare, let's not rush'. But starting early is always a good idea. At its most basic, it gives time to try different solutions.
Please read: important legal stuff.