The unclear obvious within ESG
Updated: May 13, 2021
Abstract: On a testimony from experience working with companies willing to engage with ESG (Environment, Social and Governance) themes following the movements of financial market players, the issue of quality and consistency of ESG is hereby analysed. For the purpose of supporting companies to achieve actual value creation when defining their ESG plans, a brief assessment illustrated with examples propose reasons for the mismatch between how companies are approaching ESG and how investors, financial institutions and customers or consumers perceive it. The conclusions indicate a lack of deepness around two concepts by some organisations: strategic coherence and alignment and properly understood materiality consideration. The article is based on observation and experience of the consulting work done by the founder of AdvantiKA GmbH.
Why do some companies fail to deliver a convincing environmental, social and governance (known as ESG) plan? Larry Fink latest letters (let’s take from 2018 to 2021) emphasise topics like governance, purpose, climate change, long-term value creation as key aspects for any investor to consider. Statements by BlackRock, his mainstream investment company, support that, and so the statements of many other investment groups. Banks are expanding on their rules and criteria for credit lines to include ESG topics as well. Some banks are already declining money to companies who cannot attest to relevant governance and social-environmental commitments. Following such movements in the market, companies that had not paid attention so far to those causes and matters are now asking for help to understand what is expected from them. Others are frustrated because they believe they are well engaged. Yet, investors’ assessments don’t agree, or customers seem not to be giving them credit as they estimated it should have happened. They can’t tell why.
There are a variety of reasons for those inconvenient, frustrating or upsetting outcomes. It all depends very much on each specific case. Nevertheless, I observe a few common points among customers, leads, and other organisations I interact with along my work. My experience with some of these companies, without looking into any particular case but instead proposing a reflection on such commonalities, are the grounds for this article.
ESG plans stand as a set of practices, actions, ways of working and established processes connected to goals and objectives for companies to guide themselves beyond making money and generating profit that translate into dividends to shareholders. They stand for a shift of the organisation’s attention towards a broader spectrum of stakeholders, including the planet itself, as focus points. And shareholders seem to want that to happen, considering the market movements we revised before.
It seems to me many companies struggle with making the right choices on how to go about their ESG plan. Relevantly, there are two undermining aspects into play. They will sound to many readers as obvious, yet they are frequently poorly considered by many organisations. The two aspects are strategy and materiality. They are interconnected, and sometimes what affects one is strictly related to the other. You can think of strategy & materiality as a pair of wings balancing ESG enterprises along the journey. I will focus on one at a time, illustrating the reasons that make the meagre consideration of these two aspects imperative in generating unfortunate ESG plans.
Strategy is an overused word that I believe quickly loses its meaning when companies implement their ESG actions. Many companies have no strategy whatsoever around their ESG activities. And some, in trying to be strategic, stop at the mere exercise of using language that dimly connects their engagements to their business extent.
Examples may clarify my point. Let’s say a company decides to invest in supporting the environment around its facilities or in the country where they are based on the idea this is “strategic” to keep engagement with the community. Another company decides to organise events around culture and book reading for their employees’ children because it is their “strategy” to support their workforce above other stakeholders. While those are good reasons for good initiatives, they may lack strategic connection all along.
In the first case, the one about the company investing in supporting the local environment, we can entertain we are talking about a packaging company whose primary raw material is different plastics. Suppose they have 70% of their raw materials coming from imports, and they sell 50% of their products to the internal market while 50% goes to customers overseas. The goods that use their packaging are fast consumer foods. All the portfolio of the company is based on single-use packaging. They buy some recycled material but only up to 5% because they are proud of the high quality of their products resulting from the pure material. That has been what created their market positioning in the first place. The quality and robustness of their packaging is their differentiator. Using higher levels of recycled material would impact their very value proposition, as they see it. So, in their environmental initiatives, they bring the same concept and create beautifully gardened green areas in the surroundings of their factories or offices. The gardens are perceived as of high quality and very much appreciated by the communities around. When a group of investors came to assess their ESG program, they were nevertheless not impressed. Even though they seemingly enjoyed the outdoors lunch meeting in a beautiful gazebo built to receive them during their three-day visit. The investors know that there is a general “war on plastics” going on. They also know that plastic packaging is still a highly profitable business from a purely economic perspective. And, while they appreciate the niceties and local positive impact of the implemented green areas, that does not add enough real value to the company and does not address their business risks.
Meanwhile, a national newspaper, followed by several posts on social media, runs an article about landfill enlargement and its negative impacts in developing countries. The images showcase plastic packaging from the company and its name and their customers’ name, as responsible. The company from our example don’t pay much attention to that. Still, another of their customers, a top account, decided to accelerate their plans for a change after the episode. They hosted a meeting announcing their plans on switching their packaging to different models offered by a competitor who has developed a scheme of green reverse logistics that addresses the issue. They will start with a pilot but have already committed to a steady transference of volumes to the competitor who has part of their portfolio made out of bioplastics attached to a reforestation program that compensates for their emissions.
The second example, let’s suppose, involves a company in the fashion retail sector. They take upon organising cultural events for children, and they connect it to the Sustainable Development Goal - SDG 4 – Quality Education. Customers, though, have not been impressed by this move when they see the pictures of children reading on the labels on their clothes or at the company’s online store. Some critical comments showed up on those platforms with very negative customer reviews. One customer, for instance, posted a picture of the rivers nearby a factory producing clothes for this retailer abundantly contaminated by dyes and chemicals. The image is dramatically placed side-by-side with a picture of a poorly nourished child, critically ill, after drinking the water. The headline was even more damaging, saying, “Your books could as well be full of lies. Don’t tell us you care about children’s education when you are killing so many of them”. The post had more than 700K views, 100K reposts and 50K comments of indignation with consumers pledging to never more buy from that retailer.
I know, those seem like stories you already have seen about industries where it is clear that they have a lot of responsibility of impact. Well, the news is that this is valid for all companies. And the fact that one’s sector has not been in the news does not make it more attractive to investors nor customers. And it may as well happen to something related to any organisation. And that illustration describes only one side of the story, emphasising risk, but the loss of value and missing businesses opportunities are equally or even more relevant.
What these two companies are failing to see is the deeper meaning of having a strategic ESG plan. Both investors and customer are increasingly interested in long-term goals and approaches related to the companies’ core business objectives. They want to see that the company’s plans make sense and inform about the direction the company is taking and their long-term view of how their business is and will continually impact society, the environment and people. And how it all connects directly into revenues, cost and investments.
Materiality is a word even further misused in comparison to strategy, I guess. Its concept is less clear and not necessarily intuitive to all people. Materiality here is not necessarily physical. It can, but not always relate to matter. It is better understood as resulting in an impact. It ought to correlate with magnitude, probability, frequency and relevance. It needs to be accessed from the perspective of various stakeholders as opposed to the view of the company alone.
Looking back to our examples, in the first case, our plastic packaging manufacturer cannot avoid looking into its raw material and the very different aspects related to it in its production, transport, disposal, etc., if the company wants to consider materiality seriously. And there is no other concern they can take upon to compensate for their lack of attention to the fundamental resource they use. They should look into emissions, pollution and all social aspects related to their relationship with employees, as all of this is material to their business. Still, unless they seriously, strategically and in a long-term view, establish plans to deal with plastic’s negative environmental and social impacts, they are kidding themselves. Now, you may be thinking, oh, but that is obvious! Well, not all companies have such obvious material issues, and then it is more complicated when it comes to making the right choices for their ESG actions. That is where the companies get confused.
In the case of our fashion retailer, the list of material issues is gigantic. Yet, if they do not address their COGS (cost of goods sold) to begin with, from the lenses of ESG, they are just playing fools. Suppose people producing their fabrics and sewing the clothes of their brand or of one of the brands they sell are unfairly paid, their children don’t go to school, they have no health or social benefits, all of which all are among the most significant impacts of the sector. In that case, there is no good the company can do in other areas to look convincing to awakened customers. Of course, there are also the aspects of pollution illustrated before to be considered.
Again, you may say that after Bangladesh’s disaster, we all know that. But still, look around. How many fashion brands seem to be taking these items seriously? And again, think about less clear examples, like someone running a school business, an office supplies retailer, a tourism company or a chain of restaurants. The issues in those cases are known to people who understand ESG, but they are more diverse and trickier to focus on or to choose.
The companies simply get puzzled. They seem to be more disoriented than their investor and consumers. Why is that? Partially because investors and consumers don’t have to develop this knowledge, they ask experts to tell them where to look. They trust indexes, certifications or stamps. Some of them are informed, but mostly, they go with the news and the expert’s word.
Another point of mix-up comes when companies hire consultants or experts to get inside the company and “do the materiality” analysis for them. The organisation remains without understanding it and stand not relating it to its ESG plan, or they make the wrong associations. It is not by chance my motto as a consultant is to empower the leaders and teams. It is because I see that as substantial. There is no good way out of it. The people inside the business need to understand their ESG plan basis and logic as skilfully as they know their core business.
In the case of materiality, the irony is that once the concept is well explored with the business, it is not difficult for them to correctly point out their material issues. With some guidance on the most technical or hidden aspects, they can master the whole strategy and materiality of their ESG blueprint and goals. Once that is achieved, it does not matter much which indicator, index or framework one uses. The organisation will do much better in the eyes of investor and consumers.
In summary, two are the reasons I often see companies struggling with the quality and consistency of their ESG plans and, therefore, with the unsatisfying image to the eyes of investor and customers/consumers. They relate to the following questions:
How strategic is one’s ESG plan? Is it connected to the objectives and goals of the business in the short, medium and long term? Does it generate value, risk reduction or cost reduction and establishes a basis for prosperity in longevity? Is it well-structured and coordinated, as well as measured in such terms?
How material is the ESG plan? Does it consider topics that result in pertinent impact in a relevant, critical and probabilistic way owing to its core business? Is this analysis broader enough to properly include and value the stakeholders’ view other than the company’s and its shareholders’ view?
Amidst all the complexity of climate change, planetary boundaries and societal transformation, many capable professionals can assist companies with designing a suitable plan. There are many tools, frameworks to support organisations. What I’d recommend is that companies choose a consultant or advisor who will not only do things for them or think it through for them but, who will enable them to see beyond and help them to develop specific business-related understanding and creative ideas for value generation supported by ESG fundamentals. Companies can choose a professional who will make all this complexity simple to them, not because they will provide the organisation with short (and limited) answers, but because they will show them how to get their own thinking around that going. Strategic and material ESG thinking will be more straightforward and simpler once it becomes part of the business itself.
About the author: Karime Abib is a former executive with 25 years of experience and a consultant and advisor in sustainable business models, strategy, supply chains and ESG assessment and plan development. She also dedicates herself to programs and actions for the empowerment of women. Learn more about her on LinkedIn and more about her current work visiting AdvantiKA GmbH and Empowr International.