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How industrial leaders can use sustainability to create value

Industrial companies must embed value-led, digital-enabled sustainability to better position for future success.

In brief

  • Leading industrial companies are employing innovative sustainability practices, resulting in real competitive advantages.
  • Firms are reimagining their organizational incentives, innovation processes, and supply chains as part of proactive sustainability transformation.
  • Those making the most progress are adopting a variety of tangible actions, including deployment of analytics and technology.

Environmental, social and governance (ESG) issues are now on every organization’s radar — but the need to align ESG with financial performance poses an urgent challenge for the industrial sector (pdf) in particular.

The U.S. Securities and Exchange Commission (SEC) recently proposed rules that will require detailed climate-related disclosures in annual filings. This impacts the industrial sector significantly. According to the World Resources Institute, three industrial subsectors are the fastest-growing sources of greenhouse gas (GHG) emissions: since 1990, emissions from industrial processes grew by 187%, followed by transportation (+79%) and manufacturing and construction (+56%). The indirect impact is even larger.

Despite these warning signs, the industrial sector appears to be falling behind in terms of sustainability performance. Many actions individual firms have taken, such as increasing environmental reporting and setting emissions reduction targets, are increasingly seen as minimum requirements. Companies not making additional efforts in the short term are unlikely to meet stakeholder expectations in the medium or long term.

So how can companies transform their strategies to continue long-term performance while also reducing risk and creating new opportunities around environmental sustainability? Based on our experience and research, we offer clear advice on how to move swiftly from sustainability-related promises to clear action plans that can help organizations to create value for their business, people and the planet.

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Chapter 1

Moving toward sustainability

Why the industrials sector is lagging — and why companies need to catch up.

Outside of certain subsectors with higher public profiles (e.g., automotive or chemicals), many industrial companies have been able to fly below the radar and avoid engaging meaningfully on sustainability issues. However, the massive environmental “handprint” of industrial products and processes over their lifespans means the imperative — and opportunity — related to more sustainable solutions is clear. Simply embracing the status quo is, for lack of a better term, increasingly unsustainable.

According to a Source Global Research 2021 survey, 56% of public sector and state-owned entities

planned to invest >US$51m on sustainability efforts vs. 37% of manufacturing companies, and 33% of

public sector and state-owned entities planned to invest >US$100m on sustainability efforts vs. 8% of

manufacturing companies.

How EY can help

Considering the business characteristics of many industrial companies, this lower prioritization of environmental initiatives is perhaps understandable. Longer product life cycles, complex manufacturing processes, demanding customer requirements and mission-critical applications make implementing sustainability programs highly complex. To date, industrial companies have had higher hurdles and fewer incentives to choose a greener path.

 

Yet, for firms that make the effort, the benefits can be significant. Companies with high ESG marks are securing valuation premiums, with chemicals and materials firms reflecting the greatest impact — a 116% valuation premium in the US and 229% in the EU1 — and industrial products manufacturers are seeing modest benefits as well. In addition, other institutional sources of capital and capital markets gatekeepers are increasingly factoring ESG metrics into their decision-making.

 

Some companies that have realized the benefit of sustainability leadership to their commercial and market performance are prioritizing further investment to stay ahead. Carrier (via ey.com US), a leader in building and cold chain solutions, recognized an opportunity to win business and improve environmental outcomes by helping customers achieve their aggressive ESG commitments with a broader array of offerings. Boosting R&D significantly, the company launched more than 80 new products and services over the course of a year to help maintain its sustainability-driven advantage.

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Chapter 2

Putting sustainability at the core

Five ways to embed sustainability throughout organizations and across ecosystems.

Yesterday’s sustainability-related innovations rapidly become today’s minimum standards. Forward- thinking firms in the industrial sector are raising the bar, putting sustainability at the core of their commercial and operational strategies, and increasingly demanding that partners across their ecosystems do the same.

Here are five areas where industrial sustainability leaders are leapfrogging their competitors:

1. Driving deep organizational commitment

Industrial leaders are moving beyond aspirational decarbonization objectives and rudimentary environmental disclosures which have become table stakes. Instead, they are anchoring sustainability principles across their operations. This often includes developing and executing road maps that detail technology and infrastructure investments contributing to long-term sustainability targets. They are also embedding sustainability in core decision-making and incentive structures, such as KPIs, ROI assessments, product road maps and design principles.

According to the EY CEO Outlook Survey: October 2022 (pdf), 40% of industrial sector CEOs

believe that becoming a sustainability leader reduces capital cost or provides competitive advantage, and

22% believe that environmental sustainability ratings are important to attract investors.

Sustainability leaders are actively pursuing M&A and developing alliances to add advanced capabilities more rapidly. In addition, they are carefully assessing the importance of sustainability to acquisition candidates. Companies’ environmental footprints and handprints are increasingly becoming value drivers — not just another set of questions on a confirmatory due diligence checklist.

2. Putting sustainability at the core of innovation and business models

Rather than bolting it on as an afterthought, sustainability leaders are putting environmental considerations at the center of their innovation, product design and life cycle planning, and even commercial models. Taking sustainability into account from the outset, designers can create products specifically crafted to use fewer and greener materials. Firms are also seeking longer-term benefits as they reimagine production lines or even entire factories to reduce waste and increase energy efficiency. Leaders are dedicating portions of their R&D budgets to developing more sustainable materials and technologies. They are also building innovation hubs and incubators to make sure that there are always internal stakeholders with sustainability-related advances as their top priority.

Forward-thinking firms are also increasingly focused externally as well as internally, recognizing that some of the most significant advances can be realized via increased collaboration with ecosystem partners. This can include working with customers to introduce new commercial models — improving financial outcomes for both parties, as well as the environment.

3. Reimagining entire value chains — not just individual parts

As companies increasingly pursue incremental product and process improvements to boost sustainability, leaders are also rigorously evaluating all elements of their value chains for more differentiated gains. These firms are assessing all aspects of their supply chains and manufacturing processes, as well as the environmental handprint of their products post-sale.

Depending on the nature of the offering, this may be relatively straightforward (e.g., creating circular material loops for packaging or other low-complexity offerings) or much more complicated. In the case of capital equipment, the lifetime environmental impact from inefficient utilization or improper maintenance can be considerable. By deploying digital technologies and connected devices, leaders are analyzing performance in the field to help customers increase efficiency and reduce waste. The insights generated from this sort of ongoing customer interaction can be invaluable in identifying areas for future innovation while creating immediate value as an ongoing revenue stream.

4. Reinventing supply chains

Given their complexity, one of the greatest areas of environmental vulnerability — and opportunity — facing firms is their supply chains. To minimize risk, leaders are moving beyond superficial sustainability assessments and are instead engaging deeply with their entire supply chains, mapping direct suppliers down to the initial sources of basic commodities. Equipped with a more comprehensive view, firms can better align their supply chains with their overall sustainability strategies.

Leaders are also pursuing supply chain transformations by raising sustainability requirements for vendors and instituting accountability measures. These may include third-party certifications or more technology-driven solutions, such as the use of blockchain and advanced analytics to track input attributes from raw materials, all the way to the final product. When paired with ongoing diligence measures such as audits and on-site inspections, these measures can reduce risks and costs while improving quality and transparency.

5. Deploying and partnering around innovative energy technologies

 

Increasing the use of renewable energy sources is clearly a table stakes action for industrial companies. True leaders, however, are currently exploring emerging sources and technologies to reduce their energy consumption and carbon footprints even further. Some of these technologies are sector-specific (e.g., sustainable aviation fuels), while others have broader applications. For example, green hydrogen is seen by some as having the potential to accelerate decarbonization across heavy industry, long haul freight, shipping and aviation.

 

Beyond alternative fuels, industrial firms are also focusing on electrification of factories and equipment to reduce costs and emissions, as well as deploying carbon capture, usage and storage (CCUS) technologies to help meet net-zero targets.

 

Some companies have recognized an opportunity to stay on the cutting edge via “collaborative innovation” through partnerships and alliances with universities, industry associations and advanced research institutes. Organizations such as these have played key roles in exponential technologies such as carbon sequestration2 and carbon capture while driving.3 While investing in such emerging technologies may be outside the comfort zone for many industrial firms, some leaders believe the potential economic and environmental payoff from successful commercialization is worth the risk.

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Chapter 3

Incorporating sustainability-supporting tools

Digital transformation is paving the way for value-led sustainability.

As industrial firms pursue a sustainability transformation, the ability to identify, collect and analyze data generated by their businesses is critical to informed decision-making and improved performance. Many companies have already begun their digital transformations, so incorporating environmental-related requirements into these efforts may prove to be the fastest and most powerful way to accelerate value-led sustainability across the sector.

Firms are deploying sensors across their factory floors for improved workflow efficiency, inventory management and safety. Adding sensors to power generation and transmission systems in a facility can allow for improved energy efficiency. Once these systems are in place, the data they generate enable additional opportunities, such as using blockchain to match emissions with carbon offsets. Data can also be integrated with more sophisticated sustainability reporting platforms that will make third-party validation of sustainability metrics less costly and time-consuming.

Overall, a thoughtfully implemented digital strategy must integrate sustainability considerations at the outset. Failure to do so potentially puts a company behind its peers, increases risk exposure and reduces opportunities to improve both environmental and financial performance.

Digital technologies enhancing sustainability across the value chain

Source: AWIN, Web Search, EYK analysis.

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Chapter 4

Taking action

The path forward for industrial companies pursuing sustainability transformation.

With stakeholder pressure rising and regulators raising the stakes, industrial companies should not be asking whether a sustainability transformation should be pursued, but how to best leverage sustainability for competitive advantage. What approach will enable better decision-making, improving not only environmental sustainability but also increasing value for all stakeholders? Firms that successfully move from promises into action while defending and creating value will distinguish themselves as leaders.

Here are five concrete actions senior leaders in industrial companies should take as part of a proactive, forward-looking sustainability transformation:

1. Harness digital technology to advance value-led sustainability

Leaders use increased data collection and analysis to improve energy and resource efficiency, and rapidly design and launch greener products. They also embrace tools like digital twins and blockchain to generate a range of sustainability and value creation benefits.

2. Integrate sustainability goals with ongoing transformation efforts

Leaders recognize the necessity of continuous transformation and that sustainability goals should be integrated and aligned with these efforts — from digital transformation to portfolio management and beyond. Leaders are using sustainability as an offense.

3. Incentivize corporate leadership commitment to sustainability

Leaders link executive compensation to sustainability goals and embed sustainability principles into organizational culture and principles from the bottom up.

4. Collaborate with suppliers and customers on sustainability performance

Leaders prioritize sustainability criteria for supplier selection and create incentives for customers to use their offerings in ways that improve environmental outcomes.

5. Communicate sustainability goals and performance to external stakeholders

Leaders create accountability by being transparent about sustainability goals and subsequent progress with external stakeholders. The payoff from successfully assuming this risk may come not only from customers, but also from the capital markets, as investors increasingly seek out companies differentiating themselves on a variety of ESG-related metrics.


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    Summary

    Industrial companies face myriad challenges as they seek to improve environmental sustainability. However, the benefits of pursuing proactive, value-led transformation — rather than remaining reactive — are increasingly clear. Those that lean in farthest will be best positioned to attract and retain customers, talent and investors, and boost financial performance and valuations. Firms remaining in the middle of the pack may still realize considerable value from incremental actions, particularly in conjunction with digital transformation. Whichever path a company chooses, success depends on recognizing environmental sustainability not only as an area for risk management but as a meaningful opportunity to improve overall performance.

    EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.