Why sustainability has become a corporate imperative

Greenwashing won’t wash, but organizations can embrace five essential strategies to help them succeed.

In brief

• Investors, consumers, organizations and governments are driving the shift toward sustainability.
• There are five pillars that comprise an effective sustainability strategy.

The world has endured much in recent years — rapidly increasing global temperatures leading to extreme weather, rising income inequality, deepening geopolitical tensions, and now a global COVID-19 pandemic with a subsequent deep recession.¹ These events are linked in their systemic disruption of the status quo; they affect our health, environment, society and economies.

This disruption is, however, also a catalyst for innovation. According to the authors, Dr. Oliver Eitelwein and Sean Paquet of EY-Parthenon, this disruption is an imperative to focus on sustainability, to reconsider what we thought to be fact and reshape how we interact with our environments.

This shift — away from negatively associated justifications of resource use to a positive acknowledgment of the opportunities presented by sustainable management — is being driven by four key stakeholders: investors, consumers, industry peers and governments.³

In this article, we take a look at this rapid transformation of the business landscape toward sustainability and we examine the five pillars that together support an effective sustainability strategy. We also look at how the EY-Parthenon Long-Term Value Framework can help guide a winning sustainability strategy.

Stakeholders are demanding change

The four main stakeholders seem to all have specific, non-negotiable, strategic operational demands of sustainability.

This global movement is driven by a diverse coalition of a corporation’s stakeholders. Investors, consumers, industry peers and governments are each casting their own demands to cement sustainability as a non-negotiable strategic necessity for organizations to operate successfully in the future.

Investors

Capital markets are evaluating performance against three key metrics: environmental, social and governance (ESG) in investment decisions, driven by compelling evidence that performance against these measures is indicative of an organization’s creation of a long-term competitive and financial performance advantage.⁴

Business leaders have long been skeptical of incorporating sustainability issues into their core strategy because the perception was that these initiatives would be incongruent with short-term profitability and thus would be punished by shareholders. The evidence suggests that the opposite is now true. According to a recent EY-Parthenon survey, 90% of global institutional investors revise investments if companies do not at least consider ESG criteria within their business model.⁵

The world’s largest investor, BlackRock, recently announced it would place sustainability at the center of its investment approach and actively exit investments that indicate a high sustainability risk, such as coal-sourced energy.⁶ This is important to understand, because the move clearly highlights a common driver of investors seeking sustainable investments: systemic risk. A large portion of the world’s invested capital is traded by large institutional investors, who should balance the factors affecting an individual firm’s performance with the broader factors impacting their entire portfolio, such as climate change and transparency.⁷

Amid the current COVID-19 pandemic, BlackRock and other major investors are now seeking to double their sustainable exchange-traded funds (ETF) offerings and take note of ESG risks in their portfolios and processes.⁸ This sentiment may be shared by others in the financial community. Though the short-term focus may be on managing through the present crisis, remaining investors and firms may emerge with a new perspective about risk management with the long-term in mind.

Consumer

Consumers’ demand for sustainable products is increasing. They are willing to rethink their buying habits to incorporate environmental and social product benefits into their buying decisions. This means that markets may change and open new opportunities for consumer value extraction.

Research shows:

• Revenue from sustainable products is growing at about six times the rate of other products.⁹
• 50% of consumers are willing to pay a higher price for products that have a positive social and environmental impact on the supply chain.¹⁰
• In the US, an expected $150 billion is to be spent on sustainable products by 2021.¹¹
• By 2025, consumers will consistently prefer products or services that are less damaging to the environment, human health and society.¹²

This trend is especially driven by younger generations who are more connected to the idea that their futures may be significantly influenced by the impacts of climate change.

What was previously a choice of convenience, if all other variables align, now seems to increasingly become a priority in purchasing decisions. This trend applies immediately to consumer products companies and may ripple through markets, affecting business-to-business companies as demand for sustainable products permeates the entire value chain.¹³

Industry peers

Sustainability commitments from large companies have reached a critical mass and now are placing peer pressure on any chief executive officers (CEOs) yet to announce their commitment. The sustainability imperative seems driven by a realization of the global business community: a firm’s purpose beyond profit and its codependency on other firms, organizations and individuals in the ecosystems in which it operates represent significant forces in maintaining long-term profitability.¹⁴

More businesses are adopting sustainability as a core corporate strategy because of the financial potential of sustainable opportunities and because employees now seek “purposeful” work. In turn, these businesses are exerting significant pressure over other businesses to follow their lead:

• 140 large global companies are seeking a standardized framework to report nonfinancial ESG factors.¹⁵
• Over half of US businesses have increased their commitments to renewable energy.¹⁶
• More than 9,500 companies, including 28 companies with combined market cap of US$1.3 trillion, have committed to step up to new levels of climate ambition.¹⁷

This wave of announcements is cause enough for executives to reflect on the long-term purpose and impact of their own businesses. It also legitimizes the logic and value proposition behind the movement.

Governments

So far, corporate interest in sustainable management is being driven primarily by the upside it offers to investors, consumers and corporations themselves. However, government penalties for not complying with climate regulations already hurt companies across industries. Given what is at stake if further actions are not taken, governments may increasingly bring aspects of sustainable management into hard-coded law.¹⁸

Pressure is mounting from governments around the world to hold companies accountable for sustainably operating. The German Bundestag, for example, is examining legislation that would force companies to investigate every sequence of their supply chain and likely would penalize them for unsustainability.¹⁹

The bottom line is this: the longer the free market does not demonstrate evidence-based control over its externalities that have negative impacts on society and the environment, the more severely regulatory bodies may try to impose restrictions on business operations. In this movement, it seems that the number of stakeholders, the amount of capital, and most importantly, the social and environmental risks at play may be too significant for governments not to step in.

How to build a successful corporate sustainability strategy using the five pillars

The sustainability imperative is here, and executives may consider taking one of two paths.

The first is where companies take a high-risk, superficial approach to capitalize on the sustainability movement through marketing activities while maintaining existing operations.

The second path is to become truly sustainable — transforming from the inside out to integrate sustainability into the core of the business. This corporate strategy may be more difficult, but one that we believe will separate thriving organizations from those that may not last over the long-term. Our perspective is intended for organizations taking the second road.

Transforming the core

The first pillar: sustainable products and value chains

Think of the entire value chain, building sustainability into each step and into the structure of the chain itself.²⁰

You may consider these three product strategies. The easiest and most common is to rebrand an existing product in your portfolio that already meets internal and external standards of sustainability criteria. Be sure to do due diligence to avoid the negative accusations of greenwashing.

The second strategy is to address a partially unsustainable supply chain to make an existing product truly sustainable. The risk is that rushing this process to capture market share or avoid a heavy investment can backfire. 

The most disruptive option is to create entirely new sustainable products and solutions. Here, startups may be more successful than incumbents — with new business models, sales strategies and powerful branding. One example of this strategy is Tesla’s disruption of the automotive market.

The second pillar: sustainability culture

The culture of an organization may be defined as the collective mindsets, behaviors and decisions that ultimately shape the direction of a firm. So, what does a sustainable culture look like? It should be more than encouraging employees to print less, and cycle or carpool more. It should be about nurturing a long-term mindset and connecting to a collective purpose beyond profit, also driving long-term consumer, human and societal value. A sustainability-oriented culture usually comes in two stages of maturity:

• Leaders as role models who can clearly articulate the organization’s purpose in line with its sustainability goals. This purpose then fuels individual and organizational transformations — igniting long-lasting, positive change that results in sustained improvement and innovation.
  
  The Kantar Purpose 2020 study, a survey of more than 20,000 global consumers and 100 global leading brand interviews, highlighted that brands with a highly perceived positive impact, or more purposeful companies, experienced growth of 175% over 12 years compared with 70% to 86% for brands perceived as having low or medium purpose.²¹
• Empowering the organization to make sure everyone buys into a new vision. With a thoughtful approach to balancing long-term metrics and short-term targets, provide space for people to own the vision. When individuals and corporate purposes are aligned, employees are usually willing to go above and beyond what is required to express their values.^{22, 23}

The third pillar: integration into the corporate operating model

How well managers understand and manage the required changes to run their businesses sustainably is an important factor in delivering on sustainability commitments.

Take, for example, a hypothetical business that announces a sweeping strategy to sustainably source all of its products, eliminate poor labor practices in its supply chain and make long-term investments in the communities in which it operates. As the next step, the steering infrastructure of the operating model must be altered to effectively deliver on this vision. Considerations include:

• Defining responsibilities or roles. Who will be responsible for driving toward and maintaining the new commitment to source sustainable raw materials?
• Defining new skills, tools and processes to evaluate sustainability according to a new, uniform set of criteria.
• Creating new data assets, frameworks and metrics to evaluate the performance of managers and business units. Corporate sustainability results from strategic alignment of the whole company. Hence, sustainability performance can be measured by the objectives of business units to become integrated with the company’s core.
• Measure ESG KPIs as digitally and automatically as possible to reduce the friction a massive manual effort can have on an organization’s efficiency and accuracy and, thus, the adoption of new ways of working.

Driving external value

The fourth pillar: positive reputation

Sustainable business practices can drive brand value growth. Companies should not attempt this until they are able to demonstrate the intention and results around true sustainability targets.

It isn’t only about marketing sustainability targets — since consumers and investors look for real impact. There is no way around building sustainability into the organization’s core strategy or skipping past the first three pillars.

Organizations that commit to a purpose embracing sustainability can expect exceptional growth fueled by positive reputation.

• A University of Cologne study showed sustainably engaged companies have a 50% higher brand value than average companies.²⁴
• Nielsen reported in 2014 that half of young consumers were willing to pay more for sustainable products. In 2018, that number had risen to about 85%.²⁵

Mere greenwashing may be counterproductive in extracting brand value. Greenwashing has been defined by Greenpeace as misleading consumers with regards to a company’s environmental measures or the environmental performance of individual products.²⁶ In the future global economy, only companies that have transformed to be truly sustainable may be rewarded.

The fifth pillar: capital market access

Investors are placing value on sustainability and withdrawing capital where unsustainable business practices are identified.²⁷

Companies should consider establishing a formal strategy around investor engagement to maximize the amount of capital access gained and make certain that sustainable transformation efforts do not go unnoticed. It is crucial to note, however, that capital may only be secured if the first three pillars of the sustainability strategy are already truly addressed.

To effectively engage with investors, consider these strategies:

• Establish formal channels for communicating the long-term purpose to institutional investors.
• Incorporate more long-term rhetoric into earnings calls. While companies regularly report down quarters, showing positive outlooks can result in boosts in the share price.
• Collaborate with investors to learn from their views about sustainability.

Leveraging the Long-Term Value Framework to define your new sustainability strategy

Many corporations struggle to define sustainability strategies that fundamentally transform the core of the firm toward long-term value for the company’s key stakeholders. The EY-Parthenon Long-Term Value Framework provides a very powerful method for solving the complexity of multi-stakeholder strategy development by using a structured approach.

There are five clearly defined steps.

Figure 1: The EY-Parthenon Long-Term Value Framework

1. Establish the business context

Determine the best purpose and strategy to operate in the long-term context of your business. Key questions to resolve include:

• What is the current and future context the company operates in?
• What trends will impact your business model?
• Why does the company exist?
• What are the implications for stakeholders?

2. Assess stakeholder outcomes

Identify business opportunities and risks from a stakeholder perspective and adjust your strategy to lift the potential.

• Which stakeholders are at the core of your value-creation model?
• What outcomes are you aiming to deliver to meet stakeholder expectations?
• Are some outcomes more important than others?

3. Identify strategic capabilities

Define, build and strengthen the relevant strategic capabilities to create and protect financial, consumer, human and societal value.

• Are some outcomes more important than others?
• What resources and capabilities are needed to create long-term value?

4. Develop a measurement and valuation approach

Measure your performance based on an outcome and impact perspective.

• What existing metrics can be used?
• What additional metrics are required to create long-term value?

5. Manage execution for success

Plan, track and report project development and outcomes. Identify potential risks and additional opportunities and facilitate stakeholder communication.

A potential way forward

Creating a truly sustainable enterprise may result in long-term value. Starting with the first three pillars — sustainable products and value chains, sustainability culture, and integration into the operating model — should help promote the most effective transformation, because these pillars may directly determine how sustainable an enterprise is. Only after these pillars are addressed may the value locked in the final two pillars — positive reputation and capital market access — be fully realized in the long- term, driving increased brand equity and more favorable capital structures.

The sustainability imperative seems to be here to stay. The chaos inflicted by the COVID-19 pandemic may eventually settle, putting back into focus pressing sustainability issues. It may leave behind a world that is even more sensitive to the needs and purpose of sustainability for human well-being, building even stronger justifications and upsides for those organizations that have the courage to be early movers to achieve real long-term value.

Dr. Oliver Eitelwein and Sean Paquet of EY-Parthenon authored this article.