Tying sustainability to your strategy

Twenty years after the launch of the Hannover Principles – a manifesto that argued for including a broader set of considerations, such as health and environment impacts and eliminating waste, in design principles – sustainability is starting to work its way into the fabric of corporate strategies, at least among the more evolved companies. They now see that confronting ESG issues is as much about recognizing opportunities as it is about addressing risks. For the rest, sustainability reporting is advancing in fits and starts, with the Sustainability Accounting Standards Board (SASB) resolved to formulate specific standards for 88 industries over the next two and a half years.

Roughly 95 percent of the 250 largest companies in the world now produce a sustainability report, according to the Global Reporting Initiative (GRI), and 80 percent of them use GRI guidelines. The latest version of the guidelines, known as G4 and launched on May 22, aims to help companies shift sustainability reporting from a ‘compliance mind set’ – simply checking off boxes – to a thoughtful review of the material issues relating to the key economic, social and environmental impacts of the business, based on dialogue with stakeholders, so they can determine where in the business their focus needs to be.

‘The whole idea is to look at things systemically,’ says Andrew Behar, CEO of As You Sow, which promotes environmental and social corporate responsibility through shareholder advocacy and other strategies. ‘Look at the design of a product and how it is used through its entire life, with the target being zero waste.’

Ultimately, companies are focusing more on sustainability because investors are getting savvy. They understand that sustainable supply chains mean better-managed companies that are better poised for profitability and survival over the long term, says Behar. ‘Good management is going to have good ESG principles applied,’ he explains.

Bloomberg terminals now include an ESG disclosure score for each company that lets investors – and corporate secretaries – see how its business stacks up against industry peers. ‘If you’re leaving a blank in the Bloomberg terminal on greenhouse gas emissions, you’re in the minority nowadays,’ says Mike Wallace, director of Focal Point USA, the US division of GRI.

Stock exchanges, besides disclosing their own sustainability efforts, have begun to weave GRI principles into their listing guidelines. Individual exchanges like NASDAQ prefer that uniform rules on sustainability reporting come down from the World Federation of Exchanges, which is slated to discuss the matter in October, in order to prevent firms from shopping around for exchanges with the most lenient regulations. But what exactly does sustainability mean? Corporate Secretary surveyed some of the key thought leaders on the topic to clarify what companies should be thinking about and incorporating into their business planning.

SASB defines sustainability as any issues related to ESG factors that are likely to affect value creation and are of interest to investors. ‘We look at which of those factors are likely to be material, and at how to prioritize and characterize them so companies can communicate their performance to investors,’ says Jean Rogers, SASB’s executive director.

Governance plays a key role in this and is relevant to every industry to varying degrees, she adds. It may entail a company’s management of ESG factors, or conflicts of interest, or how a company manages stakeholder impacts.

DVFA, the German society of investment professionals, defines sustainability as the creation of long-term profitability without sacrificing a company’s ESG goals. ‘Just fulfilling the criteria for sustainability without looking at the functional performance and capacity of the company to survive over the long term doesn’t make any sense,’ says Ralf Frank, managing director of DVFA. Sustainability demands that a company achieve a balance among its various duties as a taxpayer and as an employer with shareholders and other stakeholders in society to satisfy, he adds.

For investment firm Rockefeller & Co, sustainability means the issues that will most likely affect a company’s business model and the health of the society in which it operates over time. ‘A framework that captures the financial, non-financial and societal resilience related to a company, such as that developed by the Integrated Reporting Initiative, is a good example of a place to start,’ explains Farha-Joyce Haboucha, director of sustainability and impact investing at Rockefeller.

Being aware of and analyzing significant trends in society, with an eye toward continually developing fields of ESG activity and suitable responses, is critical to a sustainability program, according to DVFA. And incorporating ESG factors into the development of the corporate strategy offers companies broad potential for future success. In addition to expanding the scope of risk management to include ESG issues, it opens up opportunities to increase cost efficiency and improve the long–term prospects for success of the company.

The debate over conflict minerals such as tin, tungsten and gold from such troubled countries as the Democratic Republic of Congo is a case in point. The Dodd-Frank Wall Street Reform and Consumer Protection Act requires that companies report the source of the minerals they use. This has created a ripple effect with implications for supply chain management in multiple industries. ‘That applies to anyone using any kind of metal,’ Wallace points out. ‘It applies to every computer company out there. It also applies to the auto industry.’

Reporting on sourcing of raw materials is part of a more dedicated effort by companies to audit their supply chains. It’s being driven not only by regulations but also by companies’ unwillingness to be involved in financing genocide, says Natasha Lamb, head of shareholder advocacy and corporate engagement at Trillium Asset Management. A sustainability strategy must include the ability to identify emerging issues and be in touch with your company’s supply chain in order to move beyond compliance and stay ahead of regulation.

Similarly, the hits Apple’s stock and reputation took when inhumane working conditions at its Chinese supplier, Foxconn, were discovered in 2010 were a wake-up call, alerting companies to the need to pay attention to the labor practices of their major suppliers. ‘You may not own your supply chain, but you have a means of exerting influence over it,’ says Frank. ‘You may not be able to express the potential risk in monetary terms, but it will damage your reputation.’

Start with governance

There’s an adage that structure follows strategy, and structure often begins with governance. For Trillium, governance at the highest levels of a company is the basis for good ESG management. Getting the C-suite and the board to look at ESG issues dramatically lowers systemic risk. ‘Whether that leads to better stakeholder communication or a stronger resourcing strategy, the higher up the mandate, the better the outcome,’ says Lamb.

It’s essential that boards tie compensation to ESG performance, she adds, if companies hope to motivate stronger practices. If a company wants to lower risk across its business, it would make sense to link all employees’ compensation to ESG outcomes.

Board diversity is another governance consideration. Lamb cites a study that shows that having a critical mass of women on the board often leads to better due diligence. Having three women on a board ensures a diversity of perspectives even among the women, and empowers them to ask tougher questions. Women also lend a unique perspective to board decisions on which markets and growth opportunities to pursue, Lamb notes.

Structure can be as elementary as ensuring the board has a sufficiently high level of oversight in key risk areas. After dialogue with Trillium about its concerns over data security and consumer privacy, Apple and eBay changed their audit committee charters to grant board oversight of privacy issues, which neither company had until then.

‘If you don’t have the highest level of oversight and that fiduciary duty that rests with the board, you may not be able to achieve greater sustainability outcomes, and the company will be more at risk of data breaches and procedures that may compromise consumer privacy, lead to litigation and hurt the brand,’ says Lamb.

The need for buy-in and enthusiasm below board level cannot be overstated either, says Elizabeth Seeger, a principal at investment firm KKR, where she has been engaging with the now approximately 80 companies in its private equity portfolio on sustainability issues since 2009. ‘The thing about sustainability is that it concerns a lot of people,’ she explains. ‘There are many things that have to be done and a lot of people for whom sustainability issues are part of their daily jobs’ – from fleet managers to human resources employees to people in charge of environmental safety.

Building a robust culture of ethics and compliance is also critical from a governance standpoint. Making sure employees receive training in ethics and compliance issues and that communications plans for these issues are in place are among the metrics the Ethisphere Institute uses to compile its annual list of the world’s most ethical companies. Ensuring there’s no disconnect between policy and training is another of its criteria.

Opportunities, not just risks

Sustainability offers plenty of opportunities in addition to the risks that have to be confronted. A food retailer offering organic or fair trade products – niche categories in which consumer demand is growing rapidly – may have more favorable exposure to growth, says Lamb. In the industrials sector, companies providing energy-efficient motors will have an advantage over competitors that aren’t selling them.

There’s also an opportunity for overlap between sustainability initiatives and top-line benefits to companies, says Lamb. By providing greener software products and services, or hardware that supports a greener data center, or consulting services, IT firms can help companies save energy and reduce expenses.

Telecommunications providers are now thinking more broadly about their expertise, realizing that in addition to phone services they are also able to provide data applications around the world that can help alleviate sustainability challenges, says Rogers. Whether it’s water or weather data, or information relevant to agricultural preparedness, these companies are starting to build these functions into their product offerings.

Vodafone, for example, has enabled hundreds of thousands of farmers in Turkey to receive more than 72 million SMS text alerts of weather forecasts and region-specific crop information since 2009. The mobile communications firm estimates that this boosted farmers’ productivity by roughly $156 million in 2011-2012.

Thinking ahead: scenario planning

Some companies are taking sustainability strategy to a point that many stakeholders might view as excessive; others believe that as long as it addresses business continuity issues, such planning is indispensable.

Scenario planning has become a best practice, and requires that a company figure out which issues are relevant for its specific industry, says Rogers. Those issues could be related to weather, human capital in the supply chain, or how access to scarce resources, real estate or transportation networks may be affected by a disaster such as a hurricane.

‘Scenario planning is what risk managers have done for a long time with respect to traditional business risks, but now they’re increasingly understanding that it’s a smart way to address environmental and social risks,’ Rogers explains.

And because it concerns business continuity, scenario planning requires attention from the board, which needs to decide whether the scenarios being addressed are the right ones and what action plans are needed to tackle vulnerability issues.

It’s a mistake to think of such extensive measures as being focused solely on risks, as opposed to providing ways to identify less apparent opportunities. Consider the new frontier opened when Germany-based sportswear manufacturer Puma decided to begin quantifying and monetizing its own environmental impact. Inspired by a major study carried out by the G8+5 environment ministers, Puma is the first company in the world to provide an environmental profit and loss account, which it did for 2010, that attempts to attach costs, other than fees paid to local authorities, to services provided for free by nature such as fresh water, clean air, healthy biodiversity and productive land, which all businesses depend on.

By collecting and modeling data for greenhouse gas emissions, water use, land conversion for livestock or other agriculture and waste sent to landfills, and putting the information into a profit-and-loss format, Puma realized that only 6 percent of its impact came from its own operations, and another 9 percent from its direct suppliers. The key finding was that 85 percent of the impact came from areas considered outside the company’s direct control or influence, from the farthest reaches of its supply chain, such as rubber plantations, cattle rearing, cotton growing and petroleum refining.

These findings helped clarify ‘where we need to direct our sustainability initiatives in order to make real improvements in reducing our impact,’ Puma notes in its report. It also encouraged the company to investigate more sustainable materials and ways to reduce its greenhouse gas emissions.

A month after Puma released its results, the UK government declared the company’s analysis a best practices case study for sustainable business in a white paper. ‘By putting a monetary value on environmental impacts, Puma is also diligently preparing for potential future policy or legislative changes, such as disclosure requirements or taxation on ecosystem services,’ the government report declares. Besides strengthening risk management by better managing exposure to volatile cotton prices, the profit-and-loss account provides opportunities such as differentiating Puma's brand from those of its competitors.

The competing key performance indicators, frameworks and guidelines for sustainability are intended for broader sets of stakeholders, and companies shouldn't get distracted by them, says Rogers. 'Companies won't get value out of any of these unless they focus on what's material for them,' she notes. 'They have to be committed to managing performance on these issues and not just getting a report out.'