The Responsible Enterprise Where citizenship and commerce meet

More and more companies today are undertaking environmental and social efforts to complement traditional business activities, using these efforts as catalysts to improve everything they do—from innovation and customer relationships to brand building and beyond. The results? Higher profits. Lower costs and risks. Increased shareholder value. Competitive advantage. And, though it may not be the primary motive, a measurable positive impact on society and the planet.

Embedding environmental, social, and governance (ESG) factors into your strategy and business practices isn’t just good corporate citizenship. It’s smart business.

Overview

Historically, many companies treated ESG issues as important—but tangential to the core business. Sometimes their motivation was a desire to be recognized as good corporate citizens. In other cases, ESG issues were viewed as compliance requirements, or perhaps good public relations. But more often than not, these issues were managed as secondary activities with an indirect connection to the core business and bottom line.

All of that is changing. The market today is undergoing a significant shift, with companies increasingly expected to address ESG issues head on. At the same time, many are recognizing both the tangible and intangible value of integrating these issues into core business activities. Commitment of human and financial capital to this area continues to grow, especially among companies that see clear impacts on their value chain.

In a recent Deloitte survey (“ESG survey”) of 250 business executives about these issues, three drivers of ESG imperatives were identified: a need to bolster the corporate reputation and brand, increased regulatory scrutiny, and higher expectations from consumers and the broader community.¹ Most of the surveyed executives expect ESG issues to have a growing impact on their strategies, products and services, and operations over the next two years. Not surprisingly, large companies (with more than $10 billion in revenue) foresee the greatest impact. These companies tend to operate across industries and geographies where the social and environmental issues are most acutely visible.

Another Deloitte survey found that two-thirds of global CFOs expect their role in ESG-related strategies to increase over the next two years.² This suggests that the ESG imperative is becoming a C-Suite issue and is expected to have a material impact on the bottom line.

What’s driving this trend?

Five factors account for the accelerating growth of corporate interest in ESG issues—none of which shows any sign of letup. A new era of the responsible enterprise appears to be here to stay.

• Loss of trust. According to the 2012 Edelman Trust Barometer, public trust in business continues to decline, dropping to 45 percent in the United States, compared to 51 percent in 2010.³ Trust in government is even lower.⁴ These findings indicate a growing perception that large institutions are not serving the public interest well.
• Stakeholder pressures. Pressure from consumers and investors is an important motivator for businesses to take action on ESG issues. Globally, this pressure is increasing, especially as the ranks of the middle class expand in emerging markets such as China and India.⁵ A wealthier and more educated middle class tends to have higher expectations for corporate ESG performance, as illustrated by growing protests against new factories in China.⁶ In addition, today’s investors are increasingly concerned about short-term ESG risks and tend to reward companies that disclose more ESG information.⁷ The number of S&P 500 companies that issued sustainability reports jumped from 19 percent in 2010 to 53 percent in 2011—and is expected to continue rising.⁸
• Natural resources pressures. Growing global demand and supply constraints are generally pushing up prices for energy, agricultural products, and raw materials—an upward trajectory punctuated by periods of extreme volatility.⁹ For example, precious metal prices have increased fourfold since 2005.¹⁰ Also, the recent US drought, which affected nearly two-thirds of the contiguous states, was the worst in 60 years and drove up cereal prices by 17 percent.¹¹  Such resource trends are increasingly top of mind for business leaders and managers. More than 70 percent of Deloitte’s ESG survey respondents said their organizations were making a significant commitment to improved resource efficiency.
• Supply chain pressures. Executives surveyed by Deloitte see a multitude of supply chain risks that directly affect their businesses, including climate adaptation, regulatory pressures, and the unethical practices of certain business partners. Companies rely on global supplier networks that are largely beyond their immediate control, but those same companies are being held publicly accountable for the actions of those suppliers. Also, the strong emphasis that many companies have placed on supply chain efficiency often reduces the margin for error and makes supply chains more vulnerable to all forms of risk, including ESG risks. In recent years, companies have been hit by a number of major disruptions, including floods in Thailand, the tsunami in Japan, and labor unrest in China and South Africa. Disruptions such as these help explain why ESG survey respondents expect to commit more resources to mitigating environmental and social risks over the next two years. The increasing frequency and financial impact of these types of supply chain risks are not going unnoticed.¹²
• Social and mobile enablement. A Deloitte risk management survey of 192 US executives found that social media ranks among the top five most important sources of risk.¹³ With social and mobile technologies becoming globally pervasive, questionable business practices have no place to hide. Problems that in the past might have remained behind closed doors can now be exposed to the world in a few minutes without a lot of advanced technology—and then scrutinized in detail, long after traditional media sources would have lost interest.¹⁴

Lessons learned: What works and what doesn’t

Many companies today are transforming their cultures to more strongly reflect ESG values and align them with their core mission and strategies.¹⁵ They are actively measuring and mitigating ESG-related risks and improving transparency, using advanced analytics to improve reporting, perceptions, and management of environmental and social risks. These companies are also aligning their business models with their environmental and social goals, and their performance management systems with desired outcomes. Among the senior leaders we surveyed who work at companies that recognize the importance of environmental and social issues, 63 percent said they support changing compensation plans to reflect their ESG commitments.

See endnote ¹⁶

Looking ahead, survey participants expect to commit more human and financial resources to ESG, not only to mitigate risk and improve transparency but also to change the organizational culture. According to the executives surveyed, this commitment will require three crucial actions that are closely linked to the core business:

1) Clear articulation of the company’s ESG goals and values to all stakeholders

2) Improved alignment of the ESG strategy with the overall company mission

3) A demonstrated business case for investment in ESG initiatives

These actions can boost a company’s competitiveness by making it more attractive to investment capital and top talent in a global marketplace that is increasingly conscious of ESG issues and risks.

Where it’s happening 

“You can’t build value for your shareholders if you don’t link it to value for your people.”                                 – Howard Shultz, Starbucks CEO

After a long and spectacular history of growth, Starbucks was beginning to show signs of weakness. Financial markets and analysts had started to write off the company, leading to a loss of more than $25 billion in market capitalization. In response to the crisis, the board reinstated company founder and former CEO Howard Shultz to orchestrate a turnaround.

Starbucks had a strong track record of corporate citizenship. In fact, it was the first privately held US company to offer all employees health benefits and stock options. However, it had gradually drifted away from its core values. In a bold and symbolic move, and despite board reservations, Shultz organized a major conference that brought together all 11,000 of the company’s managers to New Orleans in the wake of Hurricane Katrina. The conference kicked off with more than 50,000 hours of community service in the city’s 9th Ward, reminding store managers how citizenship and ESG are core values for Starbucks, and a yardstick for measuring personal and corporate achievement.

Although the New Orleans conference and other ESG-related activities were just part of the company’s turnaround, Shultz believes they were a catalyst that helped people think differently and inspired them to find new and innovative ways to serve customers and improve the business. And the results speak for themselves, with the company’s share price increasing by more than 500 percent from 2009 to 2012.²⁴

Looking ahead

Aligning ESG issues and corporate citizenship with commerce can help companies create shareholder value in three measurable ways: pinch, push, and shift.

Pinch. Downside risks should be reduced or “pinched”, especially in a global marketplace that is increasingly volatile, resource-constrained, and socially engaged. One way to do this is by integrating ESG and financial reporting, which can increase transparency, improve understanding of ESG risks, and help drive targeted mitigation strategies. Improved transparency can also help build trust with customers, investors, and employees, creating a halo effect that makes it easier for a company to earn forgiveness when things go wrong, while getting more credit for things it is doing right.¹⁷

Push. Companies can also leverage social and environmental issues to create new product and service innovations that drive revenue and reduce operating costs. Deloitte’s research on innovation shows that leaders on ESG issues are over 400 percent more likely to be considered innovation leaders.¹⁸ For example, Nike’s Considered Design initiative has enabled the company to recycle 82 million plastic bottles into high-performance sportswear, reduce waste by 19 percent in its footwear business, increase the use of environmentally preferred materials by 20 percent, and achieve a 95 percent reduction in volatile organic compounds.¹⁹ In addition, our ESG survey shows that 32 percent of senior executives expect more than 5 percent of future annual revenue growth to come from products and services that reduce environmental and social impacts, while another 32 percent expect 1 to 5 percent of future annual revenue growth to come from those same kinds of sources.²⁰

Shift. Weaving ESG factors into the fabric of a company can improve shareholder value over time by permanently shifting the expected share price to a higher level, creating a valuation premium.²¹ Part of this shift comes from pinch and push, which strengthen a company’s brand, reduce risk, and fuel innovation. Another part comes from improved operating efficiency and reduced waste, which can significantly reduce costs and increase profitability. In addition, a strategic approach to ESG issues can boost a company’s value by helping to attract financial and human capital. Responsible enterprises attract more funding and enjoy a lower cost of equity capital than their less responsible counterparts.²² They also have an easier time attracting talent—especially younger workers, who tend to be particularly conscious of social and environmental issues.²³ These effects can help create a lasting competitive advantage.

The increasing focus on ESG issues is a long-term trend, driven by rising public awareness and concerns about adaptation to a changing business environment, income disparity, and quality of life around the world.²⁵  Companies that are further along the journey toward effective integration of ESG issues into risk management approaches, business operations, and strategy will likely be in a stronger position to compete in the future. In particular, they will likely have the benefit of being able to take a strategic and measured approach when responding to stakeholder pressures and environmental crises. On the other hand, companies that continue to treat ESG issues merely as compliance could be missing an opportunity to be rewarded for the good work they do, making it harder to attract the customers, talent, and capital that are crucial to value creation.

My take

Al Iannuzzi, PhD, Senior Director, Worldwide Environment, Health & Safety, Johnson & Johnson 

Demand for sustainability has increased significantly in recent years. At Johnson & Johnson, we’ve been striving to improve our environmentally sustainable product design since the late 1990s—before many people even knew what sustainability was. Back then, we did it simply because it was the right thing to do. Now, we’re seeing growing interest in sustainability from virtually every market sector. Retailers are asking for more products that emphasize sustainability. Consumers are increasingly looking for products and services with environmental and social appeal. And business customers are making sustainability an integral part of their procurement processes—creating sustainability scorecards and adding sustainability criteria to requests for proposals.

In the markets we serve, differentiation is important. Beyond the significant environmental and cost savings that sustainable solutions can offer, one of the biggest benefits for us is the ability to engage further with our customers in driving more innovation, performance, and distinct value in our products and services. This helps customers achieve their sustainability objectives and provides opportunities to drive leadership and change in the marketplace.

Our Sterilmed business is a good example of how sustainability is shaping the medical device market. Although single-use devices remain predominant in the practice of medicine, Sterilmed’s reprocessing technology (remanufacturing of single-use devices) offers a compelling new business model with significant benefits for the environment—and for our customer’s bottom line.

Moving forward, we have set aggressive corporate-wide goals to reduce our environmental impact, and have established our proprietary Earthwards® (www.earthwards.com) process to develop and market greener products. Every Earthwards® recognized product must achieve a greater than 10 percent improvement in at least three of the seven goal areas:

• Materials used
• Packaging reduction
• Energy reduction
• Waste reduction
• Water reduction
• Positive social impact or benefit
• Product innovation

Through Earthwards®, we are delivering tangible sustainability benefits across the entire product lifecycle.

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