In this post you will learn why ESG factors are important for companies, investors and all the stakeholders involved. There are 5 major pathways to the materiality of ESG factors.
- Customers
First of all, better or worse ESG performance can attract or repel customers who pay more or pay less. The most rapidly and only growing segment in many consumer packaged goods sectors are those that offer sustainably raised farms to produce products. Next time you go to the grocery store see how many products have various green, eco, organic or other labels and ask yourself how you feel about those products relative to other products lacking the same labels, and then compare the prices across those products. By contrast, stories about slave labor or harmful environmental consequences can quickly trigger customer defection into another brand. Unilever’s water savings sunlight brand of dishwashing liquid exceeds its category growth rate by 20 percent in water-scarce markets. But revenue growth is not always driven by customers alone. When governing authorities trust corporate actors, they’re more likely to award them the access approvals and licenses that afford fresh opportunities for growth. For example in a recent massive public private infrastructure project in Long Beach California the for-profit companies selected to participate were screened based on their prior performance and sustainability.
- Costs
The second pathway is costs. For building construction to data centers to inefficiently written code, power consumption is a major cost that can be reduced through innovative design. This design may be more expensive in the short-term but pay for itself in the years or sometimes months to come. Walmart, for example, has experienced dramatic cost savings from pressuring its suppliers to redesign packaging in a way that reduces waste at Walmart stores. This is also applicable to software design. If a developer has less pressure and is tasked to write better code, the company can reduce its carbon footprint.
- Regulatory risks
The third pathway focuses on a specific set of risks, those associated with regulatory or legal action. A stronger external value proposition can enable companies to achieve greater strategic freedom easing regulatory and legal pressures. Strength in ESG helps companies reduce the risk of adverse government action. It can also generate government support. McKinsey analysis suggests that on average 1/3 of corporate profits are at risk from government intervention. Regulations impact, of course, varies by industry. For pharmaceuticals and health care, the profits at stake are about 25-30 percent. For the automotive, aerospace, and defense or tech sectors, where government subsidies among other forms of intervention are prevalent, the value at stake can even exceed 60 percent.
- Employees
The fourth pathway focuses on employees and employee productivity. A strong ESG proposition can help companies attract and retain quality employees, enhance the motivation of those employees by instilling a sense of purpose within them, and increase productivity as a result. Employee satisfaction is positively correlated with shareholder returns. To the extent that a company’s output is meaningful and societally beneficial and job design and company messaging reinforced that it may be possible to get more out of your workforce and even pay them less. Just as higher ESG performance and a sense of higher purpose can inspire your employees to perform better. A weaker ESG proposition can drag productivity down. Primary suppliers often subcontract portions of large orders to other firms or rely on purchasing agents and subcontractors to manage loosely sometimes with little oversight over workers health and safety. Efforts by multinational corporations to monitor and improve supplier conditions can thus be conceived of as farsighted efforts to ensure the sustainability of their supply chains and their workforce as well as good reputation management.
- Better asset management
The fifth pathway, by which ESG factors can affect the bottom line is through the better management of assets over time. A strong ESG proposition can enhance investment returns by allocating capital to more promising and more sustainable opportunities. It can also help companies avoid stranded investments that may not pay off because of longer term environmental issues such as a massive right down to the value of an oil tanker in the oil and gas field. Whereas ESG weaknesses can preclude takeover interest or lead to investors walking away or paying less. By contrast, investments in technologies with negative environmental or social externalities are more likely to be written off or abandoned as the cost of their development and use becomes clear. Future bans or limitations on such things as single use plastics or diesel fuel cars in city centers will introduce new constraints on multiple businesses, many of which could find themselves having to catch up. One way to get ahead of that future curve is to consider repurposing assets right now.