Investors are beginning to see a strong link between corporate sustainability performance and financial performance. That’s creating a bigger demand for better data — and better business models.
The doldrums. It’s a strange association with sustainability, I know, but it has stuck with me over years of interviewing corporate sustainability leaders. The doldrums are vast oceanic regions of becalmed waters with no wind, known as the “horse latitudes” because stalled 15th-century sailors would jettison ponies overboard as food and water ran short.
Corporate sustainability leaders are like explorers in an age of business discovery. Passionate about business sustainability, they voyage across the org chart sharing their vision, converting business units to the cause. But almost universally, their expeditions stall out at the doors of the financial suite. The CFO’s office has been the sustainability doldrums, sucking the wind out of sustainability managers’ sails.
“Investors don’t care about sustainability,” was the usual response from the financiers, “They only care about this quarter’s results.” For sustainability managers, there was no easy response to this claim. Sustainability successes accrue over the medium to long term, with some benefits — like avoided PR debacles — never even showing up in Bloomberg terminals. CSR managers looking to the CFO for sustainable project funds were left dead in the water.
But in the last two years, corporate sustainability leaders have begun telling a new tale. The investor winds are shifting and sustainability matters, a view confirmed by our new 2016 MIT SMR and BCG sustainability report, “Investing for a Sustainable Future.” An overwhelming three quarters of executives in investment firms agree that sustainability performance is materially important for investment decisions, citing revenue growth, operational efficiency, and risk reduction as the boons of solid sustainability management.
The shift is catching many executives off guard. They are unprepared, and none more so than those in investor relations, where only one in four IR professionals say they explain sustainability’s bottom-line impact to investors. For IR professionals, sustainability has historically been a headache, coming in the form of hostile shareholder activists or tedious sustainability information requests. It’s no wonder that half of our IR respondents don’t believe sustainability is important for competitiveness.
This history has left IR a sustainability backwater. One anecdote captured the problem plainly. When a sophisticated group of investors inquired into sustainability issues they deemed material for a company, a meeting was arranged with the company’s head of IR and the director of sustainability. As questions became precise and technical, the IR manager was quickly out his depth. His only response? To lean over to the sustainability executive and whisper, “Psst, tell them about our charitable work.”
Discretionary philanthropy is “toddler-stage” sustainability management that never pacified activists, but now no longer satisfies investors either. As investors learn how to use sustainability information, they become more demanding, and old approaches fall away. A casualty of this progression is the plethora of sustainability rankings, indices, and generic reporting frameworks.
In the early days of sustainability, when professionals were struggling to understand what “business sustainability” would mean, a broad approach was needed. Rankings and indices were part of this era, taking a shotgun methodology and throwing up every possible issue and measure. While useful at the beginning, these tools seem crude today and provide investors with little guidance. VW’s top ranking in the Dow Jones Sustainability index provided investors with no insight into the regulatory risks that diesel engines posed. It’s thus unsurprising that less than a third of surveyed investors use sustainability rankings in investment decisions.
So what does it take to make sustainability pay off? The findings from our survey implied that corporate sustainability leaders go through a progression. They first build a sustainability strategy by clarifying which of the many sustainability issues are strategic for their company. They then build a business case for addressing the identified issues. But our survey results are disheartening here: The vast majority say they have yet to discover a business case.
The inconvenient truth is that some of them never will. Sustainability is an evolutionary force, and not all business models are fit for a sustainable future. One of the casualties that stood out in our study is coal. A series of bankruptcies was capped last month when the largest private-sector coal company in the world, Peabody Energy, filed for Chapter 11 protection. Investors are figuring out that coal is a dying industry and are getting out before the rout, divesting more than $2 trillion in assets from fossil fuel companies.
A business case is important, but worthless if it sits in a consultant’s binder. It only has a bottom-line impact when it leads to concrete changes in business practice. And our survey shows that when changes to the business model occur, returns ensue. Companies that have made a sustainability-related business model change are twice as likely to report profit from sustainability than those that haven’t.
That changing the business model is vital should be an obvious finding. If you’re not changing the business model, you’re likely spending money to merely clean up the sustainability mess your business creates. Nike is a company that constantly innovates on sustainable shoe design and production. Its Flyknit technology, for example, allows a shoe’s upper to be knit seamlessly with literally zero material wastage. If you innovate like Nike, you can design externalities out of the system and sustainable value in.
Innovation is hard for companies. MBAs are taught to optimize current business processes, not tear them down. But if you can’t build a sustainable business model, you can always buy one. It’s not just investors recognizing value in sustainability; companies are also, and doing so through the M&A boom. Colgate-Palmolive, Nestlé, Coke, Clorox and others have acquired niche sustainability brands like Burt’s Bees, Tom’s of Maine, and Honest Tea, and the premiums paid over market value make intangible sustainability value instantly tangible. Usually, companies are trying to acquire new business, customers, and revenue streams, but they are also acquiring sustainability know-how that can potentially spread to other brands in the portfolio.
So is an investor sustainability storm brewing? Not overnight. We are only seeing the first impacts of growing investor sophistication. But as valuation techniques, data, and models improve, investors are poised to become a force in business sustainability. Corporate executives should begin preparing, starting first by studying the findings in our 2016 Sustainability & Innovation Global Executive Study and Research Project.