Every business decision you make has what economists call externalities.
Externalities are the effects of the self-advancing decisions you make on your environment.
By environment, we mean not just the ecological component of our surroundings but the millions and perhaps billions of factors — social, political, cultural — that constitute the present and are deeply and impossibly entwined in shaping the future.
Call it the unavailability of free lunches or what you may, but everything comes at a cost.
Yes, granted, the cost or tax we most readily associate with business decisions is ecological — deforestation, greenhouse gas emissions, to name a few. However, externalities are various, some subtle, some profound but unknown, some profound, known but helpless, or beyond control.
Take the modern supply chain, for instance. Modern supply chains are one of the most complex networks we have yet witnessed. Renowned historians and Nobel Laureates like Yuval Noah Harari and Daniel Kahneman estimate that the number of people who will truly understand the scope of supply chains in the future would be close to 1%.
Supply chains are the sum of hundreds of individual chains — mining, transporting, building, shipping, to provide a bird’s eye view. Each chain has its own externalities — mining involves coal-hungry machines that degrade soil; cheap plastic packaging is life-threatening for our flora and fauna; building products may involve the exploitation of cheap labour.
Everything comes at a cost.
But as we learn more about how one chain affects the others, how one externality has a ripple effect on other externalities, we lose our grip on that cost. Could it be greater than we imagined?
In any case, up until the last decade, that cost was believed to be unavoidable. This is the cost of not just doing business but excelling at it. And therefore, what’s good for all of us, collectively, and what’s good for a business were mutually exclusive.
However, what if businesses were incentivized to break that norm? What if doing what’s good for all, what ensures sustainability, and achieves responsible growth was also in their self-interest? Given that unsustainable growth is a deal-breaker for most millennial investors or the fact that consumers are conscious of consumerism’s broad effects now more than ever, it certainly is in their self-interest.
Therefore, today, the most successful, best-planned businesses, carry out materiality assessment.
What is materiality assessment?
Materiality assessment is a set of methodologies that modern businesses use to determine whether an issue is important or relevant to them and their stakeholders.
According to KPMG’s latest report, nearly half of 250 of the world’s most valuable companies rely on materiality assessment to achieve sustainable growth. And nearly all of them heavily invest in ESG consulting.
ESG Consulting is the analysis of data concerning the Environmental, Social, and Governance issues that are important to stakeholders.
What businesses ought to understand is that they don’t make decisions in a vacuum. To ensure constant and long-term, sustainable growth, the values of internal stakeholders must align with external stakeholders. In other words, investors and customers.
This is what materiality assessment in ESG all about: identifying the ESG factors that are central to internal and external stakeholders and determining the degree of their alignment. The assessment is understood in the form of reports that help businesses identify risks, shortcomings, or growth opportunities, allowing them to make better strategic decisions.
For example, if both kinds of stakeholders find their business communication inappropriate or are critical of its waste policy, in the long run, it would not just be admirable, but profitable, to make necessary changes. But such an insight cannot be learned if businesses don’t ask such questions.
That’s the cost of overlooking materiality assessment. And it can be massive.
Risk, sustainability, and the importance of materiality assessment
According to a study by McKinsey, the global giant 3M has saved more than $2 billion since it introduced its Pollution Prevention Pays (3P) program. Further, another enterprise saved more than $175 million every year since it doubled down on improving preventive maintenance and adopting the use of clean energy.
FedEx has saved more than 40 million gallons of fuel after it turned to electric vehicles. And Dick’s Sporting Goods’ lost more than $100 million in sales after its CEO, Ed Stack, announced that the company would restrict the sales of guns. Its stock price, however, climbed by 14%!
According to the same study, worldwide, ESG investments have experienced a cosmic rise, more than tenfold in the last 15 years — an estimated $30 trillion. ESG advisory, unsurprisingly, is in great demand.
These astonishing numbers are clear indicators that investors today believe in trust. They believe in universal welfare, transparency, and fairness — in other words, in companies that create not just economic but environmental and social value as well.
And consumers sympathize with them.
When nearly half of forests have been cut down for human use, conscious consumers prefer brands that minimally, or in no way, engage in deforestation.
Or, when the Arctic is warming at twice the rate of the rest of the world, today, consumers turn to recyclable products. They prefer brands that have a minimum impact on climate change.
Or, when cities are responsible for more than 70% of global carbon dioxide emissions, more customers are reducing unnecessary consumption, limiting spending to essentials. They prefer clean, renewable energy to coal-powered, non-renewable energy. They are trying to minimize their carbon footprint.
This represents a dramatic change in consumer preferences over the last 100 years. And it can be attributed to the rise of the internet, to the innumerable sources of information, to social media, great journalism, great activism, and other channels that have made consumers aware of the far-reaching impact of their spending habits.
Consumers find themselves personally responsible for these atrocities when they interact with brands that contribute to them. They wish for a better future for the next generation.
So, they changed.
It’s in the best interest of businesses today to follow suit.
How to get started
Given how critical materiality assessment and ESG consulting is today, several frameworks and guidelines have been devised to make the most of them. The most eminent of those is produced by the Global Reporting Initiative (GRI).
According to GRI’s latest report, organizations ought to identify issues that reflect the economic, environmental, and social impact of their decisions with clarity.
Easier said than done.
Such a statement is vague and quite unhelpful. So, we created a guide for you that’s more systematic and easier to follow.
Identify the factors
The first step is perhaps the most important.
Now that you’ve read the blog, you understand that your decisions affect the ESG dynamics of the world. But it helps to understand the effects more concretely.
To do that, first, identify the ESG factors that impact stakeholder decision-making.
To ensure the data is of the highest quality, consult as many stakeholders as possible, internal and external. But more crucially, ask the right questions.
Simple questions will result in simple answers. Take raw materials, for example. While raw materials are a top concern, a higher resolution cost-benefit analysis would be shaped by more detailed, broken-down information. It helps to know which ones rank the highest in priority.
The greater and more granular the questions, the better your identification, and therefore, the assessment.
Quantify the factors
Next, create a score on which these ESG factors can be ranked based on their importance.
Creating a score allows you to quantify the factors, translating them into data points. This is the reason why granular identification of issues is so crucial: it makes for granular data, which is superior in quality and makes for more accurate decisions.
Without ‘measuring’ the factors, comparing their importance is a futile exercise, let alone analyzing and learning new things from them. Merely making the point that privacy is more relevant than responsible marketing makes no sense. Devising a metric or score enables businesses to make a concrete comparison.
Further, using data points or ‘weighted’ factors enables businesses to set a defined target. When the points are fed to data analysis, they yield outcomes that tell businesses how far they stand. Since this too is illustrated by data points, strategy can be readjusted more definitively.
What do you think is better, merely reducing emissions or reducing emissions by 10%?
Analysis: measuring the alignment
Once the ESG factors are measured, they can be analyzed.
There are several ways to analyze materiality assessment data. Take the simplest way, wherein importance to stakeholders is measured on one axis and the impact on the business is measured on the other.
In other words, this graph measures the importance of an issue to external stakeholders compared to the importance of an issue to internal stakeholders.
Those issues are high in alignment which are situated towards the top right.
Another method to measure alignment is to create a materiality matrix. Here’s one.
Such a matrix may work on top of the graph.
First, the graph measures the different alignment weights of different issues, translating them into unique scores. Then, the matrix gives a measure of the alignment compared to the measure of the control the business has over that issue.
This, of course, enables businesses to make even better decisions, as they learn which issues are worth tackling and how much strength would be necessary to do so.
Here’s another way to illustrate the above thought process.
Excellent materiality assessment produces excellent reports like these, which enable businesses to take definitive actions with the intent of striking a balance between importance and control.
Everything said and done, take action to make a change.
Since resources are finite, taking action entails withdrawing them from an issue and allocating them to another. It entails taking strategic decisions towards making the most of the growth opportunities sought by analysis.
Taking action is what logically succeeds learning — it is acting on what you have learned.
Document and repeat
Materiality assessment is not a one-time exercise. It is a process.
To always stay ahead of the curve, you must constantly monitor the curve, anticipate its course, and always stay on the move to match its pace.
After businesses identify ESG factors, quickly readjust their strategy, reallocate resources, and make a change, the next step is to do it again.
And do it consistently.