ESG or Environmental, Social, and Governance has now become an inextricable part of business operations. Following is a brief outline of each elements of ESG:
- E – the environmental criteria is related to a company’s energy consumption and its waste discharge, the resources required by the company, and the impact on the other living organisms on the earth. ‘E’ also includes climate change and emissions of carbon dioxide.
- S – the social criteria focus on the brand relationship that a company has fostered with people and institutions in their business community. ‘S’ also encompasses employee relations, inclusions, and diversity.
- G – governance refers to internal controls, procedures, and practices adopted by the company to govern itself, maintain compliance with the laws and regulations, make effective decisions, and meet the requirements of external stakeholders.
How ESG is creating value for businesses
ESG enables companies to tap into new markets as well as expand in the existing ones. When governing authorities have faith in their corporate actors, they are most likely to grant the licenses, approvals, and access for promising new growth opportunities. For example, at a recent giant public-private infrastructure project in Long Beach, California, the for-profit companies that were qualified for participation were screened based on their previous performance in sustainability.
Also, superior ESG execution has positively impacted mining activities. For instance, consider gold, which despite being an expensive commodity, generates the same amounts of rent for the firms that mine it, irrespective of their ESG propositions. However, a major study uncovered an underlying fact – companies with social-engagement activities, which were considered beneficial by social and public stakeholders, could actually extract resources effectively without any operational delays or need for extensive planning. Also, these companies received notable valuations as compared to their competitors who have lower social capital.
ESG also drives customer preference in current times. According to a Mckinsey’s research, customers are more willing to pay to “go green”. As per the numbers provided in the research report, more than 70% of the surveyed consumers, across different industries, including electronics, automotive, packaging, and building, stated that they would pay an extra 5% for an eco-friendly alternative.
ESG also enables companies to reduce costs significantly. Among other benefits, executing ESG initiatives effectively can help organizations handle increasing operating expenses. For example, the price of raw materials, the actual cost of carbon or water, etc. Mckinsey’s research has also discovered that ESG can impact operating profits by nearly 60% percent. Also, the research underscores that there is a significant relationship between financial performance and resource efficiency. The study also identified that several companies across different sectors have started designing sustainability strategies for a longer term.
For instance, consider 3M – an American multinational conglomerate has long realized that being proactive about environmental issues and risks can be a great source of competitive advantage. The company has been able to save $2.2 billion after introducing its 3Ps program – pollution prevention pays, in 1975. As the name suggests, the program focuses on preventing the population by redesigning equipment, reformulating products, optimizing manufacturing processes, and recycling and reducing production waste.
Another practical example is FedEx – an American multinational delivery services company that aims to transform its 35,000-vehicle fleet to electric or hybrid engines. As of today, 20% of the vehicles have been converted, which has already resulted in a reduction of fuel consumption of over 50 million gallons.
Ease legal and regulatory pressure
A robust external-value proposition can help companies ease regulatory pressure and gain higher strategic freedom. As a matter of fact, in most cases across geographies and sectors, strong ESG propositions have enabled companies to mitigate the risk of adverse actions of the government.
According to Mckinsey’s analysis, generally, one-third of corporate returns are at risk of government intervention. However, the impact of regulations varies according to the industry. For example, in the case of healthcare and pharmaceuticals, the profits that are at stake are around 25% to 30%. Whereas, in the case of the banking industry, where consumer security is highly critical, typically the value at stake is about 50 to 60%. In the case of other industries like defence, automotive, technology, and aerospace, where government subsidies are popular, the value at stake can touch 60%.
Improve employee productivity
Organizations can attract as well as retain quality professionals using a strong ESG proposition. Also, companies can improve their employee’s morale by inculcating a sense of purpose and thereby increase overall productivity. Employee satisfaction is strongly associated with investor returns. According to Alex Edmans, Professor of finance, London Business School, companies that were listed in Fortune’s “100 Best Companies to Work For”, generate 2.3% to 3.8% more stock returns every year as compared to counterparts who have been there for over 25 years in the market.
Further, for a long time now, it has been observed that personnel with a sense of satisfaction and connection have better performance. Recent studies highlight that positive social impact increases job satisfaction, while field experiments point out that when firms “give back”, the enthusiasm level of employees spikes up. For example, at an Australian bank, randomly chosen employees who received incentives in the form of company payment to local charities stated increased job satisfaction compared to their colleagues who were not picked for the donation program.
However, similar to how a higher sense of purpose can accelerate employees’ performance, a poor ESG proposition can negatively impact productivity.
Asset and investment optimization
ESG practices also help in increasing ROI by guiding firms to spend money on more promising and sustainable business opportunities. For example, scrubbers, renewables, waste reductions, etc. This also enables companies in avoiding stranded investments that may not be beneficial due to long-term environmental issues. In ESG, it is important to remember that a do-nothing approach is fruitless. Continuing to depend on energy-hungry equipment and plants, for instance, can drain cash in the future. Though the investments required to optimize operations may be significant at the moment, opting to bear it could end up as the most expensive option of all.
The rules of the game are changing – regulatory responses to emissions might affect energy prices, particularly the balance sheets in those industries that are carbon-intense. Further, limitations or bans on things like diesel-fuelled cars or single-use plastics in city areas will institute new constraints on different businesses.
Why companies need ESG consulting?
According to statistics, in the next three years, nearly half of the UK investors (48%) are anticipated to increase their ESG investments (Funds Europe).
The growing importance of ESG also underlines the need for ESG consulting. By collaborating with companies that provide ESG consulting services, businesses can direct operational efficiency and profitability in a responsible manner.
Further, availing ESG consulting services from leading firms will enable companies to determine and benchmark their sustainability performance, monitor progress, and bridge gaps, ultimately increasing the ROI of their sustainability initiatives.
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