Business innovation is one mechanism of progress around the world. It's becoming clear, however, that there are challenges that can’t be solved through the pursuit of profit alone. In fact, some are even created as a by-product of business itself. The result is that many aspects of our existence — the environment, society, and corporate practice — are in a state of decay.
If you’re a business leader, you’re legally bound to optimize your strategy and resources to maximize shareholder return. This may lead you to assume that it’s not your responsibility, or in your best interest, to care about the environment, social, and governance issues (ESG).
Although ESG is often positioned as an inhibitor to profit, this is a common mistaken belief. Making ESG a part of your business strategy can unlock growth opportunities, reduce costs, and future proof your brand in the eyes of an increasingly conscious public.
An overview of ESG
Interest in ESG has been steadily rising over time. The amount of capital allocated to ESG funds is estimated to reach 41 trillion USD by the end of 2022.
Environment, social, and governance (ESG) is an approach to evaluating and operating businesses that goes beyond the sole focus of shareholder return. Instead, ESG takes into consideration the ecosystem, both internal and external, that businesses operate in and how they affect each other.
Here is an overview of the three different components of ESG.
Environment relates to the biosphere and ecosystems of our planet, specifically, how human activity affects the natural world. This includes things like:
- Greenhouse gases (GHGs)
- Air pollution
- Energy consumption
- Water consumption
- Waste output
- Nature usage
- Environmental policies
Social encompasses the factors regarding how businesses treat their human stakeholders – both inside and outside the corporation. This includes:
- Comparative Living Wages
- Diversity and Inclusion Percentage
- Gender Pay Gap
- Employee Engagement
- Health and Safety
- Human Rights
- Wealth Generation
Governance is about how a corporation operates at the highest-level including decision making, political involvement, and ethics. This includes:
- Executive’s Pay Ratio
- Quality of Governing Body
- Ethics and Anti-corruption Policy
- Tax Paid
- Ecosystem ESG
Why is ESG Important?
As with this article, ESG is typically explored through a business perspective focused on either the benefits or consequences of not meeting commitments. Although we all have our individual challenges, it’s worth thinking outside our immediate concerns and looking at the big picture.
ESG wasn’t invented to simply be an inconvenience to executives. Instead, there are major challenges in our world, that if unaddressed, can lead to fatal consequences for everyone.
At the environmental level, we must contend with a planet that is getting hotter by the day. Small increases in temperature mean a melting of the polar ice caps and increased natural disasters such as storms and floods.
Business activity in the form of deforestation and industrial pollution means the destruction of ecosystems, extinction of species, and a less beautiful environment.
At the social level, wealth, racial, and gender disparities create a less fair society. Income inequality leads to crime and civil unrest which makes our societies unsafe for everybody.
At the governance level, corporate lobbying and bailouts create less faith in institutions and the social contract. Persecuted whistle-blowers and out-of-control executive compensation contribute to an environment where the business and political elite appear untouchable.
If these factors are unaddressed, the system we rely on to engage in business will eventually collapse – and more importantly, we may not even have a planet to live on.
Why ESG matters to your business
The good news is that a commitment to ESG is a competitive advantage for your business. This means that in addition to playing your part in creating a better world, you can also future proof your company and make it more competitive in the marketplace. Here’s why.
Depending on your industry, ESG commitments are challenges that you must overcome. If you are in manufacturing for instance, energy efficiency and waste management will be two of your primary ESG concerns. But instead of framing these challenges as an inconvenience to your business, you can change your perspective to use it as an opportunity for innovation. After all, solving problems should be the primary reason for a business's existence in the first place.
In addition, external pressure from stakeholders is going to force you to address these issues regardless, so it makes more sense to embrace the opportunity. Use ESG pressure as a mechanism to unlock the creative ability of your team. Make your processes more environmentally friendly and come up with business models and products that have greater social impact. Eventually, it’s these green products and processes that will displace less sustainable practices.
Consider how the innovations of electrical vehicles created by Tesla forced the hands of incumbents like General Motors, who had to eventually create their own electric vehicle line.
More growth and business opportunities
Millennials and Generation Z – collectively aged between 9 and 41 – are much more conscious about preserving the environment, social justice, and corporate malpractice. Combined with social media, these generations have unleashed a digital powered wave of activism where bad practices can quickly be exposed for anybody to look up.
This social consciousnesses combined with greater transparency has resulted in many consumers now using their purchasing power to reward or punish companies that aren’t meeting their ESG commitments. In fact, Generation Z consumers are willing to spend as much as 10% more on sustainable brands.
In this sense, ESG strategy has now become an essential part of brand and public relations, with a direct correlation to the bottom line. Savvy ESG execution can increase market share by tapping into the aspirations of a socially conscious public, while ESG failure can have the opposite effect.
Securing government contracts both domestically and abroad is also a factor you need to consider. Many governments now have legal obligations to only offer contracts and licenses to companies that have strong track records of ESG initiatives. Likewise, other businesses may have similar requirements for their supply chain and vendor partners.
With social pressure from stakeholders across the board, a correctly implemented ESG strategy can be the difference between sustainable growth or rapid death in the marketplace.
Better investment opportunities
In addition to customer stakeholders, investors too are critical of a company's ESG commitments. Venture capital and private equity funds, through pressure from limited partners like pension funds, are looking at ESG for several reasons.
A company with strong ESG initiatives is a safer long-term investment across certain indicators. They are less likely to be fined and regulated by governments while also having products that tap into emerging, sustainable technology.
Impact investing is growing in popularity. Some wealthy investors are looking for ways to maximize investment return in an ethical, philanthropic way.
At the stock market level, poorly managed ESG that leads to environmental or social fallout can reduce stock price and ROI for investors. The BP oil spill in 2010 is a prominent example of this effect. BP’s stock fell 51% in 40 days after the incident.
In addition to negative investor returns, your cashflow can take a hit if you neglect your ESG commitments.
With increased public pressure and regulations, governments are placing heavy fines on companies for ESG failures or poor ESG reporting. The UK government alone issued 27 million GBP in fines in the financial year 2020-21 to 33 different companies.
Operational shutdowns are also something to consider. In addition to environmental fallout ceasing operations, legal strikes from poorly paid and mistreated workers may occur. In the worst cases, regulatory bodies may step in and permanently shut an operation down.
If you operate with physical products or services, you may also be able to reduce costs in the form of sustainable processes and materials, at least in the long term. Reduced waste, recyclable materials, and less energy expenditure all play a part in keeping the cost of business lower.
Attracting and retaining talent
With competition for highly sought-after talent increasing, a commitment to ESG can work to your advantage. ESG raises the consciousness of your organization as you start considering things other than growth or profit. This translates into a more people-oriented culture which increases happiness and engagement.
An awareness of diversity, equity, and inclusion issues creates a safer environment for all members of society to take part in the workforce. 88% of Millennials indicate they want to work for a company that reflects their values. Even if you aren’t in the most exciting industry, a culture and mission of stewardship can be an attractive proposition to younger generations.
ESG reporting and frameworks
As ESG becomes a greater concern for governments, investors, and the public, there is a need for accurate reporting and transparency into a business's ESG initiatives. Depending on who your target audience is, there are different frameworks you can use.
Investors: These ESG frameworks focus on helping investors make decisions about a potential investment's sustainability-related performance. In addition, they tend to focus on financially visible activities.
Government: These ESG reporting frameworks, such as the United Nation’s Sustainable Development Goals (UN-SDGs), serve as guidelines for national and regional governments, helping them provide sustainability-related services and support to their constituents.
Management: These ESG frameworks target operating organizations, translating sustainability-related concepts into tangible activities and outcomes that organizations can execute on.
See our guide on ESG frameworks for a more detailed breakdown.
The compound effect of ESG commitments
All in all, creating and executing the right ESG strategy can serve to future-proof your business. In addition to risk management, companies that get on top of their ESG initiatives can position their brand as leaders in their market among the public, partners, government, and investors.
And with sustainable technologies edging toward an inevitable takeover, reframing ESG challenges as opportunities for innovation can lead to technological breakthroughs and more competitive products and services.
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