Environment, Society, and Governance
The notion of businesses acting responsibly has many names – triple bottom line, purpose-driven, sustainability, corporate social responsibility – and they basically mean the same thing. One name that is getting a lot of attention is ESG, which stands for Environmental, Social, and Governance.
ESG describes an approach to measuring the impacts a company has on the environment and society, and how governance practices are used to manage those impacts. There are no current requirements that companies use an ESG approach or measure any impacts. Investors may require a company to have an ESG program, but there are no public laws or regulations forcing a company to do so. The SEC has drafted a requirement, but that is still in review and will only apply to publicly traded companies if or when those requirements are implemented.
At the most basic level, ESG programs are just another means of evaluating risk. Successful companies have always managed risk, and those that manage risk the most successfully are often the most profitable. According to Gartner, “institutional investors, stock exchanges and boards increasingly use sustainability and social responsibility disclosure information to explore the relationship between a company’s management of ESG risk factors and its business performance”.
ESG programs can reduce risk, and understanding risk presents opportunities. In that sense ESG can be a powerful tool and there are many examples of its value. Unilever’s revenue growth is dominated by companies that have ESG programs. Consumers are willing to pay more for sustainable products and are more loyal to companies that sell sustainable products. And ESG programs make companies more competitive and more profitable.
Life Cycle Assessment
Another example is Levi’s. They took the initiative to complete a full life cycle analysis of water use for their 501® jeans, Women’s jeans, and Dockers® Signature Khakis. They knew that the fashion industry consumed a significant amount of water – it is “the world’s second most water-intensive industry”. Cotton crops alone consume 2.6% of global fresh water. Levi’s also understood that fashion is responsible for nearly 20% of global water pollution. Water availability and quality obviously pose a significant risk to their business.
Through that understanding, Levi’s began implementing practices to reduce water use. Stone washing required significant amounts of water, so they created a new solution to create the same worn look. By 2019, their Water<Less program had saved 3.5 billion liters of water, 68% of their products were made using Water<Less practices, and their gross margin increased by 60 bps over 2018. Understanding the environmental risk to their business provided Levi’s with an opportunity to change their practices, which increased their profitability.
ESG is here to stay
In some circles, ESG has become a dirty word. Some of the criticism includes concerns about greenwashing and inconsistent evaluation criteria or methodologies use for evaluating and scoring the impacts. All of those concerns are valid. Other criticism relates to the idea that businesses should stay out of politics, which is worthy of debate.
The thing about ESG is that it is simply another filter that businesses can and should use to manage their business. Everyone agrees that consumer focus groups are an important tool for evaluating new products. That employee surveys are critical to maintaining employee morale and improving retention. That using lobbyists to understand and influence policy is important to managing long-term regulatory risks. These are all important tools and there is no political outcry suggesting those practices should be abandoned.
ESG isn’t any different. Whatever you want to call it, there is a growing consensus that understanding environmental and societal impacts are essential to the future success of a business. If it wasn’t, few companies would be investing in ESG programs and investors wouldn’t be prioritizing it in their investing criteria. And Unilever, Walmart, Target, Apple, Microsoft, Google, Toyota, and other leading companies wouldn’t be investing in ESG and requiring their suppliers to conform with their expectations. ESG is clearly important.
The ESG movement started in the 1960s – this isn’t new, it isn’t a fad, and it isn’t going away. Businesses that continue to ignore ESG or put it off are going to be left behind.
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