The 27th United Nations Climate Conference (COP27) ended a few days ago. This summary reports that limiting global warming to 1.5 °C above pre-industrial levels requires “rapid, deep and sustained reductions in greenhouse gas emissions” by 2030. But the window is closing fast. Reaching the 1.5 °C target requires unprecedented changes. As a result, accelerating the transition to a sustainable world is more urgent than ever. Companies, through innovative business model can be at forefront of this transition. United Nations’ Sustainable Development Goals give the direction to businesses and governments on the goals that lead to a sustainable living. But are there any concrete benefits for companies in reaching those goals? This post tries to answer this question by exploring what drives the business case for sustainability.
What is sustainability
Before looking at the business case for sustainability, let’s take a step back and check why “sustainability” matters.
“Earth Overshoot Day”, the date when humanity’s demand for ecological resources in a given year exceeds what Earth can regenerate in that year, currently falls on July 28. This means that we would need 1.75 Earths to absorb our current and past environmental footprint. If this astonishing, there is more. If the whole world would live according to the lifestyle of a few resource-hungry countries, we would need more than 4 Earths.
How can we possibly use more than one Earth? Simply put, the Earth can temporarily act as a buffer and adapt to higher level of consumptions in exchange of future lower footprints that would compensate current excesses. This, of course, puts pressure on future generations, who will need to reduce their demands on Earth to compensate the debt of past and current generations. To do so, they will have to compromise their living standards. In a nutshell, here is probably the most concise definition of “sustainability”, from the United Nations’ Brundtland report:
Sustainability is the ability to meet our needs without compromising the ability of future generations to meet their needs.
Brundtland Commission, 1987
Beyond future generations, a second aspect of sustainability concerns how equally different people within our current societies are vulnerable to impact of climate change because of their geography, demography or social status. This is what we call equitable sustainability. Indeed, the Global Climate Risk Index shows how the vulnerabilities to climate change strongly variates from country to country. So, the second goal of sustainability is to ensure that most vulnerable people are more protected by impacts, such as climate change, of unsustainable practices.
The business case for sustainability
Companies can probably have the largest impact, more than governments and consumers, to reduce the human footprint on the environment. By rethinking their business strategies, companies can drive the transition towards a sustainable society. As a result, sustainability efforts can bring a new competitive advantage for many companies.
However, research shows that focusing just on philanthropy or corporate social responsibility are not sufficient to reap the benefits of sustainability. This is because most companies’ success is measured by their ability to generate profit from their invested capital. So, to be successful, sustainability should have a business case and bring a financial “return on investment”. This means that for every dollar invested into sustainability, investors and owners requires significantly more than a dollar as a return.
The good news is that there are many examples of companies that have adopted sustainable initiatives and have consequently increased their returns. On the flip side, such virtuous examples demonstrate that, to generate consistent returns, sustainability requires a holistic and farsighted approach. Indeed, most of sustainability initiatives do not generate profit in the short-term. And the short-term view is very important for managers and investors in order to measure success and earn the credibility to move forward.
The 9 drivers of the business case for sustainability
In the same way as we evaluate the future potential of a product feature idea, what are the long-term benefits of sustainability? The NYU Stern Center for Sustainable Business has developed the Return on Sustainability Investment (ROSITM) framework. It links short-term intangible benefits deriving from sustainability to the long-term financial benefits that every executive aspires to. Corporate leaders and investors use the framework as part of their long-term planning. The ROSI identifies 9 short-term corporate benefits when companies adopt sustainability as part of their strategy. The benefits are:
- Risk Reduction
- Customer Loyalty
- Employee Relations
- Product/Service Innovation
- Media Coverage
- Sales & Marketing
- Operational Efficiency
- Supplier Relations
- Stakeholders Engagement
In the long-term, these benefits can drive greater profits, higher corporate valuation and lower cost of capital. So, these are the 9 drivers for the business case for sustainability. Let’s go through them one by one.
Risk Reduction
A short- to medium-term impact of sustainability pertains risk reduction, in particular risks related to the supply-chain. By adopting sustainable practices with suppliers, companies can mitigate supply-chain risks such as regulatory risk and disruption risks. Some critical areas of investments include air pollution, water waste, labor and modern slavery risks.
Regulatory risk is important because compliance has its cost. Companies who are exposed to multiple local regulations because of their supply chain may incur litigation costs and paper-work to deal with different requirements. As aa alternative, by designing a sustainability strategy overseeing the supply chain, such costs could be drastically reduced.
Globalization has increases complexity of supply chains. Thus companies are generally more exposed to potential business disruptions, such as pandemics, natural disasters and geopolitical instability. By including sustainability into their supply chain strategies, companies acquire a more holistic view and better planning with respect to their supply chain. This makes them less vulnerable and better positioned in addressing business disruption risks. This may result into more confident investments and reduction of premiums for business interruption insurance.
Customer Loyalty
On the short-term, sustainability can boost intangible benefits such as customer loyalty and employees engagement. A 2017 survey on Americans shows how almost 90% of consumers would buy a product with a social and environmental benefit and would be more loyal to a company that supports social or environmental issues. In developed countries, generation X – those born between the mid-1960s and late-1970s – represent the generation that spends most of their income. Even if generation X is not the most sensitive to sustainability, data from the World Economic Forum shows that their spending on sustainable brands have increased by 29% from 2019 to 2021. This is partly due to the influence of generation Z – represented by the “digital natives” born between the mid-1990s and late-2010s – that represents the most sustainability-conscious generation.
Employee Relations
A recent survey by Gallop shows that about seven in 10 workers in the US say that a company’s environmental record matters to some degree in whether or not they would take a job with that company. Moreover, nearly three-quarters of generation Y, those born between early-1980s and mid-1990s, would be willing to accept a pay cut to work for an environmentally responsible company. Moreover, management research at INSEAD shows that employees who participate in corporate initiatives with explicit social and environmental impact goals are more loyal to the company. The resulting effect is higher employee retention for companies that promote such initiatives.
Product/Service Innovation
According to the Institute for Manufacturing at the University of Cambridge there are increasing levels of sustainability by which companies can design products.
- Green design. Optimizing a single aspect or feature of a product is the first, usually less costly, level towards a sustainable product design. An example of green design consists of substituting product packaging made of virgin plastic with packaging made of recycled plastic. A digital mapping application that offers consumers the possibility to find the most environmental friendly route rather than just the fastest or shortest one, is another example of green design.
- Eco-efficiency. Focusing on the full product lifecycle rather than a single product feature is the next level of sustainability. For example, companies that source environmental-friendly materials, distribute them efficiently and recycle products at the end of their lifecycle belong to this category. By going back to the packaging example, green design consists of substituting plastic packaging with biodegradable packaging. Many companies use biodegradable packaging as core value proposition of their products.
- Sustainable design. It is not enough to be green in order to be sustainable. Sustainability includes social and (why not?) economic aspects into the equation. Products with a sustainable design are those that address multiple aspects of sustainability. GreenCup, for example, is a UK coffee roaster that goes beyond the mission of selling premium-quality, ethically sourced coffee beans. They even pickup coffee waste from their customers and transform it into fertilizers or even material for interior design.
- Design for sustainability. The highest level of sustainability includes a full business to sustainability. A product conceived to be sustainable will have marketing, sales, development, operations and finance functions focused on sustainability. Patagonia is an example of company that designs for sustainability by devoting not just its products, but also most of its corporate functions to this goal. While doing so, they are strongly profitable and they created a strong identity that makes the company one of the more undiscussed sustainability brands in the world.
Media Coverage
The media can be a great way for companies to display sustainability efforts to customers and prospects. Thus, the media can amplify sustainability efforts, either for the good or for the bad.
Social media plays also a big role in communicating sustainability efforts. Empirical research on social media users in Pakistan shows that consumers who seek sustainability-related information, do so on social media. This information significantly influences consumers’ intention to finally purchase.
Sales & Marketing
As sustainability adds a new dimension to a product or service, it enables differentiation from competitors’ offerings.
Promoting sustainability efforts is generally good, as businesses and cosnumers tend, on average, to put a premium on sustainability. However, targeting each sustainability initiative to a specific customer segment is even better. Another aspect to be weary about is greenwashing. Indeed, when brands exaggerate or lie about their sustainability efforts through the media, consumers can react negatively. In other words, consumers feel mislead by sustainability buzzwords and the result may strongly impact brand reputation and ultimately sales.
Operational efficiency
Regardless of industry, some companies more than others seek operational efficiencies in order to reduce their costs and optimize resources. The Toyota Production System is a widely adopted approach that is used to optimize processes in many industries. Its key principle is the elimination of waste, because waste is money. The 8 sources of waste are production defects, overproduction, extra-processing, waiting, inventory, underutilized talents, unnecessary motion of people and movement of goods.
Elimination of waste is not only a prerogative of operational efficiency but also a central concept of sustainability. Therefore, by removing waste, managers can not just reduce operational costs, but also contribute to make production more sustainable. This is because, as a rule of thumb, removing waste has two positive effects. On one side, it saves energy and materials reduces environmental emissions. On the other side, removing waste of talent and repetitive tasks increases employees well-being. For a more detailed view of the relationship between operational efficiency and sustainability, the Penn State University has mapped how each type of waste links to sustainability.
Supplier Relations
Suppliers are one of the 5 forces that shape the competitiveness of an industry. The relationship with suppliers is key to the business model of many companies. Indeed, suppliers share risks and credibility on the downstream company. They have an impact on the company’s reputation and affect the value of the final product. As such, suppliers are essential to supporting or hindering a company’s ability to reach sustainability goals. Moreover, given this interdependence between a company and its suppliers, the opposite is also true. In other words, when a company pursues a sustainability strategy, it will also contribute to facilitate its suppliers in becoming more sustainable. As a result, the relations with suppliers improves.
Here comes the final question. If sustainability improves supplier relations, how does supplier relation improves a company’s long-term financial performance? Generally speaking, a better relation with suppliers translates into products with better quality and lower production costs. The reason is that the players on the supply chain work together more easily on eliminating inefficiencies, improving product quality and defining a common strategy. An industry where profitability is traditionally tight to supplier relation is the automotive industry.
Stakeholders Engagement
Stakeholders include all the external entities that are impacted by a company’s products and strategy. Beyond customers and investors, stakeholders include governments, local communities, the media, competitors, suppliers and distributors. Stakeholders may also include Universities and NGOs.
Depending on the industry, some stakeholders may play a bigger role than others. This becomes more relevant for companies who do not take necessary efforts to increase sustainability. For example, NGOs, local communities, governments and media may be particularly active in industries such as Mining, Oil and Gas, and Tobacco.
Therefore, by putting relevant sustainability efforts, companies can mange stakeholders and avoid repercussions than can hurt reputation or cause costly litigations.
Does sustainability pay back?
Do investments in sustainability pay back? There is no ubiquitous answer which applies to any business or industry. What is clear from research and practice is that when sustainability is addressed with a long-term perspective, it has the potential to create financial returns, either by increasing revenue or by reducing costs and risks. In fact, there are 9 business drivers that sustainability triggers to generate long-term business value.