How ESG will drive the next wave of transformation
We believe these crosscurrents are coming together to propel the next wave of corporate transformation: the ESG transformation. Like digital, ESG has the potential to revamp how successful organisations plan, implement and operate. Also like digital, ESG is a sprawling topic, making it challenging for organisations to know where to begin. In the case of digital, that uncertainty led many organisations to start small: they put a toe in, launching pilot after pilot—learning in the process, but also running the risk of being overtaken The same is true for ESG: it gets to the heart of why you are in business, who you are as a company, what your impact on the world is, how you align your business model with the needs of society, what you report, and how you engage your people and with your stakeholders more generally. With digital transformation still a work in progress for most companies, the notion of tackling another big transition may seem daunting. We’d suggest, though, that deferring the ESG transformation creates the risk that as you rewire your company, you will hard-wire in old value creation models that can’t meet the concerns of your stakeholders and the long-term needs of your business. It also becomes increasingly likely that you will fail to manage very real and material risks and you will find yourself out of step with your shareholders.
To understand what it looks like to start such a transformation, consider the recent experience of an industrial company, which has begun taking far-reaching steps to put itself on a more sustainable trajectory in terms of both climate and stakeholder concerns. ESG covers a wide range of topics, with different focus areas in different industries. In this example, the climate-related aspects are the most prominent, as they have the biggest impact on the company’s business model. Although it’s still early days for this company’s efforts, the moves the company has already made—which are influencing its approach to strategy, finance and incentives, technology, and governance and reporting—provide other organisations a glimpse of what likely lies ahead.
Strategy
The company began The company also applied a sustainability lens to future capital investments. For example, before constructing a new facility, the organisation had previously conducted traditional financial analyses such as net present value, so that it could determine if that facility represented the best use of capital. In that analysis, the carbon component was relegated to an afterthought (an internal carbon-pricing mechanism). But the company realised that this approach was no longer sufficient. By factoring in carbon in a more explicit way, the company actually changed the design and construction methods for new sites, to reduce emissions and support the sustainability goals. To cement those goals in the minds of executives, the company set aside millions of dollars in management incentives linked to sustainability performance. It is now creating a similar incentive structure for the full workforce.
Technology
Digital transformation isn’t just an analogy for the ESG journey ahead; it’s also an enabler of sustainable business practices. One of the company’s business units recently put its entire supply chain on a cloud-based ERP system—a critical first step in helping suppliers track, report and reduce their carbon impact. The company is seeking ways to partner more closely with all suppliers, so that it can push the net-zero agenda out across its entire network. This step is critical because for this industrial company, as for many large organisations, the bulk of its carbon footprint is in the supply chain, not within the boundaries of the company itself.
Governance and reporting
To reset the board conversation, the CEO asked sustainability advisers to orchestrate a set of role-playing exercises about the sustainability environment in 2050. Technical experts also held one-on-one conversations with individual directors, to answer their questions and clarify technical issues underpinning proposed investments. And the company changed its approach to future modelling for the board, no longer looking solely at financial performance but adding a carbon component. That more holistic measurement approach also is influencing the company’s reporting, which has become significantly more transparent, with clear definition of sustainability goals and regular updates on progress towards meeting them. The non-financial reporting dimension represents an important difference from digital transformations: in ESG transformations, stakeholders such as investors, regulators, nongovernmental organisations, customers and employees will require far more transparency of companies.
Already, the company has good news to report: it is a year ahead of schedule in achieving its short-term operational emissions targets. Those successes have heartened executives, employees and other stakeholders directing their energies towards the next wave of progress and more ambitious targets.
This example is focused on climate sustainability, and ESG encompasses societal issues in the same way and for the same reasons. Many companies are already working equally successfully to respond to these issues using the same approach. The ESG transformation journey will focus on both.
As with the digital journey, ESG momentum grows with successful pilots and quick wins that are connected to a bigger whole. Yet the parallels with digital go further. The business landscape is littered with dead and dying businesses that tried to implement digital transformations without thinking through the implications, leading to lost value, disgruntled customers, and executives shown the door. We predict the same for those that don’t take a proactive and comprehensive approach to ESG transformation.