By Alan Amling, PhD
This article is part 2 of a 3-part series explaining the what, why and how of Environmental, Social and Governance (ESG), its best practices and the ROI of integrating ESG priorities into supply chain management.
Carrot and Stick: ESG incentives and requirements are the new reality
Pressure is mounting for organizations to step up their ESG efforts. The 2021 United Nations Climate Change Conference, commonly referred to as COP26, continued to move the needle forward on ESG requirements, driven by growing climate and social unrest. Key outcomes included:
- A commitment by more than 40 countries to move away from coal
- A pledge by over 100 world leaders to end deforestation and cut methane emissions 30 percent by 2030
- Agreement on rules for a transparent and accountable voluntary carbon market
Financial capital is also being allocated to accelerate the global energy transition. During COP26, the Glasgow Financial Alliance for Net Zero (GFANZ), representing over $130 trillion of private capital, pledged to mobilize finance at scale to achieve net zero emissions by 2050 or sooner. Separately, U.S. Securities and Exchange Commission chair Gary Gensler ordered agency officials to propose rules that would require companies to report on climate risk. Consequently, access to the capital you need to grow will increasingly be influenced by the ESG actions of your company.
NET ZERO
Net Zero means that carbon emitted into the environment is balanced against methods to remove carbon. Reaching net zero requires organizations to both reduce their carbon output and offset the reduced carbon output with carbon removal projects such as restoring forests.
ESG commitments are ramping up faster than ESG actions
Companies have been stepping up their ESG commitments. By the end of 2021, more than 200 companies pledged to go net zero by 2040, and over 400 more have committed to net zero over a longer timeline. Whether your company has committed to net zero or not, the time to take inventory of emissions in your end-to-end supply chain and enhance your climate governance is now.
At the same time, social sustainability has become a boardroom issue. Increasingly apparent racial and gender equity issues, coupled with more than 3.9 million U.S. workers per month quitting their jobs in 2021, require businesses to strengthen their policies on human capital management and diversity, equity and inclusion.
Where do you begin? Just as there is no one right supply chain for every company, the same is true for ESG programs. To aid in navigating your unique path, examples of best practices in each ESG element are highlighted next, followed by an exemplar case study and a cheat sheet of best practices to help you turn your ESG goals into realities.
Bringing ESG to life in your company
In a 1996 article, Stanford professors Jeffrey Pfeffer and Robert Sutton introduced the “knowing-doing gap” concept. Essentially, the gap between knowing and doing is wider than between ignorance and knowing. This concept is apropos for the ESG challenges facing most companies. According to Pfeffer and Sutton, the first step in overcoming the knowing-doing gap is to put “why” before “how.” Your ESG goals will begin to take shape by first being clear about your purpose. Examples of purpose statements are:
- Archer Daniels Midland (ADM): “We unlock the power of nature to enrich the quality of life.”
- Entergy: “To grow by providing customers with low-emission, reliable energy at reasonable cost; superior service; a strict focus on safety; operational excellence and engaged employees.”
- Starbucks: “As it has been from the beginning, our purpose goes far beyond profit. We believe in the pursuit of doing good.”
These purpose statements inform each company’s ESG goals.
- ADM leverages its unique position between the farms and the consumer food brands to help create a more resilient and sustainable global food system. Consequently, they have set goals to eliminate deforestation from their supply chain by 2030 and improve soy and palm oil traceability back to suppliers.
- Entergy has set goals to ensure universal access to affordable, reliable and modern energy services and is tracking the proportion of populations with access to electricity.
- Starbucks is “doing good” by expanding plant-based menu options, shifting away from single-use to reusable packaging, and investing in regenerative agriculture, reforestation, forest conservation and water replenishment in their supply chain.
Environmental: Supply chains must be part of the solution
Your mobile phone likely traveled over 8,000 miles from East or South Asia, where they were manufactured. When we’re done with our mobile phones, about 151 million end up in landfills or incinerators every year. Consequently, global supply chains are a crucial contributor to rising Greenhouse Gas (GHG) emissions.
Leading companies are rising to the challenge, blazing a path that can be followed by others. See below for examples of company actions to improve their environmental sustainability.
ENERGY EFFICIENCY
German goods and chemical company Henkel installed energy-metering systems in plants worldwide to identify energy saving opportunities.
LOW EMISSION FUELS
Maersk plans to have their first carbon neutral ocean liner operating in 2023 using carbon neutral e-methanol or sustainable bio-methanol.
CIRCULAR ECONOMY
Schneider Electric uses recycled content and recyclable materials in its products, prolongs product lifespan through leasing and pay-per-use and has introduced take-back schemes into its supply chain.
DEFORESTATION
By 2023, 100% of Nestle’s palm oil will be procured from palm oil plantations built on agricultural or fallow lands.
Social: Your stakeholders are your company; treat them with care
In August 2019, the U.S. Business Roundtable of top Fortune 500 CEOs said that “each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities and our country.” While this was a sea change in the long-held view that companies were in business to serve shareholders, choosing between shareholder primacy and stakeholder capitalism is a false choice. Companies must have profits to live, and those profits are generated through stakeholders in the business.
Unfortunately, signatories to the Business Roundtable stakeholder capitalism pledge reportedly performed no better than other companies protecting jobs and keeping workers safe during the pandemic. Clearly, companies need to span the knowing-doing gap by including their stakeholders in their ESG plans and actions. See below for a snapshot of best practices engaging each stakeholder group.
SUPPLIERS
Mars and Unilever are helping suppliers increase resilience to drought and humidity.
EMPLOYEES
The UPS Community Internship Program immerses rising managers in the challenges of economically and ethnically diverse communities.
COMMUNITIES
Owens-Corning is on track to actively engage 100% of its employees in community outreach programs in 2022.
INVESTORS
Microsoft, JB Hunt, Sherwin-Williams and Deere are among those recognized for achieving strong profitability coupled with excellent ESG programs.
CUSTOMERS
Bumble Bee Foods allows consumers to scan a QR code to track their fair-trade certified ahi tuna from ocean to shelf.
Companies can outsource work, not their ESG responsibilities and reputation
Global firms are increasingly being held to account for their ESG actions. For example, executives from Amazon, Ikea, Nike and other major companies were asked to appear before the U.K. Parliament to address claims that their suppliers might be using forced labor. Members of the House of Commons’ business, energy and industrial strategy committee were investigating the potential exploitation of Uyghur Muslims from China’s Xinjiang region. Transparency into the ESG practices of your suppliers coupled with periodic audits has moved from a nice-to-have to a need-to-have.
Winning the war for talent
Did you know 2021 is known as the Year of the Great Resignation. A record 4.5 million U.S. workers quit their jobs in November 2021 alone, and as of January 2022, the U.S. is still down about 4 million workers compared to pre-pandemic levels. If ever there was a time to prioritize employee relations and engagement, now is that time.
Putting more focus on your ESG efforts could be a powerful tool in winning the war for talent. For example, adopting business policies that enable firms to be rated as socially responsible reduces the annual quit rate by 3 percent to 3.5 percent, which amounts to a 25‐30 percent reduction compared to public corporations that are not socially responsible.
If you think customers and investors don’t care about ESG; think again
Customers do care. Gen Z and millennial consumers are more inclined to pay for sustainable products than Gen X and baby boomers. Globally, sustainability is rated as an important purchase criterion for 60 percent of consumers (61 percent in the U.S.).
Likewise, Investec research showed that 62 percent of general partners at private equity firms declined to invest in a company due to ESG or ethical considerations in 2021. Their reasons to consider ESG in investments may not be purely altruistic. A 2021 S&P Global report showed that 19 of the 26 ESG exchange-traded funds and mutual funds with more than $250 million in assets grew between 27.3 percent and 55 percent, respectively, outpacing the S&P 500 index’s 27.1 percent rise.
Governance: You get what you measure
Governance has traditionally been associated with ESG reporting, which is required in more than 25 countries – with more to come. While improving ESG reporting should remain a priority for companies, ESG governance spans areas such as board structure, risk mitigation and executive compensation. Companies are taking action in each area.
RISK MANAGEMENT
Cisco’s supply chain agility helped them accelerate video conferencing and prioritize infrastructure for hospitals and vaccine research to fight Covid-19.
EXECUTIVE COMPENSATION
Companies tying ESG goals to executive bonuses include Alcoa, Clorox, Suncor Energy, Intel and Unilever.
REPORTING
Siemens, Schneider Electric and more than 50 other firms have adopted common stakeholder capitalism metrics to enable comparisons.
BOARD STRUCTURE
Historically male-dominated company UPS now has a female CEO and women make up 46% of the Board of Directors.
Risk mitigation under constant uncertainty
Risk mitigation has always been a priority for senior executives and supply chain professionals. Still, it took on new meaning as the pandemic through fear, uncertainty, and doubt (FUD) into the gears of global supply chains. According to the 32nd Annual State of Logistics Report, companies have been executing several risk mitigation strategies, including reevaluating the potential reshoring/right-shoring of supplier-based operations and accelerating investments in visibility, automation, robotics and electric/alternative fuel vehicles.
ESG actions are leading to ESG improvements
Board diversity took a significant turn in 2021. According to SpencerStuart research, 47 percent of new independent directors appointed in 2021 were racially/ethnically diverse candidates and 43 percent were female.
Executive compensation plans are also changing. A recent survey of 887 U.S., Canadian and European companies showed that 68 percent incorporate ESG metrics in their incentive plans. Yet, there are regional differences. Only 60 percent of U.S. companies included ESG metrics in incentive plans, while 79 percent of European companies did so. In addition, only nine percent of U.S. companies include ESG metrics in executive incentive plans across all three ESG categories.
The following UPS case study provides valuable insights to turn ESG dreams into realities.
Case Study: UPS – Bringing the E, S and G together
Do your ESG efforts feel like the flavor of the month? So often, ESG actions are uncoordinated, siloed efforts championed by well-intentioned employees trying to make a positive difference. UPS provides essential lessons on how to move your ESG efforts forward with a balanced approach. UPS has been a leader in environmental and social sustainability for decades. This global supply chain firm used electric vehicles in New York in the 1930s and began tracking data on their “green fleet” starting in 2000. UPS has also been a leader in social sustainability, reaching a volunteering milestone of over 20 million hours in 2020.
UPS is now building on this legacy with new commitments and programs. The journey began in 2020 with a new corporate purpose, “Moving our world forward by delivering what matters.” This purpose also incorporated why and how UPS operates. In 2021, the company set a goal to achieve carbon neutrality by 2050. While that’s commendable, goal-setting was just the beginning.
In 2021, UPS implemented a leadership and governance structure that coordinates environmental, social and governance initiatives across functions, business units and regions. The structure includes a program called “sustainability trailblazers,” which includes employee engagement, stakeholder collaboration, targeted promotion and critical measures to gauge impact; likely to recommend, brand relevance, net promoter score and return on invested capital.
Inspirational goals like “achieve carbon neutrality by 2050” or “positively impact one billion lives by 2040” make great headlines but do little to guide the actions of employees. To bring these goals to life, UPS created SMART goals (specific, measurable, attainable, relevant, and time-based) following a pragmatic set of guiding principles:
UPS GUIDING PRINCIPLES
- Lead with integrity
- Holistic vision of sustainability
- Deliver impact, not just promises
- Delink growth from GHG emissions
- Take an approach based on sound engineering principles
To hit its net zero goal by 2050, UPS has committed to 40 percent alternative fuel in ground operations and 30 percent sustainable aviation fuel by 2035. On the social sustainability front, interim goals include 28 percent women in full-time management globally by 2022 and 30 million volunteer hours by 2030. From a governance standpoint, recent achievements include appointing a chief diversity, equity, and inclusion (DEI) officer reporting directly to the CEO and increasing female participation on the board of directors to 46 percent.
This last effort takes on more meaning after a study released in 2021 examining gender diversity on boards and financial performance of FTSE 100 firms in the U.K. found a positive correlation between gender diversity and firm performance. Additionally, the study found that “the results become highly significant and unequivocal when three or more females are appointed to the board compared with the appointment of two or less females.
Key Takeaways
- Rally the organization around a sense of purpose that transcends profits
- Transition siloed programs into a cohesive structure incorporating environmental, social and governance
- Put stakeholder engagement at the center of your ESG efforts
- Establish a set of guiding principles, consistent with your culture, to inform ESG decision making
- Create SMART interim goals to make long-term objectives actionable
Bringing it all together
Companies are making progress on ESG, and you can, too. Don’t fall into the knowing-doing gap. Take the best practices from this article and make them your own. Let the following cheat sheet be your guide.
CHEAT SHEET: Best practices in ESG implementation
- Establish a governance structure that coordinates the E, S, and G and the various functions and business units in your organization. Create dashboards to monitor and manage your journey.
- Rally the organization around a sense of purpose that transcends profits. Use this purpose to determine potential ESG goals.
- Identify relevant stakeholders (investors, employees, suppliers, customers, communities) and engage them early and often to determine the most material ESG topics and goals to focus on.
- Set ESG goals, including interim goals, to make long-term objectives actionable and integrate them into your incentive management systems.
- Improve disclosure and transparency in advance of pressure from investors, consumers, and regulators using internationally recognized standards validated by independent third-party firms.
- Engage your employees in all aspects of your ESG campaign. People support what they help create.
- Create actionable plans to increase board and senior executive diversity that begin at the manager level.
- Ensure visibility into your suppliers’ labor and operating practices, including periodic audits. Help smaller suppliers along their ESG journey.
- Consider bringing in a third party to establish your ESG baseline and expedite your ESG journey.
- Absorb lessons from other companies and organizations to create your own ESG best practices.
Finding the ROI in ESG
In this series’ first article, we explained what ESG is and why it’s essential. This article explains how leading companies are turning ESG plans into actions. Still, a universal truth needs to be addressed: Companies can only deliver environmental and social sustainability benefits if they remain financially sustainable. The final article in this series will address the ROI of ESG, underscoring how being a good corporate citizen and driving bottom-line results are not mutually exclusive.
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