Is sustainability actually good for my company’s bottom line?

This is a question that many business leaders are asking as sustainability has become an increasingly relevant topic for companies and investors alike. With the threat of climate change, a growing awareness of fair labor practices, evolving government regulations, and other key sustainability factors threatening the core value proposition of many businesses, investors are looking more at environmental, social, and governance (ESG) metrics to determine the long-term value of firms. But are these companies’ investors sincere in their belief that sustainability drives value, or are they posturing for PR purposes while continuing with business as normal?

The evidence suggests that strong ESG performance has a positive, causative effect on long-term performance. An NYU Stern study showed that ESG performance has a strong correlation with long-term risk-adjusted returns for investors. An Oxford study reviewed empirical analyses on the relationship between ESG performance and financial returns and found that 90% of results showed a reduced cost of capital with better ESG performance and 88% of studies showed higher operational performance. With overwhelming evidence that ESG correlates with higher equity returns and reduced risk, it’s clear that integrated sustainable practices into a company’s business model has an enormous impact on the long-term value of a firm. But what are the key financial impacts of sustainability and how does it impact the bottom line?

A 2019 McKinsey report looked at the links between ESG and value creation and determined that there were five core ways that ESG improves the value of a firm: top-line growth, cost reductions, regulatory and legal interventions, increased productivity, and investment and asset optimisation. It’s worth reading that entire report, but here are some of the direct impacts that ESG can have on your company:

Greater Consumer Demand

One of the more obvious reasons that companies invest in ESG is that it creates goodwill with consumers and business partners. Brands that are considered environmentally or socially conscious drive consumer preference, command a higher price, and avoid controversies that drive consumers away from the brand. Ensuring companies attain good ESG ratings is paramount to instilling customer satisfaction and trust which will further increase customer demand. Understanding the drivers that affect customer choice and demand and influence ESG ratings are essential and give a company advantage over their competitors.

Direct Cost Savings

One of the most valuable and often overlooked areas of value in improving sustainability are in the direct cost savings. First, many companies are able to save money while innovating to make their business model more sustainable. Finding cheaper power through renewables is a big benefit for many companies. For instance, installing solar panels can provide a great long-term value when you amortise the initial investment over time. With the cost per kilowatt hour of solar and wind dropping below fossil fuels, many corporations sign power purchase agreement agreements (PPA’s) with renewable providers. This is a great way to lock in a low energy price for a long period of time, while showing that you’re committed to reducing carbon emissions. These agreements are huge cost savers for companies, while also providing valuable guaranteed revenues for renewable providers. Eliminating plastic, conserving water, and recycling have also dramatically cut expenses for companies around the worlds. Further, laws and regulations around waste and energy usage have pushed companies to implement actions that have positive results on their ESG performance.

Lower Cost of Capital

One of the largest areas of value generation is the reduction in the cost of capital. It’s no secret that ESG investing is exploding, and demand for companies with strong ESG performance is at an all-time high. The entire amount invested in 2019 was invested into ESG in the first quarter of 2021. This is because investors and lenders view companies with quality sustainability propositions as less risky and more likely to produce higher long-term cash flows. This means that companies with quality ESG performance are more likely to have a lower cost of equity and a lower cost of debt, which can make a significant difference in a company’s valuation.

Reduced Risk of Government Intervention

When investors are looking at ESG performance, they are often not as interested in how “good” your company is. Rather, they look at how your business model is expected to hold up based on environmental, social and governance (ESG) factors in the foreseeable future. Companies that are vulnerable to the threat of changing regulations or legal inquiries are especially high-risk in this regard. McKinsey looked at a range of industries, and found that industries such as banks, automotive manufacturers, telecom companies, pharmaceuticals, and consumer goods all have a risk of 25-60% of their overall profitability (EBITDA) at stake in regard to potential regulatory actions. Companies also have the potential to receive subsidies if they are seen to create shared value for society and the environment. Therefore, the gap between curating strong preferences with authorities and being under the threat of intervention can make an enormous difference in a company’s long term profitability.

Improved Employee Morale with Reduced Turnover

There have been a plethora of articles on how employees (especially in the Millennial and Gen Z generations) want to work for a purpose-driven company. As a result, companies are investing more into company culture to attract and retain quality talent. Employee morale is an intangible asset that companies have that can make a massive difference in productivity and overall performance. Companies with high involuntary turnover rates pay a lot for recruiting and training and are prone to making serious mistakes while positions are waiting to be filled, making them seem less reliable to customers and business partners in their value chain. The increase in investment into company culture has beneficial results for ESG ratings of the company.

Reliability of Investments

Companies that have high ESG performance tend to invest in their future better than their peers do. They focus more on innovation and have stronger investment potential. When companies are looking at a longer time horizon, they can invest in capital expenses that will benefit them in years to come. Investments that are subject to government regulation or tariffs - like a natural gas power plant, a mine operating in a sensitive area, or a farm that requires substantial irrigation - have a higher risk of becoming a stranded asset down the road. One of the top reasons for choosing to invest in strong ESG-performing companies is to avoid those who are at major risks of catastrophe, especially with the growing threat of climate change and higher pricing for fossil fuels, water and other natural resources.

How Eunoic Helps

A company’s value is affected both by its sustainable performance and being perceived as such. Eunoic provides resources to help in both ways. Using AI-infused applications, the company helps diagnose potential ESG issues - both in performance and perception - and provides clear and actionable ways to improve. With increasing expectations from investors, consumers, employees and other key stakeholders, sustainability is too important to get wrong. If you would like a free demonstration of our application, including sustainability report review, and news/social media sentiment analysis, please contact us for a free consultation.