Environmental, social, and governance (ESG) factors are urgently redefining the business landscape across many industries. They threaten traditional models and sectors, making them obsolete seemingly overnight. But, more importantly, they provide vast new opportunities for those that can successfully understand and act in a volatile, fast-moving world, enabling them to redefine the rules of the game. Achieving excellent ESG performance and improving competitive differentiation is not simple or predictable. Hence, Arthur D. Little (ADL) offers this collection of seven articles to share our experience and help organizations embrace ESG and its benefits.

“We’ll go down in history as the first society that wouldn’t save itself because it wasn’t cost-effective.” — Kurt Vonnegut

WHY ESG RISKS ARE ACCELERATING RAPIDLY

The pace of change and pressure on companies around ESG are increasing exponentially. It is impossible to overstate the speed of transformation in ESG and the different manifestations of risk — from consumer boycotts and citizen action to investor lawsuits and reduced access to capital. Public opinion, in particular, has propelled companies to divest themselves of businesses deemed unethical, change strategy, or close previously profitable plants due to outside pressure, whether directly from consumers/citizens or via litigation and legal challenges.

ESG is a fundamental threat to revenues and regulatory/public license to operate if action isn’t taken. Meeting regulations is not enough — as these are behind the ESG curve and can even prevent the innovation required to become more sustainable as a planet. We see explosive growth in requirements for ESG screening in every due diligence transaction we undertake as well as accelerating demand for portfolio sustainability screening and externality assessments as organizations scramble to reduce risk and deliver on ESG.

UNDERSTANDING & SEIZING ESG OPPORTUNITIES

ESG is more than compliance. It provides an unparalleled opportunity that companies need to embrace. Those that build the right capabilities early to detect and correctly interpret sustainability trends and “translate” them into concrete, measurable action will reap rewards. Businesses with strong ESG performance experience:

• Higher profitability

• Ability to create a share price premium

• Access to a broader base of investors, providing capital on better terms

• Greater loyalty from B2B and B2C customers, partners, and employees

• Better reputation in the market, guaranteeing license to operate

• First mover advantages

• Ability to access new markets and revenue streams

• Increased protection from external shocks

By taking a holistic approach that looks beyond decarbonization to cover the entirety of ESG — including ethical business behavior, transparent sourcing across the supply chain, and enabling the circular economy — ESG leaders are more innovative than peers who focus solely on meeting the growing thicket of regulations.

THE PRESSING NEED TO OPERATIONALIZE ESG

Most organizations have committed publicly to long-term goals around sustainability. Delivering on these is more difficult than it seems, requiring transformational change in both culture and mindset as well as operating against a backdrop of market volatility, immature technology, and the difficulty in agreeing on short-term actions to meet long-term targets. Essentially, most companies have not yet operationalized ESG. ADL research shows that only half of surveyed companies have modified how they manage their organization, and just 8% have changed their business models.[1] The clock is ticking — companies need to embed ESG across business operations, moving beyond compliance. It must be an integral part of overall strategy with a shared understanding and common language across the organization. Cultures and incentives must change and put ESG first, creating economically sustainable business models. Despite current uncertainty around the speed of change required, stakeholder pressure, and technology readiness, organizations must make the right decisions and invest now to safeguard their (and the world’s) future.

BEST PRACTICE CONSULTANCY TO ACCELERATE ESG PROGRESS

ADL has been at the forefront of ESG consulting for many decades, helping clients and organizations understand and meet sustainability imperatives. This collection of articles provides a holistic view of ESG, illustrating the scale of the challenge — and exploring how and why organizations must act now to unlock opportunities across their wider ecosystems.

Moving from talk to action

We start by looking to understand where organizations currently find themselves. ADL recent research looks at organizational maturity when it comes to integrating sustainability into business models. Today’s picture is of a business world in transition, struggling to “walk the talk” when it comes to sustainability. According to our research, while 80% had a sustainability strategy in place, just 29% felt it was understood across the organization. No wonder that 27% said their strategy had no impact on the company. Chapter 1 outlines these research findings, providing concrete examples of how to drive effective, fast change around ESG — and walking the talk on corporate sustainability. How are companies progressing in embedding sustainability into their strategy, governance, and organization?

Predicting the future with sustainability scenario planning

A major factor that holds back ESG decision-making is its sheer complexity and lack of clarity. It is difficult to understand or predict the pace of change, the adoption of regulations across the globe, or technology maturity — all against a backdrop of potentially long implementation timescales for new plants and processes.

Complexity must not be an excuse for inaction. It simply increases risks and means that competitive opportunities are overlooked. Many “no regret” decisions can and must be taken now, however the future evolves. Undertaking robust sustainability scenario planning exercises is key to understanding and predicting the future. Chapter 2 explains how organizations can use this technique to successfully model the possibilities and uncover and seize opportunities before competitors.

Financing the transition

It is estimated that it will require US $12-$20 trillion in investment to be net zero by 2050, 70% of which will come from the private sector. Despite short-term disruptions, such as the war in Ukraine, the long-term importance of sustainability investing to financial markets is still growing strongly.

Financing the transition to an ESG world requires transformation within the banking sector. It needs to step up and become the driver of green change, using its position to influence customers and ecosystems to achieve a sustainable future. Customers are increasingly looking for financial services companies to both improve their sustainability performance and offer the right products to help them transition.

Chapter 3 explains how financial services companies need to radically change themselves to seize the opportunity of financing ESG, including the key areas to focus on moving forward.

Take an ecosystem approach & look across the supply chain

Consumers and regulators increasingly hold companies to account for ESG performance across their entire supply chain. That means organizations need to clearly understand and manage risks such as:

• Scope 3 emissions

• Working practices of suppliers when it comes to pay, conditions, and child labor, particularly in sectors such as fashion

• Sourcing of materials, whether rare earth minerals used in batteries and consumer electronics or cotton within clothing

At the same time, the only way to solve ESG challenges is to take an ecosystem approach, based on adopting a more open, collaborative culture and mindset. Organizations need to partner across their supply chains to understand, monitor, and increase ESG progress, breaking down barriers and sharing data. But what are the boundaries of these new ecosystems? And who do you need to partner with? How do you position yourself to capture your fair share of the profit pool within the ecosystem? Chapter 4 outlines the risks and opportunities around managing sustainability in the supply chain.

The pressing need to build a circular economy

Globally, humanity uses around 1.8x the biological resources that Earth regenerates during the entire year.[2] We need to build circular economies to narrow and eradicate this gap through greater recycling (particularly of rare/difficult-to-source materials), reducing waste from end-of-life products, making fewer new products, and therefore lowering production emissions — all while meeting increasingly stringent regulatory requirements. The battery industry is a perfect example of where embracing the circular economy is vital. Production is growing rapidly due to the rise of electric vehicles and use of batteries for energy storage. Batteries have a finite life and are costly to produce, requiring many rare/expensive materials from across the globe. Dumping them increases pollution and poses major risks to public health. Regulations are consequently coming into force to mandate recycling, assigning clear responsibilities to producers and OEMs.

All this delivers opportunities across the ecosystem. Chapter 5 maps the emerging European circular economy for batteries and how players can become involved.

The ESG lessons for vertical markets — Mobility & banking

We close our collection with two pieces that focus on specific vertical markets and how they can successfully seize the opportunities around ESG.

In the mobility sector, transport providers must meet three, sometimes conflicting, risks and become more:

1. Sustainable — demonstrating a positive impact on society by widening access to transport as well as delivering on environmental requirements

2. Efficient — maximizing usage of ageing, capital-intensive assets

3. Resilient — when facing threats that range from extreme weather to supply chain collapses

Chapter 6 sets out a framework for managing these three risks in a holistic way to meet all goals.

Finally, in finance, for too long ESG has been seen as a compliance risk, rather than an opportunity. It is time for a shift in mindset to embrace the potential it brings. Chapter 7 therefore explains how greening finance and focusing on economic as well as ESG factors drives innovation and opens up significant revenues for banks.

Time is running out to take effective action around ESG. As this collection outlines, organizations across all sectors need to act now, innovate, and embrace the opportunities if they are to differentiate themselves in a fast-changing world.

Notes

[1] Milanese, Stefano, et al. “Overcoming the Challenges to Sustainability.” Arthur D. Little Report, July 2022.

[2] “How Many Earths? How Many Countries?” Earth Overshoot Day, accessed May 2023.