Managing Director, Strategy& Europe, and Global ESG Leader, PwC, Partner, PwC Germany
Global Leader for Purpose, Policy and Corporate Responsibility Partner, PwC Ireland (Republic of)
January 26, 2021
Even before COVID-19 upended business and society, the environmental, social and governance (ESG) movement was gaining steam. Far-reaching challenges such as climate change and economic inclusion concentrated the minds of investors and executives on the importance of long-term priorities and non-financial reporting; about 200 CEOs signed on to the Business Roundtable’s 2019 statement that the interests of all stakeholders, not just shareholders, demanded top management attention. Then the global pandemic heightened awareness of how interconnected we all are, how rapidly external shocks can work through the global economy, and how central trust and transparency are to the economy’s operation.
The increase, from 2018 to 2020, in total US assets under management using ESG strategies
Source: 2020 Report on US Sustainable and Impact Investing Trends, US SIF
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 by more ambitious competitors who were quicker to grasp the opportunity to reimagine their business digitally. Today, most management teams realise that capturing the true potential of digital calls for an all-in approach—a comprehensive program in which digital touches all aspects of the company, every business unit and function. Digital doesn’t just enable you to do the same thing faster—it changes what you do.
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.
The company began by setting a clear ambition centred on bold targets, initially aiming for short-term operational emissions reduction targets and to become a net-zero company by 2050 based on a combination of absolute and intensity-reduction targets. To achieve these goals, the organisation elevated sustainability to a strategic priority, and identified a set of supporting management interventions, starting with a revamped planning process with sustainability at its core. To inform its strategic priorities, the company studied new energy technologies, in areas such as wind, solar, batteries and hydrogen, along with emissions reductions technologies such as carbon capture. Based on the insights from those findings, the company developed a portfolio strategy out to 2050, showing the rate at which it would need to divest traditional businesses and power sources, and how quickly it would need to replace those with greener options. To create early options, the company created a venture fund that could identify and invest in promising technologies, through straight investments in some cases and joint ventures in others.
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.
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.
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.
Peter Gassmann is the global leader of PwC’s environmental, social and governance (ESG) practice and managing director for Strategy& Europe, PwC’s strategy consulting group in the region. Based in Frankfurt and Düsseldorf, he is managing director with PwC Strategy& Germany.
Colm Kelly is PwC’s global leader for purpose, policy and corporate responsibility. He is also the chair of the Foundation for Fiscal Studies, an independent nonprofit dedicated to promoting study and discussion of issues related to fiscal policy. Based in Dublin, he is a partner with PwC Ireland.