The profits of true sustainability
Some companies are starting to reap the financial rewards of sustainability policies. Richard Clarke explains a formula that could unlock the secrets to this successThe concept of sustainability is an ambiguous one. Like social responsibility, it is an appealing formula. But its impact is still being debated. A concrete consensus, which provides a basis for action by both governments and businesses, is yet to be achieved.
But then, how are certain companies making the most of sustainability in the real world? Having established the connection: integrity + innovation = sustainable performance (I+I), in a previous white paper, management consultant Arthur D Little (ADL) now reveals how this sustainability formula has clicked with leading businesses.
Its new report, I+I II: Sustainable Performance Delivered, has investigated sustainable performances of companies to expose the I+I relationship. This time the focus is on four determinants of business value:
- Risk exposure
- Revenue protection
- Cost reduction
- Revenue growth
In ADL's view, a sustainable business is an organisation that is successful in the short, medium and long term - because it has a broader appreciation of what constitutes opportunities for the business, and it manages a wider portfolio of risks to the business.
A 2004 study by ADL revealed that an overwhelming 95% of companies saw potential in sustainability-driven innovation to create business value. But only a minority had integrated sustainability into their business strategy and product/process design. It highlighted the example of a few leading companies that had reached the point of exploring breakthrough opportunities for their business in sustainability-driven innovation. Some notable successes have since been evident of companies turning the opportunities into reality. Certain companies have gone even further, achieving outstanding results. Though operating in disparate sectors, these companies shared strong leadership and an intense focus on integrity and innovation.
This leads to the thought: why are integrity and innovation connected? Integrity reduces exposure to unwanted risk, protecting existing sources of revenue, and together these factors influence the cost of capital. Innovation drives cost reduction and stimulates revenue growth, and together these influence earnings and cash flow. Every business decision and action is influenced by a range of forces, both internal and external. Successful business leaders enable their organisations to harness the forces that will enhance performance, while optimising their response to performance-limiting forces.
Each company has a unique extent to which specific market drivers govern its ability to achieve sustainable high performance. But a company's integrity and innovation capabilities are connected to its ability to address each driver. As another recent ADL publication, Innovation for Value, has shown, there is no one-size-fits-all solution. The levers that open up new sources of value in the telecoms sector are likely to be very different from those in the chemicals industry. But ADL suggests three common priorities.
The first is ensuring a robust understanding of the changing attitudes of government and civil society, and how these translate into potential impacts on the company and its competitive positioning, technologies and future business strategy.
The second lies in helping leadership teams understand the magnitude of these drivers and their potential impact on the business. For example, in 2001, ADL told a client in the food industry that "increasing scrutiny related to human rights and labour issues is likely to impact food supply chains". Five years later, this scrutiny had become a mainstream issue. And with ADL's support the client is now taking advantage of the growth in fair-trade products.
The third is to ensure the leadership team understands how the company should best respond, either to mitigate the negative impacts or to create strategies to turn these impacts into opportunities. Addressing these priorities step by step reveals the levers in the business where innovation and integrity will provide the most scope for value creation, in alignment with both external and internal pressures and opportunities.
Also, decision makers need to recognise the different types of value that can be created (top line, bottom line, shareholder), and decide which type of value creation is most appropriate to their business strategy. (See diagram, left.) This makes identifying the innovation opportunities and other sources of value in the business more straightforward. It also provides a necessary focus for managing innovation effectively, taking into account the context/sector in which the company actually operates and its own capabilities and values.
Measuring these factors can be difficult, and even controversial. On the innovation front, for example, agreement has yet to be reached on the best way to measure technology progress. For example, some companies use the number of patents they have been granted. Others focus on the number of new products they introduce each year, or on the amount of investment they have made in R&D. Measuring integrity indicators per se is less widespread. But more and more companies are assessing and reporting the outcomes of their integrity.
All this complexity makes it difficult to establish a direct cause-and-effect relationship between the value created and the measures of innovation and integrity employed. The solution is not to ignore the complexity, but to acknowledge and work with it - because experience shows it is possible to increase the value a company creates by actively seeking to enhance the company's performance against those measures.
Addressing the priority issues in a way that generates an optimal response to the market drivers requires both vision and pragmatism. Decision makers must sustain a strong focus on the four key determinants of value - risk exposure, revenue protection, cost reduction and revenue growth. These directly affect the cost of capital, earnings and free cash flow. In turn, they are profoundly influenced by the way the company manages its integrity and innovation capabilities.
As highlighted in the previous I+I paper, businesses that actively and consistently focus on managing these attributes are gaining a strong competitive lead over peers who draw the line at regulatory compliance or me-too practices.
In this context, your likely success at enhancing your company through integrity and innovation is boosted by knowing it well. Research in the financial services sector has found that, while strategies, tools and techniques might motivate some, they might not be enough to sustain real transformational changes that take companies beyond compliance. To achieve that extra step, businesses must focus more on:
- The people that make up the organisation
- Better understanding how internal influences and capabilities relate to corporate decision making
- Acting on this understanding to bring about change
Quite often, the task is one of uncovering value that lies hidden in the organisation, rather than trying to find radically new ways of creating it. The sources of this value can be identified through an assessment of the sustainable value of a company's operations and value chain.
A review focused on governance, integration of sustainability, environmental stewardship and social performance can identify where advantage is currently being drawn from the way the company addresses each issue, and where there are opportunities to create further value.
Each of the available options for creating that value can then be appraised. If reducing CO2 emissions has been identified as a value creation opportunity for a transport company, the various ways of doing so can be costed, compared and prioritised on the basis of how much CO2 emissions will be reduced. Carbon-cutting options may include increasing freight efficiency, switching the fleet to a different fuel, changing driver practices.
Companies in nearly every sector are feeling the benefits of a sustainability focus. In retail, Marks & Spencer has demonstrated innovative thinking with integrity through its links with the charity Oxfam. Consumers in the UK and Ireland are encouraged to donate clothes to Oxfam shops by the offer of a discount on subsequent clothing purchases at Marks & Spencer. This helps to divert unwanted material that would otherwise go to landfill, and supports Oxfam's work with communities in developing countries. Meanwhile, Marks & Spencer has strengthened its brand and reputation for both business sense and care for the planet.
Mobile telecommunications company 3 Italy, seeking to grow its share of the national market, introduced the Rigenerazione 3 concept - a recycled and carbon-neutral handset. By upgrading its product portfolio with this green offering, 3 Italy achieved sales growth of around 15%, and also free media coverage equivalent to about £7.7M worth of advertising.
The company succeeded in breaking into a new market segment, LOHAS (lifestyles of health and sustainability). In addition, 11 tonnes of waste was avoided and about 2,000 tonnes of CO2 neutralised in the first six months.
In the food and beverage sector, McDonald's has enhanced its sales and broadened its customer base in Germany, France and the UK by responding to local consumers' aspirations to healthier eating.
Actions included upgrading the product portfolio with salads and other offerings, integrating bio products into the portfolio, providing nutritional information on every package and supplying nutritional education sets to customers. The upgraded portfolio generated an increase of over 6% in sales. Meanwhile, the McDonald's customer profile has gained a significantly higher proportion of mothers and senior citizens.
Clarity and common sense are still in short supply when it comes to the sustainability of business. But an increasing number of leading companies are demonstrating through example how a focus on enhanced integrity and innovation, at the right levels of decision making and in relevant aspects of corporate behavior, yields better business performance which can be sustained over the longer term.
* Richard Clarke is director of the sustainability and risk practice at Arthur D. Little
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