ESG has a purpose, but don't confuse it with Purpose
Corporate sustainability has evolved substantially over a few decades. While there's a spectrum of how much a company's leadership perceives sustainability as vital to its resilience, leading businesses have integrated social and environmental sustainability into their core business strategy. It's increasingly becoming everyone's responsibility to improve the company's performance against social and environmental issues, including executive leadership. But there’s still confusion around ESG-led sustainability and how it differs from Purpose-led sustainability. Why is it important that the two terms are not used interchangeably?
Four approaches to sustainability
Traditionally, corporate sustainability programs evolved from three approaches: Corporate Social Responsibility (CSR), Environment Health and Safety (EHS) and Purpose-driven. Businesses undertaking sustainability efforts for years, or even decades, likely started with CSR or EHS programs. While purpose-driven organisations have been around just as long, they represented a small percentage of how companies approached sustainability. In the last decade, ESG has emerged as a fourth, and likely most common, approach today.
CSR has historically been philanthropic in nature and fairly indifferent of business strategy and risks. EHS responsibilities regularly fell on operations personnel to ensure the appropriate procedures and documentation were conducted for the health and safety of their staff while complying with regulations. Both are products of risk management or license to operate mindsets. Today, EHS has become standard practice, and a regular part of operations professionals' responsibilities as the costs of non-compliance or hazardous work environments are too high. While the CSR approach to sustainability was convention in years past, Peter Bakker, CEO & President of the World Business Council for Sustainable Development, as far back as 2015, made it clear that 'CSRis dead'. Instead, sustainability efforts must be more integrated into the core business strategy.
At the same time, there have been relatively few companies that were purpose-driven from their inception. These companies put their sustainability-minded vision and mission at the core of their business strategies, completely integrating it into everything they do. There are the classic examples of Patagonia, Dr Bronner's and Seventh Generation, which are undoubtedly purpose driven. However, their accomplishments have often been discounted because these companies are not publicly listed or found on the Fortune 500. This is what's exciting about companies like Unilever (owner of Seventh Generation), Vestas, IKEA and many more using their purpose to drive a company strategy that integrates sustainability within. Perhaps even more inspiring are the thousands of start-ups and small and medium-sized enterprises founded with a clear purpose of responding to today's greatest environmental and social challenges. For example, Redwood Materials, Coral Vita, Rheaply and Terracycle have all been founded to create economic value by addressing societal and environmental needs.
In the last 15 years, Environmental, Social and Governance (ESG) has vaulted to become the fourth and potentially most common approach to corporate sustainability today. The reason for this has been the growing investor and regulatory pressure on companies to report and disclose their sustainability results. ESG has been enabled by reporting frameworks like the Global Reporting Initiative (GRI) and rankings like the Carbon Disclosure Project (CDP). The proliferation of these frameworks and ratings has grown so much that it's actually become a challenge. Fortunately, consolidation of reporting frameworks is becoming more widely utilised. For example, the Sustainability Accounting Standards Board (SASB) and International Integrated Reporting Council (IIRC) recently merged to become the Value Reporting Foundation. ESG has come to dominate so much of today's sustainability discussion that these two terms are often used interchangeably.
Often conflated with socially responsible investing, responsible investing and impact investing, ESG investing has emerged from the investor community over the past two decades as the implications of ESG issues have materialised. ESG investing is generally understood as the consideration of ESG risks in the investment process. As you may anticipate from such a definition, there's substantial grey area around the approach, qualifications and integration of ESG factors into the investment decision process (albeit no greyer than the even more vague 'sustainability' definition). Consequently, there are growing concerns about the shortcomings of ESG and the impact it delivers. For example, Russia’s recent invasion of Ukraine sparked a debate about whether any ESG-themed funds should be invested at all in the world’s 11th biggest economy.
ESG & Sustainability
There is substantial overlap between 'sustainability' and 'ESG' as individual concepts. To many, they are interchangeable depending on who you’re talking to. For example, you may use 'ESG' on investor calls versus 'sustainability' on internal communications to colleagues. This is important, as sustainability professionals know just as well as anyone that you must use the language of the stakeholder to get them on board with the cause.
However, you need to be aware of those divergent areas between ‘ESG’ and ‘sustainability’ to ensure you have the right perspective going into strategic sustainability discussions. Some key differences to consider are highlighted below.
- First, sustainability generally refers to the approach a company takes to addressing material issues. ESG can be understood as the accounting for the results of that approach, particularly as it applies in broader investment decisions.
- The second notable difference is that while sustainability should engage and account for all stakeholders affected by the company, ESG is primarily driven by and for the investment community. Whereas in a sustainability program, stakeholders are engaged informally and at varying frequencies, ESG typically requires the annual reporting and disclosure with supplemental investor calls.
- Third, because of the stakeholder specificity in ESG, the conversation is more structured and consistent across exchanges than those you'd experience when asking for a definition of sustainability across CSOs. For example, in ESG conversations, one may quickly jump to the frameworks or rating agencies instead of a company's philosophical definition of sustainability – if they've adopted one at all.
- Lastly, ESG results are often used to assess a company's performance against an industry, regional or best-in-class peer benchmark. This makes sense for investment decisions as a similar approach is taken when comparing multiples or risk-return ratios. But this is a method of evaluating relative performance across ESG factors (e.g., 20% lower emissions than industry average). This should not be confused with understanding the absolute sustainability impacts and dependencies of a business (e.g., 90 MT CO2e emitted by the company per year). One might be more content with progress being made under a relative perspective than through an absolute one.
These variances highlight the importance of understanding whether you're taking an ESG-led strategy approach or a Purpose-led ESG approach.
ESG-led Sustainability versus Purpose-led Sustainability
There are two primary approaches to sustainability today: ESG-led Sustainability (bottom-up) and Purpose-led Sustainability (top-down) approaches. Each enables the organisation to be better positioned to capitalise on sustainability-related risks and opportunities. Each calls for sharp, passionate sustainability experts. The key difference between them is whether leadership is driving the sustainability agenda or whether that’s left up to the sustainability department.
Most companies likely fall in the middle of this spectrum, combining some level of executive buy-in while reacting to investor inquiries and rating agency submittal invitations.
ESG-led Sustainability occurs when a company’s sustainability ambitions are anchored in reporting and disclosure of ESG issues, not leadership vision or company mission. Whether driven by the investor or regulatory pressure, this approach has a bottom-up nature. The company makes a strategic decision to choose frameworks and rating agencies to define their contributions to society or purpose. In ESG-led Sustainability, leadership often understands sustainability as a cost-centre or in ensuring its license to operate. Here, sustainability activities and responsibilities remain contained within the sustainability department. Resources deployed to sustainability functions and ESG duties are extremely tight. Most sustainability time and energy focus on the annual sustainability reporting, disclosure and rating agency form submitting process. Consequently, the scale and speed of positive impact on the company’s environmental and social challenges are limited.
Purpose-led Sustainability takes a more comprehensive and integrated approach. It requires top-down implementation as leadership drives purpose across the business, allowing it to guide decision-making and enable all employees to contribute towards achieving that purpose.
The opportunities in a Purpose-led approach
There’s real economic opportunity captured in the Purpose-led Sustainability that may be overlooked in the ESG-led sustainability approach. In a 2021 Designit study, 70% of executive respondents reported prioritising purpose-led initiatives to become or stay industry leaders. By starting at purpose, the company ensures that the customer is at the centre of the companies’ ambitions for impact. This ultimately means that if a company successfully responds to customer needs, it'll likely be successful in its sustainability objectives. This will drive positive ESG results because of the business, not despite it.
Additionally, Purpose-led sustainability avoids the pitfall of oversubscribing the company's sustainability priorities to the investor. There are many stakeholder perspectives to account for in an effective sustainability approach, and it takes substantial time and energy. Often these perspectives are in conflict. The business may be much better positioned in taking a balanced approach in responding to customers, employees and partners as much as investors. These stakeholders don’t speak 'ESG' as often. They care more about reparability, Diversity, Equity & Inclusion (DEI) and human rights compliance than the company’s governance structure.
Lastly, so long as a company assesses sustainable progress against its peers or an arbitrary 2010 baseline, one will fall short of the actions needed to establish a society in which everyone is living well within planetary boundaries. Anchoring your goals against today’s performance (e.g., 20% emissions reductions compared to 2010 baseline) instead of tomorrow's needs (e.g., net zero carbon by 2040) establishes insufficient ambition. Further, it misses an opportunity for the company to align its sustainability stakeholders around its customers.
Purpose drives sustainable transformation; ESG quantifies it. A company living its purpose relentlessly progresses on its mission. Purpose is not yesterday’s marketing of unsubstantiated 'green' claims. It's not lip-service or topical messaging. In today’s social media environment, greenwashing is too risky compared to any reward it could bring the business in the short-term.
When revisiting its purpose, the company should adopt one that's ambitious, authentic and transparent. It should respond to real societal needs. Purpose should inspire while being true to who the company is, what it does, what it sells, where it plays and where leadership wants to take it. Ultimately, the company needs to be transparent with key stakeholders about its purpose and how it aims to make it a reality and whether it’s making progress.
Sustainable transformation through purpose is only possible with company leadership driving it. No matter how well-resourced, a sustainability team cannot give the company purpose alone. The CEO should champion this cause, steadily beating the drum while addressing staff, the board, investors and the general public.
CEOs should talk a big game but walk even bigger. This is where ESG comes back into the picture, to demonstrate the company’s accomplishments and justify its statements. The Net Zero movement has been a remarkable showcase of how the biggest companies in the world are willing to make bold commitments without knowing all of the answers of how they’ll achieve them. Many of these companies have never made such ambitious and forward-thinking statements publicly. The pressure is now to deliver on those commitments. It will require revisiting the company's purpose (see Royal DSM’s history of reinvention for inspiration). Everyone, however, will need comprehensive ESG reporting and disclosure to show how successfully it’s putting purpose into practice.
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