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In brief
CEOs often tell us that prioritizing multiple, often competing, objectives is their greatest challenge. While they could once focus almost single-mindedly on their businesses and value chains, they must now negotiate a far broader base of stakeholders with a much more diverse set of interests. And CEOs believe investors will not support a firm’s long-term strategic initiatives unless they address the future needs of investors, customers, regulators and employees as well as provide investors with an above-market return.
As global volatility increases and the geopolitical order continues to evolve, such external factors must be considered. This imperative creates unprecedented complexity and competing priorities for CEOs.
Sustainability — meeting the needs of the present without compromising future generations’ ability to meet their own — is increasingly a focus for CEOs and their stakeholders. Judgments about a firm’s sustainability performance affect talent acquisition and retention, access to capital, and consumer choices. New regulations translate sustainability imperatives into economic shocks, notably in energy.
The recently enacted US Inflation Reduction Act, which changes the cost/benefit dynamics of many decarbonization strategies, as well as affects internal company operations and probably heralds changes in the energy mix, is a prime example. CEOs also see competitors growing, and increasing customer loyalty, through sustainability-linked products and services and by focusing their business systems on new profit pools created by a global shift to a more sustainable economy. Like digital before it, sustainability appears an overarching strategic concern.
CEOs have, therefore, largely accepted the need to embed sustainability in their strategies to create value and renew competitive advantage. But while existing frameworks describe the elements of a sustainable business, they rarely show how to get there. CEOs are left asking: “How can I integrate sustainability into company strategy to create competitive advantage, while creating superior value for my stakeholders, including financial investors?”
Chapter 1
CEOs must account for ESG metrics, but thinking more broadly can both increase value as well as improve sustainability.
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At the intersection of sustainability and strategy, many companies adopt an environmental, social and governance (ESG) strategy. In doing so, they can be strongly influenced by the external focus on third-party ESG metrics, which are framed as a way of measuring a company’s performance in ESG.
ESG strategies, which often aim to improve key metrics in a way that a firm finds acceptable or manageable, have given many businesses a pragmatic start toward becoming more sustainable. However, as a path to a better strategy, they have several drawbacks:
For these reasons, with the way ESG and ESG strategies are framed currently, the evidence for a link between economic value and ESG ratings is modest at best. While ESG metrics are closely observed, financial performance remains much more important in corporate valuations.
Organizations should, of course, take seriously the issues underlying ESG metrics; this is an important contribution to preserving the environment and improving other key dimensions of the working world. But a focus on ESG metrics is unlikely to lead to the best combination of increased value and improved sustainability.
Chapter 2
A strategy refresh driven through sustainability principles should promote a healthier environment as well as a more sustainable business.
Treating sustainability as a new theme to be integrated into corporate strategy development and implementation across all functions of a company is a more effective path. The alternative –addressing sustainability issues through a dedicated function — is at best a stepping-stone, as sustainability considerations are then often seen by core business functions as an add-on.
The question for CEOs is whether their strategy makes the most of the market, technology, customer and regulatory trends created by sustainability imperatives: this approach will find and deliver new sources of value and advantage.
A sustainability-driven strategy refresh should enable both a healthier environment and a better, more resilient business. To achieve this, CEOs need to combine the art of crafting superior strategies with an in-depth understanding of how sustainability factors will change the way businesses prosper or fail. Joining sustainability and strategy development is the next evolution of both.
There are three major ways to trigger this evolution:
CEOs must think about updated variations on classic, top-level strategy questions:
CEOs may find some of these questions easier to answer than others, but ultimately they need to fit together in an internally consistent way. They also need to be adapted into specific versions for business units or sectors within a portfolio.
CEOs can also ensure strategic choices explicitly include sustainability imperatives. Both bottom-up and top-down approaches can help here.
From the top down, it can be helpful question to ask: “How will increased sustainability modify or create new strategic drivers?” Rather than treating sustainability as a separate strategic theme, CEOs can test existing strategic themes for compatibility with increased sustainability.
This can be achieved by:
Answers to these questions can provide insights as to how industry value chains or ecosystems are likely to evolve as sustainability has greater influence.
From the bottom up, a helpful question would be: “Which specific sustainability concerns will our strategy need to accommodate?” The focus here is on identifying areas where a significant impact is both possible and likely to be rewarded. Three interrelated qualifiers can help identify these:
This analysis helps rank issues. Prominent issues where businesses are seen to have unique contributions to make — good or bad — require close attention, as there’s likely to be an expectation of action.
Portfolio composition is an example of how these two processes can come together. Some CEOs may find very attractive businesses are not well positioned to respond to the (top-down) sustainability-driven changes in industry structure, the (bottom-up) sustainability imperatives of stakeholders, or the sustainability initiatives of competitors. Deciding on the role of these companies or business units may depend on the economics of increased sustainability, as well as the position of the portfolio as a whole. This can reveal potentially attractive, complementary acquisition targets, as well as the need to divest parts of the current portfolio.
Investments to improve social impact can appear to have negative or hard-to-estimate financial returns. It can be tempting to let such investments slide through to approval because, for example, they improve ESG metrics. This misses the opportunity to increase meaningful impact.
Investments with negative value should not generally proceed or be accepted as part of the price you pay for better ESG performance. They indicate that a firm may not have identified the best levers. Even investments to comply with current or future regulation, commonly thought of as cost, have real and very direct value when appropriately assessed.
While some investments with unclear links to value may be pragmatic — for example, as controlled experiments or to avoid reputational risk — CEOs should expect the number of initiatives with negative or unquantified value to decline over time.
Applying the same assessment methods to sustainability and commercial initiatives alike helps to embed sustainability in strategy. Many strategic initiatives — particularly those with long-term payoffs and/or in new or innovative areas — can, and even should, be assessed with “error bars” around their economics. Excluding sustainability initiatives from this discipline misses an opportunity to increase confidence in them belonging in a firm’s strategic agenda. This undermines the commitment to change.
Most firms can do more to use the data or connections they need to estimate business impacts. There are at least two major sources of relevant information:
Few firms find such business data is perfect, but in many cases it’s enough. And it has to be: the competition and regulators will not wait for perfect data. As most sustainable investment activity is very recent, and the underlying technology and market conditions are changing, few long-term case studies proving viability do not yet exist.
Chapter 3
Sustainability initiatives need to be captured in the strategic ambitions of the whole business.
Delivering strategic initiatives with greater effectiveness is a common business goal. Many firms already maintain and sustain effective mechanisms to drive strategy. Isolating sustainability activities in a sustainability team or chief sustainability officer (CSO) avoids these mechanisms, by design.
Sustainability initiatives can and should be executed with the same rigor as traditional strategic initiatives. Sustainability objectives and initiatives will only reach their full potential if they are captured in the scorecards of key business functions, such as a consumer goods business’s supply chain director, and measured with the same attention as other commercial initiatives.
EY clients identify the lack of data to measure progress against key sustainability initiatives as a common challenge. Typically, the necessary data is not captured by legacy processes and systems. CEOs need to identify early the new internal business and impact data they will use to create a true measurement of progress and achievement. The digital technology to continuously monitor performance — such as supply chain carbon emissions or plastic use — is often not just a goal in itself but a condition for successful execution.
Confusing the means with the end is a cardinal error in strategy. The end in sustainability is increasingly clear: to focus on meaningful action that delivers value for a firm’s chosen stakeholders, which in today’s world includes society, the planet and others, alongside shareholders. For CEOs, the challenge is to avoid processes that stop before this end is reached, leaving behind a set of issues that, while worthy, remain outside the organization’s mainstream strategy.
The steps above can give meaningful sustainability actions greater prominence in a CEO’s long-term agenda, with better outcomes. Our research shows this is the best way to achieve a business that — over time — will have the financial means and investor support to create a more sustainable future.
Andrew Hearn, Global Development Lead for Strategy at EY Parthenon, contributed to this article.
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