Sustainability as a Strategy | Profits Follow Purpose | SAP Insights (2023)

Decades after the company he founded made the transformation to using sustainable materials, Ray Anderson, CEO of Interface, remembered the realization “like a spear in the chest.” The large manufacturer of commercial flooring needed a higher purpose, a mission that included chasing profits but went beyond. The epiphany came in 1994, as he recounted in a company video. Business was booming, and Anderson was thinking about retiring.

At the time, several employees who had joined Interface during a recent acquisition were asking what the company was doing to help the environment. “It was a question for which we had no answers,” said Anderson, who recalled the experience in a company video before his death in 2011. “It was awkward for our salespeople, manufacturing people, research people.” So Interface senior leaders convened a task force to develop the company’s position. They asked Anderson to kick it off by sharing his vision.

“I didn’t have an environmental vision, and I didn’t want to make that speech. I was really sweating,” says Anderson. Then Paul Hawken’s book, The Ecology of Commerce, landed on his desk. It immediately influenced Anderson and the speech he gave. He ended up challenging the task force to make Interface and its products sustainable, starting by inventing carpeting made from fully recycled materials. Anderson soon found himself a full-time advocate.

“I continued to articulate the vision over and over and over, even when people thought I had gone around the bend. I was talking and didn’t know if I was connecting. People were looking at me with blank faces. I didn’t know if they had heard me or cared,” he said.

Soon enough, the tiny task force gained traction. And one by one, Interface employees backed sustainability as their unifying corporate strategy. Sustainability gave them a higher purpose to motivate and challenge everyone, while driving profit.

Interface initially identified key areas in which it needed to make progress. Then the task force set aggressive targets, including zero waste to landfills, zero fossil fuel energy use, zero process water use, and zero greenhouse gas emissions. Interface continues to be a leading light of sustainable business strategy, following a set of “EcoMetrics” that tracks materials and energy flowing in and out of the company. Most of its tile and carpet line is now made from waste products. In 2019, its net sales rose by 14% to US$1.3 billion.

Anderson could not have foreseen that his work at Interface would leave a legacy of sustainability as corporate strategy for others to follow.

Other executives have light bulb experiences similar to Anderson’s that launch them on a journey to sustainability, says C. B. Bhattacharya, H. J. Zoffer chair of sustainability and ethics at the Katz Graduate School of Business, University of Pittsburgh and author of the book Small Actions, Big Difference.

“Epiphany is an important part of the process,” he says. The executives might have pressure from shareholders to do more. Some have even faced boycotts of products that have fallen out of favor as tastes and customs change.

What follows after that moment is the process of defining a new corporate purpose, one that is broader than merely being an engine for profits – and then, a massive change management effort that enables a large organization to pivot.

Today, most public company executives know they need a plan – and a good set of talking points – directing toward more sustainable business practices. Pro-environment measures like cutting down on paper use and reducing carbon emissions are not enough.

That’s not just because addressing climate change will require more than these pro forma environmental moves. The concept of sustainability has expanded as societies around the world grapple with a range of issues.

For example, in response to the social justice movement of 2020, business leaders are now getting involved in efforts to rebalance racial inequities. Fair labor practices also have become part of the conversation as pay gaps between management and workers have stretched. Increasingly, investors, consumers, and employees are becoming keenly interested in companies’ actions on these issues. Younger consumers are gaining influence as customers and workers, and their preference to work for companies that prize sustainability is clear. Millennials and their younger peers also demand more environmentally and socially responsible practices as investors, according to Ioannis Ioannou, associate professor of strategy and entrepreneurship at London Business School. They’re saying, “I care, and I care profoundly about how my pension fund, for instance, is investing in my savings. What sort of world will I retire in if that pension fund, for instance, is investing in fossil fuels right now?”

Leaders have noticed. In 2019, Business Roundtable released astatementsigned by 181 CEOs of large U.S. public companies declaring that the purpose of a corporation should be to promote an economy that serves everyone. It’s not enough to make money for shareholders. All stakeholders – customers, suppliers, the communities in which they operate – should benefit. In one press release, these leaders broadened the traditional Environmental, Social, and Governance (ESG) goals. Sustainability means being accountable to people and the planet as well as corporate shareholders.

While some were skeptical of the pronouncement, Yale professor and author Dan Esty believes companies have little choice but to follow through. Consumers simply will not tolerate organizations that fail to redress the downstream negative effects on society that they produce (such as pollution, carbon emissions, and unequal pay).

“It’s going to be increasingly unacceptable for companies to privately gain by imposing costs on the public,” says Esty, author and editor of 14 books relating to sustainability and governance, including the best-selling Green to Gold in 2006 and Values at Work: Sustainable Investing and ESG Reporting in 2020. Over time, he says, “the market will punish companies that fail to recognize this.”

Leaders are coming around to this idea, albeit slowly. In a recent survey of 200 top executives of large multinational corporations, which was conducted by ENGIE Impact, 75% said that sustainability strategy done well drives competitive advantage. Only 30% of those surveyed called their sustainability efforts successful, however. The results suggest that the executives do see sustainability having an increasingly significant effect on corporate revenues and profits in the next five years. ENGIE Impact, it is worth noting, is a sustainability consulting firm spun off from ENGIE, a French multinational electric utility.

“We’re seeing more and more companies realize that putting sustainability at the core of their business strategy is actually a strategic advantage and is profitable,” says ENGIE Impact CEO Mathias Lelievre. While less than one-third of executives surveyed felt their sustainability efforts had been successful to date, the majority expected that to rise in five years.

For example, Lelievre sees large companies like Unilever and Microsoft greatly stepping up their move toward carbon neutrality both within their own organizations and throughout their far-reaching supply chains. But the real story does not concern only traditional eco-friendly measures. The standard-bearers of the new, holistic view of sustainability are companies that have taken a traditional product or line of business and reimagined it to be better for people and the environment. These companies are transforming their entire business strategies to make the world a better place.

Not surprisingly, as Interface’s Anderson discovered, shifting an organization’s strategy to sustainability requires a major effort, says Bhattacharya. It’s driven by relentless communication and change management efforts from the top, with leaders helping the company’s people to incubate, launch, and entrench sustainable practices. A shift toward sustainability also requires a new set of metrics beyond traditional measures that are found on company financial reports.

At its heart, effective change happens when leaders mobilize the organization and manage resistance to the shift before the opportunity dries up. It’s about communicating what is being done and why, so employees can make sustainable strategy their own. “Successful strategic shifts require intensive organizational change management, the more so the further the pivot tries to move the company from its existing culture and capabilities,” says Paul Strebel, professor emeritus of governance and strategy, International Institute for Management Development (IMD).

It’s hard to imagine a bigger shift in strategy than the one cigarette maker Philip Morris International (PMI) undertook in 2016. The company identified what it saw as a tremendous opportunity to begin shifting completely away from its core product, cigarettes, to alternatives scientifically substantiated as better choices for adults who would otherwise continue to smoke. PMI believed doing so could meet consumer demand for better choices and positively impact public health. PMI CEO André Calantzopoulos reaffirmed this commitment at the company’s 2017 annual shareholder meeting, saying the company was committed to a smoke-free future and shifting its resources toward the development and responsible marketing of scientifically backed alternatives.

The change in strategy was driven by the realization – a long time coming – that PMI had to address the negative effects of its product, according to Huub Savelkouls, a 26-year PMI veteran who was its chief sustainability officer until his recent retirement. (Jennifer Motles is the new CSO.) Since its change in strategy, PMI hired an army of scientists, now numbering 900, who have spent the last 10 years and $7 billion researching smokeless tobacco.

Its first main smoke-free product, IQOS, is now sold in 61 markets, recently including the U.S. IQOS is an electrically heated tobacco system that heats tobacco rather than burning it. Because the tobacco is not set on fire, there is no smoke or ash, and the levels of harmful chemicals are significantly reduced compared to cigarette smoke. This benefits the individual user, bystanders, and the environment. In July 2020, the U.S. Food and Drug Administration authorized the marketing of IQOS as a modified risk tobacco product, the first (and so far, only) product to receive such approval. However, the company states that IQOS is not risk-free and delivers nicotine, which is addictive, and that the best choice is to quit or never start smoking.

According to Savelkouls, PMI explicitly refrains from marketing to youth, as well as former smokers and those who have never smoked, and only markets its smoke-free products to current adult smokers who would otherwise continue to smoke. The message is to fully switch and replace cigarettes with better choices.

Savelkouls says the effort has been working: “Our current switch rate is 70%. Consumers don’t use both products.”

PMI’s journey has been marked by the need for constant communication, both inside and outside the organization.

To start with, PMI employees were naturally concerned when they heard their company intended to sunset their mainstay product. Would they have jobs in the near future? What would remain after the company’s main product was gone? Senior leaders spent – and still spend – much effort communicating with employees about the company’s new direction and why it was necessary.

As Anderson discovered at Interface, in order for sustainability to take hold as strategy, communication – to shareholders, the media, customers, and a wider group of stakeholders – is endless. Suppliers are another important group to include in change management. PMI’s CEO and Savelkouls’s team were cognizant that the shift would affect others in its value chain, such as the tobacco farmers. (PMI has closed 10 cigarette factories in the last 10 years and plans to close more.) Also, the IQOS devices have an electronic component, so for the first time, Savelkouls and his team needed to start learning about practices for sustainable electronics manufacturing.

Since announcing its commitment to move away from cigarettes, the growth of PMI’s revenues and profits have dipped a bit as the giant company refocuses on its smoke-free offerings. Still, the company says sales of its “reduced risk products” have grown to $4.9 billion, or about one-quarter of its total net revenues. And the market is following PMI’s lead. The global e-cigarette market was valued at $14 billion in 2018 and is expected to grow to $29.39 billion by 2022, according to The Business Research Company.

Savelkouls believes the transition to new smoke-free products gives PMI 15 to 20 years of relative security from a revenue standpoint. In the meantime, the company is open to possibilities for entirely new product lines driven by its sustainability work. For instance, it has a small venture in Europe that offers life insurance to consumers who used to be smokers but who now have switched to smoke-free alternatives. In the past, these people would not have been able to buy life insurance; now they can – from PMI, which is backing up its belief that smoke-free products are a better choice than cigarettes. “We will for sure develop new competencies,” says Savelkouls.

PMI is not alone in shifting its traditional business strategy in a new, more sustainable direction.

The trend cuts across industries.

CVS, for example, has transcended its role as the corner drugstore where you stop in for a pack of cigs and a candy bar. It officially became a healthcare company in 2014 with high-profile moves to stop the sale of cigarettes and offer minute-clinic health services and vaccinations at its stores, which now number 9,900. CVS Health revenues have increased every year since 2015, and its competitive position is strong.

Unilever, the consumer-packaged goods giant, is another interesting case. It plans to put sustainability squarely in the face of consumers by labeling the carbon emissions associated with 70,000 of its products as it cuts emissions to zero by 2039. Lelievre of ENGIE Impact says Unilever is also working to hold suppliers accountable on sustainability goals. That’s a critical step, since the supply chain typically represents 90% of a company’s carbon reduction opportunity.

H&M, Sweden’s giant of fast fashion, was the first large fashion retailer to offer transparency about its manufacturing, starting with its Conscious collection. Consumers can click on a mock-turtleneck sweater, for example, and see that it’s made of acrylic, polyester, and wool (the retailer’s goal is to use all recycled or sustainably sourced materials by 2030) and that it was made in China by H&M supplier Shanghai Jingrong Science & Technology Co. Ltd.

Even energy companies have made moves to less carbon-centric lines of business. Examples in Europe abound:

• The former coal producer Dutch State Mines, now Royal DSM, has morphed over a decade into a science-based health and nutrition company. Its revenues showed growth up until the pandemic.
• Danish Oil and Natural Gas transformed itself from one of Europe’s most coal-intensive companies into Orsted, a green-energy leader, without sacrificing profitability.
• Enel, the Italian electric utility, is shifting a majority of its power generation to renewables, which offer a faster return on investment, more consistent earnings, and a better earnings before interest, tax, depreciation, and amortization (EBITDA) margin than fossil fuel power generation plants, according to a recent report from the Shared Value Initiative.
• Spanish utility Iberdrola comes in as the second fastest in decarbonization and rates highly on many ESG scoring systems, according to the report. It also comes out significantly better when one considers decarbonization and profit together.

These strategic shifts don’t occur overnight. Take DSM, which Strebel studied. Its transformation took nearly 10 years and hundreds of meetings to complete. “DSM used a rolling series of strategy dialogues with managers to gradually articulate the new biotech vision,” says Strebel.

“They can begin to build their strategy around those opportunities,” says Stewart. “This is an exciting time for companies and for investors where we start to see the markets drive solutions, innovation, and growth on pressing world problems. There has been this enormous public awakening, and it’s reflected in companies and in investors.”

SASB standards identify the ESG issues that are financially material within 77 vertical industries, from apparel and automotive to technology and transportation. Companies aren’t necessarily managing the factors that matter to financial performance, Stewart says, “and as a result, they may not be seeing the impact of the increases in performance that they deserve for the effort they’re putting in.”

The industry standards that SASB provides lay out in detail how companies can change this. Take the example of an electronics manufacturer that Stewart recently spoke with. Like many companies, it had been working hard to reduce greenhouse gas emissions and to better manage its water use. “These two issues are front of mind, but in the standard for electronics manufacturers, neither one is financially material,” says Stewart.

That means that from the point of view of the company’s income statement, balance sheet, and cash flow, reducing greenhouse gases and better managing water use will not affect company performance. What is material for electronics manufacturers, adds Stewart, are things like energy management, hazardous waste disposal, and – beyond those factors – an energy-efficient product line.

So if this company uses energy wisely and disposes of waste properly and then increases its focus on energy-efficient products, that will drive performance and increase customer loyalty. “For management, they might be thinking so much about what comes out of their smokestacks that they’re missing the factors that actually will drive better performance and enable it to attract the capital from investors who want to believe their investment will make an impact,” says Stewart.

The Sustainability Accounting Standards Board (SASB) provides standards that identify the Environmental, Social and Governance issues tied to financial performance in 77 industries. Each industry has its own set of disclosure topics and accounting metrics that will help companies in that space move the needle on profitability.

SASB’s standard-setting process includes evidence-based research, participation from companies, investors, and subject-matter experts, and oversight and approval from an independent standards board. (For more detail, see the SASB Rules of Procedure, which in November 2020 were open for public comment.) SASB standards are increasingly cited by financial asset managers in their proxy voting guidelines, including those from BlackRock, Goldman Sachs Asset Management, Neuberger Berman, and State Street Global Advisors.

The following are examples of three industries from the 77 classified by SASB with their disclosure topics. The accounting metrics within each disclosure topic can be found in the full SASB standards, which are available to download on the SASB Web site:

• Apparel, accessories, and footwear: Disclosure topics include management of chemicals in products, environmental impacts in the supply chain, labor conditions in the supply chain, and raw materials sourcing.
• Restaurants: Disclosure topics include energy management, water management, food and packaging waste management, food safety, nutritional content, labor practices, supply chain management, and food sourcing.
• Software and IT services: Disclosure topics include environmental footprint of hardware infrastructure, data privacy and freedom of expression, data security, recruiting and managing a global, diverse and skilled workforce, intellectual property protection and competitive behavior, and managing systemic risks from technology disruptions.

Global climate change is threatening the fate of the world. Unrest and economic inequality are destabilizing both governments and populations. And then there’s the peril to the business entity itself. Senior executives face the choice of adapting their strategy toward sustainability or risking displacement by companies that do just that. “It might be the Teslas of the world, it might be the Beyond Meats of the world that enter established industries and replace the incumbents,” Ioannou says.

Stewart calls the shift to a sustainable business strategy a “genuine awakening.”

“It’s continuing despite COVID-19. So this concern about climate, about inequality, about diversity, there’s an enormous will to address ESG issues. These are fundamental business issues,” says Stewart.

We are now at a watershed moment, says sustainability consultant Mike Barry. Many decades of globalization have lifted millions of people out of poverty and raised the standard of living for virtually everyone on the planet. But globalization also brought about economic losers as jobs migrated east, created a hyperconnected world where a pandemic can spread with ease, and plundered nature. Says Barry, “These problems are increasingly evident as wildfires burn, plastics choke sea life, and citizens take to the streets to protest. Most business leaders are recognizing the need for profound change to an economy that has the tenets of fairness, equality, inclusion, and well-being at its heart.”

And once they see the need for that kind of change, it is unlikely executives will ever un-see it. In the words of the late Ray Anderson, “There are no ex-environmentalists.”