Yes, Investing in ESG Pays Off – Andrew Winston
[I published this piece, co-authored with Paul Polman, in Harvard Business Review a few weeks ago. This is another in the realm of the “business case” for sustainability (within a corporation for its own capital and investment decisions, not as an investment thesis for investors). I don’t love the use of “ESG” in the title here — publishers choose titles and I didn’t object, knowing it would get more views that way, since it is now the term everyone uses. I’ll explore why reality makes me uncomfortable in another article coming soon. I admit to being very tired of making the business case at all, andI get some question like “does it pay?” every day. In reality, except for a few points, I could have written this many years ago (and did do versions of it). I try to take the new level of interest in this discussion as a good sign — people in business, like CFOs, are coming to the table in earnest now, so maybe we have one more large round of “proving” that it’s “good business” to invest in…lowering costs and risks, driving innovation, attracting and retaining talent, building brand value, and, oh yeah, trying to ensure the thriving and survival of humanity. This article got some good debate on my LinkedIn post. Enjoy.]
With the rush of money into ESG investment funds — more than $1 trillion in the last two years — it’s easy to think everyone clearly sees the business value of sustainability. But many leaders still see an inherent trade-off between choosing a more sustainable future and achieving business growth and profit. They see ESG-related spending — a capital expense to reduce energy use, opting for renewable energy, paying living wages, and so on — as purely cost, not investment. With little resistance, CEO’s will spend money on IT, training, new factories, R&D, and more; but when it comes to investing in the future of the business and humanity, they hesitate.
Worries that clean energy costs more, for example, are wildly out of date. More generally, a growing number of studies prove the payoff from focusing on long-term value and ESG. Just Capital, for example has created a list of companies prioritizing stakeholders (not just shareholders) that they call the Just 100. This group has outperformed the market. It should also be clear that there’s also a big upside waiting for those who embrace the world’s shift to ESG: multi-trillion-dollar markets in clean energy, electric and autonomous vehicles, plant-based proteins, precision agriculture, AI-driven efficiency technologies, and much more. So why do so many in business still feel that sustainability doesn’t “pencil out”?
Much of the reason comes down to five big problems with how we make decisions.
1. The Numbers Hide the Truth About Real Costs
Our economy relies entirely on inputs from the natural world, from the things we grow and dig up to the harder-to-measure benefits, such as providing a free dumping ground in the sky for pollution. Every ton of carbon emitted raises the temperature a tiny bit and reduces air quality, but companies never pay for those costs to society, also known as externalities. They also get, for free, the tens of trillions of dollars in value and services nature provides. And what’s worse, perverse government subsidies and regulations make it cheaper to do the less sustainable thing — burn more fossil fuels or degrade soil to maximize yields today at the expense of tomorrow.
Solution: Price the unpriced.
Many leading companies internalize the externalities by putting a “shadow price” on carbon inside the business (some collect real money as a self-imposed tax). Raising the price on carbon or other inputs drives different capital and investment decisions. But it’s hardly enough; these leaders need to come out into the sunlight and advocate for a binding market price on carbon. Systematic and forward-thinking lobbying is what we call net positive advocacy; i.e., working with peers, NGOs, and governments to enact policies that improve the system for all. Beyond carbon, the same logic applies to supporting social issues like living wages as a minimum, or increased spending on social infrastructure to reduce inequality. Get those price signals and spending priorities right, and sustainable products and investments will look much better in comparison.
2. Our Own Biases Trick Us
Even when the sustainable choice is more profitable by traditional measures, it doesn’t mean people opt for it. We all have biases in how we make decisions, including thinking in linear, non-systemic terms, or going with what’s easy or right at hand. Nobody is immune — not CEOs, CFOs, or bankers. Investors may say to themselves, “I know how to make money on investing in fossil fuels, so I’ll keep doing that.” That may be unwise given the economics of clean tech, but people are not purely economic animals.
Solution: Diversify the group making decisions.
If we tend to go with what we know, or fall into groupthink and inertia, then we should expose organizations and their leaders to different perspectives. Bring civil society into the decision making — ask NGOs who are critics to come in and help educate and solve problems (but avoid the cynics that just want to tear you down). And flush out old thinking by inviting younger people into the room; your own, newer employees expect companies to find solutions that enhance people, planet, and profit. They also add a longer-term perspective — twenty-somethings are logically much more concerned about what a changing climate would look over the next half century than leaders in their seventies and eighties. Talk to twenty-somethings and actually listen.
3. We Focus on Short-Term Costs and Benefits
While it’s wrong to say sustainability always costs more, it’s no more accurate to say it always pays off, at least in the short run. There are technologies that may cost more now, until they get to larger scale — which describes every new technology.
A few years ago, for example, UPS proudly announced it would buy electric delivery vehicles at the same up-front cost as its gas models. The story told was that it finally paid to go electric. But earlier, when the list price of EVs was higher, they were already a better deal over the lifetime of the vehicle, with much lower operating costs and higher uptime. UPS and other shippers should have bought these vehicles and reaped the benefits in savings and lower emissions earlier, even when the up-front sticker price was higher. Similarly, a sustainability goal like a zero-waste factory can take investment and time to get right. But the effort improves the operation more holistically, resulting in higher productivity and nimbleness.
Solution: Redefine your tools for investment decisions.
Metrics like ROI or IRR are generally broken. They miss sources of value and use a too-high discount rate, which makes any investment in the future look worthless. On a gut level, we know that can’t be right. Instead, find and internalize the data that proves the value of longer-term thinking. A study from McKinsey Global Institute and FCLTGlobal showed that companies operating with a true long-term mindset made critical decisions like investing more in R&D and, as a result, had 47% higher revenue growth and faster growing market caps. Better tools and thinking can lead to more and better action.
4. We Think About Costs in Silos (Instead of Systems)
A focus on paying living wages will raise costs today in every tangible way — it’s kind of the point. But focusing only on the budgetary silo of wage expense gives only a partial, narrow view on the investment choice. Intangible benefits also accrue to a company that invests in its people and supply chains: attraction and retention of talent, more productive workers with lower turnover, stronger relationships with communities, and a better (and true) story to tell customers about your net positive impact on the world.
Solution: Broaden thinking on value and think in systems.
Again, ROI and other tools don’t work correctly here. The “return” part of the equation doesn’t capture the intangible value from choosing the sustainable, net positive path (employee engagement, customer passion, resilience, and so on). For example, shifting from part-time and contingency hiring to creating more permanent positions may cost more immediately, but easily pays off in less attrition and higher productivity. We also ignore systemic benefits like more efficient and lower cost value chains, or communities that are more functional and healthier to do business in. Silo thinking locks in lower value. A more systematic view on the connections between worker treatment and many levers of business success gives a more complete and positive view. So make a point of listing and valuing, as best you can, all the benefits of an ESG decision. Work to broaden the definition of “return” on your investments.
5. We Miss the Bigger, Existential Costs
According to insurance giant Swiss Re, not acting on climate will destroy around 18% of GDP by 2050. That number is equivalent to a deep economic depression, but it may sound survivable. Yet the number is aggregated and tells only a partial story. Some areas, like Canada or Siberia, may actually see longer growing seasons and economic gains. But many more places, like Miami, huge parts of Bangladesh, and all low-lying island nations, will flood permanently. Some cities will become too hot to live in. The downside risk to those regional economies is not 18%; it’s 100%. The societal losses also cost business directly. Droughts ruin crops, extreme weather shuts down parts of supply chains, employees and customers face hardship — all of these hit the P&L, often hard.
Solution: Understand the world’s thresholds and learn to think in net positive terms.
We humans are notoriously bad at predicting the future. Big failings include not understanding exponential change and only seeing the local situation. So study the big trends that are moving non-linearly — climate change, inequality, resource use, clean tech economics, AI, misinformation, and more. Consider some extreme outcomes, like a city you operate in becoming unlivable, and lay out the material risks from the tails of the probability distribution (you may have to anyway: the U.S. Securities and Exchange Commission is on the verge of mandating disclosure of climate risks). But also ask yourself, “What’s the net positive value on investments to avoid these existential risks?” Learn to think in net positive terms by working on systems challenges, with others in the value chain or in the full system (NGOs, governments, citizens), to solve the biggest problems to the benefit of all.
. . .
These five mental hiccups are not the only missteps that affect outcomes, but they are the primary ones that drag down sustainability investment. The mental models expose a win-lose, narrow, and negative mindset. In our book Net Positive, we explore ways to build businesses that solve societal problems and improve the well-being of everyone they impact. It takes courage and humility, but also a mindset that we can, in collaboration, solve many problems and improve the economics on sustainability for all. It’s not as simplistic as “win-win” but working together, we can get more done (what we call 1+1=11).
It’s easier (and frankly lazier) to think in old ways. We can fight these issues and make sustainability fit into a normal model of seeking a good return on investment. But let’s step back a moment. Why exactly do we have to stick with traditional terms? It’s increasingly absurd and surreal to have to justify investing in our very survival — or have to prove that we should stop funding what’s killing us. At the macro level we’ve long passed the point where the cost of action is far lower than the cost of inaction — i.e., huge swaths of the planet becoming uninhabitable, which, again, is kind of bad for business. It definitely pays to invest in our shared future.
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