How the E in ESG creates business value

For executives and investors alike, understanding the links between ESG and business value is essential to making sound decisions about how to allocate capital and other resources.

Environmental, social, and governance (ESG) priorities have reached the mainstream in finance and management. In the past six years, the quantity of global assets managed according to sustainable-investment strategies more than doubled to $30.7 trillion, equivalent to one-third of all managed assets. The US Business Roundtable released a statement in August 2019 affirming business’s commitment to a wide range of stakeholders, including customers, employees, suppliers, and communities, as well as shareholders. Investors and executives, it appears, increasingly accept that paying attention to ESG concerns is good for business performance – a view supported by academic research, which finds that strong ESG propositions relate to higher financial returns and lower downside risk. As executives consider how to reinvent their companies for the period that will follow the Covid-19 pandemic, many will find it helpful to factor ESG issues into their plans.

Yet the ways in which ESG links to business value aren’t always clear. For executives and investors alike, understanding those ties is essential to making sound decisions about how to allocate capital and other resources. This blog post offers a closer look at the value-creation potential from the E in ESG, which covers environmental criteria, such as the energy and resources your company takes in, the emissions and waste it discharges, and the consequences for living beings. In particular, the E links to value in the five ways described below.

Top-line growth

Having a strong environmental proposition helps companies tap new markets and expand into existing ones. McKinsey research conducted prior to the Covid-19 crisis has shown that customers say they are willing to pay to “go green.” Although there can be wide discrepancies in practice, including customers who refuse to pay even 1% more, we’ve found that upwards of 70% of consumers surveyed on purchases in multiple industries, including the automotive, building, electronics, and packaging categories, said they would pay an additional 5% for a green product if it met the same performance standards as a non-green alternative.

The payoffs from meeting this kind of consumer demand are real. When Unilever developed Sunlight, a brand of dishwashing liquid that used much less water than its other brands, sales of Sunlight and Unilever’s other water-saving products proceeded to outpace category growth by more than 20% in a number of water-scarce markets.

Cost reduction

Among other advantages, executing on E well can help stall a company’s rising operating expenses, including the true costs of water, carbon, and raw materials. One of our studies found a significant correlation between a company’s resource efficiency and the strength of its financial performance. It also found that reducing resource costs can improve operating profits by up to 60%.

Consider 3M, which saved $2.2 billion since the 1975 launch of its “pollution prevention pays” (3Ps) programme, which involves reformulating products, improving manufacturing processes, redesigning equipment, and recycling and reusing waste from production. FedEx aims to convert its entire 35,000-vehicle fleet to electric or hybrid engines. To date, it has converted 20% of vehicles, which has reduced fuel consumption by more than 50 million gallons.

Reduced regulatory interventions

Careful management of environmental issues can ease regulatory pressure on companies and reduce their risk of adverse government action, enabling them to achieve greater strategic freedom. The value at stake for your business may be higher than you think: one-third of corporate profits are typically at risk from state intervention, according to our analysis. For the automotive, aerospace, defense, and tech sectors, where government subsidies are prevalent, the value at stake can reach as much as 60%.

Employee productivity

A company with a record ofpositive environmental impact can find it easier to attract and retain quality employees, motivate them by instilling a sense of purpose, and increase productivity. Employee satisfaction is positively correlated with shareholder returns. The London Business School’s Alex Edmans found that the companies that made Fortune’s “100 Best Companies to Work For” list generated 2.3 percent to 3.8 percent higher stock returns per year than their peers over a greater than 25-year horizon. Moreover, it’s long been observed that employees with a sense not just of satisfaction but also of connection perform better.

A questionable environmental record, on the other hand, can lower productivity. The most glaring examples are strikes, worker slowdowns, and other labour actions. Productivity constraints can also manifest across your company’s supply chain. Primary suppliers often subcontract portions of large orders to other firms or rely on purchasing agents, and subcontractors are typically managed loosely, sometimes with little oversight of their environmental practices.

Investment and asset optimisation

A strong environmental proposition can enhance returns by allocating capital to more promising, more sustainable opportunities (for example renewables, waste reduction, and scrubbers). It can also help companies avoid investments that may not pay off because of longer-term environmental issues (such as write-downs in the value of oil tankers). Taking account of investment returns requires that you start from the proper baseline: A do-nothing approach is usually an eroding line, not a straight line. Continuing to rely on energy-hungry plants and equipment, for example, can drain cash going forward.

The link from environmental issues to value creation is solid. In a world where environmental concerns are becoming more urgent, the five levers described above can make a difference.

About the authors

Tim Koller is a partner based in McKinsey’s Stamford office and Robin Nuttall is a partner based in the London office.

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