Bridging the Gap Between Sustainability and Financial Metrics
Steering a company by financials alone is like ignoring a storm at sea – you risk losing everything.
Resource depletion, pollution, and climate change, as well as social challenges such as food insecurity, now sit directly in the path of success. Meanwhile, customers, employees, investors, regulators, and other stakeholders are pushing companies to reckon with these enveloping winds and roiling seas (in some cases, literal).
As a result, more and more companies are elevating sustainability to the same level of importance and guidance as financials. Their leaders see that pressure from nature is constant, not episodic, and that it requires continuous measurement to, for instance, navigate the effects of climate change on the supply chain and understand its financial toll. So they measure sustainability in terms of gains and losses – integrating sustainability metrics with financial metrics for a unified view.
In other words, the mental model for managing the business – long predicated on financials alone – appears to be reaching its expiration date. We’ve tended to think of sustainability as fixing what’s broken and cleaning things up – essentially a side activity with no direct impact on the business (besides cost). We’re also accustomed to hearing organizations talk about sustainability at an abstract level, through carbon neutrality pledges and sustainability reports that roll up statistics about consumption of energy and natural resources, or people “diversity indicators” that are often unverifiable.
But a survey from SAP Insights of over 11,000 global executives shows that sustainability is becoming embedded into the deepest operational level of the organization: business processes. It’s at this level that sustainability – and its metrics – will be incorporated into how the organization thinks, operates, and defines its success in tandem with its financial performance.
Bridging the Gap Between Sustainability and Financial Metrics
A global survey confirms that sustainability has become a tool for improving business performance. The next step: integrating it with financial metrics to guide executive decision-making.
The big three: revenue, efficiency, risk
The survey looked at how business processes are changing as measured against three common goals: improving revenue growth, increasing efficiency, and reducing risk.
Respondents ranked which of the three was most important to short-term results, along with their strategies for improving performance in each area and the business processes that need to be improved to assist with their goals.
They told us they’re prioritizing revenue growth over improving efficiency and managing risk (see Figure 1), perhaps because they’re influenced by the pandemic and its attendant supply chain problems.
Yet they see sustainability as a focus for improving performance in each of the three areas together with tried-and-true approaches that companies have used to steer their destinies for more than a century.
Sustainability for innovation and growth
“Increasing sustainability in your products and services” was the top choice among respondents who were asked to pick their top three priorities to improve revenue growth (see Figure 2).
However, sustainability isn’t simply a new card shoved randomly into an old deck. It’s equal with strategies that we already associate with innovation, such as introducing new products, improving the customer experience, or improving brand recognition and reputation.
This connection becomes clearer when we look at the types of innovation that respondents see as critical to their businesses in the next three to five years (see Figure 3). While technology innovation may top the list, sustainability innovation is in a tie for second place with product and service innovation and digital experience innovation.
Sustainability and efficiency
The value that respondents place on sustainability is also apparent when we look at how they plan to become more efficient.
For years, the common wisdom has been that running a business sustainably is expensive and that being green or socially responsible costs more. Our research suggests that we’ve already reached a tipping point at which that is no longer true (see Figure 4). While survey respondents chose improving cost control and spend management more than any other efficiency strategy, they ranked making operations more sustainable a relatively close second.
Again, how sustainability ranks in comparison to other strategies is important. In this case, sustainability placed significantly higher than automating processes – the most hyped solution in the business press and among consultancies ever since the “reengineering revolution” of the 1980s. Sustainability also ranked far ahead of ensuring the dependability of supply chains, despite all the attention during the pandemic to container ships languishing at sea and consumers roaming the grocery aisles in an often-fruitless search for staples.
Attention to environmental risks
There’s also evidence that respondents are attuned to the risks they face if they don’t pursue sustainability.
We asked them how they expected to reduce near-term risks to their internal operations (Figure 5.)
Not surprisingly, their list of top strategies reads like a bulletin board of current threats: shoring up fragile supply chains, avoiding damage to the brand, and protecting against cybersecurity attacks. All of these have roots in recent crises, including the pandemic, and increases in ransomware attacks.
At the bottom of the stack are perennial strategies such as protecting against new market entrants, fending off the competition, and addressing the burdens of data regulation. Although these are responses to risks that are always looming over businesses in both the short and long term, for now respondents see them as less urgent.
Notably, the one sustainability-related strategy we asked about – reducing reliance on scarce resources – also ranked higher as a priority for reducing risk than the perennial factors.
Meanwhile, respondents are also noticing the limits to the planet’s ability to absorb the weight of our collective footprint. We asked them which longer-term risks concerned them in the world at large, which we drew from a list developed by the World Economic Forum (Figure 6).
Not surprisingly, the issues weighing most heavily on respondents are those that are most visible and felt most keenly right now, with economic stagnation at the top.
However, risks related to sustainability – global natural resource shortages and climate change – are among the choices respondents picked most often. This suggests that they understand both the short- and long-term risks of delaying action.
The survey findings make clear that respondents see sustainability as a tool for improving performance in the broadest possible sense: increasing revenues, improving efficiency, and reducing risk.
And they’re putting that tool to use at the business process level, where it’s becoming a mechanism for gaining market advantage.
The question then becomes how to elevate sustainability to a strategic input for making decisions at the highest levels of the company. There are two related areas in which business leaders can start: changing their mindsets about the value of sustainability and using sustainability metrics to manage their companies.
Treat sustainability metrics equally with financials.
If CEOs have performance dashboards, the gauges are likely mostly, if not entirely, tuned to financial goals and metrics – because that’s what the company and its stakeholders have been trained to understand as determining success and failure. But stakeholders are increasingly demanding that business leaders include sustainability goals and metrics when they evaluate performance.
The survey results show that sustainability has become a tool for improving performance deep within the belly of the company – at the process level. But for this work to be fully successful, executives at the top of the company need to recognize sustainability’s value for steering it.
Connect sustainability with financial materiality.
Previous research by SAP Insights suggests that most companies don’t yet see sustainability as financially material to their companies. Yet all the ways that our survey respondents tell us they’re using sustainability to improve performance at the process level suggests that that view is changing. We think data makes the difference: in our previous research, we found that companies with more data about the environmental effects of their businesses are more likely to expect that operating sustainably will increase long-term revenues and profits.
Create an integrated balance sheet.
If sustainability is to have equal stature with financials as a management tool, business leaders need to understand the environmental and societal effects of the company with the same degree of precision with which they understand their finances.
Admittedly, this hasn’t been easy. There are so many arcanely named organizations working on competing sustainability measurement standards that they’ve practically cornered the market on acronyms. And many of these standards are still works in progress.
But this shouldn’t be an excuse for inaction. For companies doing business in the European Union, new sustainability accounting regulations will soon hit harder than a slab of breakaway Arctic ice. Starting in 2024, the EU is going to mandate double materiality analysis for 55,000 businesses in Europe and millions more globally with an EU footprint.
According to the EU, companies must “report about how sustainability issues affect their business and about their own impact on people and the environment,” in addition to reporting on issues and events that are typically considered material to financial results, such as the purchase of a competing company or the costs of a new factory. In other words, the EU has recognized that stakeholders need to know how a company affects people and the planet and how both affect a company to fully understand its financial health.
For example, it’s important to know how much a company emits in pollutants or is complicit in human rights violations in its supply chain because it could end up violating regulations, which would trigger fines and require investments for remediation. Similarly, it’s important to know how rising seas or more extreme weather might affect production costs.
Fortunately, you don’t need definitive measurement standards or perfect data to get started. The previous SAP Insights survey found that the largest percentage of respondents developed their sustainability metrics in-house.
Merge digital transformation with sustainability efforts.
We rarely see digital transformation and sustainability treated as symbiotic goals. But as we said earlier, the first step toward integrating sustainability into business governance is through measurement, which requires data that increasingly comes from digital processes.
Meanwhile, if (as our survey suggests), business leaders want to use sustainability as a tool for improving business performance, digital is to rethinking processes what flour is to pancakes.
Digital technologies are the only inputs into a business today that have continued to drop dramatically in cost while increasing exponentially in power. That kind of power and savings are needed if sustainability efforts are going to satisfy investors, 81% of whom say they aren’t willing to give up more than one percentage point of their returns in the pursuit of environmental, social, and governance (ESG) goals (even though they also insist they care about these), according to a PwC survey.
The shift is underway
Our survey confirms that respondents no longer see sustainability as a burden but as a strategy that makes a difference where it counts: in making money and reducing cost and risk.
Sure, saving the world is nice, too. But business leaders are motivated to pursue sustainability because they understand it to be intrinsic to innovating new products and services or making business processes more efficient. And environmental as well as social issues are being recognized as risk factors that need to be managed to protect business performance.
All those carbon neutrality pledges that companies are making may be sincere, but they will generate no meaningful value unless they’re fused with business goals. Companies need not only metrics and frameworks but also a change in mindset that considers sustainability as important as financials when valuing and managing a company.
Maybe that’s not the prevailing wisdom yet. But the clock is ticking.
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