Guest Post by Valerie Bockstette, Managing Director, FSG – There has long been a debate on whether or not corporate engagement on societal issues effects corporate performance and related to that, whether shareholders should care.
For many realms of corporate engagement with society, the answer is a clear no. When it comes to shared value, the answer is a clear yes.
First, let’s differentiate three different ways that corporations engage with society: (1) giving back, (2) following standards, and (3) creating shared value.
Companies can and should engage in all these ways. But if you throw them into one pot, shareholders and their advisors will be ambivalent or confused. You must differentiate and only selectively share information with the street.
Through philanthropy, corporate foundations, and volunteering, companies act as good corporate citizens by sharing a slice of what they’ve earned with society.
Data revolves around: How many dollars were given? How many hours were volunteered? How many people received free medications? Complementing this data are stories that fill glossy, 100-page corporate citizenship brochures.
It is right that companies give back this way. And there may be indirect impact on the business. Studies show that employees become more engaged when companies act socially. Volunteering can be motivating to staff. Customers may become more loyal. PR on this might help the brand.
But be honest, if you’re investing in a stock, would you care? Would you invest in Company A over B only because its foundation donates twice as much or its citizenship brochure has better stories?
It is difficult to make a direct link to competitiveness and cash flow based on giving back to society because there rarely is one. Moreover, corporate philanthropy will not solve the world’s problems.
This does not mean that companies should not give back. But let’s not tie ourselves up in analytical knots to prove the direct business value to traditional investors.
Companies follow a plethora of standards that go beyond laws and regulations: UN Global Compact; Global Reporting Initiative; Carbon Disclosure Project; UN Framework on Business and Human Rights.
Measurement is driven by standardization and check-lists, because there is an urge for comparable data. EBITDAs are comparable, so let’s make ESG comparable, too.
For investors focused on sustainability and ESG – who manage 10% of global assets – checklists matter.
Research is slightly on the side of standards and checklists:
- A 2012 Harvard Business School paper found that sustainability leaders tend to have better stock performance and greater return on equity
- 2011 research funded by CalPERS found that of 36 studies, 86% showed neutral or positive impact of ESG factors on risk and return
- A 2008 meta-analysis of 150 studies by the Network for Business Sustainability found that 63 percent showed a positive relationship between sustainability and stock market performance
However, therein lies the challenge. It is all about correlation. The studies find that companies that happen to perform on ESG and sustainability standards also happen to perform well financially. But pinpointing the direct source of that value creation remains elusive.
Example: in 2012, Microsoft’s annual report to shareholders on financial performance was 87 pages. Equally long was the Citizenship Report. The GRI report, with hundreds of indicators on environmental and social performance, was 431 pages. Five times as long as shareholder report. That ratio is wrong!
If you are a traditional investor or research analyst, you would have neither the patience nor the skillset to read through 431 pages and find direct drivers of value creation.
Valuation models – trust me, I used to build them – don’t have a line item for “correlations”.
The good news about standards such as GRI is that they’ve inspired companies to become socially and environmentally aware. And they allow investors that care about sustainability to identify investments. But impact on corporate action, investor mindset and the planet have been largely incremental.
Leading corporations do not drive its strategy from checklists and standards. They do so by finding and seizing tailored opportunities for their unique business lines. This is what investors want to hear about.
Creating shared value
As we’ve established, giving back and following standards are good things for companies to do, but:
- They don’t necessarily create break-through change for society
- They don’t necessarily contribute to the bottom line in direct ways
- They don’t at all speak the language of traditional investors and company valuations
Shared value creation – that is value creation for society and the business simultaneously – on the other hand achieves all of this. The intent is to address societal issues that directly create business value.
Companies create shared value when they:
- Reconceive products and markets to address unmet or under-met societal needs. With our planet approaching 9 billion people, these needs are ever-growing in the areas of nutrition, healthcare, water, clean mobility, sustainable building materials, etc.
- Redefine productivity in their value chain: At a minimum, companies should ensure they are not wasting resources and unnecessarily incurring costs. However, they can go further and reimagine their value chains to create even more value.
- Strengthen their operating context: To compete and thrive, companies need reliable local suppliers, a functioning infrastructure of roads and telecommunications, access to talent, and an effective and predictable legal and financial system.
- Realizing that many of the Millennium Development Goals could benefit from Dow’s innovation ability, the company launched “Breakthroughs to World Challenges”, a challenge to business units to apply innovation to global problems and develop new markets in affordable and adequate food supply; housing; energy & climate change; sustainable water; improved personal health and safety. Big wins and revenue generators to-date include healthier cooking oils that have taken 1.5 billion pounds of trans- and saturated fat out of the American diet as well as solar shingles, which the company predicts will bring in $10 billion in revenue by 2020.
- Novartis adopted a shared value approach when it founded Arogya Parivar to reach people who couldn’t afford or gain access to health care. Starting with rural India, it studied the needs of the 800 million undeserved and estimated that by 2015, they could account for 25% of the $15 billion Indian drug market. It now offers 80 drugs in 12 therapeutic areas by making them more affordable, enhancing the value chain by investing in a network of local distributors to ensure dependable supplies, and strengthening the operating context by training hundreds of local educators to teach people health seeking behavior. The venture is now serving nearly 50 million people in tens of thousands of villages in India, and the company is rolling it out in Indonesia, Kenya and Vietnam.
- In 2008, the Norwegian fertilizer company Yara launched a partnership to develop underutilized land areas in Africa, initially in Mozambique and Tanzania, to connect subsistence farmers to infrastructure that provides access to inputs and outlets to markets. Because it takes large-scale investments to tackle this issue, these “growth corridors” involve cooperation between governments, private companies, donors, development institutions and academia. By enabling farmers’ access to markets, the goal is to drive rural development and economic growth. For Yara, this means an increased ability to sell to these farmers.
How does measurement work here?
First the bad news, there are NO CHECKLISTS OR UNIVERSAL STANDARDS. This is about highly tailored strategies. Building roads and silos in Mozambique should be measured differently than training health care workers in India and taking trans-fats out of fast food in the US.
So while measurement in shared value creation is not standard, three key elements are critical:
- It is forward looking! Companies describe the size of the pie they’re after: tons of cooking oils forecasted to be consumed over the next decade, Indian pharma market growth, number of smallholders that need connections to input markets.
- It is direct! Companies create a clear line of sight to financial performance. It is not about an ESG that might correlate. It is about an EBITDA that will show up on the P&L: For Dow it is revenue and market share; for Novartis revenue, market share, and lower distribution costs; for Yara revenues, growth potential and lower costs because others are co-investing in infrastructure.
- It is data-driven. An incredible amount of research went into creating these business cases so they are robust and credible. Dow closely looks at which challenges have a business case based on the magnitude of the issue; Novartis carefully studied the dynamics of the Indian market; and Yara intentionally picked the initial corridor countries based on market research.
If you’re an investor, and you get information that is forward looking, directly related to financials and data-driven, well, you can do something with that information.
These true stories drive the point home:
Company A is a food company worried about hunger in its local community due to rampant unemployment. So the company decides to create a nutrition-rich meal in a can, donates 200,000 cans and runs a PR campaign on this.
Let’s be investors– would a donation of 200,000 cans convince you to invest in Company A? No.
- There is no forward looking market information in this story.
- There is no direct link between donating cans and the company’s financial statement.
- There is no data about what the problem is and what the scope for value creation might be.
I also doubt that 200,000 cans made any difference in the local hunger situation.
Let’s look at a second example.
Company B has zero to do with food. It is a telecoms company planning its growth strategy. Since by 2050 the world needs to produce 70% more food to feed 9 billion people, the company invested in deep research to better understand the problem. Turns out the required productivity increases will lead to an increase in farmer income of $138 billion. So the company develops custom mobile solutions in support of this: providing information to farmers via SMS text and helplines; improving access to financial services such as crop insurance; enhancing famer’s access to markets and improving supply chain efficiency between smallholders, distributors and retailers.
This is a story an investor can understand.
- It is forward looking – there are hundreds of millions of smallholders that can benefit from productivity improving mobile technology to generate billions of new income.
- It is direct in that we can estimate future revenue potential from estimating market share, pricing of new solutions and growth rates.
- And it is data-driven as it is underpinned by rigorous research developed by the company, its customers, government and NGO partners.
So, to sum up, when you’re going after shared value creation, you must develop a forward-looking, direct, data-driven business case to impress investors.
Companies that have been successful at this include Nestlé and Unilever. Nestlé focuses its shared value creation on three core areas: Nutrition, Water and Rural Development. In its annual investor seminars, an explanation of this targeted strategy, and supporting data, are front and center.
Unilever’s CEO, when launching its Sustainable Living Plan, famously said: “if you buy into this long-term value model, which is equitable, which is shared, which is sustainable, then come and invest with us. If you don’t buy into this, I respect you as a human being, but don’t put your money in our company.”
It will take a few more years before the majority of analysts on the street recognize the importance of shared value. But when they do, it will be the companies that already have a strategy for this that are rewarded, not companies that are just starting to scramble to find these new opportunities.