The Strategic Race to Sustainability

When Belgian recycler Umicore recognized that there were likely to be scarcities in key metals (including lithium and cobalt) as the global energy transition progressed, it created a closed-looped business model that aims to turn waste into feedstock for its customers and its own clean mobility production. The company also signed long-term contracts to obtain sustainable lithium supplies from two vendors to further secure inputs for its battery cathode products.

Restructuring Stranded Assets. As leaders transform a business in pursuit of the sustainability advantage, parts of its asset base will no longer be fit for purpose. This is especially true in high-emitting industries with long-life capital assets. In the oil and gas sector alone, the associated risks of stranded assets are estimated to reach $1.4 trillion of cumulative net present value by 2036.4


Notes:

4
G. Semieniuk, et al., “Stranded Fossil-Fuel Assets Translate into Major Losses for Investors in Advanced Economies,” Political Economy Research Institute, October 7, 2021.


To reduce the significant risk of less sustainable assets becoming stranded, leaders need to identify at-risk assets, determine how to invest to transform them or wind them down, and set up the appropriate corporate and financial structure to facilitate the transition, perhaps with financial partners.

Identifying at-risk assets necessitates that leaders evaluate the company’s assets against a sustainability scenarios matrix and then segment the assets by the actions required for disposal and the timing. In many cases, the investment demands for achieving the sustainability advantage in existing assets will rise above historical levels, sometimes by multiples. To meet this demand, leaders should encourage innovation across corporate structures, financial engineering, and capital mix. For instance, companies may need to tap new transition-financing instruments, sustainability-linked bonds, or public-private financing, or all three.

In 2008, when Dong Energy embarked on the black-to-green transformation that would eventually lead to its 2016 IPO as Ørsted, it was producing 85% of its heat and power from fossil fuels, and it was responsible for one-third of Denmark’s carbon emissions.5


Notes:

5
E. Reguly, “A Tale of Transformation: The Danish Company That Went from Black to Green Energy,” Corporate Knights, April 16, 2019.


To meet its ambition to turn its portfolio on its head and generate 85% of its production from green sources, the company took multiple steps to wind down and transition stranded assets, including closing 40% of its generators, converting coal generators to biogas, making divestitures, and, in some cases, abandoning projects.

How Must the Company Be Rewired to Act Now?

Most companies will need to reshape their organization structure and culture to capture the sustainability advantage. Often, reshaping will require refreshed incentive and decision-making frameworks that can drive an accountable, sustainability-oriented culture. It will also require a reorientation of a company’s innovation agenda, supply chain, and ecosystem to support the quest to capture new value streams. And, as always, reshaping will require a compelling, integrated investor narrative that articulates a differentiated approach to sustainability that is aligned with the corporate purpose and anchored in competitive advantage.

Create an accountable sustainability-oriented culture. To drive the growth of a company, sustainability needs to be explicitly embedded in leadership and decision-making frameworks, capital allocation and governance practices, and incentives. Otherwise, the ability to practice sustainability as an advantage can run into resistance as it confronts mindsets and corporate DNA that have been developed and reinforced by decades of functional and operational optimization focused on shareholder value and quarterly earnings.

The race for sustainability requires new muscles and the courage to run off-trail. Thus, it isn’t entirely surprising that our analysis of corporate sustainability initiatives found that more than 90% of the initiatives that created the most robust and resilient business models with the most significant environmental and societal benefits featured an internal vision and purpose that helped to energize an accountable sustainability culture. In this regard, CEOs must be convincing and clear and continuously assure stakeholders that this race will be worth running—and that it will be run.

Tying the compensation, retention, and promotion of individual leaders to sustainability is essential, of course, but it takes more to activate a culture and an organizational mindset that embeds sustainability into every facet of the business and applies it as the lens through which decisions are made. It requires rethinking capital allocation tools (for example, new discount rates and payback periods), finding mechanisms that internalize the costs of externalities (such as carbon, water, and waste), creating governance structures (for example, carbon budgets), and re-equipping leaders, functions, and businesses with the necessary skills (such as those required for systems dynamic mapping).

Most industrial companies have analogous experience in embedding a safety-first culture. They have reset employees’ safety mindset by continuously making changes on the shop floor, integrating indicators on dashboards, reworking capital investment templates, and including performance measures in senior executives’ compensation. Years later in such companies, many employees say, “Safety is just how we do things.” We expect sustainability to follow a similar journey.

Reset the innovation agenda. Winning a sustainability advantage requires the creation of new technologies, business models, ecosystems, and markets. Accordingly, R&D and innovation investments need to be redirected.

An innovation agenda aimed at a sustainability advantage should be anchored by the company’s R&D portfolio, enlist external strategic partners, and reflect emerging technologies in the rapidly expanding startup space. In addition, senior leaders need to be clear as to how that agenda will deliver on the company’s strategic priorities and bolster its product and business portfolios.

Dow, a US-based chemicals and plastics manufacturer, redirected its innovation agenda toward sustainability by identifying and focusing its investments on three priority areas: climate protection, the circular economy, and safer materials. In 2020, the company invested approximately $770 million in R&D, with 80% of its R&D projects focused on those areas. Dow also linked its Sustainable Chemistry Index, a tool which assesses the sustainability attributes of its businesses and products, to its innovation agenda.

Restructure the supply chain. Fully implementing sustainability innovations at scale will require fundamental rewiring of a company’s supply chain. Many innovations will be able to deliver their full sustainability and business potential only if the underlying supply chain is shifted to ensure that sustainability is measured and optimized at each step of the production process.

There are five actions that companies can take across their value chain to bolster sustainability and resiliency. They can improve the sustainability of inputs, redesign products and packaging, increase resources within the chain for resilience, optimize the networks considering both efficiency and resilience, and pursue circularity.

We see examples of companies taking some of these actions, but few are doing all five in a way that will fully transform the supply chain. Consider McCormick & Company. Its sustainable sourcing standard “Grown for Good” focuses on safe and ethical supply chains, regenerative production systems, and resilient communities. The standard is certified by third-party verification and goes beyond industry standards by including criteria for women’s empowerment and farmer resilience. It has been a driving force for reshaping the company’s supply chains for sustainability beyond carbon, and it is the first standard to cover spices and herbs specifically.

Shape the ecosystem for sustainability. Sustainable companies need a sustainable ecosystem, and they should shape it in ways that benefit their strategic goals through bilateral partnerships, sustainability business ecosystems, and corporate-led sustainability alliance. For example, a beverage manufacturer may aspire to have sustainable packaging but be limited by the recycling capacity in key markets. The manufacturer should pinpoint the short-term and long-term recycling constraints and then determine when and where to collaborate with others to overcome those constraints.

An ecosystem for sustainability can encompass supply partnerships, solution partnerships, or alliances aimed at shaping standards and influencing public policy. For instance, in 2021, Texas-based Hyliion, a maker of low-carbon, electrified powertrain solutions for the heavy transportation market, formed an ecosystem named the Hypertruck Innovation Council to advance electrification solutions for commercial transportation. The council is a group of leading companies focused on removing barriers to sustainability, while creating unique sources of advantage. The companies—including Agility Logistics, American Natural Gas, NFI Industries, and Ryder System—collectively represent 100,000 Class 8 commercial trucks globally and represent some of the world’s largest private fleets. Hyllion is working with the innovation council to pilot Hypertruck ERX, a net-carbon-negative commercial transport.

Communicate to stakeholders and investors. Capturing the competitive advantage of sustainability requires engaging stakeholders and investors in the company’s sustainability ambition and initiatives. The table stakes here include reporting ESG performance (compared with the converging standards), applying better disciplines in target setting (such as using science-based emissions-reduction targets), and being transparent about material ESG issues. But standing out means, at a minimum, clearly demonstrating, particularly to investors, the links between the company’s sustainability agenda and the quality, competitiveness, purpose, and resiliency of the business.

This higher standard means infusing the company’s sustainability ambition into brand and corporate narratives. The goal is to activate employees and strengthen their affinity because they know they are part of a company that is changing the world for the better. It also means strengthening the loyalty of customers and suppliers because they benefit from the value that the company brings to their journey to sustainability.

A decade ago, the luxury fashion retailer Kering started to develop an interactive tool that presents the environmental impact of its activities in order to demonstrate transparency to its stakeholders. Its online environmental profit-and-loss statement deconstructs the monetary impact of the company’s environmental externalities across business units, processes, value chain players, and raw material inputs. This approach enables Kering to report its environmental performance in each area, maintain a running tally on its progress, and communicate clear targets for the overall environmental impact of the business.

A Call to Action 

We are on the cusp of a remarkably broad and deep business transformation propelled by corporate and infrastructure investments estimated at more than $3.5 trillion per year through 2050. This transformation offers enormous growth opportunities for the companies that understand how to pursue sustainability for advantage. Investors wielding trillions of dollars are on the hunt for companies that can deliver this sustainability advantage, and they are increasingly willing to penalize the laggards. Emboldened by hardening public opinion, governments are putting in place increasingly ambitious sustainability targets and backing them up with spending. But most companies are not moving with the bold foresight, ambition, and speed needed to secure sustainability as competitive advantage and reset the basis of competition. Companies must up their game to win what may well turn out to be the most important race of this business era.

Leave a Reply

Your email address will not be published.