Jānis Ozoliņš: Being light years ahead of competition – why should companies pursue happiness in sustainability?

Now that sustainability is the current buzzword, one may get the impression that each of us adheres to the best sustainability guidelines in our daily lives, as well as in our businesses, that we strive to take on more responsibility, be environmentally-focused and caring more for our future. However, in reality, only a small number of companies have embarked on a real and serious process of changing and are thinking beyond their drafted corporate social responsibility policies. One might say that the current trend is to think and talk about it rather than practice it. However, it is obvious that the companies that seriously integrate sustainability into their operations, will be light years ahead of their competitors in the long run. Why is sustainability appealing to companies? Will it pay off eventually?

Acting as if we planned to stay here

Jānis Ozoliņš
Head of Real Estate financing at SEB bank Latvia

Sustainability has become particularly topical during the Covid-19 pandemic, when we talk a lot about how the global economy will recover from this crisis and we see that this is a great opportunity to attribute growth specifically on sustainability. However, the understanding of what exactly this means is quite different. The concept of sustainability goes far beyond eco-friendly lifestyles and green bio-shops. One of the simplest definitions of sustainability is: “Act as if we planned to stay here”.

Sustainability is also very much related to corporate governance. It must be incorporated in staff management - how the company takes care of employee development and employee inclusion aspects. It also applies to manufacturing processes, demonstrating care for the working environment, health and safety of employees, as well as the resources used in the manufacturing processes and the resulting by-products. Evaluating suppliers is also important – do we only look for the lowest price, or consider the supplier’s reputation and concern for the working conditions and salaries of their employees?

The results of research are increasingly supporting that being a sustainable company does pay off. Generally, the benefits of a sustainable business can be categorised into three main areas - higher return on capital, growth opportunities and risk mitigation.

Higher return on capital for companies with a favourable sustainability strategy in place

The results of 90% of sustainability studies show that great sustainability standards reduce the cost of capital, while the results of 80% of studies suggest that the share price of a company has a positive correlation with sustainable governance,¹ according to the results of the analysis of nearly 200 pieces of sustainability research carried out by asset manager Arabesque Partners and Oxford University.

It is therefore logical for investors to pay attention to the securities issued by sustainable companies. According to the data provided by the Forum For Sustainable And Responsible Investment, between 2018 and 2020, the amount of the securities managed by sustainable investment strategies in the US market increased from USD 12 trillion to USD 17.1 trillion, aggregately accounting for one- third of professionally managed investment portfolios.²

Likewise, the international management consulting company McKinsey&Company has emphasised the favourable impact of sustainability on the valuations of the companies. According to it, investors would be willing to pay up to 10% more for a company with a favourable sustainability strategy compared to a company that does not pay critical attention to sustainability.³

The focus on sustainability is important not only for companies represented in the financial markets. Little by little, the manner in which banks in the Baltic countries evaluate whether a loan should be issued to a company and for what purpose is changing, as well as sustainability issues are being incorporated into the credit risk assessment. As the banking sector plays an important role in economic development, it is capable of making a very important contribution to achieving sustainability goals. We anticipate that it will not be long until we see some differences in the banking terms and conditions for companies with different approaches to sustainability matters.

Growth opportunities - people are willing to buy sustainable products

Over a few years, corporate sustainability has transformed from an idea to reality, which has been especially driven by the change of the mindset and also by change of generations. Younger generations are paying increasing attention to sustainability and consider it their responsibility to buy goods and services that are great for the environment and the public. This is an additional motivation for companies to carry on work on the creation of sustainable goods and services with a view to being able to meet the growing demand in this product category.

Although there are significant differences of opinion on whether sustainable products can be sold at higher prices, several studies suggest that 70% of buyers in different product categories would be willing to pay 5% more for a sustainable product compared to a regular product, on the premise of identical quality of both products.⁴

In many cases it is not even necessary to develop a completely new product, it is enough to  make small changes to the existing product, such as replacing only an individual component or differentiating the pricing model. For example, the international pharmaceutical company GlaxoSmithKline focuses its business model not only on developed but also on developing countries, where purchasing power is lower than in developed countries by applying flexible product pricing models. The company’s goal is to make the  medicine available to wider audiences and new markets, which not only is a sustainable approach, but also increases the company’s sales.5

In this regard, the international furniture retailer IKEA has also set ambitious goals, by committing itself to inspiring and enabling at least one billion people to live better by 2030, considering the planet’s limited resources.⁶ One billion is an ambitious figure in any industry, which makes seeking the most efficient ways to work, reducing costs and making products more accessible to more buyers. This inevitably leads to the innovations coveted by today’s buyers, i.e., the products that use less electricity, take up less space, are lighter, more efficient and ensure that overall resource consumption is reduced throughout the product life cycle.

Risk mitigation – penalties and threats to reputation
Looking at the historical aspect of sustainability, it has been around for many years - at the time when regulations in many areas were only being developed conflicts between supervisory authorities and companies in the supervised sectors emerged. The limits of how far one can go to get the most benefits were tested, which often resulted in significant fines.

This problem still exists today. According to the study carried out by McKinsey & Company, nearly one third of the corporate profitability (EBITDA) is exposed to the risk of penalties imposed by supervisory authorities. In some sectors, such as automotive, aviation and defence, this risk can be as high as 60% of a corporate profitability.⁷

Practical examples are not hard to be found. One of the most highlighted cases is the notorious “Dieselgate”. In 2015, the automotive giant Volkswagen was accused of misrepresenting the CO2 emissions, and the German company was subject to a fine of one billion euros. At the time, it was the largest fine ever imposed on a German company.⁸