On Purpose: The Basics of Measuring ESG Impact
As more and more companies adopt socially and environmentally responsible business practices, they raise a thorny question: how do you measure and report on the social and environmental impact of these initiatives? It’s a question that’s becoming more pressing for companies, as this data is now part of how they compete to win business and attract investors.
It’s a journey that began in the early 1990s, when the concept of CSR (corporate social responsibility) started making its way into corporate strategy. Back then, the key channel for the disclosure of a company’s social and financial impact was the CSR or sustainability report. This document was separate from the company’s financial report and was often largely an exercise in public relations.
Things began to change in 1997, when a non-profit organisation called the Global Reporting Initiative (GRI) started offering companies guidance on sustainability reporting. Today, around three-quarters of the world’s largest 250 companies use the GRI, as do about two-thirds of the N100 (5,200 companies comprising the largest 100 firms in 52 countries).
When it comes to climate change, the framework developed by the Task Force on Climate-related Financial Disclosures (TCFD) has been rapidly gaining acceptance. Those supporting its approach include companies with a collective market capitalisation of almost $20tn.
Much of the impetus for impact measurement is coming from investor-led standard setters seeking robust data with which to create ESG (environmental, social and governance) investment portfolios. One example is CDP (formerly the Carbon Disclosure Project), which helps investors with more than $110tn in assets request that companies disclose to the CDP their risks and opportunities related to climate change, water security and deforestation.
More recently, asset managers such a BlackRock and State Street Global Advisors have been pushing companies to align their reporting with the disclosure guidelines of the Sustainability Accounting Standards Board (SASB), which was founded in 2011 to develop sustainability accounting standards.
Adding to investor pressure are regulatory developments. While the EU has led on pushing for climate-related reporting regulation, others are following. In the UK, for example, the TCFD framework will become mandatory for some companies in 2022.
Meanwhile, in May the Biden administration issued an executive order instructing Treasury secretary Janet Yellen and the Financial Stability Oversight Council to work on reducing risks to financial stability. One result could be a mandate for US banks and companies to disclose their climate change risks.
None of this makes it easy for companies to measure and report on the social and environmental impact of their commercial activities, however.
First, they need to identify exactly what – from carbon footprint and water consumption to labour conditions and gender diversity – should be the focus of their measurement efforts. It makes no sense, for example, for a legal firm whose employees are professionals based in London or New York, to spend time assessing its impact on labour standards in developing countries. On the other hand, this would be a key sustainability indicator for a global clothing manufacturer.
This is known as “materiality” – the environmental, social and governance factors likely to affect the operations and financial or operating performance of a business, depending on its sector and type of commercial activities. In recognition of this, SASB has developed a set of corporate sustainability accounting standards that cover the different issues that are material for 77 industries.
Companies also need to establish the points in the value chain at which they need to focus most on impact measurement, depending on the nature of their business. For some, impact may occur largely within facilities they own and operate. For consumer goods companies, most of the impact may come during use of their products once in the hands of consumers. For others, suppliers’ operations may represent their biggest social or environmental impact.
In fact, the supply chain presents one of the biggest measurement headaches for companies, particularly given that today supply chains are global and increasingly complex.
Take Gap, the global apparel company. Globally, it has more than 3,300 company-operated stores and more than 500 franchise stores and thousands of suppliers. This means monitoring everything from the environmental impact associated with its retail stores and distribution operations to the labour standards in the factories from which it sources its products, which are often in developing countries.
When it comes to environmental impact, one option is to use life cycle assessments (LCAs) to capture the impact of products along the entire value chain, from raw material extraction and production to transport, use and disposal or recycling. This is the approach at Novozymes, the Danish biotechnology company. The advantage of the LCA assessment, says the company, is that it can also use its data to help customers verify their sustainability claims.
Whether focusing on materiality or LCA assessments, an important part of the process for companies is to conduct a cost-benefit analysis to make the business case for the investments needed in the transition to more sustainable business practices.
This means first establishing a baseline for consumption of resources such as power and water and assessing how much can be made in savings – and over what timeframe – from investments in new technologies such as sensors to monitor water leakage or energy efficiency measures.
Sustainable costs and benefits
Of course, the cost-benefit of some things is easier to measure than others. In 2016, for example, FedEx said that by implementing efficiencies in its flight operations and replacing older airplanes with more fuel-efficient models, it had saved more than 153 million gallons of jet fuel from a 2005 baseline (while avoiding carbon emissions equivalent to those generated by more than 150,000 homes in one year).
By contrast, investments designed to attract consumers looking for more sustainable products or services may pay off in increased sales, but that is harder to measure and requires more long-term planning than investments in cutting fuel, water or energy consumption.
Other cost considerations include the financial impact of possible disruption to the operations during the implementation of sustainability initiatives or the shift to new business practices, the investments needed in re-training employees and the cost of marketing efforts required to promote new sustainable goods and services among consumers.
Assigning responsibility – Including HR
Whether measuring cost or impact, a company also needs to build the resources necessary to manage the evaluation process. And while impact verification may require the service of third-party auditors, internal resources also need to be devoted to managing reporting and disclosure demands. This means assigning responsibility for collecting and managing the data and providing the appropriate training to employees in those roles.
At the same time, companies need to take an enterprise-wide approach to impact measurement. When, for example, Gap implemented the SASB standards, the process was comprehensive. Its global sustainability team engaged with departments and committees across the enterprise, from finance and legal to supply chain management.
Similarly, at Anheuser-Busch InBev, the world’s largest brewer – which uses standard setters and measurement frameworks that include GRI, SASB and CDP – rather than creating a dedicated ESG reporting team, different business units, from logistics to procurement, are all given responsibility for keeping track of the data.
This is perhaps the most critical element of successful impact measurement. Companies will, of course, need to develop internal capabilities, build the right expertise, train staff and create new executive roles for the oversight of the process. The human resources department can, for example, play a role in ensuring company-wide compliance with diversity and inclusion initiatives, while learning and development teams can ensure that staff understand the operational implications of the company’s environmental goals.
However, equally important is treating impact measurement as a holistic endeavour and implementing it across departments and business units. Companies need to secure buy-in from everyone from C-Suite executives to operations staff and sales teams and, as is the case in any form of cross-functional collaboration, ensure that impact measurement is uniformly applied across the enterprise.
In some ways, the need to standardise impact measurement internally reflects what is happening externally in the world of standards setting, where work is being done to harmonise what is known as ESG’s “alphabet soup” – that is, the crowded landscape of different organisations and measurement methodologies.
Whether internally or externally, however, recognition is growing of the need for standardisation in ESG measurement. For if assessments of corporate impact – whether on biodiversity or local communities – are to be useful to consumers, regulators, investors and companies themselves, they must be comparable. And this means making sure everyone is talking the same language.
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