As economies reopen after lockdown many organizations are finding the competitive landscape has shifted beneath their feet. ...
Too many companies still focus on extracting value from society. But being stuck on a “low road” of negative societal impact can be costly for their businesses in the long run. They underestimate the associated ESG risks, particularly from their core business. And when these ESG risks materialize, they are caught flat-footed, facing high costs to deal with the consequences, and possibly fundamental changes that make their business model obsolete.
Instead, companies should be looking to take the “high road” to positive societal impact, which will ultimately generate rewards for both shareholders and stakeholders.
To help executives achieve this, we present a framework for the journey required to shift from negative to positive impact on society. The approach is based on our research on the link between sustainability and business performance and experience working with executive teams worldwide on responsible governance, long-term strategy and sustainability. The framework has been shaped by discussions in IMD’s MBA program and with corporate clients.
But first we explain why companies get stuck on the low road of value extraction and negative societal impact.
Companies should be looking to take the “high road” to positive societal impact, which will ultimately generate rewards for both shareholders and stakeholders.
Although value extraction can be very expensive for society, the costs of ESG risks to shareholders often are not apparent enough to dissuade companies from staying on the low road. Increasing market power creates the temptation to engage in anti-competitive behavior and exploit weak stakeholders rather than become more innovative or efficient. And creating societal value is challenging when the bottom line is under pressure, or shareholders are clamoring for payouts. It is often easier and faster to pursue value extraction. This happens in several ways:
Value extraction can have a corrosive effect on the culture of the firm and its ability to generate competitive as opposed to extracted profits, because it stifles the innovation needed to create real value.
In 2007 Purdue Pharma pleaded guilty to misleading the public about the risks of opioid addiction from its product Oxycontin. The company agreed to pay a fine of $600 million and three executives pleaded guilty individually. But deception was so culturally embedded that Purdue persisted with the business for more than a decade, until October 2020 when it pleaded guilty to criminal charges for its role in exacerbating the US opioid epidemic and paid an $8.3 billion settlement. Purdue was subsequently shut down.
Too many executives believe they can change their company’s societal impact by publishing a sustainability report communicating initiatives on environmental and social responsibility, without taking real action.
Despite adopting a green logo and continually talking about safety, BP for many years cut costs and sacrificed safety to compete for leadership in the oil industry with risky deep-water exploration and extraction. The 2010 Deepwater Horizon disaster was one of the most massive oil spills in history. In addition to huge environmental consequences, 11 rig workers died and 17 were seriously injured. The oil spill had direct costs to the company of more than $65 billion.
Some companies refuse to accept the evidence on how they are harming society or the environment. Instead, they mount an intensive campaign to show that their detractors are distorting reality and out to get them.
When, in the 1950s, research evidence was presented to the tobacco industry that smoking might be cancerous, the industry quietly funded numerous studies to prove the opposite. But the evidence of smoking’s cancerous effects accumulated and civil society in developed countries put increasing pressure on politicians until smoking was banned in public buildings. The industry shifted to aggressive advertising in developing countries, but the ethical duplicity and health implications of this stance have become too difficult to defend in the presence of globalized information.
Sovereign wealth funds, institutional asset managers, wealth managers, and family offices have responded to heightened customer concern about environmental and social issues by favoring investment in companies that take their social responsibility and greenhouse gas emissions seriously. The $1 trillion Norwegian sovereign fund has excluded a set of oil companies from its portfolio, for example.
The CEO of Shell, Ben van Beurden, initially underestimated such forces, arguing that setting hard carbon emission targets was a “superfluous experience”, but after coming under pressure from investors he announced in 2018 that the company would set short-term targets to cut its carbon footprint.
Many of the largest companies believe what is good for them is good for society. They accumulate so much market and political influence that they feel they can shape reality to their advantage. When significant opposing forces emerge, they overestimate their ability to continue shaping their environment.
David Cicilline, chairman of the US House of Representatives Judiciary Committee, said in July 2020 that Apple, Amazon, Facebook, and Google needed to be properly regulated and held more accountable, and that some of them should be broken up because of their monopoly power. In 2019 HSBC estimated that “nearly 40% of Facebook’s valuation (was) on the line from regulatory risk”. Yet, despite a new administration in Washington in 2021 and a Federal Trade Commissioner committed to curbing their power, there is little sign of any change in the behavior of the big tech companies.
In a world of global information, aggrieved customers, angry voters, and the threat of radical political change, executives in democracies risk being punished if they ignore the impact of their core business on society at large, and superficial actions will not convince anyone.
Anglo-American and BHP have converted old coal mines in Australia into green hydrogen energy hotspots, and Mark Zuckerberg set up the independent Facebook Oversight Board, to render binding decisions on whether content should be taken down. But neither of these moves addressed the value extraction in the companies’ core activities, environmental exploitation in the case of the miners and the monetization of user information in the case of the tech giant.
Getting from the low road where the company is extracting value from society onto the high road where it makes a positive societal impact involves a journey of several steps:
The value a company creates for society beyond shareholder value comprises the net benefit stakeholders get from participating in the company’s business, for example the value employees and hosts derive from working with Airbnb. The value created for society also includes the benefits to stakeholders not directly involved in the company’s business, like the communities in which Airbnb operates, or benefits to the environment from telework and green energy that reduces carbon emissions.
In contrast, value extraction reduces stakeholder benefits or steals value from society at large.
But companies have a choice about the impact they have on society. Will companies benefiting from telework compensate employees for the cost of working at home, or extract value by pocketing the benefit? Will tech giants benefiting from the surge in online activity use the proceeds to strengthen their monopoly positions in advertising and distribution, or create more open and fair business ecosystems protecting personal information and sharing value with their users?
A company’s impact on society depends on whether the value created for society beyond long-term shareholder value is greater or less than the value extracted, and on the main nature of its influence – social or environmental. Companies with negative societal impact fall into two main categories with very different paths to the high road: real-asset-light subjugators that extract value mainly from their stakeholder ecosystem, and real-asset-heavy exploiters that extract value mainly from the environment. To transition to the high road, subjugators need to transform or adapt their stakeholder relations, while exploiters need to replace or reconfigure their real assets.
The next step is to commit to transforming the core business using a growth opportunity to motivate the shift. Decisive leadership is needed to shift away from a position in which sustainability is seen as a burden that has to be borne to satisfy compliance requirements. Beware of resistance in the form of hubris and the temptation to continue easy value extraction or make bigger payouts to shareholders.
The test of sustainable leadership intent is a commitment to opportunities that will truly transform the core of the company, not merely create some positive value on the margins. Attempts to transform peripheral parts of the business, rather than the core, will expose management to attacks of green or whitewashing.
Consider this real setting experienced by one of the authors:
When an executive for a major oil company presented his division’s efforts in renewables such as solar and wind farms to a group of about 25 owners and top executives of medium-sized companies, the audience was not convinced. “You are only a small fraction of the sales of the company,” said one participant. “You are trying to make the whole company look good when you are just a side activity,” said another. “If you as a company believe so much in sustainable energy, why don’t you exit the old-fashioned oil business?” asked a third.
Focusing on a megatrend that affects the core business is key to creating a strong business case to justify taking the high road in terms of long-term shareholder value, especially when the legacy business is very valuable. The biggest value-creating opportunities will involve the megatrend where the company has its main societal impact.
For real-asset-light companies with social value extraction, taking the high road involves seeing pressure for greater social responsibility as a growth opportunity to be exploited.
International telco Telenor identified the UN’s 2030 Agenda for Sustainable Development and the Global Compact Principles as a growth opportunity in its transition from the mature voice network business to data- and internet-based services. It describes SDG 10 (Reduced Inequalities) as part of its global business strategy, because of the empowering capabilities of mobile phones.
Airbnb was initially seen as an exploiter, a scourge on livelihoods and society. The continued growth of its business model was driven by landlords using Airbnb to turn residential apartments into illegal hotels for tourists at the expense of rented housing for locals. But CEO Brian Chesky said prior to its listing that he was committed to making Airbnb a stakeholder company serving both society and shareholders, by ensuring that home-sharing grows responsibly and sustainably, and through responsible employee relations.
For real-asset-heavy companies with value extraction from the environment, taking the high road requires seeing sustainability as a growth opportunity.
A few months before the 2009 United Nations COP15 climate summit in Copenhagen, the Danish Oil and Natural Gas Company (DONG, later renamed Ørsted) adopted a radically new vision. The company, which made 92% of its 2008 revenues from fossil fuels, announced it would instead seek to generate 85% of its energy from renewable sources, primarily wind projects, by 2040.
The Finnish company Neste was a traditional oil-refining company with a research and innovation focus. In the early 1990s, management identified biofuels as a growth opportunity, and the company has maintained heavy investments in biofuels since then, despite a number of setbacks along the way.
Taking the high road successfully requires the right capabilities to exploit the opportunities. The challenge for subjugators is to develop the right stakeholder relations and for exploiters the right real-asset portfolio.
When the existing competitive advantage of a firm’s stakeholder relations is decaying rapidly, transformation is required. For subjugators transforming their stakeholder relations, innovative value propositions and organizational agility are key to success.
Telenor’s advantage in the historically stable telecom industry had come from its scale and cost competitiveness in Norway, Sweden, and Denmark. To accelerate the switch from voice to data, it had to transform relations with its customers and continually offer them completely new value propositions. It also reinvented its approach to talent management to “nurture and appreciate the risk-takers and innovators”.
When stakeholder relations are an ongoing source of competitive advantage but are contested, subjugators must adjust these relationships to deal with the threat.
To address concerns over the social legitimacy of its business model, Airbnb struck deals with officials in selected cities to collect and deliver taxes from its hosts. The company’s Open Homes program helped more than 25,000 people in need to find temporary housing in 2019, and when the pandemic hit, hosts got payments to cover the cost of COVID-19 cancellations and a relief fund was provided for those who rent out their own home and needed help paying their rent or mortgage.
When the whole real-asset portfolio is threatened by the damage it does to the environment, exploiters must replace it. Typically, this involves a fundamental change in technology and transformation of the business portfolio through divestment, liquidation, acquisition, investment, and/or innovation. Financing the transformation is often a challenge, and the timing of the disposal of old assets needs to be calibrated so that it provides the cash flow needed for the acquisition of new sustainable assets.
To facilitate and finance its transition to lower emissions, DONG shifted its operations and asset portfolio from coal to gas. But then international gas prices dropped, and its debt was downgraded. It was nearing bankruptcy when Goldman Sachs agreed to inject $1.2 billion into the business for an 18% stake. The company’s financial crisis persuaded the government and employees to accept a new focus on wind and the restructuring and divestment of its oil and gas business. To complete the transition to renewables, DONG later added solar photovoltaic and storage solutions to its portfolio. In 2016, DONG completed its IPO, as a renewable pure play company under its new name Ørsted.
When only parts of the real-asset portfolio are threatened by damage done to the environment, exploiters can creatively reconfigure the rest of the portfolio to substitute sustainable for unsustainable assets.
In 2009, when Matti Lievonen became CEO of Neste, the company faced dramatic challenges including a sharp fall in oil prices, declining refining margins and new carbon emissions legislation in the EU. Neste had well-developed capabilities on the demand, refining, and distribution sides of the business and reconfigured the rest of its business model around renewable fuels derived from organic waste. The company is today the world’s largest producer of renewable diesel made from organic waste, a product that reduces GHG emissions by up to 90% compared with fossil fuels.
Once the transformation of the business core is addressed, it can be complemented by creating societal value with the company’s ancillary activities: companies that have transformed their real assets can focus on building new stakeholder relations, while those that have transformed their stakeholder relations can work on the impact of their real assets.
Neste went beyond the reconfiguration of its real assets and collaborated with multiple stakeholders to improve its societal impact. It had been operating in organizational silos, but switched to what it called an outside-in approach aimed at changing mindsets around what it called complementary learnings. The Neste business ecosystem was then extended to co-create value with customers by understanding their specific needs.
After locking in the transformation of its core business, Ørsted also began enhancing its stakeholder relations. It shifted its customer focus from governments towards new clients in global markets, especially North America. In financing, it moved from relying partially on government subsidies to increased funding from private investors. And it started working with partners on production initiatives, such as its cooperation with BP on the development of industrial-scale green hydrogen in Europe.
Having transformed its stakeholder relations, Telenor started reducing the environmental damage associated with its real assets, especially electronic waste (e-waste). In 2019, around 225,000 mobile handsets and batteries were collected and recycled, 3,900 tons of e-waste was removed from active operations, and 90% of that was resold or recycled.
Creating high value for society requires best governance practices that promote value-creating opportunities for direct and indirect stakeholders (people and planet) and shareholders (profit).
Value-creating stakeholders must be rewarded for the long-term value created for the firm, with compensation tied to sustainability goals, and a corporate purpose and culture that involves the whole organization. Greenwashing and whitewashing of any remaining value extraction should be resisted, and ESG risks associated with possible backsliding need to be tracked.
But alert governance is also needed to ensure that positive societal value is not created at the expense of long-term shareholder value. ESG stars are businesses that are able to combine a focus on people, planet and profit.
Telenor’s commitment to quality governance was given particular impetus in 2016 when two of its executives resigned over the company’s ownership stake in Amsterdam-based peer VimpelCom, which admitted to bribing an Uzbek official. This prompted the group to set up a more unified and consistent compliance function. It also changed performance reviews to ensure a stronger focus on non-financial performance, ethical business conduct, and sustainability. A specific sustainability and compliance committee constantly assesses how the company serves society, and the stock price has quadrupled since the IPO in 2001.
Ørsted integrated governance for people, planet and profit by having one executive oversee responsibility for corporate strategy and regulatory affairs, as well as sustainability, to track progress towards holistic objectives. The company is on track to phase out coal by 2023 and reduce its CO2 emissions by 98% by 2025, and in the three years after its listing, the stock price soared by over 165%.
Quality governance for people, planet and profit can only succeed if it incorporates financial performance. In June 2020, Danone’s shareholders, at the behest of Chair and CEO Emmanuel Faber, agreed to alter its bylaws and declare the sustainability champion an “enterprise à mission”, a purpose driven company. Nine months later, Danone’s board fired Faber after a marathon meeting driven by two activist shareholders. The board agreed with the activists that Danone was suffering from chronic financial underperformance. An adviser commented: “It is all well and good to topple the statue of Milton Friedman [as Faber said when he put purpose above profits]. You can do that (only) when your financial performance is better than competitors and your governance is above reproach.”
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