A company’s corporate report on sustainability issues does not always give the reader confidence that the company understands sustainability issues, or that it’s managing them effectively. This article provides insights into effective sustainability management, and recommends that companies review their list of sustainability issues and manage those that are most material to the business.
Sustainability issues, challenges and concerns come in all shapes and sizes. Some are societal imperatives, such as improving the savings culture of citizens, or redressing imbalances through Broad-Based Black Economic Empowerment. Others are environmental, such as conserving water, or reducing the corporate carbon footprint in order to lessen a company’s impact on climate change. Then there are issues relating to governance, such as fairness of competition in the marketplace, ethical behaviour and the temptation to commit fraud or to corrupt government officials. Customer issues make up another large category, covering areas such as responsible labelling, customer education, ethical advertising, warrantees, etc. These issues can be direct and indirect, as distinguished in the three carbon footprint scopes, or determined by how far back in the supply chain an issue may affect the business.
Many of these issues are automatically listed in the integrated report accompanied by basic performance information. It is questionable, though, whether analysts and asset managers in the investment industry take much notice of this information when attempting to evaluate their buy, sell, or hold decisions.
Growing consumer awareness drives response
How well do companies really understand their sustainability issues and how effectively do they manage them? To be fair, this question should be given some context. Thirty years ago, consumers of sports shoes in the West were not asking about the working conditions in sweat shops in the East. Likewise, the only concern with fossil fuel consumption revolved around political instability in the Middle East, rather than the impact on the climate of rising CO2 levels. Cartels and oligopolies were practically enshrined in legislation (remember our agricultural produce control boards?) and nepotistic dealings and old-boy networking was the norm for business conduct.
Today, public consciousness has evolved through social scrutiny, government legislation and stricter reporting standards, resulting in an environment where most companies realise the importance, at least to reputation and to licence to operate, of strategically managing non-financial issues relevant to their industry.
While allowing that a more demanding environment increases the complexity of compliance, one would also expect that industry should be far better educated by now as to the expectations of society. Surely the price-fixing scandal in the milling industry back in 2005 would have ensured better corporate governance to prevent collusion practices from re-occurring elsewhere?
And yet, this is exactly what we read in the press again today – that collusion in the construction industry was “almost entrenched”, according to Oliver Josie, acting deputy commissioner of the Competition Commission, resulting in many municipalities paying substantial premiums for infrastructure development in the run up to the 2010 Soccer World Cup.
Measurement without management
It would appear that companies continue to experience difficulty in managing the softer, so-called sustainability issues that so often emerge to dent their performance and future prospects. Why is this so? After all, most companies list their issues in their annual reports, providing a surprising amount of data on performance. Surely, if we go by the saying: ‘that which is measured is managed’, companies should be on top of these issues? Let’s unpack this ‘measurement equals management’ statement by looking at typical reporting on sustainability issues and its usefulness.
Often environmental issues, such as carbon footprint, energy consumption, water consumption, waste to landfill, etc., are listed in a table of material issues along with their absolute values, such as ‘453 288 tonnes of CO2’ and ‘335 198 kilolitres of water’. In the management disclosures (to use the GRI jargon), companies express their concern for the impact of these issues on society and their commitment to doing their bit to improve matters. However, in hardly any of these reports is there an explanation of the long- or short-term implications for the business of falling short on their commitment.
Rarely is any comparative performance information given that can assist the reader in understanding the impact on the business. If another zero was added to the 453 288 tonnes cited above, practically no one would notice, not even the company directors themselves. And where are the targets that the company is committing to achieve in a certain time period?
A mature approach
Some sustainability issues receive far more mature treatment in today’s integrated report. Employment equity (EE) is one such issue. This sample text from Distell’s 2013 integrated report is a case in point:
“Our employment equity (EE) score weakened to 1.89 this year (2011: 2.2), due to the new dti compliance targets (six to ten-year target). This remains one of our most challenging B-BBEE performance areas due to our low turnover rate at senior management level.
We remain committed to grooming the future leaders of Distell. Our strategy focuses on retaining black technical staff through competitive salaries and benefits while developing skills internally to provide a talent pipeline of competent black staff ready for management. As discussed on page 23, 67% of our training spend and 95% of internship spend is allocated to previously disadvantaged individuals (PDI).”
Note that the report provides comparative performance figures and makes it clear why EE is a challenge. It goes on to show how the company is responding to the issue. It doesn’t, though, go as far as to explain how its response to the issue will impact the company in the short or long term.
Confused signals cast doubt on management
From the above examples, it is clear that numbers without context, lists of unsubstantiated actions, or vague commentary in a report cannot give the company’s stakeholders an understanding of how the issue is being managed. In fact, the opposite may be true. Such reporting might actually cast doubt on the company’s ability to deal with the long-term issues confronting the business.
Asset managers seem to think so too. While Coronation’s integrated report declares that it considers a company’s performance regarding triple bottom-line reporting before deciding to invest, including sound quantitative and qualitative analysis of all significant ESG-related issues, it notes: “In practice, a business with an ambiguous ESG profile requires a much higher hurdle rate to justify inclusion”.
Business case – the missing link
Shareholders and investors are particularly interested in how a business manages issues that are of significance to its ability to generate cash flows into the future. Management of sustainability must therefore revolve around the business case. This needs to be the first step, for once business leadership understands the significance of its issues to the business, it is far more likely to think and act strategically.
Understanding business significance (also referred to by reporters as ‘deriving materiality’) requires proper analysis of the external environment, including economic and legislative risks, market opportunities and threats, as well as of stakeholder concerns, such as from customers and affected communities.
The result of such analysis may reveal, for example, that the direct carbon footprint of a bank has no business significance. On the other hand, the issue may have a lot more significance in the company’s corporate finance division, which could be dealing with clients exposed to environmental risks. Companies in heavy industry should be evaluating a number of potential impacts: the direct cost of relying on Eskom for power, the impact of potential power outages, the likelihood and impact of a possible carbon tax, and the damage to the company’s reputation of polluting neighbouring communities with emissions from its furnaces.
Towards policy-led management
Once the company understands the significance of an issue to its business, it is far more likely that the company’s leadership will take responsibility for managing the issue strategically. The next step is to establish an approach, or a policy, that sets direction and commits resources to action. Without a policy, activities required to make an impact are either insufficient or are discontinued due to lack of budget. Policy not only gives authority to taking action, but also provides direction in a considered manner. The policy should also contain an indication of accountability from the company’s leadership.
Particularly problematic is the ‘off-the-shelf’ policy that is acquired and adopted for compliance reasons without management applying their minds as to its appropriateness or impact. For example: “We have a zero-tolerance approach to safety” is not an effective policy. More useful would be: “We will only mine where and when we have established conditions that can accommodate a level of safety better than an LTIFR of 2.0”. Such a policy gives a clear guideline that can be used when evaluating new mining proposals. If the safety risk factors are too great, management has to go back to the drawing board.
Sustainability reports are rife with accounts of what is being done without any reference to what is being achieved.
Evaluation, performance and response
The next step for management is to derive indicators that allow measurement of performance. Sustainability reports are rife with accounts of what is being done without any reference to what is being achieved. Energy-efficiency actions are more plausible if savings can be quantified, or costs are related to an ROI. Even if the outcomes are less direct, such as with training programmes or diversity workshops, the intended benefits of this effort should be articulated and monitored.
Evaluation leads naturally to reporting on progress, or performance, and this in turn demands from the company a meaningful commentary on the performance. If safety performance slipped, was it a result of a more risky environment, or had the safety-first training programme been allowed to lapse? Finally, related adjustments can be reported, such as renewed commitment to a better and more engaging safety training programme.
Relevance makes reporting easy
Sustainability and integrated reports are the public face of corporate sustainability. These reports don’t always do a great job of making the connection between real issues that impact the sustainability of the business and the appropriateness of the corporate response to these issues. Reporting can never be a pure proxy for quality of management, but if the management of a key issue is flawed, then reporting on it is no more than a veneer that is easily exposed.
Applying leadership investment to managing key issues takes more time and energy than simply talking about them in corporate communications. If the issues are less relevant to the business, then any significant investment becomes a labour of wasted effort, and is confusing to shareholders. Where issues are relevant, management needs to buy into the value of a mature and considered response. Creating policy, formalising management processes, and useful monitoring and evaluation will gradually and surely take the business forward. Reporting the progress then becomes easy and a lot more meaningful.
Written by Rob Worthington-Smith
Published on the Trialogue Website: March 17th, 2015