In today's highly competitive markets, it is critical for manufacturers to embrace environmental, social and governance (ESG) initiatives. While doing good may be its own reward, it is becoming increasingly evident that sustainable manufacturing processes and ethical business practices produce financial benefits. And mounting pressure from investors, customers, employees and regulators is rapidly transforming ESG from a laudable goal into a business necessity.
WHAT IS ESG?
In simple terms, these initiatives focus on three areas:
- The environment component considers your company's impact on the environment, including the energy it uses, the waste it produces and the resources it consumes.
- The social element examines your business's relationships with people, communities and institutions. It includes fair labor practices, worker health and safety, diversity and inclusivity, and your company's impact in general on the community or communities where it does business.
- Governance includes policies, practices and procedures your company adopts to govern itself. Considerations include business ethics, openness and transparency, legal compliance, executive compensation, supply chain management, data protection and product quality and safety.
To be a good "corporate citizen," it is important to recognize the impact of your company's activities on the environment and the people it interacts with — and to implement business practices that minimize any potential adverse effects.
DO ESG MATTERS MATTER?
Pressure on manufacturers to adopt ESG practices comes from multiple fronts. Customers are increasingly considering ESG issues — particularly sustainability, environmental impact and fair labor practices — when making purchasing decisions. Similarly, a growing number of influential investors are making ESG performance a priority when deciding how to invest their capital. These stakeholders are interested not only in your company's ESG record, but also in the records of your suppliers and other business partners.
Moreover, governments around the world are prioritizing ESG practices. Failure to comply with laws or regulations related to environmental issues (such as pollution and carbon emissions), social issues (such as labor relations, worker health and product safety) and supply chain issues (such as the use of conflict minerals and human rights violations) can lead to fines, remedial costs and reputational damage. In addition, governments may impose ESG standards on the companies they do business with that go beyond what the law requires, placing additional pressure on manufacturers that rely heavily on government contracts.
Changes in the labor force are also having a significant impact. Manufacturers are facing a growing "skills gap," which requires them to compete for a shrinking pool of talented workers. And because younger workers are more likely to consider a potential employer's ESG practices in deciding where to work, ESG initiatives can provide companies with a competitive advantage.
WHAT ARE THE BENEFITS OF ESG PRACTICES?
Adopting strong ESG practices may produce several significant financial benefits, including:
Customers are increasingly considering ESG practices in making purchasing decisions. Some may even be willing to pay more for "green" products.
Focusing on sustainability can help companies identify ways to reduce their energy consumption (See Sidebar: Green Factories Reduce Energy Costs), streamline their supply chains, eliminate waste and operate more efficiently. ESG initiatives can also help companies avoid the costs associated with government intervention and liability concerns, such as product liability lawsuits, recalls or boycotts.
Improved Access to Capital
ESG initiatives can provide companies with access to low-cost capital. Investors are increasingly considering ESG issues when choosing companies to invest in. Plus, companies that implement ESG considerations are often perceived to be lower-risk investments.
Greater Ability To Attract and Motivate Talented
According to consulting firm McKinsey, "a strong ESG proposition can help companies attract and retain quality employees, enhance employee motivation by instilling a sense of purpose, and increase productivity overall."
Generally, good ESG practices translate into better financial performance. According to McKinsey, more than 2,000 academic studies have been conducted on this subject. About 70% of the studies "find a positive relationship between ESG scores on the one hand and financial returns on the other, whether measured by equity returns or profitability or valuation multiples."
To take advantage of these benefits, it is critical to communicate your ESG performance to customers, investors, business partners and other stakeholders. Many companies today are combining ESG information with financial performance data in an integrated report. In response, proposed Securities and Exchange Commission rules may require the disclosure of certain ESG information. And reports that combine financial and nonfinancial information provide a more accurate picture of a company's long-term potential to create value than traditional financial statements.
SIDEBAR: GREEN FACTORIES REDUCE ENERGY COSTS
Helping to save the environment may be reason enough for manufacturing plants to "go green." In addition, there may be significant financial benefits from reduced energy costs.
To identify opportunities for reducing energy costs, consider conducting an energy audit to evaluate the efficiency of your equipment, systems and devices. Given the high cost of electricity and other utilities today, investments in energy-efficient lighting and equipment and in alternative energy sources, such as solar power, can pay off over the long run. Also, many manufacturers use smart devices, such as smart thermostats, to minimize unnecessary energy use.
You should also take advantage of federal, state and local tax credits and other incentives for investing in energy-efficient equipment and building systems. Contact your ORBA tax advisor for more information.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.