Investors increasingly are hopping on the ESG train, while the COVID-19 pandemic, concerns over climate change, growing numbers of cyber incidents, global supply chain issues, economic gaps and social justice movements have become catalysts for spiking adoption rates in businesses.
Environmental, social and governance (ESG) is a framework for sustainability management, ethical practices and conscious consumerism that is gaining widespread popularity in the business world. But it's not a new phenomenon. Rather, it's a continuation of socially responsible investing that has gone mainstream. The term ESG officially originated in 2004 with the publication of the UN Global Compact Initiative's first "Who Cares Wins" report, and ESG investing has evolved and expanded since then.
Socially conscious investors and other stakeholders -- including employees, customers, regulators, suppliers and distributors -- want to know about a company's stance on socioeconomic factors, its sustainability efforts and its corporate governance processes. According to Bloomberg Intelligence, global ESG investment assets under management might surpass $50 trillion by 2025, one-third of the total assets it projects then.
While passing the investor and stakeholder test and setting up a successful ESG plan may seem challenging for any business, a well-conceived ESG strategy can help lead to various business benefits.
What is an ESG strategy?
An ESG strategy is an organization-wide approach that adjusts a company's environmental, social and governance practices to increase business sustainability. Now more than ever, the success and growth of a business are directly tied to a solid ESG strategy, which also involves conducting business in a way that provides long-term value without producing any negative effects on the environment or society -- or minimizes the effects, at least.
A good ESG strategy includes various sustainability factors -- such as a company's efforts toward reducing its carbon footprint, going green, encouraging diversity or introducing employee wellness programs. It also focuses on initiatives that matter the most to a business and are the easiest to put into action. As such, an ESG strategy paves the way for a company to gain investor confidence, earn customer loyalty, reduce operating costs and improve both asset management and financial performance.
5 ESG benefits for businesses
Using the ESG framework can bring tangible benefits to both businesses and investors. For businesses, it opens access to a larger pool of capital and promotes a stronger brand identity, and investors can demonstrate their values and often get returns that are similar to or better than traditional approaches through investments associated with an ESG-centric brand.
Here are five benefits of ESG for businesses:
1. Offers a competitive advantage
Companies participating in ESG efforts often gain a competitive advantage over business rivals. For example, a 2022 survey of 1,062 U.S. residents by GreenPrint, a sustainability tools provider that's now owned by PDI Technologies, found that 66% of the respondents would be willing to spend extra money to buy environmentally friendly products. Similarly, 70% of 400 IT professionals surveyed in 2022 by TechTarget's Enterprise Strategy Group division said they think their company would pay more than a 5% price premium for IT products from vendors that have strong ESG practices.
The various ESG metrics tracked and reported by companies are also important to consumers, employees, lenders and regulators. Company leaders who make efforts to improve labor conditions, promote diversity, give back to the community and take a stand on socioeconomic issues play a major role in strengthening a company's brand.
2. Attracts investors and lenders
The inclusion of ESG reporting in earnings reports or in separate disclosures is trending among businesses. Investors and lenders are becoming highly attracted to organizations that invest in ESG and use ESG disclosures to shed light on their sustainability efforts. A Gallup study released in 2022 found that 48% of investors are interested in sustainable investing funds, while a Dow Jones survey of 200 investment professionals, also conducted in 2022, projected that ESG investments would more than double over the next three years.
Public concerns caused by the pandemic, climate change and misuse of natural resources are driving investors to shift their lenses toward sustainable businesses and weed out the ones with outdated practices -- such as unfair wages, investments in fossil fuels, unsustainable agriculture methods and the manufacturing of nonrecyclable products. By providing a comprehensive view of their practices, businesses engaged in ESG initiatives can influence investment decisions and enable investors to pick a company that offers a sustainable future with a low risk profile.
3. Improves financial performance
ESG not only makes a business favorable to investors, but it can also improve the overall financial performance of a business. Even small efforts toward sustainability -- such as going paperless, recycling or making energy-efficient upgrades -- can improve a business's bottom line and ROI.
To keep up with ESG programs, companies must track key metrics -- such as energy consumption, raw material usage and waste treatment -- that can eventually lead to reduced energy bills and cost reductions. Companies that stay compliant with ESG-related regulations also have less exposure to fines, penalties and other business risks, which positively affects their bottom line.
For example, in 2020, food and beverage company Nestlé announced it would invest up to $2.1 billion by 2025 to transition from conventional plastics to food-grade recycled plastics. This shift is expected to help Nestlé reduce its carbon footprint and cut compliance costs -- especially in regions where there are stricter laws against the use of plastic packaging.
4. Builds customer loyalty
In a 2021 survey conducted by Accenture of more than 25,000 consumers across 22 countries, 50% reported that they had realigned their priorities when shopping for products as a result of the COVID-19 pandemic. These consumers are willing to pay extra for brands that align with their values and are more loyal to organizations that treat people well. Today's socially conscious consumers want to know what the businesses they support are doing for the greater good.
Companies that adhere to ESG principles can attract and retain more customers by being transparent and effectively communicating their ESG efforts to customers.
5. Makes company operations sustainable
Companies investing in ESG initiatives can sustain and adapt to an ever-changing landscape. For example, businesses that properly integrate ESG principles into their core operations are better able to identify cost-saving opportunities and enjoy lower energy consumption, reduced resource waste and an overall reduction in operational costs.
While ESG reporting is only mandatory for publicly traded companies in some jurisdictions at this point, it seems to be heading in that direction for the rest of the corporate world, too. Companies that overlook ESG policies now might have to deal with them later, in the form of legal, regulatory, reputational and compliance issues.
Is ESG for businesses of all sizes?
Sometimes, SMBs assume that their lack of resources can be a hindrance to ESG adoption and that their ESG efforts won't pay off in the long run. However, investing in ESG -- even on a smaller scale -- can always have a positive effect on a business.
While larger organizations may have extra resources to set up ESG policies or form high-level sustainability partnerships, SMBs can attract socially conscious investors without going through the bureaucracy and red tape that larger organizations face. Smaller businesses often are also in closer proximity to their customers and have ample opportunities to share their sustainability stories and connect at a deeper level.
ESG for the long term
An effective ESG plan demonstrates a company's commitment to risk management, cost reduction and care for the environment. It also indicates that a business has a strong stance on socioeconomic issues -- including customer satisfaction, labor standards, social injustice and sustainable investments -- and is willing to proactively evolve with the changing market.
With all its positives, ESG also faces some market and political backlash as critics -- including many Republican politicians in the U.S. -- claim that ESG investing isn't capable of producing the real-world results it promises. However, that doesn't seem to slow down ESG adoption rates among businesses, and ESG investments can in fact generate solid returns as a whole. ESG and sustainability funds brought lower volatility and often outperformed conventional funds in 2020 and 2021 and achieved similar returns in 2022, according to Morningstar index data.