By Lloyd Macfarlane
Michael Porter, one of the world’s most respected management theorists, argued that there are only two ways for firms to compete: by charging a lower price, or by differentiating their products or services from those of their rivals.
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The modern value proposition increasingly incorporates factors that are not just related to the product or the service (such as price, quality or relevance) but to factors associated with the organisation itself, such as reputation, transparency, accountability and corporate performance against sustainability targets, for example.
Companies that have embarked on a sustainability journey can use the reporting process to distinguish themselves in the value chain by targeting and marketing points of differentiation.
Differentiation – Product, Service and Company
Companies spend time and money trying to differentiate their offerings under the abovementioned [showad block=null]headings, in order to be more attractive to their target markets. Differentiation is a basic economic principal that promotes competitiveness, and one that has been focussed on by many of the classic theorists, such as Edward Chamberlin (Theory of Monopolistic Competition, 1933).
Customers make purchases based on the value propositions presented by their suppliers. A value proposition (in this context) is quite simply the unique value offering that the customer will receive from a transaction (as compared to value propositions from others).
A number of factors go into the assessment of value and in the first instance the product or service is usually assessed for relevance (or usefulness), desirability, price and quality. However, the product or service is delivered by a company whose profile is of increasing importance in the procurement process. This means that the assessment of value is being broadened to include factors that relate to environmental, social, governance or empowerment (SA) credentials. Far more opportunities for brand and company differentiation are emerging in the value chain.
Drivers of differentiation
Forces and pressures are usually responsible for innovation and creativity. If there is no need to change, re-package or improve then there is unlikely to be much differentiation.
Some of the forces/ circumstances in which differentiation is more likely to occur:
Mature markets or sectors:
Companies in mature markets or sectors are more evolved and value propositions are more similar, so there is a greater need for differentiation, particularly with service providers that have less opportunity for tangible innovation.
Take established cellular service providers for example – call costs and network coverage of competing companies can be almost identical and yet these companies spend millions letting you know how different they are by building a corporate identity that you can relate to. Conversely, in new markets or new sectors (and in good economic times) less differentiation is apparent – there is less need for differentiation when there is no threat from competition.
Economically stressed markets:
When margins are tight and procurement budgets have been cut, buyers look more closely at the value proposition and sellers tend to increase levels of innovation and differentiation. The world has been on a tough economic treadmill since the collapse of the financial markets in 2008/9 and this has seen the emergence of new ideas and not surprisingly corporate sustainability has enjoyed prominence in this regard.
Regulated markets or sectors:
Regulation or supply chain policies can elicit forced (e.g. tax or incentive) or voluntary (e.g. reporting) responses from suppliers. Government can use incentives to speed up change and perhaps the best example of this is carbon taxation which will be introduced in South Africa in January 2016.
Carbon tax will see the need for more measurement and management of carbon across value chains and this will bring about procurement policies that require suppliers to measure their carbon footprint. These policies may further evolve to specify an acceptable range of carbon emissions per unit of output or per square metre of operations in any given sector, for example.
Supply Chain Sustainability
The real power of the economy lies in procurement. The quantity and availability of products and services is directly affected by demand and because demand is affected by supply chain/procurement policies, the supply chain can be a most powerful agent of change.
Companies are introducing sustainability into their supply chains not only because it’s the right thing to do, or because they are under pressure to do so, but because they see the value of doing so in the context of their medium to long term strategies.
The United Nations Global Compact (UNGC) is encouraging corporate leadership in this regard and many businesses use the ten UNGC principles to inform their supply chain policies. Similarly, the recently launched Global Reporting Initiative (GRI) G4 Guidelines contain much emphasis on supply chain sustainability, traceability and chain of custody.
The next big opportunity – supply chain differentiation
The most significant recent step up in corporate sustainability is the increased emphasis being placed on sustainability in the supply chain.
Procurement policies that encourage and even enforce certain key sustainability principles can meaningfully affect markets and should be noted by suppliers looking for opportunities to differentiate.
Importantly, supply chain policies take a closer look at indicators relating to companies and not simply their products or services.
This is placing more emphasis on environmental, social and governance issues and represents an exciting new opportunity for differentiation for those companies that are first to move.
Risk, reputation and leadership
Large customers are auditing suppliers using various criteria, but generally these audits will seek to establish:
• Whether there are any risks in an association, based on how the supplier’s business is conducted.
• Whether the supplier has a reputation that could cause any harm.
• Whether the supplier’s reputation could add value
• Whether there are any examples of leadership that could be amplified for mutual advantage.
Supply Chain Differentiation – Strategic Approach
Any random approach to differentiating under sustainability indicators is unlikely to succeed in the medium to long term. This is mostly because customers are beginning to use sustainability frameworks and systems to determine a holistic and materiality- based set of procurement indicators in their supply chains.
Therefore, an authentic approach must be driven by a sustainability plan that includes clear statements of objective and vision, where these have been informed by a process of identification and assessment of material issues for the company.
Companies are increasing the degree to which they report on sustainability in their supply chains. They are reporting on the sustainability impacts of their suppliers and on the influence that they have had in changing the sustainability performance of their suppliers.
This means that an opportunity exists for suppliers (and potential suppliers) to:
- Target (or report on) internal interventions that will be acknowledged by customers as meaningful to report on.
- Package sustainability information for large customers and other stakeholders.
- Strategically target key customers and new prospects using this information.
- An authentic sustainability/integrated reporting process will adhere to certain principles that are important in the identification of real opportunities for performance and therefore differentiation. The process of identifying and reporting on material indicators, particularly if inculcated in functional centres, will:
• Highlight data for comparison with competitors
• Highlight opportunities for intervention and performance management
• Establish targets, which can form the basis of future differentiation
Internal capacity and stakeholder engagement
Key stakeholders are engaged by various employees in various ways. Many of these engagements can be opportunities for communication of the company’s primary points of differentiation.
It is therefore necessary that key employees in functional centres of the business are familiar with the terms and tenets of corporate sustainability, the company’s sustainability plan and the role that they can play in the strategic approach.
Building this capacity in the organisation is important to the success of the overall plan.
Sales and marketing
Any sales and marketing plan should incorporate a customer needs analysis. As the needs and the requirements of the customer begin changing to incorporate sustainability indicators, it is important for suppliers to be ahead of this process.
This is only really possible with an engagement process that elicits information that can be used to for innovation and differentiation. This engagement process will ensure that targeted areas of differentiation are aligned with customer requirements.
After the requirements are known, a marketing plan should consistently reinforce messages that are directed at the
establishment of the desired ‘profile’ for the company. A multi-media approach can be effective to leverage packaged information to establish a desirable corporate image – one that is aligned with the ideals and requirements of the targeted customer.
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Source: The Integrated and Sustainability Reporting Handbook Volume 1
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With the Intergovernmental Panel on Climate Change (IPCC) continuing to produce updated and scientifically robust detail on the causes and impacts of climate change, there is little doubting that the issue of man-made carbon emissions will continue to be a hot topic.
The IPCC says there is 95 per cent certainty that global warming is being exacerbated by emissions from the anthropogenic (human induced) burning of fossil fuels such coal, oil and natural gas.
In its most recent report on the impacts of climate change, the IPCC predicts increased temperatures over much of the world and decreased global production of maize, rice and wheat of 25 per cent by 2050. Much of this will happen in sub-Saharan Africa.
With such attention on climate change, there is going to be increased scrutiny on those who are responsible for the emissions that cause it.
As corporate sustainability reporting matures, so too does the issue of carbon emissions and the measurement of companies’ carbon footprints (the volume of greenhouse gases emitted by a company).
So prolific has the carbon footprint become, that it can now be considered a “charismatic specie” of sustainability reporting, with international and national awards being offered for completeness and performance of companies’ carbon accounting activities.
In years gone by the measurement of carbon footprints were the preserve of the major accounting firms. Excessive pricing, however, opened up the market to specialist carbon footprint and carbon management companies. In recent years there have even been a number of small one-man bands offering carbon accounting services in South Africa. Newly designed software solutions are also being introduced to the market. Of course, the levels of service, delivery and budgets vary and companies must decide on the best type of service for their needs.
What is of paramount importance in choosing a carbon footprinting firm is to ensure that the correct accounting methodologies are being deployed and that the practitioners are professionally qualified to carry out the task. At present there are two accepted methodologies.
The most widely used, internationally, is the Greenhouse Protocol that was developed by the World Resources Institute (WRI) and the World Business Council for Sustainable Development ( WBCSD). This was launched in 2001, and was shortly followed by an almost identical derivative produced by the International Standards Organisation (ISO 14064-3).
Both methodologies categorise a company’s greenhouse gas emissions into three scopes, according to whether the emissions are generated by equipment that is owned by the reporting company (referred to as “direct” emissions) or whether the emissions are generated by the company’s electricity usage or other areas of its supply chain (both referred to as “indirect emissions”).
Emissions from owned equipment (Scope 1) and electricity usage (Scope 2) are mandatory reporting under both footprinting methodologies, while those emissions emanating from a company’s supply chain (Scope 3) are voluntarily reported, although it is good practice to do so. All companies that we deal with in South Africa measure their Scope 1 and 2 emissions, as well as a certain number of categories from Scope 3.
These indirect emissions captured in the supply chain typically include business travel activities, paper usage, employee commuting, waste generation and courier services. Ironically Scope 3 emissions often take the longest to measure, due to their complexity and data-heavy nature. Equally ironic is that most companies are able to report on business travel, which usually accounts for a small percentage of supply chain emissions.
Prudent practice would be to focus on employee commuting, or other large emitting activities in the supply chain that account for a significant portion of Scope 3 emissions.
See Nampak’s publically available carbon footprint that follows.
Nampak 2012 carbon footprint
In absolute terms, South Africa is the 12th largest greenhouse gas emitter in the world – considering the size of our economy that is an ignominious record. Driving this reality is the fact that we are heavily dependent on the use of low-grade, high emitting, dirty coal for 95 per cent of our electricity generation.
These figures are neatly reflected in how our carbon emissions are apportioned by business and industry.
As the generator of electricity, Eskom is by far the largest emitter at 228 million tonnes of carbon dioxide equivalent (the de facto measure of greenhouse gas emissions), out of a national total of 560 million tonnes per year.
South Africa cannot, however, lay the blame only on Eskom. It is, afterall, everyone’s
(business and individuals) demand for electricity that forces Eskom to generate it. If any pressure is to be placed on Eskom it should be encouragement to adopt cleaner energy sources (renewables and gas), and wean itself from the dependence on coal. Following Eskom, Sasol and ArcelorMittal are the next largest culprits of emissions at sixty and 11 million tonnes respectively.
For most companies, the majority of their emissions come from their electricity usage. In many cases it is as much as eighty per cent. Hence, we are witnessing an increased focus on reducing electricity consumption as a sure way of reducing carbon emissions.
In fact, many companies have introduced targets to reduce carbon emissions that are based on a determined effort to reduce electricity consumption.
Sample of carbon reduction targets as reported in CDP South Africa 100 Climate Change Report 2013
The transparency with which companies are reporting their carbon emissions and reduction targets are largely a result of the Top 100 listed companies on the Johannesburg Stock Exchange (by market capitalisation) being requested for information from by the Carbon Disclosure Project (CDP). The CDP represents 700 over number of global investment houses that request this carbon specific information from major listed companies.
The trend will continue in South Africa as the King III Codes of Corporate Citizenship demand all listed companies to report on their non-financial performance in addition to their financial. This will place responsibility on companies to report their environmental impact and, as described earlier, this will invariably include carbon (if not all scopes, at least Scope 1 and 2).
In addition to the investor demand for measurement, so too will the introduction of any potential carbon tax regime. While it was expected that such a tax would be
announced in South Africa in February this year, it is still very much on the radar screen of Treasury. The Department of Environmental Affairs developing a national greenhouse gas registry to which major emitters, at least, will have to report is supporting this.
It can be confidently claimed that, as the world becomes increasingly conscientised to the causes and effects of climate change, so the demand for carbon reporting will grow. There is much detail held in a carbon footprint. It is imperative that reporters employ the services of bona fide carbon footprint analysts who can assist them in understanding the challenges of compiling the correct data and adopting the correct methodologies.
When properly understood, companies can use this information to their advantage by focussing on their high emitting areas of business and deploying appropriate targets to reduce the consumption causing the emissions, thereby invariably cutting costs and wastage.
Source: The Sustainability and Integrated Reporting Handbook Volume 1
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Even though more investors worldwide, particularly institutional investors, now say they assess corporate environmental and social performance in their investment decisions, most companies are still unsure exactly what these key stakeholders want to know and therefore what and how to report.
Similarly, while leading banks increasingly apply environmental and social risk management in their lending practices, it remains unclear how this translates into competitive advantage for their corporate clients who boldly adopt innovative solutions to environmental and social problems.
The importance of risk management remains high in the conversation about corporate sustainability. It will likely continue to be the key focus of sustainability-driven investor activism at shareholder meetings for some time to come. Major accidents, fatalities and environmental pollution are common causes for concern. And with shareholder activism on the rise, companies are seeing more shareholders requesting special meetings with the board on the issues that concern them most. Governance and executive remuneration currently top the lists of responsible shareholder concerns, but environmental and social issues are growing in visibility.
According to Ceres, 110 sustainability- focused shareholder resolutions were filed with 94 US companies during 2013. Many called for board oversight of sustainability and comprehensive disclosure of data through sustainability reports. Issues of interest were climate change, greenhouse gas emissions, supply chain issues and water-related risks.Investors withdrew more than 40 of the 110 resolutions after the companies responded affirmatively to their specific requests.
That said, investor activism on sustainability issues inevitably clashes with two entrenched business realities: firstly, the majority of shareholders still want to see superior financial returns, preferably on a quarterly basis; and, secondly, company executives manage a multitude of shifting priorities to maintain their companies’ competitiveness and profitability – with environmental and social responsibility being relatively new arrivals.
Consequently, there is still resistance on the part of companies when it comes to really innovating in the sustainability space, even though the massive rise in integrated reporting has brought more firmly to the foreground the real risks and costs of not doing so. Part of the problem may be that the stakeholders with the most leverage, namely investors and financial institutions, don’t yet systematically demand such innovation.
It’s not surprising then that the really interesting conversation between companies and investors – the one about sustainability and business value creation – still needs to get off the ground. For instance, first-movers in this space are testing if they can improve investment returns by focusing on sustainability leaders – companies with a track record of good environmental and social management, high-level commitment, and proactive stakeholder engagement. Research by RobecoSAM, covering a ten-year period, revealed superior long-term results. This confirms academic findings which tie sustainability leadership to good management, innovation and financial outperformance.
So why isn’t sustainability being adopted more systematically as a lens to identify well-managed, innovative companies with lower business risk? Fortunately, several major shifts in the financial ecosystems of emerging markets indicate this situation may be set to change.
Banks getting serious about sustainability
Currently 79 financial institutions in 35 countries have officially adopted the Equator Principles, a financial industry benchmark for determining, assessing and managing environmental and social risk in projects. It is estimated the Principles now apply to over 70 percent of international project finance debt in emerging markets. Ten African banks have adopted the Principles, including Nedbank, Standard bank, and FirstRand.
While the Principles apply to project finance above US$10 million, the community of Equator Banks are increasingly exploring ways to integrate sustainability into all aspects of how they do business, including green finance products and managing their own corporate footprints as a way to build brand visibility.
Nedbank’s journey is a powerful example. In 2005 Nedbank became the first African bank to adopt the Equator Principles. Since then, Nedbank has rolled out a green affinity program with WWF, funded projects under South Africa‘s Renewable Energy IPP programme, actively manages its own carbon footprint, launched South Africa’s first Green Index in 2011, created the Nedbank Capital Green Mining Awards, and most recently held the first Nedbank Capital Sustainable Business Awards.
Businesses can see this trend as a signal that banks are building capacity to take a market-based approach to sustainability. New products and screening tools will offer incentives as well as penalties to stimulate better sustainability performance by loan recipients.
Transparency is a first requirement to make this engagement between banks and companies work. So anticipate more interest from banks in the quality and details of integrated reports. As banks become more astute in assessing particular aspects of performance – such as energy, water use, waste management, and labour practices, for instance – expect to see more specific requirements in these areas. Bigger picture questions about license to operate and stakeholder support will no doubt take centre stage and quickly mature as a discourse.
Pension funds join the conversation
South Africa was one of the first countries to introduce a regulatory requirement for pension funds in 2012 to actively consider environmental and social risks and opportunities in their investment strategies.
New regulation 28 of the Pension Fund Act, in conjunction with the Code for Responsible Investing in South Africa (CRISA), triggered an industry wide response over the past two years to design a practical approach for pension funds.
Sustainable Returns for Pensions and Society, an initiative led by the Principal Officers Association of South Africa, the IFC, major pension funds, the Institute of Directors of South Africa, the Financial Services Board, Labour, and other key stakeholders, resulted in the publication in September 2013 of “Responsible Invesment and Ownership: a Guide for Pension Funds in South Africa”.
The guide provides a roadmap to introduce policies and systems that anticipate risk and inform proactive investment strategies.
As major investors in companies listed on the Johannesburg Stock Exchange, pension funds could therefore be set to play a much bigger role in moving South Africa’s private sector towards more responsible business practices.
South Africa’s Government Employees Pension Fund (GEPF), with 1.2 million active members and assets worth R1 trillion, already has a responsible investment policy in place and engages directly with major listed companies on ways to improve environmental, social and governance performance. South Africa’s example is being closely watched by other emerging markets, and could signal a global trend. Other parts of the financial ecosystem are also likely to follow suit.
For the most part, pension funds are still in the early stages of incorporating sustainability issues into decision making. With policies and priorities in place, they will hand implementation to asset managers who invest on their behalf.
Businesses can therefore expect to see an increase in interest from the asset management community in a wide range of environmental and social issues prioritised by their clients.
Thanks to the naturally long-term view of institutional investors, the emphasis will be on issues that have a medium and long-term impact on investor returns, while still seeking to avoid any significant short- term losses. As pension fund beneficiaries become more aware of sustainability, special interests may lead pension funds to seek out specific types of investments that have social and environmental benefits, such as renewable energy and affordable housing.
Companies’ integrated reports should therefore reflect a mix of:
- appropriate sustainability risk management,
- resource efficiency to reduce costs and dependencies; and
- quantifiable positive impacts on people and the environment that can be shown to reinforce strong financial performance over the medium and long term.
Green building practices are one such example. With pension funds able to invest up to 25 percent of their assets in property, implementation of green building standards can reduce energy and water costs, improve the health and well being of occupants, enhance the urban environment, and increase property value and rent premiums . From a portfolio perspective the value proposition is clear.
A major role for regulators
Another strong signal that sustainability has taken root in the financial landscape is the move by banking regulators in emerging markets to introduce national policies and incentives that promote sustainable banking.
A key factor is the creation of a level playing field to ensure banks retain their competitiveness when taking innovative steps towards a green and inclusive economy.
China introduced a national green credit policy in 2008 and technical guidelines in 2012 which now apply to all Chinese banks and include requirements related to international lendin. Bangladesh introduced a similar policy in 2011 and provides incentives to proactive banks who the meet the new standards.
In 2012, Nigerian banks collaborated with the Central Bank of Nigeria to introduce voluntary principles for sustainable banking, focusing in particular on financial inclusion and supporting women entrepreneurs. These leading countries are part of a community of regulators who now meet annually to share their experiences in creating enabling frameworks for sustainable banking. Member countries are learning from each other and replicating successful models.
Still in early stages of testing and implementation for many countries, this trend is moving quickly. South Africa’s example in the pension fund industry and the presence of three leading Equator banks locally, make it well suited to adopt similar policies. Businesses can therefore expect more active participation by regulators in establishing monitoring and incentive structures to track and promote private sector sustainability. Rating agencies will assist this process by making data more easily available. Eco-labels and industry standards will become more common and nuanced to measure performance on specific aspects and help businesses position themselves in the marketplace.
Shifting the conversation
With these various trends taking shape, conversations between companies and their financial stakeholders are likely to get much more interesting in the near future. While this may mean an additional reporting headache for companies initially, it may also quickly evolve into a more collaborative partnership between companies and their investors or lending institutions.
There is a growing spectrum of business benefits from improved sustainability, such as reducing resource costs, improving employee productivity, reducing absenteeism and staff turnover, avoiding business interruptions, strengthening relationships with suppliers, adding market share, and protecting license to operate.
The main problem is that for too long these aspects haven’t been measured and the business case hasn’t be clear.
South Africa’s adoption of comprehensive integrated reporting opens the door to a much more informed conversation about the different ways sustainability adds value. While comparability and consistency of data are important, the links with value creation are going to be as diverse as the companies that implement them.
Consequently, it remains for companies to tell their story of sustainability well, to articulate what they have tried and what the results have been, to explain how sustainability is a driver of their future business success, and how they are preparing for a changing climate and shifting social and economic conditions.
As more success stories of value creation surface, there’s a good chance investors and banks will be first to promote replication within and across industries and to seek out clients that demonstrate sustainability potential. Some of the questions already front of mind for conscious investors include: • Are water or energy costs significant contributors to business overheads and how is the company managing them?
• Is the company getting left behind in terms of new technology that could dramatically increase efficiencies or even change the game in terms of market position?
• Is the company treating workers fairly, maintaining high standards of health and safety, and offering fair pay?
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