Why We Can’t Shop Our Way to Sustainability

(Photo by iStock/Ryan McVay)

Sustainability is usually framed as a problem of consumer choice, in which the solution to the climate crisis is in recycling, eating more organic vegetables, or cutting back on single-use plastic. This makes a sharp contrast with the current public health crisis—in which government, citizens, and business are combining to shelter in place and work from home and to provide the welfare, medical equipment, and supplies needed to grapple with the challenge. When it comes to the climate crisis, however, consumers’ wallets must carry the burden, as companies cite the lack of consumer demand for sustainable products and services as the reason they can’t become more sustainable (while government policy fails to provide the leadership and economic incentives for business or consumers to assume the urgency required).

When both business and government pass the buck, then, consumer choice becomes the only path forward to sustainability. But can consumers be held responsible for driving corporate and government responsibility? Should they be? Could they ever be successful in doing so?

The answer is no. Offering sustainable products and being a sustainable organization are not the same thing and managers cannot expect customers to buy the company a way out of their (and our) sustainability challenge. Instead, business leaders must partner with government and society to re-focus their companies on new forms of market exchange, ones that will not be based on unrealistic expectations of consumers and capital markets. Ask yourself: how much direct influence consumers’ wallets (or even shareholders) have on whether you decide to switch to renewable energy; hire a female Board Director; upgrade workers’ salaries and benefits or hire a disabled employee? Sustainability will not be sold on the marketplace. It cannot be one choice among many. The entire business must be re-imagined preparing the organization for the challenges it faces.

Profit as a Fixed Variable

According to normal financial theory, profit is straightforward: revenue from sales to consumers minus the cost of creating the product or service. To maximize profit, firms do a handful of things. They use their brand power to differentiate their goods and services and increase customers’ willingness to pay for them; they produce premium products to command higher prices; and/or they reduce costs.

In practice, however, that’s not how it works. While there is some elasticity in pricing, price ranges are largely set by competitive forces and capital markets who expect that profit will be within a specific range, one set by analysts’ expectations of peer companies that offer alternative investment opportunities. Though shareholder capitalism is a relatively new variety of capitalism, emerging in the mid-1970s, maximizing shareholder value has become the dominant form of business systems worldwide. The result is that the real equation is the reverse of what it is supposed to be: revenue minus profit, equals cost. And in the business-as-usual context of shareholder capitalism, profit is an almost fixed variable. This modification of the profit equation means the level of profit entered by managers tends to align with the expectations of financial analysts and shareholders for the forthcoming quarterly, bi-annual, or annual reporting period.

While it is axiomatic that profit is instrumental in determining cost, public goods like air or water are not factored into the equation, and so, sustainability will struggle to justify itself in conventional, short-term accounting terms. It will only be included in this equation, if it is at all, in the cost component. In this way, maximizing shareholder value constrains the potential for corporate responsibility, not only by exerting coercive pressure on managers to generate short-term profits, but also to favor the distribution of profits in the form of dividends and share buy-backs, rather than in investment in research and design, skills development, higher wages, and technology upgrades. In its current form, then, shareholder capitalism reduces the possibility of greater corporate responsibility.

Despite the rise of environmental, social, and governance (ESG) reporting and investing—which promise to link a company’s access to capital and its future performance to the company’s environmental, social, and governance impacts—public companies continue to have a fiduciary duty to maximize value for their shareholders. That duty to maximize shareholder value translates to the expectation that investments made in stock markets (and the companies that make them up) should double in value every six years or so. In practice, the wealth generated by companies gets extracted by shareholders (including managers on equity-based bonus schemes) in the form of short-term profits and dividends rather than long-term investment in the company. But this combination of short term-ism and lack of productive investment has a detrimental effect on the health of companies and is jeopardizing their future.

Sustainability as a Consumer Choice

With profits virtually fixed by the financial system—and by the self-perpetuating interests of stakeholder groups embedded in the sunk costs, store of trust capital, and expectations of business-as-usual—it’s not surprising that companies turn to the consumer to fund sustainability. And so we get the default assumption that the route to sustainability is through offering sustainable products and services, suggesting that what consumers buy (or don’t buy) will be the key to a sustainable future. But this means that when companies offer ecological products and services—at premium prices to protect profit—they can then cite consumers’ lack of willingness to pay more for them as the reason they cannot become more sustainable.

This should not be surprising: premium pricing is, axiomatically, a niche strategy, placing the goods and services beyond the reach of mainstream consumers, almost by definition. But it means that it is disingenuous to treat profit as a fixed variable and then frame sustainability as a consumer choice. And consumers are more drawn to products and services that are both sustainable and fairly priced; they do want to join and work harder for companies that they perceive behave more responsibly and they hold responsible companies in higher esteem than competitors. But beyond affordability, consumers also face impossible trade-offs in assessing the carbon neutrality, for example, of the average shopping basket. Does almond milk from California result in more-or-less CO₂ emissions than cows’ milk from Cornwall? Such a trade-off is so complex and requires so much information that a consumer could never be sufficiently educated to make that kind of informed choice.

Why should companies force individual consumers to confront these trade-offs and moral dilemmas on an everyday basis instead of taking on this responsibility themselves? Businesses cannot ask their customers to buy them a sustainable future.

The COVID-19 Consumer

This problem becomes even more grave during a pandemic. During the COVID-19 crisis, and in the recovery from it, consumers’ consumption choices will be more restricted, as many face unemployment, depleted savings, and an uncertain future. As many small and medium-sized businesses close, it will further concentrate market power in the hands of the largest companies. And prices are likely to be increased as sectors like medicine and food seek to reduce their reliance on global supply chains and bring production closer to home. Unless it becomes affordable and mainstream, it is simply not likely that consumers will suddenly embrace sustainability in their purchasing behavior.

Reluctant business leaders should not, however, confuse consumers’ behavior with their growing expectations of companies. The COVID-19 crisis has confronted consumers with the vulnerability of key workers upon whom our societies depend and the precariousness of their own lifestyles: their expectations for companies to step up and tackle the challenges of climate crisis and social inequality are greater than ever.

There’s Never Been a Better Time to De-Risk the Political Process

Change almost always meets with some resistance: employees accustomed to working practices, managers vested in operational and reporting procedures, shareholders banking on double-digit growth. Persuading such vested interest groups of the need for change and then winning their support to make it happen is a political exercise involving some element of risk. But COVID-19 has also accelerated expectations of a new normal. There will never be a better time for company leaders to minimize that risk and to start the process of winning the hearts and minds that are central to becoming a sustainable company (independent of consumers’ purchasing behavior).

Here are four steps to de-risking the change process and managing the politics with shareholders, competitors, regulators, and employees:

Attract ESG Capital to Your Firm

The risk that shareholders won’t give you the time or freedom needed to develop sustainable practices can be mitigated with environmental, social, and governance capital (ESG). Over $12 billion was invested in the first quarter of 2020 into funds that claim ESG practices, double the same period last year. This investment not only demonstrates an appetite for more sustainable practices, but this appetite was rewarded: more than 70% of ESG funds outperformed their peers across all asset classes during this period, according to the investment research platform Morningstar Direct. In another study from Refinitiv, on average ESG funds compared to conventional funds outperformed on the up-side, reduced underperformance on the downside and had a narrower spread between the best and worst-performing funds.

Many investors and companies believe the time for ESG funds has come. Why not attract ESG capital to your company—which not only gives you the time and resources but also the impetus to invest in sustainable practices?

Create an Industry Tipping Point

While changing how you do business always runs the risk of losing short-term competitive advantage, the COVID-19 crisis has hit the pause button on whole industries. This levelling-of-the-playing-field presents a unique opportunity to build a coalition of like-minded leaders: by reaching out to some of your peers in the industry and agreeing to change to more sustainable practices you can mitigate the loss of short-term competitive advantage and create the tipping points needed to create scale.

For example, after the Rana Plaza disaster in Bangladesh in 2013—when a complex housing five garment factories collapsed killing 1,132 people and injuring more than 2,500—over 180 European retailers and brands came together to improve safety. This collective leverage incentivized local investment in healthier and safer working environments and practices, and since then, exports from Bangladesh have risen by 40 percent. It is estimated that new behaviors practiced by 30% of an industry’s leading firms is sufficiently large to create a tipping point and cause the industry to follow suit.

Build a Consensus Around the Need for an “ESGAAP”

Companies are increasingly reporting on ESG issues (and will be expected to do so even more in years to come), but the risk is that your investors, customers, and regulators might draw unfavorable comparisons with your peers. Again: short-term competitive advantage is a problem. At Sustainability for Sceptics, a recent symposium held at King’s College London (which brought together business leaders and researchers), the state of ESG reporting was compared to the state of annual reporting before the Wall Street crash of 1929. The incentive to report lacks clarity and the consequences of misreporting are unclear. Who, after all, are companies reporting to and what should they report? Currently each company sets its own benchmark according to its objectives and targets. There is no consistency of baselines across companies or industries and no requirement for ESG reports to be audited.

Forward-thinking business leaders should engage with competitors, regulators and peers from other industries to encourage an ESG equivalent of the international financial reporting standards (IFRS) or GAAP i.e. generally accepted accounting principles, standards, and procedures. The introduction of an “ESGAPP” would ensure a level reporting field.  

Take Advantage of Changing Expectations

Societies, governments and competitors’ expectations of a new normal have accelerated presenting company leaders with a unique opportunity to embrace sustainability. Historically low interest rates offer business leaders an unparalleled opportunity to invest in new technologies to encourage employees to work from home more often, to reduce business travel (and CO₂ emissions), and to diversify and upskill workforces. During lockdowns office employees’ expectations of a better work-life balance and greater productivity have been raised. Potential savings from reduced office space and business travel can help to subsidize employees’ increased costs such as improved connectivity, new IT equipment or rental of a workspace.

As many jobs are set to be changed or replaced by technology, the combination of more efficient business practices, real estate savings, and low interest rates can also be used to diversify and upskill workforces to future-proof the company. Finally, historically low and falling alternative energy prices offer a unique opportunity to embrace renewable energy in core operations, further improving the company’s contribution to sustainability.

Conclusion

A good recovery for companies after COVID-19 will recognize re-energized consumer and societal expectations of the need to tackle the much larger, dynamic crises of climate and economic and social inequality. These crises have been smoldering for years, building up energy and force before their full impact will be felt. To become a sustainable company leaders can use this time pro-actively to do two things: firstly, they can (re)align success with the longer time frame of sustainability rather than with the quarterly and annual cycle of business-as-usual. Secondly, leaders can (re)focus expectations on single-digit growth which allows the efforts of multiple stakeholders (as well as shareholders) to be rewarded and improves environmental and social impacts over longer time frames (in line with ESG investing).

In short, becoming a sustainable company requires a return of profits from being virtually a double-digit constant (in the business-as-usual equation), to a single-digit variable that is aligned with the timescales of the crises the company (and society) faces. BlackRock’s announcement earlier this year (that it would vote against managements who fail to take steps to mitigate climate risks) and the substantive shifts in capital markets towards ESG funds are early indicators that becoming a sustainable company is more realistic than ever. Indeed, the opportunity cost of not setting your organization on a more sustainable path might now represent the greater risk.

Read more stories by Marc Lepere & Giana M. Eckhardt.