The Why and How of ESG for Manufacturing Companies

Sharon Lindstrom, Managing Director Manufacturing and Distribution Industry Practice Leader
Steve Wang, Managing Director Internal Audit and Financial Advisory

Manufacturing companies still wondering whether an environmental, social and governance (ESG) program is necessary have one thing in common: They’re losing valuable time. If companies want to maintain a competitive advantage and thrive in the future, they must begin to prioritize ESG efforts now.

Several leading companies across industry sectors are well-advanced in their ESG efforts and they have established targets and commitments to pursue ESG-minded best practices and initiatives. That includes automotive manufacturers pledging to go green and major oil and gas companies working to help the world achieve net zero emissions.

Regulatory pressures are one factor driving ESG efforts but there’s more. The events of the past year, from the global health crisis to heightened social unrest, have awakened companies to the fact that commitment to ESG matters more than ever before. And being a good steward of the environment is just one aspect of ESG. It extends to how the organization promotes worker safety and well-being, what progress the company is making on diversity, equity and inclusion (DEI), whether executive compensation is tied to ESG goals, and more.

More Evidence for Placing ESG on the Front Burner

Manufacturers seeking access to capital should consider the following: Investors who value ESG practices are growing in number and influence. Recent research from the US SIF Foundation found that sustainable investing assets now account for $17.1 trillion — or one in three dollars — of the total U.S. assets under professional management. That’s a 42% increase over 2018.

Major investors like BlackRock have also made it clear to the business community that sustainable investing is a priority. In his 2021 letter to CEOs, BlackRock’s chairman and CEO Larry Fink wrote, “The more your company can show its purpose in delivering value to its customers, its employees, and its communities, the better able you will be to compete and deliver long-term, durable profits for shareholders.” Fink also pointed to research from BlackRock that shows “purposeful companies, with better [ESG] profiles” outperformed their peers over the course of 2020.

And for public companies, there’s this: Allison Herren Lee, acting chair of the Securities and Exchange Commission (SEC) in the U.S., issued a public statement in February directing the Division of Corporate Finance to enhance its focus on climate-related disclosure in public company filings. She wrote, “Now, more than ever, investors are considering climate-related issues when making their investment decisions. It is our responsibility to ensure that they have access to material information when planning for their financial future.”

Start by Defining the Value Proposition for ESG

Companies that want to move beyond “checking the box” on ESG will need to define their value proposition, or reason they are investing in the effort.  This includes identifying who their key stakeholders are – both external and internal – and understanding what matters most. Asking the following questions will determine the level of commitment the company is willing to embrace:

  • Is our goal to reduce or avoid regulatory, activist stakeholder or legal interventions on the business?
  • Do we want access to “green” capital by demonstrating that our business has an ESG program with a compelling narrative?
  • Is our goal to develop a long-term strategy to pursue growth opportunities and maximize market opportunities through an ESG lens?
  • Or are we aiming even higher and pursuing ESG goals because it is the right thing to do for our employees, our customers, and the world as a whole, and are we aligning our strategy and business model accordingly with these aspirations?

Once a company defines the value proposition — and there may be several — it can start building an ESG program that aligns with those propositions. Executive management and the board should be in agreement on the value proposition to encourage buy-in and establish a strong tone at the top for ESG in the organization.

Defining who owns the ESG program early on can help drive its success. In many manufacturing firms, it’s often investor relations personnel or general counsel taking the lead on ESG. We’ve also seen chief financial officers or marketing take on that responsibility. And some organizations that want to demonstrate a strong commitment to ESG may hire a chief sustainability officer, a vice president or director of sustainability, or both.

Building an ESG Program

How a company’s ESG journey unfolds depends on how advanced its ESG efforts are currently. Here are four areas we recommend addressing as part of that journey:

  • Discovery and strategy-setting. That includes evaluating the organization’s existing activities related to sustainability, gauging stakeholder interest, and conducting a materiality assessment to identify key risks and issues related to sustainability. The outcome of this phase should be a road map for the organization to use as a formal guide for implementing and monitoring the ESG program.
  • Data management and development. This involves identifying the data that will support the analysis of ESG activities. There needs to be data collection, aggregation and validation processes specifically defined for the ESG program.
  • Performance monitoring and reporting — and looking for ways to drive improvement in both of these areas. The company should ask itself: “How do we currently monitor our sustainability program objectives?” and “Are we providing comprehensive and transparent reporting to stakeholders on ESG performance?” In addition, “Do our disclosure controls and procedures support the reliability of our reporting?”
  • Governance and risk management. This involves designing or enhancing the company’s governance framework to better address ESG risks and compliance requirements and taking steps to strengthen the internal control environment.

There’s work underway to make sustainability reporting easier. Organizations like the World Economic Forum, the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB) are working together to establish a global sustainability framework, with the IIRC and SASB announcing their intention to merge. This move should lead to the development of a comprehensive reporting framework that will give companies less of a reason to put off ESG reporting — or help them improve on it — while also addressing the market’s need for transparency and comparability.

The Opportunity Window Is Now

Companies that hesitate or are unsure if an ESG program is the right effort right now may well miss their opportunity to establish themselves as a leader and jeopardize their ability to tell a compelling story to their investors, customers and other stakeholders, including their current and future employees.

Many workers today, particularly millennial and Gen Z professionals, specifically seek out employers with a strong ESG track record — especially on the DEI front. This isn’t likely to change. Manufacturing companies that don’t respond to this sentiment may struggle to hire and keep the talent they need to thrive in the future (a top risk identified in Protiviti’s latest top risks survey).

When it comes to addressing ESG issues, any step is the right step if no steps have been taken. However, using a planned approach to set up an ESG program, like the one we’ve outlined here, is likely to bring the highest return on the effort.

 

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