Harrell & Oriola: 5 steps for implementing measurable ESG strategy

When a human body is suffering from disease, we tend to seek medical treatment in response. Sometimes a cure exists. Other times there is no cure. When the cure has evaded our brightest minds, we still celebrate treatments that provide an “added benefit,” like less pain or even a moderately longer life. We might say that, in medicine, we have learned to “not let perfect be the enemy of good.” In the race to a low-to-no carbon economy, there is great wisdom in that mantra.

The immense amount of work to achieve carbon “net zero” or “net negative” milestones is a global Rubik’s Cube and means that we cannot afford the luxury of perfection. Perfectionism in sustainability is unsustainable. Yet implementing the “good” instead of waiting for the “perfect” — especially in the fast-paced and sometimes ambiguous world of environmental, social and governance (ESG) — is not easy.

However, similar to a doctor rejecting a less-than-perfect medical treatment for a patient, businesses awaiting the “perfect solution” or “perfect time” to implement ESG efforts could ultimately do more harm than good. Taking a fear-based, passive or unsatisfied purist stance and delaying action in anticipation of something better (or hoping someone else figures it out) could put otherwise addressable ESG-related matters out of reach with the passage of time.

To be clear, it is equally foolish to charge haphazardly ahead without intentional, well-informed strategy that is continuously evaluated and refined. Accordingly, the five steps below provide an initial starting point for moving past “analysis paralysis” and into practical implementation of ESG strategies.

Step 1: Establish an understanding of ESG factors

The foundational aspect of any ESG analysis is understanding the core ESG factors:

• “E” encompasses all things environmental. This includes concepts like “net zero” along with considerations regarding how businesses and their products/services interact with and impact the environment.

• “S” deals with the social element. This factor focuses on issues involving a business’s relationship with its stakeholders, suppliers and the community. The “S” factor also includes diversity, equity and inclusion efforts, facilitating equitable social initiatives and even historic inequities forced on certain populations.

• “G” is a broad category that includes holistic oversight of a business’s board of directors in addition to more traditional governance issues like cybersecurity, board composition and ethics.

Establishing an understanding of ESG-related issues present in your business also requires becoming familiar with various corporate disclosure frameworks. This is of utmost importance, especially given the recent push by regulators for disclosure of ESG-related issues and emphasis by lenders and investors making lending/investment decisions. A leading disclosure framework that has enabled companies to better track material ESG-related issues is the Sustainability Accounting Standards Board. SASB is an ESG guidance framework that sets standards for the disclosure of financially material sustainability information by companies to their investors/stakeholders. In total, SASB standards track ESG issues and performance across 77 industries, as set out in the SASB Materiality Map. Thus, SASB (and other frameworks) provide a starting point to develop a strong data foundation, which can help position your company to meet fast-evolving ESG reporting requirements.

Step 2: Adopt a conceptual strategic approach

It can be overwhelming to sift through the “ESG information overload.” At times, this vast and amorphous landscape can feel unwieldy and awkward. However, adopting a conceptual strategic approach helps cut through the noise. The approach outlined below involves viewing each ESG factor through a series of three lenses (i.e., entity, products/services and investor/consumer expectations).

• The “entity” lens facilitates examination of how the business entity’s operations affect the environment and the entity’s relationship with the environment (e.g., evaluating Scope 1, 2 and 3 emissions, climate-related financial risks, energy resilience, etc.). Notably, this lens evaluates the environmental and economic sustainability of the business entity.

• The “products/services” lens involves analyzing product lines and life cycles (e.g., impact of manufactured goods on the environment after useful life, efficacy of carbon reduction/carbon capture technology, availability of services to vulnerable populations, offering services to further social goals, etc.).

• The “investor/consumer expectations” lens helps businesses understand how “entity” and “products/services” considerations combine to shape investor and consumer expectations. One specific goal is to help stakeholders make informed decisions by being able to distinguish between companies’ risk and opportunity profiles. This is important because investors/consumers increasingly care about sustainability (i.e., there is growing consensus and demand from investors/consumers that is driving ESG developments).

Organizing and viewing ESG factors through these “lenses” helps develop an intersectional understanding of ESG risks and opportunities, which leads to creating a tailored ESG approach over the near-, mid- and long term.

Step 3: Incorporate measurable ESG criteria into business KPIs

Companies desiring to evolve their ESG efforts must align their mission-critical business functions with ESG objectives. One way to achieve this is to merge business metrics with ESG key performance indicators. For illustrative purposes, a manufacturer could tie unit production goals to each ESG factor:

• Environmental: KPIs may include energy consumption per unit of production, per unit of revenue, per employee, etc. When a company is able to increase energy efficiency, it could then invest company profits to incorporate additional renewable energy and low carbon technology solutions.

• From a social perspective, the manufacturer could reinvest a portion of the energy savings into employee-based benefit programs (e.g., child care stipend) and/or boost community initiatives (parks, greenspaces, food scarcity, etc.). Note that the environmental KPIs also play a role here (e.g., improving pollution control would positively impact communities).

• The company’s governance efforts may include transparent reporting of enterprise-wide efforts to reduce carbon footprint, improve production efficiency, improve community surroundings, workforce enablement, etc.

This step requires cross-functional collaboration between business and financial leaders within the organization. An aspirational goal for businesses working to establish measurable ESG/business KPIs is to ensure that business leaders and managers across the organization are empowered and held accountable on each aspect of the company’s ESG strategy.

Step 4: Monitor and measure performance

Continuing the example from Step 3, the manufacturer would track and quantify its progress for established KPIs (e.g., energy efficiency improvements, whether energy investment and value chain adjustments resulted in increased unit production, increased sales, higher employee retention, etc.).

Step 5: Practice continuous improvement

This step underscores that there is not a “final ESG destination” compared to an ever-present need to adapt and refine. Continuous improvement occurs at macro (company-wide ESG audit, board of director education, supply chain management, etc.) and micro (reviewing and updating ESG-related contracts, evaluating job roles and responsibilities, employee performance evaluations, etc.) levels.

Each step will look different across industries and businesses. The most important takeaway is that the process is demanding, but it does not demand perfection. Postponing “good” efforts for perfection creates a perverse result. The better barometer is the ever-increasing consumer/investor expectations that will weed out entities that take mediocre or half-hearted approaches (which should be avoided at all costs). By contrast, the continuous improvement paradigm embraces a “can do” attitude with the practical recognition that there will be a degree of trial and error accompanying the complex, intersectional global transition to decarbonization.•

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Julian Harrell is an Indianapolis-based partner at Faegre Drinker Biddle & Reath in the environment & energy practice group and a member of the carbon markets and ESG teams. Walé Oriola is counsel at the firm in the investment management practice group and is based in Washington, D.C. Opinions expressed are those of the authors.