Embedding ESG Principles (Part 2)
In Part 1, I discussed the rising tide of the ‘ESG movement’ by corporations adopting and embedding ESG principles within the functional activities of their organizations. I provided a conceptual framework for the different concepts surrounding ESG and gave a logical order as to how they map to each other. Further, I discussed some of the top-down and from-the-trenches views on ESG principles. There is no doubt that ESG is here to stay and increasingly investors, governments, employees, and customers are looking towards how companies are incorporating these principles into their business models. But how do we make businesses not just adopt these principles as a veneer on top of business-as-usual behavior? Therein lies the rub — ‘embedding’ vs. ‘acting’ — whereas the former will be sustainable and will do real good, the latter will simply create a facade of seemingly-legitimate action without any real underlying benefit.
Part 2 (this article) is about getting more into ESG in terms of ‘integrating’ it into a business vs. ‘embedding’ it. I also get into some examples of companies who I think are ‘living’ ESG principles, and finally, offering some preliminary thoughts about how one would characterize a business model that embeds ESG principles into its core.
Integrating vs. Embedding ESG
I use the word ‘embedding’ intentionally and specifically: that it needs to be so deeply ingrained that you don’t even realize you’re doing it. It needs to become an innate sense of ‘right’ and ‘wrong’, just as our social norms are. No one questions or debates stopping at a red traffic light because it is ingrained sufficiently in us that we do it without a second thought. Such should be ESG — not just ‘integrated’ but in fact ‘embedded’. What’s the difference?
Whereas ‘integrated’ implies putting two disjoint pieces together via some sort of ‘bridge’, but the pieces remain disjoint, ‘embedded’ implies building around a core, where the item is firmly lodged within a unit and is thus inseparable. ‘Embedded’ ESG principles means that there is no ‘list’ of criteria to compare against. The material specification list will include not only the technical specifications, but also the ESG policy of the company, in an inseparable structure, hence making just one list of criteria to gauge suppliers by.
So is this a simple question of two specification lists vs. one list? No, it is a question of mindset. In the ‘integration’ case, the ESG principles can be seen as a ‘soft’ constraint that can be negotiated perhaps, whereas the ‘embedded’ case, it is a ‘hard’ constraint that cannot be violated. In the ‘embedded’ case, the ESG principles are built right into the technical specification and there is no negotiation about how much compliance there is or should be — it becomes automatic, simply a functional way of working, and not something to debate or negotiate. This is the point at which ESG becomes ‘frictionless’.
Unilever’s Sustainable Living Plan Embodies ESG
Unilever, the Anglo-Dutch global consumer goods and foods giant, created a blueprint for ESG called the Unilever Sustainable Living Plan (USLP) back in 2010, before ‘ESG’ was even coined as an acronym. The principles of this plan include all three dimensions of ESG, i.e. Environment, Society, and Governance. The underpinnings of the plan are simple: engage in creating and fostering better, healthier, and safer living standards for people so that they may thrive economically, socially, culturally, and have a better sense of self, and through this, they become ardent users of the products that drive these principles. Their goals are to improve health and well-being for more than 1 billion people, reduce their environmental footprint by half, and enhance livelihood for millions of workers…and all this while growing the business in a profitable manner. How do they do this? It’s actually quite logical: having a better environmental footprint allows you to save money and increase profitability (e.g. using less plastic in bottles reduces not only waste but also the demand for plastic, driving down the price per unit as well as subsequent shipping cost, packaging cost, inventory cost, fuel spend, and lower emissions.). This incremental profitability can be banked in part, but also used to create better working conditions for second and third tier suppliers as Unilever partners with their suppliers and audits them diligently for their practices and suggests better practices through education, transparency, and enforcement of world-class business practices. Hence, brands take on a purpose and are better respected by the consumer, which, in turn, drives sales higher, creating a virtuous cycle.
One such example is the refill pack of their surface cleaner product — Unilever Cif Refill which uses 75% less plastic by simply marketing the concentrated active ingredient which can be added to water in the same spray bottle that the previous product was purchased in. This has the impact of reducing the environmental footprint significantly. On the social angle, Unilever is one of the biggest producers of tea, and by actively partnering with their tea growers, they have helped them increase their productivity significantly, enabling the tea growers and farmers to substantially increase their standard of living. “In 2017 Unilever enabled around 716,000 smallholder farmers to access initiatives aiming to improve their agricultural practices or increase their incomes”.
The outcome for Unilever using their USLP has been quite positive. Since launching in 2010, Unilever has delivered 80% of its goals (last reported in 2018), with sustainable brands (e.g. Dove, Lipton) driving 70% of the turnover growth. It is interesting to note that it’s most sustainable brands grew 46% more than the traditional brands, a powerful reflection of the corporate benefits and social outcome of embedding ESG. The stock value has also reflected this reality, as the growth of share value is increased since 2010, when the ESG embedding began, reflecting the market’s positive outlook on the Unilever Sustainable Living Plan as the core of Unilever’s roadmap to growth and greater profitability.
Unilever’s ESG Centered Business Model
The underlying business model puts ‘sustainable living’ (ESG) at its core, as described in its annual report:
Unilever’s characterization of their business model, as shown in the Figure above, consists of Sustainable Living at the core, and broadly describes the inputs and enablers of value creation and value capture. The ‘inputs’ are essentially the value creation elements, and include the Brands, the Operations, and the People of the business. The value creation and capture elements are described in the graphic of ‘how we drive profit’, and include the mechanisms by which the business delivers profitable growth in product volume (number of units or cases sold), innovation through marketing investment, and cost leverage through efficiency.
The Central Business Model Component : Sustainable Living (ESG)
Paul Polman, the CEO of Unilever describes the business logic of sustainable living in his interview with Rik Kirkland of McKinsey & Company: “The Tropical Forest Alliance is a good example of what can be done. If we keep going with deforestation, which accounts for 15 percent of global warming, our business model and, frankly, our whole society are at risk. On top of that, the consumer is saying, “I’m not going to buy products anymore created through deforestation.” So industry got together and said that we need to use combined scale and impact to create a tipping point. The Consumer Goods Forum (representing $3 trillion in retail sales), which we helped to create, is one of these coalitions of the biggest manufacturers and retailers. When they said, “By 2020, we’re not going to sell any more products from illegal deforestation, whether soy, beef, pulp, paper, or palm oil,” that sent an enormous signal across the total value chain and generated action on the supplier side. Governments are now joining. We’re actually close to a tipping point to address these issues. That is the new world we have to learn to live in” (Kirkland, 2015).
With sustainable living at the core, Unilever leadership has made the strategic choice about its central component of the business model. Explained in the interview that I conducted for the case study, in the words of a former Senior Vice President of the Global Personal Care Category, “At the core of our business model is sustainable living, and then everything thing else is around that business model. The core of it is independent. What I mean by that, I think sustainable living is what drives brands with a purpose, like Lifebuoy or Dove for example in perspective. I think sustainable living also drives having the future, the future conditions for under which Unilever can be a successful profitable business, which is access to water, access to consumers. It’s got money to spend because sustainable living is also about how you insure communities have employment, and therefore have funds to spend, or it’s about reduction in waste or it’s about sustainable agriculture, sustainable fisheries, and sustainable palm oil.”
So actually at the very center of the model is recognition of the long term. Without sustainable living, Unilever will be a less successful business because the macro environment in which we operate will be less advantageous, or even completely disadvantageous to the kind of business and the product forms that we’ve got. At the heart of it is absolutely sustainable living for that reason, but then when you move out to the next level, how sustainable living impacts different brands will be different by those brands.”
From the above two descriptions of the business model, I find that the central component of the business model is not just what holds the business model together but appears to permeate the entire decision-making process of the business; its not just a choice of what to organize the business around, but in fact, how to do business, i.e. a way of working. A Senior Manager in the Procurement function pointed out to me that Unilever has specific procedures in place to audit the labor forces of two degrees of sourcing from the direct supplier (i.e. tier 1, tier 2, and tier 3), and gave me an example of a case (some years ago) where Unilever discontinued use of a tier 3 supplier when they discovered (during a routine audit) that the supplier of one of the ingredients of the input required by the direct supplier was using questionable labor practices. Similarly, a Senior Vice President in the Refreshments category pointed out that their ice cream production processes are much more expensive with sustainable sourcing than without, but the fact is that customers are willing to recognize the value for sustainably sourced product, and it is a self-reinforcing loop that Unilever is capitalizing on.
 A public–private partnership created by the US government and The Consumer Goods Forum to decrease tropical deforestation undertaken to source commodities, such as palm oil and soy. The alliance now consists of multiple nongovernmental organizations and national governments, including those of the Netherlands, Norway, and the United Kingdom.
Generalizing the Business Model Design for ESG
In Part 3, I will discuss the architecture and characterization of business models in general, and specifically, a new framework for developing a business model with an ESG core. For this, I will use the basis framework that I created in 2016 - The Beacon: a New Framework for Business Model Reconfiguration for Complex Enterprises. The framework will dive deeper into the case study of Unilever’s ESG underpinnings, and shed light on how other companies can reconfigure their business models to make ESG frictionless and a way of working, in order to successfully embed them into their business practices and harvest the fruits of these practices while doing good for the world and themselves.