ESG (environmental, social and governance) – or sustainability, has taken up social space and dominated business agendas, swaying consumers and investors alike. It's more than just a trend – in some shape or form, the term has been around for quite some time, subsuming the concepts of corporate social responsibility and responsible business. As the demands rise for sustainability to be viewed as a business risk – or opportunity, stakeholders are turning to ESG ratings to quantify performance. If you’re a vendor or business partner in a supply chain, this demand may materialize in a form of a sustainability questionnaire from your customers.
The Acronym Rules
For any given company, few sustainability topics will be of equal importance. The environmental piece appears to be on top of the list, with decarbonization and net zero driving much of the business agenda. Yet, the E, S and G are individually and collectively essential. This interconnectivity is what we need in aiming for sustainable business.
“What gets measured, gets managed” rings true for most businesses. But for companies today, how to build, implement, measure, and report on ESG is no easy task. It involves setting quantifiable targets that measure environmental aspects, labor practices, business ethics, and how well a company will hold up against relevant laws and regulations. The thicket of metrics and reporting standards – many of which vary by industry and location – makes it notoriously hard to make sense of the overall company performance and how it compares to others. Moreover, the measurement system would ideally be adequate for the company to know how it can improve.
Not All ESG Ratings Are Created Equal
Organizations can gauge ESG performance internally, creating in-house monitoring and reporting systems. That plays well if the objective is to benchmark performance across different organizational units or do a period-over-period analysis. But to compare trading partners against peers or industry standards (as your customers are seeking to do), companies need an external view with standardized information. ESG ratings from independent, third-party agencies can provide exactly such objective viewpoints and benchmarkable results.
Metrics and assessment outputs vary markedly by service providers. Each has a unique methodology for collecting and analyzing information. Some providers don't provide company-specific ratings, only aggregate data for the requestor to assess the materiality for themselves. Other providers analyze company data submitted through interviews or questionnaires, underpin it with publicly available information and distill the results into a rating or scorecard.
Take the example of the EcoVadis assessment. Through an evidence-based online platform, EcoVadis gathers company information, validates and analyzes it to measure 21 sustainability indicators grouped into four themes: Environment, Labor & Human Rights, Ethics, and Sustainable Procurement. Metrics and questions are weighted into a numerical score on a scale of 100.
The Difference an ESG Rating Makes
What do ESG ratings do apart from assigning a numerical result? For one, although many ESG measurement systems give out rankings (think listed companies or funds), some can tell us about the absolute performance. The EcoVadis' 100-point range is enriched with a qualitative scoring scale, with five performance thresholds ranging from insufficient (high-risk) to outstanding. Second, the ESG rating process can help companies map out a sustainable improvement path, as the EcoVadis scorecard does. By highlighting priority areas, it provides a means to improve, and potentially outperform the competitors.
In an age where sustainability matters, demonstrating how well a company manages its environmental, social and governance responsibilities can differentiate it from its peers. Showing commitment to drive sustainable growth has never been more critical – this seems to get you through the doors these days. Network effects are at play because companies that don't go down the path of sustainable business may find themselves rejected by buyers and suppliers. Companies that are committed and invest in ESG are willing to walk away from those that make little effort in this area. This carries more weight for small to mid-sized companies – larger companies can easily replace partners who don’t share their vision, so smaller companies need to work on getting their ESG value proposition right.
High ESG ratings are an always-moving target, shifting as industry conditions change. The good news is that it shouldn’t be difficult for most organizations to accomplish, so long as organizations realize that engaging with ESG is more than just lip service. It’s a continuously developing process requiring systematic efforts and outcomes assessment. Whatever the results may be, they’re always a good baseline to work against.
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