What is ESG for a Manufacturing Company?

Manufacturing businesses that are currently debating whether or not to implement an environmental, social, and governance (ESG) programme share one trait: they are wasting critical time.

Which manufacturing sectors lead in ESG?

Numerous top firms across multiple industrial sectors are well advanced in their ESG efforts, having established objectives and commitments to pursue ESG-conscious best practises and initiatives. However, this article relates to everyone, and not just those in mass production processes. Even the SME / SMB is affected as every manufacturing company is a component of a supply chain.

This includes automakers committing to greening their vehicles and major oil and gas firms reacting to the demand that industry accelerates its adoption of tools and invests in new technology to achieve net zero emissions and positive climate change. As we will see, much of their impetus is due to consumer pressure and investor activism.

From an ESG perspective, supply management remains in its infancy. However, with ESG investing finally a mainstream concept, the power of social media has highlighted that a flawed supply chain can cause a company’s reputation to plunge overnight.

Such ESG issues lead to investment choices which define near-term large scale business activities. Updating any business process to create finished goods with climate change friendly materials requires companies commit to investing in negative screening their supply chain as much as it does in investing in human rights. The financial returns, and the costs of the skills required, enable all industries to realise positive gains from any such investment.

Environmental stewardship

Regulatory demands are one driver of ESG activities, but there are others too are increasingly important. The events of the last year, from the global health crisis to increased social unrest, have brought corporations’ attention to the reality that ESG commitment is more critical than ever.

Environmental stewardship is only one facet of ESG. It encompasses how the firm supports worker safety and well-being, the company’s progress toward diversity, equality, and inclusion (DEI), and whether executive compensation is linked to ESG objectives.

The impact of your manufacturing processes

With the ongoing worldwide pandemic and increasing climatic circumstances, the ESG imperative is even more critical today. We are all familiar with some of the most prominent concerns motivating business ESG activities, such as excessive carbon emissions, water scarcity, fossil fuel supply, and extreme weather events that disrupt service, cause inefficiency, and create waste.

However, there are more reasons contributing to the increased emphasis on ESG. Let’s look at four of the most compelling reasons why ESG activities are a high priority in large scale manufacturing this year, and how technology might aid in their effective implementation.

What is ESG investing, and what is the impact?

Institutional investors are weighing a raft of ESG criteria to guide their socially responsible investing decisions. Manufacturing methods, the intermediate processes, the human capital required and, especially, the raw materials, mean that ESG investing is exploring far more than the financial factors of yesterday.

ESG is risk-centric

ESG risks, such as climate related financial disclosures, are prompting the investment industry to seek detailed sustainable investing data. Such investment analysis is leading to the financial analysts of banks, ESG funds, mutual funds, and so forth to place a premium on companies which have the policies and procedures which can demonstrate their commitment to the environmental, social and governance factors demanded.

Exceeding buyer expectations

Purchasers are demanding more information than ever before on ESG goals, and not simply from a sustainability standpoint. In recent years, there has been a significant increase in firms requesting information about their suppliers’ significant environmental implications.

2020 saw a 24 percent rise in major purchasers requesting environmental data from their suppliers, compared to 2019. Many of the West’s biggest brand names are now motivated not just by a growing understanding of the impact of environmental hazards on their company.

Critically, these same brands are motivated also by their desire to satisfy their more discriminating consumers and, according to PWC, younger customers (those between 18 and 38) are nearly twice as likely as older consumers to consider ESG factors when making purchase decisions. Manufacturing companies must strive to meet this demand.

Honesty, transparency, and integrity!

Transparency about ESG practises is now synonymous with businesses providing customers with straightforward product and manufacturing information. Finished products, whether bespoke or mass produced, are all derived from materials which have climate change related costs.

The process of manufacturing a single pair of jeans consumes many materials beyond just denim, since the tooling must also be purchased and maintained and the production process fuelled. In terms of ESG issues, since every pair of jeans requires 7,500 litres of water, the process must recognise the negative impact upon the environment.

Think also of how consumers are also investors in companies: whether they are investing in a new car or a pair of jeans, they want to purchase only finished goods which are made with a minimal environmental impact.

The need for ESG data will grow

Significant regulatory fines are expected to be imposed on businesses who fail to comply with ESG standards. Legislation governing due diligence is already being considered for businesses operating in the European Union (EU), and these same regulations impact thousands of businesses in the United Kingdom also.

For example, more than 70 countries have enacted legislation aimed at reducing plastic waste, and 170 countries have committed to “substantially reduce” their use on plastics by 2030.

Note the 2021 move by the US SEC who announced the new ‘Climate and ESG Task Force’ to complement its enforcement activities. This new body will explore strategies to proactively uncover ESG-related misbehaviour. Additionally, the task group will examine transparency and compliance problems linked to the ESG strategies of investment advisers and funds.

With high regulatory fines and the adoption of various ESG programmes and legislation, manufacturers and other businesses will soon be required to satisfy sustainability targets in order to avoid severe penalties.

Manufacturing and director’s duty

This comes on the heels of the PRI, UNEP FI, UNEP Inquiry, and UN Global Compact publishing is guide to ‘Fiduciary Duty in the Twenty-First Century’. According to the research,

“failure to examine all long-term investment value drivers, including ESG concerns, is a breach of fiduciary responsibility.”

As to the interpretation of the law in relation to investors and ESG problems, this was explored by the law firm Freshfields Bruckhaus Deringer. They determined that not only was it allowed for investment firms to incorporate ESG factors into their investment analyses, but it was also potentially part of their fiduciary obligation.

The evidence toward a relationship between consideration for ESG issues and financial performance is becoming greater and the combination of fiduciary duty and a wide recognition of the necessity of the sustainability of investments in the long term has meant that environmental social and corporate governance concerns are now a top priority.

Executives in the boardroom and C-suite are under pressure.

With global sustainable investment now exceeding US$30 trillion – up 68% since 2014 and tenfold since 2004 – pressure on boardroom directors and C-suite executives of all companies to make sustainable investments is increasing.

Approximately 57% of CFOs alone have prioritised ESG efforts since the start of 2020, with 23% stating that ESG investments are more critical for their organisations now than they were before to 2020. The evidence of a sound financial return for establishing an ESG task force has never been stronger.

Additionally, businesses are beginning to link executive compensation to ESG objectives and key performance metrics (KPIs). This reinforces the need of developing and implementing relevant ESG strategy, especially in the manufacturing sector.

According to PWC, 45 percent of the Financial Times Stock Exchange (FTSE 100) corporations now include an ESG metric in CEO remuneration, which means leaders are compensated financially for advancing the company’s ESG agenda.

The changing nature of the workforce

The labour force for manufacturing is shifting, owing in part to the “great resignation” and “grey tsunami”-induced shortages. The latter is predicted to increase the number of retirees in their late careers, resulting in a manufacturing skills gap in the United States that could leave up to 2.1 million manufacturing jobs vacant by 2030. We see the same in the United Kingdom where companies engaged in manufacturing are investing in production automation and other new technology just to keep their processes flowing.

When it comes to employment selection, younger generations have a significant preference for organisations that prioritise sustainability and have ESG goals in place. Indeed, nearly 76% of millennials take ESG commitments into account when picking where to work. Millennials and what is now commonly referred to as ‘Gen Z’ now account for 46% of the full-time workforce in the United States, but are expected to reach 74% by 2030.

Companies will increasingly need to commit to ESG activities in order to fill the talent pipeline, particularly among younger generations. After all, a new employee is investing in the company and your talent acquisition team will require quality ESG data – the tools, as it were – to attract the best.

Technology, ESG, and the manufacturing process

Manufacturers will need to use new technologies in order to provide the visibility, traceability, and data necessary to create and manage ESG projects. Digital technologies, artificial intelligence (AI), the internet of things (IoT), connectivity, blockchain, and 5G are enabling manufacturers to more easily safeguard critical information about their supply chains, environmental effect, and frontline worker safety.

Leveraging scalable technology will be critical. The four criteria listed above will continue to expand at a rapid pace. For instance, by investing in the tools to digitise standard operating procedures (SOPs) that are utilised daily by production line employees, corporate organisations may have a better understanding of how their ESG obligations are being met. This information may be updated in real time to guarantee companies that best practises in material use and safety are maintained.

A pivotal moment

This paradigm change toward sustainable development and ESG objectives for businesses, particularly manufacturing, is a watershed point in history which some are describing as an industrial revolution. Addressing these four concerns via the development of solid, sustainable, and realistic ESG efforts, backed up by the appropriate digital tools and technology, will be a given.

Further justifications for manufacturers to Prioritise ESG

Manufacturers seeking funding should have the following in mind: investors who place a premium on ESG standards are increasing in both size and impact, and our manufacturing industries are particularly exposed. According to recent analysis from the US SIF Foundation, sustainable investing assets now amount to $17.1 trillion — or one-third of all assets under professional management in the United States. This is a 42% increase over 2018. The investment decision making process has changed forever.

Significant investing leaders such as BlackRock have also communicated to the corporate community the importance of sustainable investment. Larry Fink, chairman and CEO of BlackRock, wrote in his 2021 letter to CEOs,

“The more your company can demonstrate its purpose in delivering value to its customers, employees, and communities, the more competitive you will be and the more long-term, sustainable profits you will generate for shareholders.”

Fink also cited BlackRock research indicating that “purposeful enterprises with stronger [ESG] characteristics” will outperform their counterparts in 2020, and it matters not whether you’re a multinational firm or an SME, this holds equally true.

Investors are now more than ever considering climate-related problems when making investment decisions, and it’s the board of every business which will have to react accordingly.

Manufacturers must define the ESG Value Proposition.

Businesses seeking to advance beyond “checking the box” on ESG will need to articulate their value proposition, or the reason for investing in the endeavour. For example, this involves identifying their primary stakeholders – both external and internal – and determining what is most important to them.

By posing the following questions, you may ascertain the degree of commitment that the business is willing to make:

1.     Is our objective to minimise or eliminate regulatory, activist stakeholder, or legal intrusion in our business?

2.     Do we want to get access to “green” funding by proving that our organisation has a strong programme of ESG integration, and are we aligned with their investment process?

3.     Is our objective to build a long-term strategy focused on pursuing growth prospects and capitalising on market opportunities while considering ESG factors?

4.     Or are we striving higher and pursuing ESG goals because they are the right thing to do for our employees, customers, and the world at large, and do we have the tools to align our strategy and business model accordingly?

Developing your ESG programme

Once a business has defined its value propositions — which may be many — it can begin developing an ESG programme that is consistent with those propositions. Executive management and the board of directors should agree on the value proposition in order to foster buy-in and set a strong tone for ESG across the firm.

Early on, establishing who owns the ESG programme may assist ensure its success. Often, it is head of investor relations or general counsel who take the lead on ESG integration in industrial / manufacturing organisations. We’ve also seen chief finance officers and marketing executives assume this role.

Additionally, some manufacturing firms that wish to demonstrate a significant commitment to environmental, social, and governance issues may appoint a chief sustainability officer, a vice president or director of sustainability, or both.

Constructing an ESG Program

How a company’s ESG journey evolves is determined by the extent to which its ESG activities are now progressed. We propose tackling the following four topics as part of that journey:

Exploration and formulation of strategies

This includes assessing the organisation’s existing sustainability initiatives, the tools available for gauging stakeholder enthusiasm, and performing a materiality assessment to identify critical sustainability risks and challenges. This phase should result in a road plan that the company can use to guide the implementation and monitoring of the ESG programme.

Management and development of data

This entails identifying the data necessary to conduct an analysis of ESG activities. Data collection, aggregation, and validation methods must be established expressly for the ESG programme.

Monitoring and reporting on performance

Monitoring and reporting also encompasses identifying opportunities for improvement across these areas. The organisation should consider the following questions: “How are we presently monitoring our sustainability programme objectives?” and “Are we providing thorough and transparent reporting on ESG performance to stakeholders?” Additionally, “Do our disclosure controls and processes support our reporting’s reliability?”

Management of governance and risk

The management and governance of risk includes developing or expanding the governance architecture of the business to better manage ESG risks and compliance needs, as well as strengthening the internal control environment.

At ESG PRO, we are pleased to see the continued efforts to simplify sustainability reporting, and how the World Economic Forum, the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), and the Sustainability Accounting Standards Board (SASB) are working in unison to develop a global framework for sustainability.

Armed with a comprehensive reporting framework, manufacturing companies will have fewer reasons to procrastinate on their ESG reporting, while also meeting the market’s requirement for openness and comparability.

Social responsibility akin to raw materials

Socially responsible investing means that the entire manufacturing process must optimised for ESG considerations. The proper management of human capital is now as central to the value of a company as raw materials and the manufacturing output. The manufacturing value of the finished products will be determined by a market which places a premium on risk.

Financial factors will dominate, especially in large scale production environments which involve chemical processing, and the use of raw materials which have an intrinsic negative environmental reputation. The use of specific raw materials will lead to innovation in the manufacturing process if only to satisfy the demands of the investment industry which takes reputation risk into account.

The bottom line

Businesses that delay or are unsure whether an ESG programme is the right effort at the moment risk missing out on an opportunity to establish themselves as a leader and jeopardising their ability to tell a compelling storey to investors, customers, and other stakeholders, including current and future employees.

Today’s workforce, particularly millennials and Gen Z professionals, actively seek out companies with a solid ESG track record, and the employment market is unlikely to change in the near future. Manufacturing businesses that ignore this opinion may struggle to recruit and retain the talent necessary to prosper in the future.

When it comes to resolving ESG concerns, it’s time to take that first step forward. Manufacturing must review its processes and take a deliberate approach to establishing an ESG programme, such as the one discussed here, as this is likely to yield the strongest return on investment.