I suppose it was only a matter of time. Perhaps it was an inevitability. Paradigm shifts like this are bound to disrupt the status quo for many, and so it is only natural that this one would result in some unhappy people.
ESG has ‘arrived’ as a concept to op-ed pages of some of America’s most prominent publications. What was largely an initialism to be found in business journals and corporate impact reports is now something your uncle might bring up during a lull in the conversation at Sunday dinner.
I will admit some amount of disappointment that the ESG shift has become fodder for political talking points. As a company that has committed to ushering in a new era of positive societal impact through the framework of the private sector, Next Stage believes activating the big system of capitalism to align to social good outcomes is a complete no-brainer. But we know the road ahead may be a little rocky. Societal change that ushers in a new, more just and equitable era almost always is.
An ESG Refresher
I’ve written a lot about ESG this year. I’ve unpacked how ESG and corporate social responsibility relate to each other, how it is disrupting the status quo inside of companies, and most recently how people are at the heart of a new era of collective ownership. This has turned into a continuing essay series – an attempt to narrate what we are learning at Next Stage and why we think it is important. Those would be good primers for this essay, the fourth installment in the series.
As a catch-up, ESG stands for environment, social and governance. They represent domains of the private sector in which a company works on behalf of positive societal outcomes that go beyond maximizing shareholder wealth. It is related to stakeholder capitalism, which is the new corporate buzzword for business practices that center goals that reach beyond profitability.
If that sounds like Profit & Purpose, the big report we published a little over a year ago, that’s because it is. Sort of. Funny enough, we wrote a 92-page report about the trendlines driving this shift but referenced the term ESG just five times. Less an indictment of the report, it speaks to the incredible speed with which ESG has altered the landscape of corporate America in the year since.
In Profit & Purpose, we made an argument for how increased expectations from customers and employees are requiring companies to rethink how they do business. What we missed was the importance of shareholders, particularly Millennial and Gen-Z investors who are increasingly wanting to ‘live their values’ in all aspects of their lives, including through their retirement portfolios.
According to the US Sustainable Investment Foundation, socially responsible investments (SRI) have increased 25-fold since 1995, growing from $600 billion to nearly $17 trillion in 2020. The growth was particularly strong over the last decade as the Millennial generation moved into their 30s and began to save for the future. An ESG fund is the shorthand for this type of mutual fund investment vehicle.
With the rise of interest in socially responsible investing came a need to codify what qualifies a company for inclusion. Two primary standards have emerged – the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB). Companies that want to qualify for inclusion in these portfolios must submit disclosures that demonstrate how they are setting goals across each area of ESG and what they have done to move the needle.
The Internal ‘S’
So much of what you just read is still relatively new not only to those of us who work for Next Stage but also to the management teams of countless companies. Areas of sustainability, social impact and governance have traditionally been managed individually and without a great degree of intersection. Breaking up those silos of management to knit together more cohesive strategies is a big challenge for companies who are trying to keep up with the pace of change.
The dominant theme of the ‘S’ in ESG has been an internal one, with social impact expressed as a combination of diversity, equity and inclusion (DEI) and economic mobility for front-line employees. This was a trendline that pre-dated the pandemic but was sped up considerably by both the disruption of COVID-19 and calls for increased racial and social justice in the wake of the murder of George Floyd. Companies that had been slow to prioritize equity and wellbeing for their workforce were suddenly making them mandates.
It was a big wake up call for corporate leaders. We highlighted it in our Profit & Purpose report, where increasing employee engagement and developing the workforce pipeline were significant sections. In the year that followed its publication, concerns for a workforce shortage have only amplified, gripping corporate America with renewed focus. Companies aiming to be an ‘employer of choice’ are being faced with a need to reshape how their workforce is treated as lifeblood. That includes creating a workplace culture that celebrates diverse backgrounds, creates equitable ladders of promotion and cares for the health and wellbeing of the entire workforce.
Talk about a rollercoaster. Maintaining one’s workforce during a time of crisis was reason enough to focus on the social implications of internal employment policies. The process of ESG reporting tethered those activities happening inside countless companies to a framework for goal-setting, transparency and accountability.
The results thus far have been nothing short of extraordinary as companies lock in on supporting their people. As the adage goes, “real change starts at home.”
The External ‘S’
So, what do those of us at Next Stage believe is the next horizon for the ESG shift? I’m so glad you asked.
As we’ve outlined previously, much of this movement began nearly two decades ago with increased focus on the ‘E’ in ESG – environmental sustainability. The early 2000s saw companies with complicated supply chains rethink how to address negative environmental impacts, with a primary focus on carbon emissions. Rather than wait for regulators to force a change, corporate leaders recognized getting ahead of it would lead to increased profitability in the long run.
This past decade saw the ‘Internal S’ of DEI and employee wellness as a must-do to remain competitive for talent. The last two years has seen this focus go into overdrive as strategies driven at the C-Suite level are resulting in transformed workplaces.
The common theme for both of these phases is a primary focus internally. Goal-setting has focused on aspects of the corporate business model that management can more easily control, areas like supply chain, hiring practices, compensation and access to healthcare. Optimizing the business model in an era of heightened focus on ESG has meant reimagining how work gets done. That change management is demonstrated by how many companies have hired ESG teams to focus on a new model of internal operations.
We believe the next horizon for companies will be the ‘External S’ – how a company looks beyond its own walls to make a positive impact on society. At some point in the future, optimizing the internal business model will no longer be sufficient to stand out from the pack for inclusion in portfolios for socially responsible investment. And when that time comes, like the sustainability work that began two decades ago, proactive companies will be best positioned to win the day.
This area of focus has primarily been the domain of corporate social responsibility officers who lead a company’s collaboration with community institutions. For many companies, that has meant financial investment in nonprofit organizations as a form of ‘corporate charity.’ What is changing is why those allocations are getting made and how the impact of those investments get measured. It is reimagining the relationship between companies and nonprofits as partnerships of mutual benefit.
Next week, my colleague and co-author of Profit & Purpose, Janet Ervin, will walk through this in greater depth, outlining how the development of a ‘theory of impact’ can help harness a company’s ‘External S,’ and how this new approach to corporate investment in social good is translating into exciting new collaborations.
Suffice it to say, if corporate social responsibility was once viewed as a ‘slush fund of feel-good investments,’ the future is the exact opposite. The next horizon for ESG is Corporate Citizenship in an external context, boldface and in capital letters.
What Do You Stand For?
Next Stage is proud to be working with private sector companies to assist them in solving for externally expressed corporate citizenship through comprehensive strategies with an eye toward future impact reporting. That includes aligning ‘External S’ activities with UN Sustainable Development Goals, identifying connectivity with GRI reporting standards and leveraging the big systems of a company that go well beyond their financial investments in nonprofits.
We believe that activating the people power of a company – the very customers, employees and shareholders that are driving the ESG shift to begin with – is a big part of how companies will be evaluated in the future. Transactional social impact activities are shifting to more meaningful and strategic expressions of commitment to causes.
We are already seeing this with cause marketing. Those who would criticize a company for ‘empty expressions’ of social cause alignment through communication channels are missing the much bigger point – brand advertising is normalizing the position of corporations in service to these social causes. In this way, we see it as the ‘canary in the coal mine’ for the much bigger change we will see in the decades to come – a change being driven by younger generations who are making ‘taking a stand’ a corporate mandate.
That this is disrupting the status quo in a way that leads to politicization is not a surprise. But, data suggests this is not being done to companies, but rather proof of how a free market works. This is capitalism driven by the preferences of customers, employees and shareholders, like it or not.
What does this mean for the private sector? We think it means there is still significant work to do, and Next Stage is committed to helping companies navigate the next horizon of the ESG pivot – the ‘External S.’
Interested in learning more? Get in touch – we’d welcome the chance to learn more about the needs of your company.
An essay written by Josh Jacobson