Sustainability Strategy: Building a Sustainable Business

 

When building a business, a corporation wants to ensure they are building something that lasts for the long term with the sustainability at the centre of its business. Understanding the market and customers as well as value chain, having sustainable business model, planning well and putting in the work early on will set the company up for the competitive advantage and sustainable success. 

In the face of the volatile, uncertain, complex and ambiguous (VUCA) business environment, every company needs to prioritise. For corporate responsibility and sustainability leaders, a strategy sets out the priorities and goals to attain a competitive position. It provides an agreed framework for deploying resources, creating an impact and communicating results. When done effectively, the process of developing a strategy can help to allocate resources and drive performance for lasting business which eventually can achieve sustainable business.

A sustainable business can support itself and offer a profit to its owners and shareholders as well as an overall value encompassing the environmental, social and economic values which are embedded the sustainable value at the centre of the business. For a company to develop real sustainability, it must meet its consumers' demands while balancing the needs of its employees and stakeholders. The larger a company gets, the more difficult it is to attain sustainability. Yet, it's large corporations that benefit most from implementing sustainability in their company structure. 

From a broader perspective, a sustainable company is one whose purpose and actions are equally grounded in financial, environmental and social concerns. But unfortunately, the road to sustainability for most businesses is not easy. Sustainability is crucial to longevity in a business. Unsustainable businesses tend to be a drain on resources, and their owners shut them down after they fail to prove viable. The more sustainable a business, the much longer it will last in the market.

Developing a Sustainable Business Model

Over the years, many companies still focus on past traditional business models in creating value for the business owner which is clearly outdated in the ever changing, competitive and cut-throat business landscape. This was later expanded to include internal stakeholders such as shareholders. However, these business models are still incomplete in terms of sustainability and thrivability. This is because those companies don’t calculate and measure the effect a business has on the environment, society or the impact of those effects on the business itself. They just merely focus on the financial impact.

In the larger perspective, a sustainable business model (SBM) is one that takes a holistic approach incorporating the environmental, social and economic aspects of the business or industry that companies operate and compete. No business operates in isolation; it competes fiercely with other peers or competitors. it exists within an ecosystem comprising of the industry landscape, political environment, international trade barriers and local as well as global communities. At the very least, it relies upon a supply chain and a delivery chain in the value chain architecture. The sustainable value model shows how an organisation creates value from this ecosystem. To continue generating value from the environment, an organisation must calculate its effects on that environment (Evans et al. 2009).

Society is pressuring business leaders to look beyond creating shareholder value. People want companies to generate value for the environment and society as well. Long-term financial gain is only possible through sustainable development. A company must include the full impact of sustainable business practices on external stakeholders to determine the net value it produces.

The Relationship of Sustainable Business Model and the Value Chain

As supply chains have become increasingly globalised, complex and competitive, companies make payments to numerous suppliers annually, including those in local communities or markets as well as in the international markets. At the same time, consumers demand for green and ethical products, environmental regulations on business activities and investors’ sustainability expectations are growing.

Nicole Oertwig et al., discussed that in order to successfully achieve sustainable corporate development, enterprises have to define and implement a pragmatic strategy.  The firm’s overall objectives thus become multidimensional and have to be broken down to the individual departments and business fields ultimately balancing economic, ecological and social performance factors, to ensure optimised decision-making (N. Oertwig, et al., 2017).

As companies operate globally, they strive to work with their customers, suppliers and other value chain participants to promote sustainable practices across the full life cycle of their products and services. Michael Porter brilliantly shared in his influential book called the Competitive Advantage of Nations (1985) that the value chain analysis can be adopted and used widely as the strategic tool for companies to create value and look for ways to add more value which are critical elements to build competitive advantage for sustainability.

As global corporations, they have to take an integrated systems approach to value chain sustainability and sustainable business model (SBM) strongly supported by the right people and strategy, enterprise resource planning (ERP) and the technology platforms, which are designed to assess and work with others to improve the sustainability impacts of their upstream global supply chains, inbound and outbound logistics, and their products as they move through the value chain from raw materials (inbound logistics), processing (operations) and delivery of their products and services (outbound logistics) greatly supported by their marketing and sales and after sales services as well as other corporate teams globally. 

Furthermore, businesses can broadly categorise their value chain sustainability which is primarily driven by their sustainable business model as follows:

Responsible procurement and sourcing – integration of sustainability considerations into procurement and logistics in their inbound and outbound supply chains including shipping, delivery, quality, etc

Operations and process stewardship – meeting the responsible procurement and sourcing expectations of the market across geographical areas.

Product and services stewardship – influencing the sustainability performance of their downstream value chain where they do not have operational control, taking into account of the aspects and environment and society as the sustainable business values.

Human capital, marketing, technological and financial stewardship – greatly supporting and integrating the support activities in adding more value across the value chain architecture and business landscape.

They seek to identify and improve performance across a wide range of relevant issues, including people, environment and communities and its impact areas. In determining where to focus, they consider financial impact as well as environmental and social materiality to attain business sustainability.

Benefits of Sustainable Business Model

When strategically implemented and executed, companies that use sustainable business models are more likely to succeed (Lindgardt et al. 2009). Additionally, business sustainability is the single most effective way to ensure long-term success (Fedeli, MD 2019). Economic growth needs to be coupled with social value and mitigation of environmental impacts. A sustainable business model identifies risks in the current supply and value chain. It then integrates innovation to combat those risks and ensure prosperity.

Adopting an SBM also helps to create a positive brand image. People are becoming more critical of corporate impacts on the global environment and society. SBMs are ethical business models, providing value to both shareholders and society. This makes them more attractive to eco-minded consumers, as well as potential employees and investors. It also promotes a better economy where there is little production waste and pollution, fewer emissions, more jobs, and a better distribution of wealth and prosperity for all nations.

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Integrating and Aligning ESG with Corporate Strategy

 

Environmental, social, and governance (ESG) has been the important focus of many corporations to integrate it into and align with their corporate strategy for some time now. The unprecedented and very challenging Covid-19 crisis and the recent protests against racial injustice have forced some companies to rethink and reevaluate their corporate strategies and commitments to the ESG priorities and goals. Companies that are better prepared to handle and overcome these challenges are often those which integrate and align ESG goals as part of their corporate strategy rather than standalone initiatives.

In terms of investors’ expectations and demands placed on publicly listed companies, major investors have adamantly pushed companies to address ESG matters as it will influence and affect share prices. In order to respond to this demand, it goes without saying that companies must benefit alltheir stakeholders, including shareholders, employees, customers, and the communities in which they operate. Consequently, companies must serve a social purpose. To achieve business sustainability, every company must not only deliver financial superior performance, but also it must stay committed to ensure environmental sustainability and make a positive contribution to society.

In addition to increased pressure from investors, publicly-listed companies are facing growing expectations to take positions on ESG issues that are important to stakeholders and customers. On top of that, ESG disclosures are also being tallied and sought more now than ever – with stakeholders searching for company commitments to ESG through public disclosure of information on a website, sustainability reports, annual reports, or via business publications.

Finally, companies may have to monitor their ESG objectives and achievements through Key Performance Indicators (KPIs) and ESG metrics which are used to assess a company’s exposure to a range of environmental, social and governance risks. For sustainable growth and development, companies should also consider the importance of circular economy which puts redesigning production, reuse, resource efficiency and recycling forefront in their business models by limiting the environmental impact and waste of resources, as well as increasing efficiency at all stages of the product economy.

Embedding and Building Sustainability into Corporate Strategy

Corporations are increasingly building environmental, social and economic sustainability into their corporate strategies, evaluating and assessing and linking outcomes to the Sustainable Development Goals (SDGs) that can be depicted in the chart below (The Integrated Reporting - Value Creation Framework (2021) and The 17 UN SDGs mandated by the United Nations).  Many companies have been issuing annual sustainability or corporate responsibility reports in accordance with the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) as part of ESG disclosures in their annual reports. The SASB and the IIRC have recently merged to form the Value Reporting Foundation (VRF). Corporate Strategy development framework as depicted in the chart below  plays a very important role to capture the sustainability issues with the aim to contribute to the achievement of the SDGs by demonstrating how the International Integrated Reporting Framework can help organizations align their contribution to the SDGs with how they create value in their respective organizations as well as stakeholders (employees, customers, investors, communities, etc).

Many corporations do not automatically make the link between their mission and sustainability, or simply review the SDGs and sign on. They go through a rigorous and lengthy process. First, a progressive acknowledgement of the importance of environmental, social, and governance issues (ESG) to the company’s business interests. That leads to an understanding of the relevance of the broader issue of sustainability and, for some companies, subsequently seeing how specific SDGs fit with their business interests. They select the SGDs that best fit with their corporate strategy in line with their respective industry classification.

The “drivers” that link sustainability and the SDGs to the corporate interest can be either business-case or values-case. Business-case drivers involve maximizing growth opportunities and minimizing risk and are the rationale for many companies.

Some of them have moved a step further to a values-case by adopting a corporate values or vision and mission statement that moves the corporate strategy beyond just financial return but also covering environmental and social impacts. Eventually, they link their corporate strategy to specific SDGs connected to their business activity which they plan to contribute. The SDGs provide a useful frame, both internally and externally, to organize and articulate a company’s sustainability goals.

Companies embed sustainability in their corporate strategies through three mechanisms:

Strategic Integration is the starting point. This takes place with the transition of the corporate strategy from concentrating just on creating shareholder value to creating shared value. It involves incorporating ESG, alongside financial returns, into the corporate strategy.

Operational Integration involves identifying and communicating specific, measurable, time-bound goals to hold the company accountable for the strategy. Companies sets key impact areas by engaging stakeholders in identifying and managing sustainability issues that are likely to affect the business the most and where the company can have the greatest impact. The SDGs most frequently linked to corporate strategies are 3 (good health and well-being), 8 (decent work and economic growth), 12 (responsible consumption and production), and 17 (partnerships for the goals), however, it all depends on each respective industry.

Organizational Integration is a complex process that extends from the boardroom to the channels. It calls for strong thought leadership from the board and senior company executives and buy-in all the way down the line. At the governance level, companies execute this function through a board committee on sustainability, an executive providing oversight on sustainability, and/or cross-functional sustainability management.

The Role of Sustainability Accounting in Corporate Strategy

According to Wikipedia, sustainability accounting (also known as social accounting, social and environmental accounting, corporate social reporting, corporate social responsibility reporting, or non-financial reporting) is considered a subcategory of financial accounting that focuses on the reporting and disclosure of non-financial information about a firm's performance to external stakeholders, such as capital holders, creditors, and other authorities. Sustainability accounting represents the activities that have a direct impact on society, environment, and economic performance of an organisation.

Sustainability accounting in managerial accounting contrasts with financial accounting in that managerial accounting is used for internal decision making and the creation of new policies that will have an effect on the organisation's performance at economic, ecological, and social (known as the triple bottom line or Triple-P's; People, Planet, Profit) level. Sustainability accounting is often used to generate value creation within an organisation (Perrini, Francesco; Tencati, Antonio, 2006). Sustainability accounting is a tool used by many corporations to become more sustainable and respond to investors’ expectations.

Over so many years the requirements of sustainability accounting were involved into the corporate strategy of many companies. Besides the economic goals they also determine the exemplary social as well as environmental and governance (ESG) considerations. The application of the appropriate management methods and tools are needed to measure of the economic, social and environmental impacts of the strategic decisions and activities within the organization. The interaction between the corporate strategy and sustainability accounting as its key success factor can be further elaborated. First, it starts from the conceptual definition of the sustainability and process of the sustainability strategic management. Then, it introduces the new approaches for the appraisal of the strategic performance beginning with the conventional accounting, through the environmental accounting, to the sustainability accounting. Finally, it demonstrates the role and contribution of the sustainability accounting to the successful implementation of the corporate strategy.

Measuring Sustainability Through KPIs and ESG Metrics

Company is always faced with the challenge of measuring goals. They face the lack of consistent tools and methodologies to assess impact, especially for social and governance issues. Resource constraints also limit impact measurement, with corporations having to incur a substantial cost for the assessment with limited visible value-add. Measuring outcomes is more readily performed at the program level and more difficult in aggregation and determination of overall impact. Efforts to standardize the field include the Global Reporting Initiative, the Worldwide Benchmarking Alliance and the Sustainability Accounting Standards Board which connect businesses and investors on the financial impact of sustainability.

The last two decades have seen a rise in genuine commitment by corporations to sustainability and, more recently, by retail and institutional investors as well. These investors are realizing that how a company performs on a relatively small number of ESG issues will limit downside risk and create upside opportunities in their business undertakings, especially as it relates to the environmental, social and governance issues in the respective industries they are operating. These investors usually want to practice “ESG integration,” which means considering a company’s nonfinancial performance just as they do its financial performance.

In the ESG metrics, the financial impact of the environmental accounting and social activity accounting can be categorized as follows:

• Environmental conservation costs: investments and expenses (prevention of atmospheric pollution, water pollution and soil contamination, bad odors and noise), mitigation of climate change, prevention of ozone layer depletion and management of chemical substances; efficient use of waste, conservation of water and treatment of waste.
• Administration costs and R&D cost.
• Environmental remediation costs
• Social activity costs
• Governance costs (audit and assurance)

(Source: KPIs for ESG, DVFA, EFFAS, 2009)

The above KPIs for ESG Framework (EFFAS, 2009) outlines that the reported ESG-KPIs must be accurate (i.e. free from significant errors), plausible, and definitive, and not in contradiction with current measures, other company documentation (including annual reports). The information, data, processes, and assigned competencies required for the preparation of ESG reports should be recorded, analyzed, documented, and disclosed in such a way that they would stand up to an internal and external audit or review.

An independent audit by well-qualified third parties is a particularly good way to increase the assurance capability (i.e. perceived reliability) of the reported ESG-KPIs. This also serves to ensure the credibility and acceptance of ESG communication among the target groups. As a rule, external auditing carries the additional advantage that ESG reporting and ESG management can be improved based on the best practices referred to by the auditor. For any recommendation other than these, corporates should generally align ESG reporting with all other reporting to the capital markets.

Implementing Best Practices in Sustainability Accounting

Since companies operate in industries with different business and regulatory landscapes, there is no one identified best practices that result in a sure success of sustainability integration. Nevertheless, there are usually eight good practices of companies adopting, building and implementing a sustainability strategy: 

1. Identify, assess and evaluate the key drivers of sustainability
2. Set up a strategy that encompasses both sustainability and corporate goals
3. Determine and communicate specific, measurable, and time-bound sustainability goals
4. Create a stakeholder management strategy on sustainability issues
5. Build partnerships and alliances that leverage core capabilities
6. Embed and integrate sustainability within main business functions
7. Monitor, analyze and measure KPIs and Metrics and its impact on the Triple Bottom Line (environmental, social and economic)
8. Measure value creation for the organization and other stakeholders

Companies tend to prioritize SDGs that align with their core business, rather than taking an all-encompassing approach. Most companies see their contribution to the SDGs directly through corporate sustainability goals and practices.

Global companies annually report their SDGs results in annual corporate or sustainability reports, they identify priority SDGs and mention them in their business strategy in their annual financial statement disclosures. There clearly is a broad trend, to which it is hoped that it opens a window on how companies are adapting to the SDGs.

The Importance of Sustainability Reporting and Disclosure in Publicly-listed Companies

Sustainability reporting and disclosure on environmental, social, and governance (ESG) issues is increasing globally. Many publicly-listed companies publish sustainability reports and disclosures This initiative reflects how sustainability reporting is increasingly seen as a way for companies and their stakeholders to see a changing world more clearly and create long-term value.

Given the proliferation of reporting frameworks and standards, companies have had to decide for themselves which ones to apply. These frameworks and standards allow businesses considerable freedom to choose their sustainability disclosures. Many companies select their disclosures by consulting members of stakeholder groups—consumers, local communities, employees, governments, and investors, among others—about which externalities, or impacts, matter most to them and then tallying the stakeholders’ interests in some way. More recently, stakeholders have asked for increased disclosure about how companies address opportunities and risks related to sustainability trends, such as climate change and water scarcity, which can meaningfully affect a company’s assets, operations, and reputation.

The scope and depth of these disclosures differ considerably as a result of the subjective choices companies make about their approaches to sustainability reporting: which frameworks and standards to follow, which stakeholders to address, and which information to make public. The following SASB Disclosure Topics and Their Financial Impact chart clearly explains the choices companies take in the development of their sustainability reporting and disclosures and its financial impact on each of the disclosure topics selected. The Conference Board Inc. (2018) further explains the comparative sustainability reporting standards by the leading sustainability standards boards in the subsequent matrix indicated below which helps organizations in reporting different aspects of their non-financial impact (environmental, social and governance impact).

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MANAGING DEBT: How to Avoid Corporate Bankruptcy

 

Introduction

Since the global financial crisis that took place in mid 2007 till early 2009, there has been growing concern that the corporate sector is being burdened with too much debt. This has resulted in an ongoing concern which is founded in the belief that highly-leveraged firms could default in large numbers in the event that there is major recession or unprecedented crisis such as the very challenging Covid-19 pandemic.

Many of financially distressed firms choose private renegotiation of their corporate debt rather than seek bankruptcy protection. There has been a number of insights into the corporate debt restructuring decision in which about half of financially distressed firms successfully restructure their debt outside of the bankruptcy protection procedure. If strategically and appropriately negotiated, financial distressis more likely to be resolved through private renegotiation when more of the firm’s assets are intangible, and relatively more debt is owed to banks or financial institutions. On the other hand, private negotiation is less likely to succeed when there are more distinct classes of debt outstanding owed to many different trade creditors.

Shareholders generally fare better under private renegotiation than bankruptcy protection application. The market usually anticipates and appears to be able to identify which firms are more likely to succeed at restructuring their debt outside of the bankruptcy protection procedure. Private contractual arrangements for resolving corporate default are generally less costly to the legal remedies provided by the bankruptcy protection procedure.

Corporate Default and Debt Restructuring

In the event of corporate default and in the face of debt restructuring, a firm must restructure the terms of its debt contracts to remedy or avoid default and it is commonly faced with two choices; it can either file for bankruptcy protection or attempt to renegotiate with its creditors privately. The alternatives are similar in that relief from default is obtained when creditors consent to exchange their impaired claims for new securities in the firm depending on circumstances and other factors.

Whether financial distress is resolved through bankruptcy filing or private renegotiation depends on two factors. First, stockholders and creditors will collectively benefit from settling out of court when private renegotiation generates lower costs than bankruptcy. Second, the lower-cost alternative will be adopted only if claimholders (creditors) can agree on how to share the cost savings. Attempts to settle privately are more likely to fail when individual creditors have stronger incentives to hold out for more favourable treatment under the debt restructuring plan. 

Bankruptcy practitioners determines that efforts to settle outside of the bankruptcy filing are more likely to succeed when relatively less debt is owed to trade creditors, and more is owed to bank lenders. The difficulty is particularly severe for trade debt as the number of trade creditors is usually quite large, and their claims are relatively different. A debt restructuring plan is commonly considered successful if the firm does not file for bankruptcy within a year of the last reference to the restructuring. 

If, however, the firm cannot move back successfully along the value line, then distress may grow to the point that the firm’s value decreases sharply (assets value deterioration) and perhaps to its liquidation value in extreme cases (e.g. Hyflux Singapore, The Business Times, June 2021). This will occur when disappointing cash flows occur, lowering the unlevered value of the firm, and/or asset sales are disappointing or impossible (usually due to changed market conditions) and coupled with unprecedented crisis that was previously not expected nor factored in (scenario planning).

Corporate Failures – Why do they happen?

Without a doubt, the most plausible reason for a firm’s distress and possible failure is, among other things, managerial incompetence. There are many reasons for failure, and of course, most firms fail for multiple reasons, but management incompetence isgenerally at the core of the problems. As corporate failures dictate, the ultimate cause of failure is usually simply running out of cash, but there are a variety of reasons that contribute to the high number of corporate failures and other distressed conditions in which firms find themselves. 

These reasons include: 

• Unsustainable decline in revenue.
• Deteriorated assets value.
• Huge capital expenses.
• Enormous financial losses due to unsuccessful expansion.
• Chronically unhealthy industries in the market. 
• Deregulation of key industries.
• High real interest rates in certain periods.  
• Increased leveraging leading to overleveraging.
• Huge corporate debt.
• Slow and pro-longed corporate restructure.
• Unprecedented crises (global financial crisis, Covid-19 crisis, etc)

Managing a Financial Turnaround – What should be done to avoid corporate bankruptcy?

Corporate Deleveraging – Cutting down the financial leverage

As corporate finance suggests, to be successful a highly leveraged firm must reduce its debt substantially and usually within a short period of time after the restructuring transaction to strengthen its balance sheet. It goes without saying that firms with toxic debt can face a substantial blow to their balance sheets. Consequently, failure of not achieving this deleveraging is apparent leading to the consequent increase in corporate defaults and possibly bankruptcy if not achieved substantially and timely.

Deleveraging can be done voluntary (financial strategy) or not and the latter can result from forced distressed exchange issues whereby the creditors of a distressed firm agree to accept a package of new securities in lieu of the existing debt. Invariably, this package contains equity in the troubled firm which tests the ability for firms to accomplish an equity-for-debt swap. Deleveraging can also be prompted by the fear of a crisis situation such the unprecedented Covid-19 crisis where firms are exposed to even greater debt risks.

Leveraged Restructuring – How to increase corporate value

Depending on its shareholders’ interests, firms can explore some financial scenarios in which case a restructuring of the permanent capital could increase firm value. First, a firm can do a debt-for-equity swap and second, a leveraged buyout (LBO). These two leveraged restructuring strategies are seen as commonly used by many companies and institutional investors to unlock corporate values.

Debt-for-Equity Swap: This financial scenario involves a debt-for-equity swap, or exchange, which is a type of leveraged recapitalization in the corporate finance. On top of the commonly derived tax benefits inherent in a debt-for-equity swap, there is evidence that a firm’s exchange offer is usually perceived and interpreted by the market as a signal about the ability to generate future cash flows in the company. The leverage-increasing exchange offers could result in decreases in debt risk and increases in earnings, sales, and assets for the firm.

Leveraged Buyout (LBO) Restructuring: This financial scenario also covers the same initial condition, except now the swap is an extreme one with all of the equity purchased through a leveraged buyout (LBO) and the public firm becomes privately owned. Most LBO and financial restructuring advocates state that a firm will usually become more efficient in its cost management and productivity increases after it goes private as the firm implements the discipline of debt management as a good motivation for increasing firm values and not to mention the tax benefits that may be obtained.

On the other hand, those who oppose LBO restructurings debate that the enormous debt will burden new investment and puts the highly leveraged firm at a distinct long-term disadvantage. Further, optimistic forecasts of higher earnings and cash flows and successful asset sales do not always materialise and the huge amounts of debt cause good companies to falter. In these problem situations, both the new debt and equity holders could lose a significant proportion of their investment.

Firms can minimise the risks of business failuresto increase value through: 

• Redesigning, redefining and implementing an overall strategic turnaround and restructuring plan for their businesses;
• Obtaining strategic consultation for the financial turnaround;
• Getting consultation services by addressing bankruptcy risks or firm failure;
• Negotiating for a debt restructuring (e.g. debt-for-equity swap, LBO);
• Injecting more equity financing (right issue, additional new share capital, etc); 
• Selling assets or closing down their unprofitable business; 
• Deleveraging and cutting down the financial leverage or corporate debt and
• Executing a priority timeline for corporate turnaround.

From a corporate perspective, deleveraging commonly strengthens balance sheets. It is a sound financial management strategy and commands a strategic course of action to get a corporation back on the right track. 

With their experienced and strong corporate team in place, firms usuallyimplement strategic priorities and execute actions well in avoiding future bankruptcy risk situations should they are faced with the financial distress and possible bankruptcy.

How to Achieve a Successful Financial Turnaround

• Create financial turnaround strategies.
• Install an experienced and competent financial turnaround team.
• Negotiate debt restructuringstrategically and quickly: Do not wait too long to restructure and turnaround, if there are signs of trouble. The faster the better, to avoid a financial deterioration.
• Conduct accurate assessments: If firms have an accurate assessment, they can refine their strategies and execute them quickly well.
• Reduce business complexity and streamline operations and structure;
• Focus on core activities and processes and maintain critical roles;
• Align senior leaders and managers’ tasks and responsibilities;
• Manage uncertainty and resistance through regular communication; and
• Stay agile and flexible during the financial turnaround period.

No firm is immune from failure. The most important thing is that the leadership and management team must be able to execute the financial turnaround strategies, so that more time is available for managing debt, negotiating and restructuring it to avoidfinancial distress, further crises and to remain in business and stay in the game.

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