Why Do Most ESG Strategies Fail, and What Is the Mindset Required for Real Sustainable Growth?

Is Your Company Just Reporting ESG Data, or Are You Building Lasting Business Resilience?

Feeling lost in the ESG debate? Learn how to move beyond simple data reporting to build a resilient business mindset that navigates controversy and drives long-term, sustainable growth. If you’re ready to move past the political noise and learn how to build an ESG mindset that creates genuine business resilience, this guide breaks down the actionable principles for long-term success.

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Leaders in publicly traded industries may face pressure to align with Environmental, Social, and Governance (ESG) practices for long-term sustainability. Those pressures can challenge their corporate culture. ESG, which emerged as a financial tool in the 2000s, offers opportunities for transformation and growth. However, as author Matthew Sekol reports, deployment can raise issues. Different types of businesses define ESG to fit their brands or strategies, so regulating across industries can prove difficult. The “intangibles” underpinning these initiatives may tempt leaders to cut it to its “simplest form,” but they should not risk diluting ESG’s relevance. Sekol’s message: If you’re going to do it, make it businesslike, make it real, and make it matter.

Take-Aways

• Environmental, Social, and Governance (ESG) practices mean different things to different organizations.
• ESG is not merely data.
• Companies that embrace ESG face unique challenges.
• Technology is the invisible “fourth pillar” in ESG.
• Criticism and controversy can hinder ESG.
• ESG’s pillars interconnect.
• Companies that harness ESG have proven successful.
• The ESG mindset goes beyond operations.
• ESG must respond rapidly to a complex and volatile world.

Summary

Environmental, Social, and Governance (ESG) practices mean different things to different organizations.

ESG has its roots in Corporate Social Responsibility (CSR) and Socially Responsible Investing (SRI). However, ESG differentiated itself from both by 2004 with its broader definition of “material value” and its willingness to deal with intangibles that can affect a company’s value. ESG has three pillars:

• Environmental – How the company affects the planet in its use of resources and its sustainability practices across its value chain.
• Social – How the company prioritizes diversity, equity, and inclusion (DEI) and protects its labor force from exploitation.
• Governance – How the company’s board and executives engage with values, ethics, and purpose and practice strong accountability and transparency.

ESG remains difficult to define because it links intangible values with material, measurable results.

“[The] goal here is to enable a consistent corporate perspective on ESG to help companies build resilient businesses long enough to save the world, if they choose.”

Every enterprise and industry has its own operating principles and mission, making alignment challenging. An “ESG mindset” helps leaders manage crises in an increasingly complex world.

ESG is not merely data.

Because ESG requires data to inform decision-making, companies may simply report their data without employing leverage. When financial services first utilized ESG, analysts focused on data to determine a company’s material value. Now, however, ESG is more nuanced, and its reach is more extensive. Choosing which data to prioritize, interpreting the data, and conveying the data to stakeholders have become increasingly difficult. With more stakeholder engagement comes more demands for accountability, which burden companies with “data proliferation.”

“With an insatiable need for stakeholders to review ESG data and new regulations, the company must now account for everything, creating a sprawling ESG data supply chain.”

Companies should inventory their “data estate” by reviewing their internal and external data sets. They should determine which information is proprietary and requires protection and which they can share to conform to regulations and to demonstrate transparency and sustainability.

Companies that embrace ESG face unique challenges.

The challenges companies encounter affect all three pillars of ESG. Between 1970 and 2004, global emissions increased by an astounding 70%, making the environment ESG’s most important pillar. Climate change affects everyone and poses existential risks that extend far into the future. ESG focuses on its material impacts and impact on long-term growth.

For example, activists could bring shareholder proposals to a bank demanding that it stop investing in fossil fuels. The bank could align its ESG with these demands by shifting funding to renewable energy. It could negotiate contracts with renewable energy providers. Or, the bank could make a transition by diversifying its holdings and funding companies that use renewable energy or carbon capture.

Public pressure is real and has risks. Stakeholders, including customers, employees, suppliers, communities, and shareholders, could use social media to try to influence a firm’s business practices. Customers or even employees could destroy a company’s reputation by canceling it, a form of public shaming. Users who research companies online could expose corporate misdeeds such as exploitative labor practices or poor sustainability policies. One solution, in terms of governance, is for publicly traded companies to provide guidelines showing how their boards make decisions, including those that involve ESG or affect stakeholders.

“Globalization has compounded systemic issues and risks with issues like child welfare, climate change, forced labor, equity and justice, and so on, which have led to many of these crises.”

While boards may mandate that ESG is integral to their operations, they still need to shift their decision-making practice from the short term to the long term to pursue their material goals. Boards often have trouble defining their ESG goals or priorities, leading to murky and inaccurate reporting. A direct link must exist between ESG deployment and material impacts. Otherwise, ESG will not be effective.

Technology is the invisible “fourth pillar” in ESG.

Technology’s vast infrastructure can wrangle and support ESG transformation, solving wicked problems with its extraordinary processing power. Blockchain, the metaverse, and generative AI are all recent developments with the potential to facilitate ESG goals and opportunities. Adapting these new technologies to serve your purposes may require stakeholder buy-in or updating or replacing legacy systems.

“To deliver on the promise of digital transformation and gain ESG insights to solve these challenges, a company must modernize legacy technology, break down internal technology and business unit siloes, and solve complex cultural fear of change.”

Technology produces data that is integral to ESG analysis and decision-making. With AI, the Internet of Things (IoT), and other capacities, companies can assess their material risks and goals. Technology facilitates communications among stakeholders. Top-level executives need technology to furnish up-to-date, reliable financial data. However, companies whose operations are technology-driven are exposed to cybersecurity risks, another reason to constantly upgrade and protect your tech infrastructure.

Criticism and controversy can hinder ESG.

ESG is vulnerable to political pressure due to polarization, particularly in the United States. Activism from both the left and the right further complicates the issues ESG already faces. For instance, some conservative business leaders chafe at progressive social initiatives such as DEI. While public trust in free markets and corporations outweighs trust in government, the private and public sectors must collaborate to ensure ESG’s continuing relevance.

The state of Texas, for example, has put forth anti-ESG legislation to protect its fossil fuel industry – though ironically, it also has dedicated profits to renewable energy sources.

“Companies need to be mindful of these new pressures as every complex issue increasingly becomes whittled down to black or white, at least in the USA, putting stakeholders at odds against each other.”

Controversy has also arisen around the accuracy and fairness of ESG scores. Tesla founder Elon Musk, for example, caused a stir when he criticized rating agencies’ ESG scores which gave Tesla lower ratings than tobacco companies.

Tesla scored low for lack of transparency about employee relations and for not having a carbon strategy. However, tobacco companies have high visibility for their products’ negative health impact. Some of these companies, such as Philip Morris, have identified evolving strategies and acknowledged their social risk as they make a transition toward smoke-free products.

ESG’s pillars interconnect.

By examining how the pillars of ESG interconnect and conducting risk analysis, a company may uncover new issues and find opportunities for improvements that add to its resilience and adaptability in a crisis. For example, a fabric plant that uses a lot of water might address several ESG material goals simultaneously. The company could examine a local watershed to monitor its water consumption and switch to dry dyes — though that might affect its supply chain. Such new processes could spur changes in governance and protect the company from being sued by residents who rely on the water table.

“Companies must recognize, against a short-term mindset, that these long-term interconnected crises will become material to every company over time, despite the goals and commitments set.”

Changes that address systemic problems can influence both a firm’s internal workings and its external stakeholders. For example, both good and bad outcomes resulted when employees switched to remote work during the COVID-19 crisis. For the Social pillar, remote work granted employees more flexibility in their schedules. However, having employees abandon downtown offices could lead to problems for declining cities. Real estate owners may not be able to retrofit their buildings to comply with sustainability goals unless they can secure government subsidies.

Companies that harness ESG have proven successful.

Pepsico, Lego, and Target have leveraged their investment in ESG goals in various ways.

• Pepsico and the Beverage Industry Environmental Roundtable (BIER) – Pepsico founded the BIER consortium in 2019 to address systemic industry issues, particularly around water use. Its members include Oceanspray and Coca-Cola.
• Lego and sustainability – The iconic Lego brick is oil-based, and 75% of its emissions come from its suppliers. The company committed to switching over to sustainable materials by 2030. However, it has found that manufacturing durable products with recycled plastics is challenging.
• Target and community impact – DEI efforts contributed to 28% revenue growth for Target retail stores between 2019 and 2022. Target leverages the Social pillar of ESG by hiring a diverse workforce and practicing community outreach.
• Paramount and Content for Change – Instead of simply deploying DEI concepts in its hiring practices, Paramount aligned stakeholder engagement with its core product: storytelling. Its unique content, which focuses on diverse stakeholders, demonstrates Paramount’s commitment to addressing systemic issues with an ESG mindset.

The ESG mindset goes beyond operations.

Operational improvements alone are no longer sufficient for companies that want to help solve systemic problems. With tipping points in the Environmental and Social dimensions on the horizon, some businesses will face large-scale disruption that could leave them struggling to react. For example, new systems that may come along to replace extractive capitalism can imperial businesses based on resource extraction.

“Only after a company can prove or at least start the journey to impact can it inspire others in its value chain to do the same, which is a powerful way to use influence.”

Companies have several ways to leverage their ESG goals while remaining profitable.

• B Corps – By becoming a “benefit corporation,” a company can acknowledge stakeholders’ impact while enduring less scrutiny of its practices since B Corps members clearly identify their long-term goals.
• Value chain improvements – Procurement teams can use their expertise to enforce more accountability in their companies’s value chains.
• Industry collaboration – Industries can form consortiums to scale up their ESG commitments.

ESG must respond rapidly to a complex and volatile world.

ESG must evolve to address systemic issues and respond to world events. It must grapple with intangible value, complex global economic development, and crises that can upend the status quo. No one could have predicted a global pandemic in 2020, nor the war in Ukraine that began in 2022. Severe weather events affect businesses as well.

A serviceable definition of ESG remains elusive, with short-term profits counterbalancing long-term sustainability practices. For ESG to be relevant, it must move from following the data to fomenting measurable change.

“The material Environmental, Social, and Governance issues that impact a company today and drive toward long-term resilience and sustainable growth [include] systemic issues that the company can influence, which may return material impact over time.”

Technology helps companies address complexity, but it requires buy-in across stakeholders, as well as sufficient coordination to produce and handle change at scale and across a multiyear time horizon. For example, using generative AI may improve data analysis, but users must share information ethically to protect their companies from reputational risk exposure. With various political agendas – such as pushback against DEI programs – companies face increasing pressure to standardize their ESG material goals, define the ESG mindset, and demonstrate how to put it into action.

About the Author

Matthew Sekol is an ESG and sustainability advocate at Microsoft.