How to judge the ROI of your sustainability efforts

Faced with pressure from customers, regulators, investors and employees, many companies have ramped up spending on environmental, social and governance (ESG) projects. But as they work to integrate sustainability into broader business strategies, finance chiefs must still show that the initiatives offer good value for money.

This process might well be daunting for those at the beginning of their ESG journeys, especially if the exercise sets alarm bells ringing about the C-suite’s commitment to sustainability. But according to James Stacey, a partner at sustainability consultancy ERM, there’s no need to fret. Companies simply need to assess the return on investment (ROI) of their ESG initiatives in the same way they would judge other investments that could impact their future financial performance and success.

“Understanding ROI is really all about understanding how the sustainability agenda or a subset of it – let’s say carbon emissions and the transition to net zero – interacts with a business’s revenue, costs and the assets and liabilities it’s got on its balance sheet,” he says. “At that level, where these issues are strategic drivers of future financial performance, the ROI exercise is really the same as it is in other business circumstances.” 

But because different ESG issues have different degrees of financial impact on different types of business, there’s no one-size-fits-all approach when it comes to measuring that ROI, Stacey says. “Something like carbon emissions and climate change will be all-pervasive, whereas some other sustainability issues can have equally significant material impact but will often be more specific to a sector or geographical context, rather than affecting all industries in a significant way,” he says.

Intangible sources of value

The ROI might not always be purely financial. For instance, as employees become more engaged on ESG topics, they are more likely to leave their jobs if they feel their employers’ values are not aligned with their own, meaning that part of the value of any ESG initiative lies in the benefits it provides through staff retention. 

“A big driver of our positioning on ESG is our people, and that’s an unquantifiable ROI,” says Tamsin Ashmore, CFO at Ultima Business Solutions, an IT services company. “There’s a significant expectation across all of our employees that we as a business are doing the right things. For me, there’s an element around this that is based on attraction and retention. We are a business with exceptionally low attrition, and that has an inadvertent P&L impact because the cost of rehiring people is significant.”

The growth of sustainability regulations over the past decade means that the ROI of an ESG initiative could be as simple as maintaining your licence to operate, says Jaideep Das, a partner at ERM. 

Take a business that has an outsize impact on a local community in a region that suffers from water scarcity, for instance. “If you’re operating a very water-intensive operation, you might be creating a lot of jobs but it’s going to have an impact on the community’s ability to draw on water resources,” says Das. “There have been very good, well-run plants which have been stopped from operating either by regulators or by communities because of issues like that. So while there might not be a dollar benefit of tracking broader stakeholder engagement, it totally impacts their licence to operate.”

There are other non-financial elements of ROI that should be considered, such as the organisation’s ability to access funding now that lenders and investors are increasingly scrutinising ESG performance. “If you have a business that wants to borrow money or is seeking investment, if you can’t quantify your ESG impact or sustainability performance, then it becomes difficult to access capital and that means your growth becomes stunted or you can’t achieve your business ambitions,” says Daniel Usifoh, co-founder of Axiom, an ESG reporting software provider.

What’s your reputation worth?

Other ESG issues might not have a direct financial impact, but could affect a company’s brand reputation, impacting its ability to grow and attract new customers. “There is a business case for being robust and diligent around conduct and performance across those less directly financially impactful KPIs [key performance indicators] that don’t have an immediate and obvious impact on revenue or cost,” says Stacey.

Of course, some sustainability initiatives can have a direct financial ROI, even increasing a company’s competitive advantage and boosting top-line growth. Das points to business-to-business (B2B) companies. “In the supply chains of customers with ambitious ESG goals, these companies are increasingly getting selected because their products and services will help their customers to reduce their carbon footprint or meet certain targets for the ‘S’ part of ESG.”

Ultima, for instance, has a target that 75% of its products should help customers reduce their carbon footprint. In that instance, the financial ROI is straightforward: if customers are choosing to buy its products, it feeds through to revenue and the company’s bottom line.

Efforts to reduce carbon emissions can also help deliver a direct financial benefit, either by reducing business travel expenses or lowering electricity costs. “What drives both emissions and costs within your internal operations is energy consumption, so if you’re able to reduce energy consumption through your ESG initiatives, then it follows that your operational cost reduces as well,” says Usifoh.

An accountant’s nightmare

Of course, CFOs might not be able to point to such factors on a balance sheet, says Ultima’s Ashmore. “It’s all in those hidden areas of the P&L, so you wouldn’t be able to directly attribute it to ESG,” she explains.

It can also sometimes be challenging to access reliable data to track progress made on ESG initiatives and how that translates into ROI. “As an accountant, you want everything to be really black and white and really clear, but we’re still very much in a world where the robustness of reporting is not completely ironclad,” she continues.

That is creating a backdrop where organisations can potentially massage their ESG figures and make their ROI look better than it is. “Everyone can show themselves in the best light that they choose to at the moment, and there’s an element to ESG around how good is the marketing firm that is doing all of this for you,” says Ashmore. “We’ve got to get under the hood of this, and that can only be done through regulation, otherwise you’re relying on organisations to just be passionate about what they’re doing.”

Ultimately, if organisations can’t accurately measure the impact of their sustainability initiatives – be it for assessing ROI or meeting stricter regulatory requirements – the potential implications could be severe. “This is no longer just a nice to have,” says Usifoh. “Measuring ESG’s financial performance is a must if you want to remain in business in the long run.”