Insights on Total Societal Impact from Five Industries

Related Expertise: Social Impact, Corporate Strategy

Insights on Total Societal Impact from Five Industries

By Douglas BealRobert EcclesGerry HansellRich LesserShalini UnnikrishnanWendy Woods, and David Young

This is an excerpt from Total Societal Impact: A New Lens for Strategy.

Companies have long focused on maximizing total shareholder return (TSR) for investors. Today, under increasing scrutiny from all stakeholders, companies must also consider their total societal impact. TSI is not a metric; it is a collection of measures and assessments that capture the economic, social, and environmental impact (both positive and negative) of a company’s products, services, operations, core capabilities, and activities. Adding the TSI lens to strategy setting naturally leads companies to leverage their core business to contribute to society in a way that enhances TSR.

Past research has demonstrated a link between a company’s performance in social and environmental areas and its financial returns. For example, a 2011 study showed that companies with good environmental and social policies not only have higher stock market returns but also perform better on return on assets and return on equity than companies that have not adopted good environmental and social policies.1 Notes: 1 R. Eccles, I. Ioannou, and G. Serafeim,  “The Impact of Corporate Sustainability on Organizational Processes and Performance,” Harvard Business School Working Paper, 2011. In addition, research published in 2015 found that average stock returns for firms with good performance on material environmental, social and governance (commonly known as ESG) topics  are significantly higher than the returns for firms with poor ratings.2 Notes: 2 M. Khan, G. Serafeim, and A. Yoon,  “Corporate Sustainability: First Evidence on Materiality,” Harvard Business School Working Paper, 2015. And a recent meta study of over 200 papers revealed that 80% find that better ESG is linked with better stock price performance.3 Notes: 3 G. Clark, A. Feiner, and M. Viehs,  From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance, 2015. ESG data is not designed to measure a company’s TSI. In particular, ESG provides a limited window onto the largest impact of a corporation: the intrinsic societal value created by its core products or services. However it is the best way currently available to quantify a company’s societal impact.

While these studies provide support for the value of contributing to society, they do not offer a blueprint for how companies can actually go about this. To that end, BCG conducted a comprehensive study of how companies in five industries—consumer packaged goods, biopharmaceuticals, oil and gas, retail and business banking, and technology—are integrating the pursuit of societal impact into their strategies and operations. In four of those industries, we quantified the relationship between specific topics and financial benefits, helping companies understand which ESG topics they should focus on.4 Notes: 4 The measures we deemed most relevant for our analysis were not available for technology. Also, see Goldman Sachs,  “The PM’s Guide to the ESG Revolution,” 2017; and Bank of America,  “Why Companies That Do Good May Be the Best Performers.”

The BCG Methodology

There is no well-established methodology for measuring the full economic, social, and environmental impact of a company’s activities on society. We can, however, measure how well companies are performing in ESG topics.

Our first step was to identify the ESG topics that are most important in each industry we studied. These topics all relate to the companies’ core business models and operations and concern both the creation of positive societal impact (such as expanding financial inclusion in retail and business banking) and the minimization of negative societal impact (such as reducing waste in oil and gas).

To identify these ESG topics, we gathered extensive input from BCG industry partners, clients, and industry experts. We also drew on information from many organizations, in particular, the Sustainability Accounting Standards Board (SASB), which has zeroed in on nonfinancial topics that it considers to be “material”—that is, likely to be of interest to investors because they can affect financial performance. Our list of important ESG topics by industry ultimately included topics deemed material by the SASB as well as additional topics that BCG believes are important to society, irrespective of their current financial materiality in the industry.

A number of ESG topics are common across industries. Efforts to support diversity and to reduce the environmental impact of a company’s operations, for example, are relevant for most corporations in all the industries we studied. In addition, there are some less obvious areas—most notably, efforts to address humanitarian crises—that are applicable to multiple industries. (See “Business to the Rescue.”) More often, however, areas where companies have the most leverage to deliver societal and business impact are distinct to their industries.

Business to the Rescue

Addressing humanitarian crises—whether a natural disaster, a flood of refugees, or a major health threat like the Ebola outbreak—cannot be a reactive endeavor. A comprehensive approach focusing on preparedness, response, and recovery is required. Historically, such efforts have been spearheaded by governments, the United Nations (through its Office for the Coordination of Humanitarian Affairs), agencies like the World Food Programme, and NGOs such as Save the Children. While some companies, such as logistics providers, have been deeply involved in disaster preparedness and response, the role for most private-sector companies has been limited to writing checks to fund efforts by governments and NGOs.

That is changing. Companies are increasingly bringing their knowledge, skill set, and assets to bear on some of the most pressing humanitarian crises around the globe.

Airbnb, for example, made a bold pledge in early 2017 to arrange short-term housing for 100,000 people in need over the next five years, including refugees, disaster survivors, relief workers, and other displaced people. The company has already provided homes during almost 50 global natural disasters to thousands of people. These efforts have not only provided visible social value but also have helped grow the business—almost 50% of hosts who join the platform during these disasters were not previously registered with Airbnb—and improve the company’s standing with government leaders. For example, in Florida, ahead of Hurricane Irma in September 2017, Governor Rick Scott encouraged evacuees to find free accommodations on Airbnb through the company’s disaster relief tool.

DHL, meanwhile, has created a series of disaster response teams. The sudden influx of supplies and aid can be overwhelming after a natural disaster, making it difficult to get those things to people who need them. DHL is able to use its logistics expertise—on a pro bono basis—to help solve that problem. After a devastating cyclone hit Fiji in 2016, DHL organized the logistical handling of all the relief supplies that came into Walu Bay or Nausori Airport and provided Fiji’s National Disaster Management Office (NDMO) and NGOs with an accurate count of what aid was available and where.

In many cases, private-sector companies in an affected region are uniquely equipped to respond to a disaster given their on-the-ground presence. Consider steel and mining company ArcelorMittal, which has long invested in preparedness by tracking and monitoring potential risks to its operations and workforce around the world. During the Ebola crisis, which peaked in 2014, the company stepped forward to partner with the response agencies. It conducted Ebola initiatives focused on community awareness and screening and used its machinery and capacity to construct treatment centers. In addition, the company’s leadership was instrumental in organizing in-country companies into a coalition called the Ebola Private Sector Mobilisation Group (EPSMG), which eventually included over 80 companies. This group shared information internally and became a single point of contact for the public sector. The coalition, with its long-term presence and commitment in the affected countries, became a powerful voice to governments on shaping policies in the midst of the crisis that supported rapid response and long-term recovery.

Coalitions like the EPSMG can amplify the impact of the private sector by bringing companies together. In the Philippines and Nigeria, company networks have been extremely valuable in responding to natural disasters. The UN, under the Connecting Business initiative, is seeking to support the creation of such national-level private-sector collective action around the world. Such moves will allow companies to leverage their scale in addressing major global crises, generating rewards both for the companies involved and for society at large.

After identifying the right topics for each industry, we determined which we could measure with available data. There are a number of sources that measure company performance on these topics. For this study, we used data from MSCI and Oekom Research, two of the leading providers of such information. We then selected for analysis the largest companies in each industry that collectively represented at least 80% of the industry’s market capitalization and for which there was publicly available data for at least the past three years. This yielded 39 to 141 companies for each industry.

We then analyzed, by industry, the relationship between nonfinancial (ESG) performance and two key financial variables: valuation multiples and margins (EBITDA margins and gross margins).5 Notes: 5 EBITDA (earnings before interest, taxes, depreciation, and amortization) margin is EBITDA divided by revenue; gross margin is gross income divided by revenue. For banking, we used net income margin, a more relevant metric for that industry. Valuation multiples reflect investor sentiment about long-term prospects and risk, and margins reflect current value-added. Both are important contributors to corporate value creation, as reflected in TSR. The analysis looked at ESG performance and valuation multiples for 2013 through 2015, while the margin analysis used data from 2014 and 2015.

Our valuation analysis relied on Smart Multiple, BCG’s well-established, proprietary approach for predicting quantitatively the valuation of public companies. (See The 2013 Value Creators Report: Unlocking New Sources of Value Creation, BCG report, September 2013.) The Smart Multiple approach uses a multiple regression model incorporating traditional financial performance measures such as margin levels, growth rates, debt leverage, and company size. By adding nonfinancial measures to the Smart Multiple model, we can determine the incremental impact on valuation of ESG performance, separate from financial performance. In our margin analysis, we used a similar approach to control for a variety of factors—for example, R&D spending—in order to zero in on the incremental impact of ESG performance.

We did, however, run up against some data limitations. Metrics for many of the areas on which technology companies are focused—such as using their products to improve social and economic inclusion—are not yet detailed and nuanced enough to adequately reflect the variety of emerging business models in the industry. For that reason, we could not include the technology industry in our quantitative analysis. However for the four industries we were able to analyze—consumer packaged goods, biopharmaceuticals, oil and gas, and retail and business banking—ESG data was available for two-thirds of the ESG topics we thought were relevant. (See the Appendix for more on our methodology.)

The Link Between ESG and Financial Performance

Our quantitative analysis revealed a concrete link between performance on specific ESG topics and both valuation multiples and margins. We found positive, statistically significant correlations on valuation multiples for 16 topics and positive, statistically significant correlations on margins for 17 topics out of a total of 65 topics examined across all industries.6 Notes: 6 We looked at ten ESG topics that applied to all four industries and at industry-specific topics: five in retail and business banking, six in consumer packaged goods, six in biopharmaceuticals, and eight in oil and gas. 67 Notes: 7 We looked at ten ESG topics that applied to all four industries and at industry-specific topics: five in retail and business banking, six in consumer packaged goods, six in biopharmaceuticals, and eight in oil and gas.

It is important to note that our analysis does not prove causality. In fact, in some cases it may be that higher margins, for example, allow companies to invest more in ESG initiatives, resulting in stronger ESG performance. However, in many cases it is likely that performance in these topics is contributing to financial performance. Ultimately, the two factors—strong ESG performance and strong financial performance—may be self-reinforcing.

The results of our valuation and margin analyses provide encouragement to companies focusing on ESG-related issues. We expect that evidence of the positive correlation between ESG and financial performance will continue to emerge as data becomes more reliable and available and as companies actively pursue TSR and TSI in tandem.

The Link Between TSI and Valuation Multiples. We found that companies with strong performance in material ESG topics enjoyed a premium valuation multiple.7 Notes: 7 If median performers had a valuation multiple of 10x, and top performers had a 20% premium, the multiple for those top performers would be 12x.

This finding yields a powerful insight. While it has long been understood that fundamental financial factors such as margin structures, growth rates, and financial risk are key drivers of valuations, our results show that nonfinancial performance metrics—the ESG measures—add significant and incremental information that also affects valuations directly. Factoring in ESG made our valuation models more accurate. In oil and gas, for example, adding ESG factors to our model increased its predictive power, with nonfinancials explaining 9% of valuation and financials 74%. (See Exhibit 1.)

What does all this mean for executives? They need to know which ESG topics have a positive correlation with valuations in their industry. (See Exhibit 2 .)

As we looked at those topics, we noted a pattern: nearly all are related to risks or other negative impacts that are particularly relevant in certain industries. Examples include ensuring a responsible environmental footprint and maintaining robust occupational and safety programs. We call these downside topics. The remaining topics are upside opportunities, optional activities that can generate revenue. Nearly every one failed to show a positive correlation to valuations.

We aggregated all downside topics and analyzed their combined connection to valuation multiples.8 Notes: 8 This includes downside topics for which we did not find a correlation individually. This revealed a linear, positive relationship between ESG performance and valuation multiples. To give a sense of the connection, we examined the difference in valuation multiples between top performers and those at the median for the entire group in the ESG topics. We defined top performers as those companies at the median of the top quintile (the 90th percentile).

In all four industries, top performers for combined performance in all downside topics had market valuation premiums relative to the median performers in those topics. This premium was 11% for consumer packaged goods, 12% for biopharmaceuticals, 19% for oil and gas, and 3% for retail and business banking.

So, why would we see a correlation with downside topics but not upside opportunities? The downside topics are well known and so, not surprisingly, relatively good metrics have been developed to measure them. The upside opportunities, in contrast, tend to be newer concepts for which the relevant metrics might be difficult to collect or of weaker quality. If a bank aims to increase financial inclusion, for example, what would be the most meaningful measure to track that? It is possible that given the challenges of measuring upside opportunities, investors are not able to integrate them effectively into valuations.

The Link Between TSI and Margins. We found a positive correlation between margins and both upside opportunity and downside ESG topics in consumer packaged goods, biopharmaceuticals, oil and gas, and retail and business banking. In our analysis, we examined margin premiums—the percentage point difference between margins for top performers in ESG topics and median performers. In oil and gas, for example, if median performers in the health and safety topic had an EBITDA margin of 30%, our analysis showed that the EBITDA margin for top performers in that topic—all other things being equal—was 33.4%. (See Exhibit 3.)

In most cases, for consumer packaged goods, biopharmaceuticals, and oil and gas, the positive relationship showed up in both EBITDA and gross margins. For the purposes of the industry discussions that follow below, we highlight the measure for which the correlation was strongest.

It is not difficult to understand why strong performance in the downside topics would contribute to higher margins. Many of them are related to practices that can lower costs, such as the reduction of water and energy use and minimizing the likelihood of a catastrophic operating incident.

While performance in many upside opportunity topics may not yet be rewarded by investors (as reflected in our valuation findings), it can have a direct effect on performance by helping a company create a sustainable competitive advantage over rivals. A more inclusive supply chain, for example, can help a company attract a broader, more socially conscious customer base.

Insights on Societal Impact by Industry

Our quantitative analysis reveals the power of a focus on ESG. So, what ESG areas are linked to financial performance, and what are individual companies doing in those areas? Here we address those questions for each industry in our analysis. For the purposes of this report, we examine company activities related to topics where our analysis found a quantitative link—and a few where we did not.

Consumer Packaged Goods: Helping Suppliers and Customers

Biopharmaceuticals: Bringing Life-Saving Medicines to Those in Need

Oil and Gas: Facing the Challenge of Climate Change

Retail and Business Banking: Innovating to Expand Financial Inclusion

Technology: Expanding Economic and Social Inclusion

Our analysis of all five industries reveals that some companies are embracing novel approaches to improving their societal impact. As further evidence emerges of the financial rewards of doing so, more companies are likely to find innovative ways drive societal progress.

Insights on Total Societal Impact from Five Industries