Sustainability As Key Role For The CFO
Increasingly, the CFO is responsible for measuring, reporting and managing an organization's sustainability performance – functions that until recently at least in part were those of a Sustainability Officer. In the adjustments that the sustainability transition requires in business operations, CFOs therefore play a crucial role. In practice, they are still searching for the best way to fulfil that role.
This to some extent has to do with the language used. It is difficult to express sustainability in terms such as EBIT, margins, balance sheet or profit and loss account, which are still central to both education and professional practice. Moreover, the impact of sustainability on issues like attracting new customers or customer returns is difficult to quantify. For example, how does an investment in more sustainable packaging translate into returns? Perhaps the biggest stumbling block is the fact that most CFOs are captive to everything they have to comply with. They hustle from month-end closing to quarterly reporting, from budgeting to shareholder meetings. The balanced scorecard, a method for achieving strategic objectives, already contains numerous KPIs and they are struggling to incorporate sustainability as yet another element.
Beyond budget
It is our opinion that this is exactly what needs not to be done. Instead of adding yet another checkmark to the current framework, CFOs can take control and present proposals to revise that framework. Sustainability simply does not fit into the traditional boxes of KPIs in the field of finance, employees and customers. Instead, it should run integrally through the entire operation, like a skewer. By embedding and valuing it in all of an organization's products, services and activities, it becomes part of its DNA rather than an extra element that needs to be added. Companies focused on consumer products especially, are already quite far advanced in this regard. The Unilever compass is designed to ensure their strategy for growth is consistent, competitive, profitable and responsible. Heineken's Evergreen strategy also bets on the 'Green Diamond’ of four pillars: growth, profitability, capital efficiency and sustainability.
Nor can sustainability be managed on a quarterly or annual basis. It requires looking beyond the budgetary cycle with a rolling forecast – a progressive prognosis in which, looking at future objectives, based on current developments and insights, it repeatedly assesses how developed an objective is and what is needed to (still) achieve it within the set timeframe. This method – which we call beyond budget – assumes a shift of time and attention to that which really adds value.
Risk management
If CFOs want to integrate sustainability into the entire operation, this can only be successful if the subject is sincerely embraced by the CEO, said COO Jacqueline van Lemmen of biotechnology company Corbion this May in an interview with Management Scope. Many of the (sometimes substantial) promises in this area are sparsely realized. If sustainability is still seen as a stand-alone theme, it is often the first casualty when there is a 'fire' in the boardroom. The reality is that the long term tends to give way to the short term. This now leads to increasing regulation and legalization, with all the associated risks of failure. The result is that risk management has become one of the main tasks of the CFO, added to the compliance requirements after the financial crisis, and the pressure on cash flow and profitability due to the COVID pandemic. This has already made the finance function quite diverse and forced it to broaden its perspective. The sustainability transition requires yet another step. Together with the CEO, CFOs can choose the direction and set ambitions, and discuss them with Supervisory Board members and shareholders. They already proved that it is possible to integrate risk management into business operations. The next step is to do the same with sustainability.
Short- and long-term value creation
Ostensibly, there is always a tension between long-term sustainable investments and short-term profit maximization. The CFO can help bridge that gap by using a positive narrative. For example, he or she can encourage the sales department to investigate whether customers who consider sustainability important are also willing to pay more for the more sustainable products in the current portfolio, which implies a price advantage to be gained. The reverse is also possible: to make less sustainable products more expensive for non-sustainably minded customers. In this way, the CFO holds out a proverbial carrot to the organization. This can be more constructive than declaring radical upheaval because new legislation demands it.
At a more fundamental level, CFOs can ensure proper allocation of costs, whereby the (financial) benefits of sustainable choices and the (financial) disadvantages of non-sustainable choices are included in the business case. Factoring in the human and environmental costs – a realistic carbon price is a simple first step – would make existing products a lot more expensive and thus sustainable choices a lot more attractive by comparison, and, increasingly, even cheaper. Many companies do not (yet) see this.
Reducing risk
It is also time for a different type of discussion between companies and shareholders. Shareholder value is ultimately a discounting of all future profits of a company. If the CFO can show what that future looks like and what portion of capital expenditure must go towards sustainability to ultimately make more profit or simply to survive, shareholders may be more inclined to collaborate. A company producing lubricating oil for internal combustion engines is not future-proof and already requires investment in the plants and product portfolio needed to survive at all. A bank that discounts mortgages, part of which are used to make a home more sustainable, does not cut shareholder value but rather ensures that those homes yield more, and that customers can pay off their mortgages more easily. In doing so, the bank limits its own risk on that customer group.
It takes some agility from the CFO to show that the sustainability strategy can go hand in hand with a good balance between short-term and long-term value creation. At the same time, there are situations where shareholders will have to accept that they will get less in return, for example because a company wants to remove child labour from the chain or pay a fair wage to suppliers. Here, too, the CFO can help make the right trade-off. What does it cost to remove child labour from the chain? How great is the risk that customers will walk away because they cannot pay that fair wage? Or conversely, how great is the risk of losing customers or being fined at some point if you do nothing or too little?
Materiality analysis
Organizations should not only be transparent about their sustainability choices, equally important is for them to make the right choices. Materiality analysis can help give the sustainability strategy the right focus and avoid chasing trends. Where one company can make the most impact by reducing emissions from its own factories, another will achieve more by fighting injustice against people and the environment. Moreover, it is important that this materiality analysis includes the (often unintended) effects of a sustainable change of direction. The chemical industry, for example, is currently busy looking for alternatives to fossil. One possible route is to grow crops that are then used as raw material for fuel. The idea is good, because if you grow what you will later burn, at least the chain is circular, and no new emissions are emitted. Still, there is a problem, because growing those crops comes at the expense of agricultural land. Moreover, those crops are also edible, so if the chemical giants start actively pursuing this, they are – despite all good intentions – breaking into an already fragile global food system.
Greater purpose
In the current paradigm, such considerations often do not reach the boardroom and thus are not included in decision-making. It is up to the CFO to introduce a different and broader paradigm, where it becomes natural to weigh both the positive and negative impact on the environment and society in every decision. To steer behaviour in the right direction, not everything has to change at once. It is more effective to gradually adapt existing KPIs and incentives to the sustainable ambitions and the phase of transformation in which the company finds itself. We expect that the introduction of such a new framework will give CFOs the opportunity to break the negative cycle – the covetous system that is currently so frustrating and takes up so much time – and thereby increase the sense of purpose.
Essay by Alexander Tamminga, partner at Kearney, and Pim Rossen, principal at Kearney. Published in Management Scope 07 2023.