Inflation, Sustainability and Consumer Behaviour

High inflation rates have persisted for quite some time now. As a result, inflation affects both (a) how businesses operate in a high inflation environment and (b) how consumers respond with their purchase decisions.

Rising prices
Photo by Monstera: https://www.pexels.com/photo/graph-with-increasing-euro-profitable-investment-6289026/

In an inflationary environment, businesses face higher costs due to increased input prices. Staff costs rise too as the company needs to compensate people for a higher cost of living. Nominal interest rates raise the cost of borrowing. While all costs are rising, businesses have limited capacity to pass on the cost increases. While the worker (who is also a consumer) receives higher wages, she does not get fully compensated for inflation. Thus, the worker or the consumer sees an effective reduction in her purchasing power. With tight demand, higher prices will only drive away the consumers. Add to this chaos consumer preference for sustainable products. 

A study by GfK indicates that about 80% of consumers globally say that sustainability remains important to them. At the same time, about 30% of Europeans, 40% of people living in the US and 50% from developing Asia indicate that they will put their own economic security and wellbeing before environmental problems.

This makes reading the situation confusing. So what’s a company to do?

Finetune your messaging: Undertaking sustainable actions is not enough. These actions need to be communicated credibly too. Communication without action is easily caught out and can cause irreparable harm. For instance, if you are an appliance manufacturer, help the customer understand your repair and refurbish programme and make it easy for them to avail of it. Or, prevent food waste by providing discounts near expiry dates. Provide net zero labels that are easily visible or communicate net zero credentials powerfully on other mediums. 

Build core sustainability capabilities: The customer’s view on sustainability has shifted from “cleaning up” to “saving the planet” – given the magnitude of the problem and increased awareness of sustainability issues. Thus, companies will need to continue to build a strategic focus on sustainability. Then, when inflation ebbs, the company will be ready to cater to customers opening up their wallets.

The opportunity for sustainable products is immense. Increase their perceived value, ensure its effective use and create compelling communication to build trust with the consumer.

Stranded Assets and Finance

The shift to net-zero requires moving away from fossil fuels (coal, oil, and gas) and decarbonizing production processes and supply chains. Thus, new equipment or new methods may be required. This results in stranded assets. In this article published in Artha (journal of IIM Calcutta) I explore stranded assets and their implications and focus on environment-related stranded assets.

The August issue is available at https://www.iimcal.ac.in/FinLab/email-template4/

A Just transition

Faced with the climate crisis, companies are rapidly transitioning to a green economy. However, this transition is often painful, disrupting people’s lives and livelihoods. Businesses have often gone about the transition as if “transition is assured, justice is not.” Trade unions questioned this mindset in the US in the 1990s. The concept of just transition emerged from these struggles. 

Source:  LOGAN WEAVER | @LGNWVR / Unsplash

While the term still refers to the support for workers who lose their jobs due to environmental protection policies, it is now seen more widely to include support for racial justice and social equity in environmental and climate policy and includes impacted communities. 

The importance of a just transition is underscored by The Paris Agreement of 2015, stating, “Taking into account the imperatives of a just transition of the workforce and the creation of decent work and quality jobs in accordance with nationally defined development priorities.”

A just transition model must include the following:

  • Income support for workers during the entire duration of the transition
  • Local economic development tools for affected communities
  • Realistic training/retraining programs that lead to decent work
  • Knowledge sharing — the adoption of best practices from other jurisdictions
  • A framework to support labour standards and collective bargaining
  • A sectoral approach customized to regions and work processes
  • Research and development to provide support for technological adjustment
  • An equity lens to understand the impacts on racialized and indigenous communities

Companies are increasingly talking about stakeholder values. They must demonstrate their commitment to stakeholder value by ensuring that their sustainability commitments include a just transition. A just transition must be woven into the design for transition. Becoming net-zero needs to be backed up by a just and fair process. A just transition brings together the Environmental and Social pillars in ESG and Governance pillar provides the glue that keeps them together.

Earnings Calls and ESG

Companies periodically provide financial and increasingly non-financial information to the public to reduce the information asymmetry between investors and the company. Apart from annual reports, communication takes place through three mechanisms: (a) investor’s day, (b) earnings calls and (c) guidance calls. While some companies have started ESG calls, they are not particularly common.

The time is ripe to stop treating ESG as a sidebar and integrate them into financial reporting. Management fusses over quarterly earnings and reports. Investor relations see it as a vehicle to see the equity story. Many studies show how quarterly reports emphasise short-term profit generation. Long term investments and research and development take a backseat. Sustainability often does not even merit a mention even though ESG has a significant long term impact on the company. As companies increasingly integrate ESG into corporate strategy, communicating ESG to investors.

So, how should companies go about doing this? A joint project between the New York University Stern Center for Sustainable Business and the CEO Investor Forum of Chief Executives for Corporate Purpose suggests the following steps: 

  1. Integrate ESG and long-term content sequentially: Begin to integrate ESG and long-term strategy content into existing disclosures to build comfort and confidence within the investor base and management.
  2. Prep the analysts: Get your sell-side analysts to ask questions on ESG. This prep provides an opportunity to discuss these issues fuller.
  3. Develop an earnings call schedule: Figure out how you would use each of the four quarterly calls to drive the discussion on ESG. Usually, ESG updates are annual. So, investor relations can use the quarters to drive conversations on ongoing work.
  4. Highlight sustainability and financial value: Describe management’s thesis on the impact of ESG strategy and performance on the company’s financial performance. Investor relations can build this link through the following means:

a. Growing the top line: Studies show that consumers increasingly make their purchase decisions based on the product’s sustainability. Thus, a sustainable product is likely to add value to the company.

b. Cost reduction: Reducing energy usage or water usage is likely to reduce costs for the company.

c. Avoidance of regulatory roadblocks: Regulators increasingly see companies with strong ESG practices positively. Also, increased regulatory pressures are less likely to impact a company focused on ESG and may even gain subsidies and faster regulatory clearances.

d. Productivity improvements: Like the consumers, employees also see sustainable companies positively. A company’s focus on ESG will likely raise employee morale and productivity.

e. Reduced stranded assets: Companies that proactively move towards newer technologies or have reduced investment in older technologies are less likely to be left with stranded assets.

5. Monetise risk: Consider including an assessment (and specific examples) of the value at risk associated with not acting on a particular ESG theme, e.g., the potential costs of avoiding human capital expenditures. 

A robust mechanism to incorporate ESG into earnings calls will go a long way in telling the corporate story. 

Where organisations go wrong on sustainability

The climate crisis has firmly pushed organisations to be more sustainable (or ESG-centric). While many organisations have done well and are on the path to becoming sustainable, others have struggled in their endeavours. Here are some roadblocks that hinder companies from becoming sustainable.

Hierarchical mindset: The organisational culture is that of obedience. Employees only do what their bosses tell them to do. Organisations are primed to follow government mandates. Both organisations and employees avoid going beyond what their superiors ask them to do. Thus even when the organisation or the employee has the competence and resources to be sustainable, they seldom do so as they wait for mandates or orders.

Not my job: Environment and sustainability are separate functions in most organisations. Executives often see sustainability as a different programme or function and do not integrate it with purchase, production, marketing, sales, design etc. This siloed approach often leads to the status quo. For an organisation to be sustainable, sustainable actions need to cut across departmental boundaries.

Lack of vision for sustainability: Many organisations do not have a clear vision on sustainability. They rely on either ad-hoc actions or believe that mere compliance with regulations is enough. A clear vision motivates and excites people leading to increased commitment and energy.

The cause and effect confusion: Most companies tend to take actions that reduce emissions and discharges. These emissions and discharges are the effect and not the cause. Emissions and discharges come from the way products and processes are designed. The materials, chemicals and energy used to produce are the cause. Emission control temporarily masks these problems.

Information gaps: For sustainability actions to succeed, people across levels require information on the benefits of sustainability programmes. Unfortunately, many organisations fail to communicate the needs and purpose, strategies and expected outcomes of their sustainability efforts effectively..

Learning gaps: Many executives have grown up without studying sustainability. The topic is now gradually entering syllabuses. Thus, executives need to be incentivised to expand their knowledge, test new ideas, and learn how to overcome barriers to change.

Failure to institutionalise sustainability: The success of sustainability programmes depends on how sustainability is institutionalised in an organisation through operating procedures, policies and culture. Benefits accrue when an organisation links compensation, promotions, new hiring, and succession planning to sustainability. However, with many organisations failing to embed sustainability into their core policies and procedures, employees’ commitment to sustainability remains superficial.