A prescription for a healthier business

Sustainability-related risks are forcing companies to rethink the way they operate, argues Pat Dwyer, Founder and Director, The Purpose Business.

On a visit to Hong Kong back in January this year, Elon Musk (founder and CEO of Space X) warned anyone considering starting a business to ensure that they have a high pain tolerance. ‘There’s a friend of mine who’s got a great saying about creating a company which is: “trying to build a company and have it succeed is like eating glass and staring into the abyss”,’ he said.

While the definition of an entrepreneur is someone who sets up a business taking on financial risks in the hope of profit, the reality is more someone who wants to make money out of a passion, or a gap in the market through a cocktail of luck, confidence and a bit of ambition. It’s not for everyone!

Drilling down further, there are three main drivers: the first is to be profitable for everyone connected to the business, be they suppliers, employees or shareholders. The second reason is the desire to bring a new product or service to market – one with a perceived demand and a purpose whether functional or aesthetic. The final is simply to establish a business and make it last. Businesses with a legacy are the ones that evolve and reinvent themselves because they take the long-term view. They aim to be here for the long haul, for generations to come. In my opinion, businesses today need to reflect more profoundly on the value of taking a long-term view.

The value of long-term planning

Some 98% of all local companies in Hong Kong are SMEs, there are more than 320,000 of them and they represent 50% of private sector employment. These SMEs presumably have taken the long-term view of building to last as long as they can – at least at the time of business registration. Yet if this is true, how is it that so many fall victim to short-term measures of success? More to the point, the need to perform and demonstrate results for publicly-listed companies have driven them to focus primarily on quarterly earnings – and an obsession on generating these timely reports. This pressure detracts companies from focusing on things that take a longer period to turn around, such as strategic planning, people development, the creation of service standards and more.

‘It is absurd for complex multinational companies to have to invest huge amounts of time preparing detailed income and margin statements every quarter,’ says UN Champion of the Earth Awardee and Unilever CEO Paul Polman. ‘No other aspect of business is run on such short time horizons – certainly not R&D, capital investment programmes, buying contracts, even advertising. So why should financial reporting?’

This isn’t an invitation to recklessness and a disregard for day-to-day profits. Rather, as we adapt to real-time pressures that impact our business, we should look to focus on careful strategic planning and astute but innovative capital investment decisions. Management thinker and now best-selling author Roger Martin calls this ‘expectation management’ in his book, Fixing the game: bubbles, crashes, and what capitalism can learn from the NFL (Harvard Business Review Press; May 2011). ‘Our single-minded focus on the expectations market will continue driving us from crisis to crisis to ruin – unless we act now,’ says Martin. He reflects on the big accounting scandals and breaches in ethics that have plagued business, now of course including the Volkswagen emissions scandal.

In taking a longer-term view, companies are not only able to better seize opportunities, but they can also take a more careful approach to managing risks that they may not have previously prioritised, such as water scarcity, food safety, supply chain transparency, management of natural resources, gender and diversity, governance codes and more.

There is no shortage of cases where the ruthless pursuit of profit has meant that business deprioritises other values such as health and safety, employee welfare, labour and human rights. Only three years ago the deadliest disaster in the history of the global garment industry took place in Bangladesh. Over 3,000 workers in Rana Plaza , 80% of whom were women below the age of 25, refused to come to work on the morning of 24 April due to large and dangerous cracks in the factory walls. Media reports quoted the owners of the building having beaten workers with sticks to force them into the factory. When the building collapsed – 1,137 were killed.

Closer to home in 2008, the World Health Organisation (WHO) referred to the milk scandal in China as ‘one of the largest food safety events… and a crisis of confidence among Chinese consumers’. A WHO representative said it was ‘clearly not an isolated accident, [but] a large-scale intentional activity to deceive consumers for simple, basic, short-term profits’. About 300,000 children were affected.

Ethics and sustainability

These are both examples of sustainability-related risks forcing companies to rethink the way they operate – while not losing sight of profits. Part of this rethinking needs to be a genuine internal reflection on a company’s value system. There has to be a general belief structure that companies go back to when things get difficult – whether it be due to a disagreement among senior leaders, a product recall, or a breach in operational standards. This is business ethics in action.

Ethics is the branch of moral philosophy which seeks to address questions about morality, concepts like good and bad, right and wrong, justice and virtue. It looks at the standards that govern the conduct of a person or a company, especially when faced with business dilemmas.

There is an inextricable link between ethics and sustainability, especially if companies are to manage risk. But businesses will continue to face complex issues and risks, whether they are equipped to deal with them or not. Elon Musk is right – a high pain tolerance is needed to face profit problems. It is also needed for setting up simple structures in order to run businesses well. We all see pockets of good governance practices – whether it be a simple employees’ handbook or a series of regular performance reviews and these all form part of investing in structures that allow businesses to operate methodically and without prejudice. Yet there always is room to strengthen the ways a business operates depending on the major risks it faces and this is as true for a start-up as it is for an established listed company. One way of managing risk is through disclosure and transparency.

We are not short on recent examples. Volkswagen equipped 482,000 diesel cars with software that would only meet emissions regulations when they were being tested. Takata, makers of air bags sold to Honda and Toyota, were found guilty of faulty inflators and admitted to failing to alert US regulators to defective air bags in a timely manner, affecting 34 million vehicles in the US and another seven million worldwide. Whilst these are high-profile examples, there are countless others which don’t make the headlines. All of which point to the pressing need for a stronger sense of business ethics and greater transparency.

It is no surprise then that investors are in fact increasingly demonstrating interest in disclosures of environmental, social and governance (ESG) performance. Investment research houses like Morningstar and MSCI have introduced sustainability ratings for funds globally, giving investors a new way to evaluate investments based on ESG factors. Some of them go as far as identifying companies with high net exposure to sustainable impact themes while meeting minimum ESG standards.

You may wonder whether investors value unsexy information such as sewage discharge or recycling rates but in light of the Volkswagen and Takata scandals, how could they not? They may not put the environment as their first area of concern, but investors funding the development of a five-star hotel in the Cayman Islands or the Maldives will have to assess the property’s vulnerability levels to constant flooding or sea level rise.

The regulatory imperative

What does this mean for Hong Kong? 2016 is a year of change for issuers – they will have to disclose more about their ESG activities. Following a consultation with the market in 2015, Hong Kong Exchanges and Clearing Ltd (the Exchange) issued a set of reporting guidelines commencing on 1 January 2016, and these will become fully effective for accounting periods starting on or after 1 January 2017.

The reporting standard focuses mainly on environmental and social disclosures. There is a list of aspects for reporting for each, and for 2016 all of these aspects have been upgraded to comply or explain. In addition, all the key performance indicators (KPIs) under the environmental subject area will be upgraded to comply or explain.

This is a long overdue development for the Hong Kong market, and one that keeps Hong Kong tracking in the same direction as other international capital markets where there are increasing demands for more transparency on ESG matters as well as more non-financial indicators expected by investors and stakeholder groups. This will also help steer investors present in this market to better understand the environmental and social impacts of their investments and with it manage their risk more effectively. We at The Purpose Business don’t believe in disclosure for disclosure’s sake, but that ESG factors should be embedded in a business strategically to the benefit of employee welfare, improved governance and a more robust supply chain, among other things.

ESG reporting may seem like a serious headache, but it is arguably an effective natural remedy that keeps businesses healthy and helps to reduce Elon Musk’s need for high pain tolerance.