Learn how to evaluate sustainability investments from a company that’s been recognized as an ESG leader. Functional leaders can use these strategies to fund initiatives that boost resilience by creating long-term value for the business, the environment and society.
The right social and environmental investments contribute to your business’s sustainability along with the planet’s. Organizations that understand and act on this will be better positioned to respond to future disruptions. Early rumblings are already audible today:
Higher capital costs for companies with significant exposure to climate risk
Increased pressure from competitors with innovative solutions to social and environmental issues
Reallocation of long-term investors’ capital toward sustainable companies
Younger employees’ preference for responsible employers
Logistics company UPS is proof that businesses don’t have to choose between profits and sustainability. The organization has been successfully creating value for shareholders since its IPO in 1999, with dividend growth averaging 10%. Its return on invested capital — which has averaged 22.43% over the last four quarters — has historically been higher than that of industry peers and well above its weighted average cost of capital (6% for the trailing 12 months).
At the same time, UPS has been recognized for its ESG efforts. This year, the company was named to Corporate Responsibility Magazine’s annual 100 Best Corporate Citizens for the 11th consecutive time. And it has been part of the Dow Jones Sustainability North America Index for 15 years in a row.
As the executives in charge of resource allocation, CFOs play a critical role in helping to achieve corporate ESG goals. But deciding how much (and where) to invest to generate the most value is no small task, especially at a time when companies are increasingly under pressure from a wide variety of stakeholders to maintain cost discipline. At the same time, they’re expected to be more socially and environmentally conscious.
Brian Newman, CFO at UPS, talked to us about how he evaluates and prioritizes ESG investments to maximize returns for the business and society. He works closely with Laura Lane, UPS’s Chief Corporate Affairs and Communications Officer, who answered our questions separately. We’ve distilled some practical lessons from our conversations with them about how they make sound resource allocation decisions.
Newman plays a critical role in determining how much money UPS can invest in ESG. As he does with any other investment, he evaluates financial scenarios developed by his team and runs stress tests to determine how much the company can afford to spend. If you are undertaking this exercise, Newman recommends being clear about what you must protect under any circumstance. For UPS, this includes the company’s dividend, credit rating and corporate values (see Figure 1). Everything else, according to Newman, is up for discussion. Make your own list together with leadership. It will give you the reassurance and flexibility you need to make the right decisions.
Once you’ve decided what proportion of the budget to allocate to ESG projects, you’ll need to select initiatives to invest in. Newman recommends prioritizing the projects that most closely align with corporate strategy. For instance, UPS made donations to help organizations affected by COVID-19. This investment wasn’t purely philanthropic; the goal was to help “support the sustainability of communities so they’re there to work with us” in the future, Newman explained. In addition to being good for society, the decision supports the company’s four pillars for growth: small and midsize businesses, e-commerce, healthcare and high-growth international markets.
To identify projects that align with corporate strategy, Newman reviews UPS’ materiality matrix. It shows how important ESG issues are to stakeholders and to business success (see Figure 2). Investing in ESG projects that adhere to corporate strategy will simultaneously advance company objectives, contribute to a cohesive story for investors and make a positive impact.
Environmental and social issues tend to be complex and nebulous, making it hard for CFOs and their teams to quantify the expected returns from investments. But UPS believes it’s always possible to measure the impact; if you can’t capture everything, you can get at least part of the way there. UPS finds three tactics helpful:
Finding the link between the investment and the business
Considering the opportunity cost of failing to invest
Assessing the expenditure using a cash value-added model
As a good starting point, Lane recommends finding the intersection between the ESG investment and your business — and then leveraging expertise from the right internal stakeholders. For example, assessing the value you may generate from supporting LGBTQ causes may seem difficult at first glance. At UPS, finance worked with public affairs, sales and business development to find out how many untapped LGBTQ-owned companies are out there and determine how much more business UPS could attract from them.
Similarly, deciding against an investment can carry strategic and operational risks — not just legal, compliance or reputational exposure. Include these opportunity costs in your calculus to expand your understanding of the investment’s value.
For instance, UPS made an equity investment in U.K. startup Arrival, and plans to purchase 10,000 electric vehicles from the company. That spending partly serves as a hedge against getting kicked out of important markets. As cities become more congested, regulations increasingly aim to reduce traffic and pollution; for example, London introduced a congestion charge in 2003 for most vehicles driven through the city center between 7 a.m. and 10 p.m., adding a discount 10 years later for ultra-low emissions (for example, from electric cars). Newman recognizes that if fuel-burning UPS vehicles might one day be excluded from clogged (and smogged) cities, the company would face significant losses.
Newman also recommends using a cash value-added model, which calculates the cash flow the investment will generate, to make the case for significant upfront costs on the basis of long-term impact. This logic helps UPS make spending decisions — such as installing solar arrays on facility rooftops and purchasing alternative fuel vehicles. The savings in electricity and fuel costs down the line make the initial investments attractive, in addition to reducing emissions.
Even when guided by corporate strategy and quantified as much as possible, environmental and social investments will often look less appealing than business investments on paper. It may take longer to realize returns, and the rate of return may be lower. To turn the right ESG projects into reality, Newman recommends using a different filter to evaluate them.
He chairs the capital committee, which includes UPS’ head of accounting and planning, chief strategy and transformation officer, chief engineering officer and CIO. They review and make decisions about all corporate investments, but Newman makes sure ESG projects are treated differently during discussions. The committee has agreed to:
Tolerate a longer cash-back period of six to 10 years, compared to the typical two- to three-year period for most business investments.
Be comfortable with a value assessment that’s up to 75% qualitative.
Take a portfolio view, balancing the potentially lower rate of return for an ESG initiative with more aggressive business investments.
Allowing for a longer cash-back period benefits the business because it gives a leg up to projects with the potential to improve products, services or processes. For example, UPS invested in revamping its navigation system to minimize fuel usage and emissions, partnered with TerraCycle to design reusable totes that reduce waste from packaging and rolled out temperature-sensitive packaging for delivering medicines to people in need. These address environmental and societal imperatives while expanding the company’s portfolio of innovative capabilities.
Newman acknowledges that for all the effort that goes into measuring and quantifying, sometimes evaluating these investments is more art than science. To qualitatively assess the value of a potential investment, he challenges committee members to ask themselves questions such as:
Does the investment align with company values?
Does the investment have a benefit? (It doesn’t have to be financial, it could also be something that benefits the workforce, customers or society.)
Does the investment address an issue that is important to stakeholders (for example, employees, communities, customers)?
Does UPS have unique expertise or abilities to help address this issue?
Through these types of discussions, UPS came to support initiatives such as pioneering the drone delivery of vaccines in remote areas of Rwanda and Ghana, planting trees and making charitable donations to the United Way. The ROI of these investments may not be fully quantifiable, but the impact is unquestionable. They support corporate values and meet important societal needs. And from a pragmatic perspective, UPS has the resources and expertise to make a difference without making a huge dent in the company’s overall budget.
Finally, the capital committee contextualizes ESG projects within the entire portfolio of corporate investments. Even though some social or environmental initiatives may yield a lower return, they are a relatively small part of the total budget, so the overall rate of return across all investments will still be attractive.
The committee is uniquely positioned to maintain this balance. For instance, when the COVID-19 crisis began, it approved unplanned charitable donations but made up for them by prioritizing more aggressive business investments. Adopting a similarly holistic perspective will help you allocate resources efficiently to best serve all stakeholders.
“In reality, delivering returns to shareholders comes when we play a responsible role in terms of serving communities and helping lift them up,” Lane told us.
by Oana Lupu and Jessica Kranish
This article is from the .
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Bloomberg Terminal, accessed 27 August 2020.