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Making Sustainability Profitable Through Business Model Innovation

Corporate Governance

Making Sustainability Profitable Through Business Model Innovation

  • Making Sustainability Profitable Through Business Model Innovation Pursuing sustainability can benefit the bottom line but most companies are struggling to achieve it. The key is transformative business model innovation. And boards can help set that in motion.
  • Date: Mar 22, 2022
  • Category: Corporate Governance
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Pursuing sustainability can benefit the bottom line but most companies are struggling to achieve it. The key is transformative business model innovation. And boards can help set that in motion.

A growing body of research indicates that sustainability initiatives are not only strongly correlated with good financial performance but can also bring in new business opportunities. The ICDM 2022 ASEAN Board Trends Survey  indicates that ASEAN boards recognise the importance of incorporating environmental, social and governance (ESG) considerations into business strategy and more than 50% of them are looking to increase their oversight capabilities in sustainability. 

As ASEAN boards embark on this endeavour, it is crucial to first gain a clear understanding of what separates companies that are able to capture value from sustainability from those that fail to do so. 

If companies innovate, they can simultaneously improve ESG and financial performance

Sustainability and profitability cannot truly be attained through peripheral or one-dimensional initiatives like acquiring renewable companies. Whilst such sustainability programmes are good for the community and the environment, they are often created outside of a company’s core business with no major innovation. And they tend to be cost centres and are less likely to contribute positively to the bottom line. 

Through the econometric analyses of more than 3,000 organisations from 2002 to 2011 by Professors of Harvard Business School Robert G. Eccles and George Serafeim, they found that in the absence of substantial innovation, the financial performance of companies declines as their ESG performance improves (See Exhibit 1).

Exhibits 1

The research shows that minor or moderate innovations, such as efficiency improvements, can nudge a downward-sloping performance frontier up slightly. However, only major innovations in products, processes, or business models can shift the slope from descending to ascending.

This article lays out three considerations for boards to set transformative business model innovation in motion to help their companies become both sustainable and profitable simultaneously.

1. Take an expanded view to innovate your business model for long-term value creation

For decades, companies were able to grow with the sole focus of delivering shareholder value without having to worry about the negative consequences such as loss of biodiversity, pollution and poor labour standards. Today, playing an active role in safeguarding environmental and social sustainability is regarded as a license to operate. Based on this shift in expectation, companies should refresh their business model to connect company success with the well-being of the planet and people.

According to Boston Consulting Group’s survey of executives and managers, conducted jointly with MIT Sloan Management Review, 37% of the respondents who said sustainability-related actions had added to their company’s profit attributed the increase to business model innovation, in which they made significant changes to their value chain, cost models and organisational structure.

What is Business Model Innovation?

Business model innovation is the art of enhancing advantage and value creation by making simultaneous and mutually supportive changes both to an organisation’s value proposition to customers and to its underlying operating model. At the value proposition level, these changes can address the choice of target segment, product or service offering, and revenue model. At the operating model level, the focus is on how to drive profitability, competitive advantage, and value creation through these decisions on how to deliver the value proposition: (1) where to play along the value chain; (2) what cost model is needed to ensure attractive returns, (3) what organisational structure and capabilities are essential tosuccess.

Source: Boston Consulting Group

One good example of such business model innovation is Ørsted. In the late 2000s, Ørsted was known as DONG Energy. It was one of Europe’s most coal-intensive energy companies. At the time, the company was profitable with an expanding oil and gas production business. However, in 2008, when their plan to develop the government-approved 1,600-megawatt coal-fired power plant project was met with strong opposition from the local community and upon recognising that the world was beginning to move in a different direction, they made a decisive, strategic decision to move away from an unsustainable business model based on fossil fuels to become a green energy company.

To drive that transformation, Ørsted formulated the vision of creating a world that runs entirely on green energy and began to invest heavily in renewable energy, particularly offshore wind. Their transformation journey was not all smooth sailing. In 2021, when Ørsted came under intense financial pressure, they introduced a financial action plan to streamline business portfolio, divest non-core assets and make ways for new investments to fund future growth. They also corrected their operating model, putting in place global functions, clear project governance, and a product-line organisation that brings efficiency. They have cultivated a “one company” approach and established a management-team forum to facilitate open discussions to break silos, align their approach, and build a strong network among senior leaders.

Today, Ørsted is one of the world’s most sustainable energy companies, and is well-positioned to make its next step in helping more countries and companies transform by decarbonising. This is all a result of their ability to confront their reality in the changing landscape some 14 odd years ago, which is also the first of the seven lessons distilled from the Ørsted story of transformation. As they aptly put, “it is about taking an honest view of the long-term viability of your current business model in light of the changing context, even if it is unpleasant and challenges what you do or who you are.”

Exhibit 2 below is a model we have formulated to provide an expanded view to help boards and companies get a sense of where they are now, whether they are just putting in place peripheral sustainability programmes or on track to capture emerging opportunities to become sustainable and profitable enterprise from within.

Exhibits 2

Where companies should aspire to be is at the intersection between the business’s core competencies, what people are willing to pay for, and what’s good for the planet and people.

Upon establishing where they are and where they want to be (strategic direction), companies can focus on the most material ESG concerns and begin to embark on a series of strategic innovation programmes to make sustainability a part of their DNA that generates profits.

2. Supercharge strategic innovation efforts with an ecosystem approach

Sustainability is a society-wide issue with scope and scale going beyond the controls of one company. It is thus imperative that organisations take steps to work with key partners within the ecosystem, from the regulators to suppliers, social enterprises to start-ups, to unleash fresh ideas through collaboration and co-creation.

As Wharton management professor Rahul Kapoor famously expressed, you are only as good as your ecosystem. The ecosystem approach to innovation, leveraging outside enablers to complement internal efforts, is one of the best ways to transform and achieve sustainable growth.

3. Adopting digital thinking to accelerate transformative innovation

Digital technology is fast becoming the backbone of society and a seamless element of our everyday life. Many answers to the sustainability concerns companies face today will also likely come from digital innovation. In that regard, a company’s pursuit for sustainable transformation will also be closely related to its digital maturity level.

There is a wide array of digital technologies available now and to be developed that can be used as accelerants of sustainable business model innovation. For example, artificial intelligence can help increase the circularity of economic activities, such as designing out food waste and improving e-waste recycling. Blockchain technology can be used to improve the integrity of value chain transparency.

However, successful adoption of such digital technologies is greatly dependent on a company’s ability to embed digital thinking into its processes and culture to keep pace with the rapidly evolving digital landscape. Being conversant with digital technologies will engender exploratory and smart risk-taking behaviours, which are vital for breakthrough innovations for long-term value creation and sustainability.

Understanding Sustainability

  • The idea is often broken down into three pillars: economic, environmental, and social also known informally as profits, planet, and people.
  • In that breakdown, the concept of “economic sustainability" focuses on the portion of natural resources that provide physical inputs for economic production, including both renewable and exhaustible inputs. The concept of "environmental sustainability" adds greater emphasis on the “life support systems," such as the atmosphere or soil, that must be maintained for economic production or human life to even occur. In contrast, social sustainability focuses on the human effects of economic systems, and the category includes attempts to eradicate poverty and hunger, as well as to combat inequality.

Source: Investopedia

To succeed in sustainability requires a fundamental shift in mindset and deft in transforming to a new business and operating model. And that necessitates companies to do things differently and explore alternatives to current established systems and processes to meet stakeholders’ needs in a net-zero future.

If sustainability is the goal, then continuous innovation is the engine of progress. Boards can certainly make an impact by nudging management towards making innovation ubiquitous in their pursuit of sustainability.

About the Author:

  • Michele Kythe Lim is the President and CEO of the Institute of Corporate Directors Malaysia (ICDM) Under her leadership, ICDM has embarked on a series of director development programmes, board advisory services, as well as research and advocacy projects to build and strengthen the country’s corporate governance standards and culture. Michele works with a wide range of boards and directors, from both the government and the private sectors.

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