Building business for the long run
Together with the financial sector, the Erasmus Platform for Sustainable Value Creation aims to enhance knowledge of sustainable finance. Lars Kurznack, partner at Environmental Resources Management (ERM) and co-author of the publication A model of long-term value creation, analyses what kind of business models are here for the long-term.
Business leaders are increasingly aware that the performance bar for companies has changed. Business practices and capabilities that have led to success in the past do not guarantee success in the future. Companies in virtually every industry are affected by new disruptive and complex societal trends, such as climate change, energy transition and social inequality.
At the same time, companies are increasingly competing on speed and Environmental, Social and Governance (ESG) performance. In this new business reality, companies need to invent new strategic directions, pioneering growth strategies focused on creating long-term value, not just for shareholders but for all stakeholders. But how to do this? How can you build more long-term orientation, ESG and resilience into business strategy, business models and organisations?
A look at the investor communications and events of some global companies in the first six weeks of 2021, is enough to realise that something is changing in the way companies aim to create value and grow their business. Last week, Shell presented “Powering Progress”, its new strategy to accelerate its transformation into a provider of net-zero emissions energy products and services towards 2050. A week before, ExxonMobil announced the creation of a new business – ExxonMobil Low Carbon Solutions – to commercialise its extensive low-carbon technology portfolio. And, companies like UBS, Rabobank and Rio Tinto put significant emphasis on ESG-related matters in their financial performance reviews. And on top of this, BlackRock’s CEO Larry Fink mentioned in his annual letter to CEOs in January that he believes that companies with a well-articulated long-term strategy, and a clear plan to address the transition to net-zero, will be the winners in the future.
There are three key trends that drive this change in the way companies create value and are being evaluated by investors. The first trend is the changing risk and opportunity landscape of companies. Numerous sectors are increasingly being disrupted by highly disruptive, unpredictable and long lasting societal or ESG-related issues such as climate change, changing demographics and energy transition.
The second trend transforming the way companies will create value is the increasingly volatile, uncertain and unpredictable business environment companies need to operate in. To be agile and able to commercialise future opportunities, companies need to stop focusing exclusively on short-term shareholder value creation. With a more long-term orientation, companies would be better prepared and able to adapt to changing market circumstances. In addition, the Covid-19 pandemic has showed us that a company’s ability to be resilient in times of distress is rooted in both financial and non-financial factors, including ESG factors.
The third and final trend is the changing role of companies in society. There is mounting social and political pressure on companies to do more for the good of society (Mayer, 2018). The need for companies to show they are good corporate citizens that add value to customers, employees, suppliers and society has never been greater. Companies that exclusively focus on maximising short-term shareholder value, optimising dividend pay-outs and share buyback-programs are increasingly putting themselves at risk.
To anticipate these three key forces and to remain competitive, leading companies are rethinking the way they create value and grow their business. The winning companies of the future tend to be the ones that aim for long-term value creation (LTVC). These companies can create both economic and societal value by continuously adjusting their business and operating models to capture opportunities and mitigate risks created by societal trends, such as the energy transition and greening of the economy.
But, only a few companies have begun to invent new strategic directions, pioneering strategies focused on creating long-term value, not just for shareholders but for all stakeholders. A recent survey by FCLTGlobal shows that senior executives continue to feel pressure from shareholders and directors to meet near-term earnings targets at the expense of strategies designed for the long term. Other senior executives might struggle to define their pathway towards LTVC. Rio Tinto’s CEO, for example, admitted that the company’s net-zero ambition is clear but their pathway not (Rio Tinto, 2020).
A playbook on how to create long-term value is currently lacking, making it difficult for companies to capture the opportunities and mitigate the risks created by these societal trends.
That said, a straightforward, back-casting approach can set the wheels in motion:
- Articulate your long-term performance ambitions and objectives. Begin with a rigorous, fact-based analysis of what your business environment would look like in 2030 or 2050. What environmental or social trends will shape the world towards 2050? How will demand for sustainable products and services develop itself in the next 10 years? How much carbon reduction should take place within your sector towards 2030 to stay within the planetary boundaries? Next, determine your company’s target end-state in this likely future business environment. What should your business model and organisation look like to win in this new reality and thrive it?
- Understand your starting point. The same type of in-depth fact-based analysis should take place to determine the starting point of your company in the transition towards the company’s target end-state. Measure your company performance on financially material ESG-factors, assess the current and future exposure of matters such as climate change or changing demographics on your product and service portfolio and organisation.
- Set your transition pathway or game plan and win over investors and other stakeholders. Work across multiple time horizons in strategic planning. Draft a pathway based on a combination of low-hanging fruit, no-regret moves and more long-term oriented higher-risk investments. It is crucial to identify specific business actions that not only create value on the longer-term, but also actions that enhances the business performance on the short-term. And, it is also critical to construct, communicate and report a coherent and convincing investor story about the value creation potential of the game plan on the short and longer-term and to engage closely with all relevant internal and external stakeholders about the impact and progress of the corporate transition.
This is a blog from the Erasmus Platform for Sustainable Value Creation at Rotterdam School of Management, Erasmus University (RSM). The Platform aims to enhance knowledge and debate on sustainability in the financial sector. Curious to learn more? Please see our webpage.