PURPOSE, INC.

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S2_EP7 Embedding Purpose and ESG into the Muscle of the Business with Bruce B. Simpson of McKinsey

Transcript

Participants:

Michael Young | Founder | CEO of Actual Agency | Partner, Millwright Holdings

Bruce B. Simpson | Senior Advisor to McKinsey & Company

Michael Young:

Throughout my professional career, whenever I have sought to better understand an issue in business I’ve looked to the research that comes out of McKinsey. McKinsey is a firm without peer globally as a producer of vast amounts of insightful data-driven analysis.

So, as I wanted to understand stakeholderism, corporate purpose, ESG and its impact on business, I of course turned to McKinsey. There I found, as you would expect a treasure trove of writing, research, insights and analysis on this topic.

My guest today was the co-author and contributor to much of McKinsey’s thinking on the topic of Purpose and ESG. Bruce Simpson is former Senior Partner of McKinsey where he built and led the Purpose/ESG Practice, and he is now a Senior Advisor to McKinsey on Purpose/ESG. Bruce is also a Senior Advisor to Blackstone on ESG, and serves as CEO of the Stephen A. Schwarzman Foundation.  In the role of CEO Bruce helps Mr. Schwarzman deliver on his bold and creative vision for philanthropy in the 21st century.  

Bruce’s experience and expertise cuts across the private, public and social sectors. Today on the podcast Bruce delivers an incredible summary and analysis of the state of corporate purpose—from definitions and what’s missing and misunderstood in purpose and ESG

Bruce notes how societal expectations of companies have changed and how this provides businesses with a unique opportunity organizations have to engage differently with their stakeholders.

We talk about the new and evolving social contract, and about managing the inherent tension and trade-offs within purpose and ESG.

The problem of short-term thinking, and why long-termism is where shareholder and stakeholder interests converge.

We of course talk about the perils of purpose washing; best practices for delivering on the new social contract; strategic differentiation based on purpose.

Ultimately what it means to embed purpose and ESG into the muscle of the business, and why companies that create products and services that matter and are truly sustainable will outperform those that pay lip-service to these ideas.

Bruce’s insights today are jam-packed with data, facts and relevant examples from companies PayPal to Oatly are delivering on the promise of a more-purposeful. Strap-in and buckle-up for a thrilling and exciting ride. Without further ado, my conversation with Bruce Simpson.

Bruce B. Simpson:

My pleasure. It’s great to be here.

Michael Young:

Thank you. All right. So a lot to talk about today. So let’s start with a couple of definitions. How do you think about stakeholder capitalism and corporate purpose and ESG broadly defined? And just unpack those any way you like. And also, maybe you’d lead into what do you think is maybe missing or misunderstood in some of those generally accepted definitions?

Bruce B. Simpson:

Great. Well, I think it’s useful to take a capitalist route into the conversation which would start with the unbelievable math perhaps that 65% of CFOs today would not support a positive NPV project that would more than earn its cost of capital if that project would cut into their quarterly earnings such as the tyranny of the quarterly earnings conversations. And yet companies oriented for the long term by which I mean five to seven years actually earn a lot more returns. We have some great maths which shows that over a 15-year period, the revenue of long-term oriented firms grows 47% faster than short-term oriented firms. Their earnings grow 36% faster and economic growth grows 81% faster if they think of the long-term first and foremost. And it’s in the long term, that five to seven year period where stakeholder and shareholder interests actually align because these are the companies that have a healthy ecosystem. Regulators are happier and less interventionist. Employees are engaged. Suppliers are more collaborative because they have a healthy dialogue and partnership with the company they're supplying. And consumers and employees also well engaged. So those long-term interests align of stakeholder groups including shareholders.

And purpose and ESG then provides like a concept or a framework, an approach to crystallize the stakeholder capitalism which is this long-term approach. Purpose provides the answer to the key question, what is my company’s core reason for being? If we disappeared, could another company simply replace what we do or is there something unique that we bring to society? And all companies had a purpose at inception. Some might have been forgotten. Purpose-shaped strategy inspires people, and it really helps the company steer its choices during moments of truth like COVID. And what it does then is it then anchors ESG and the different buckets that ESG provides—environmental, social, and governance—anchors ESG focus in areas which link to what the company is actually trying to achieve, to its strategy. ESG without purpose is just a list of metrics. But purpose-driven ESG where those two things are integrated enables you to anchor ESG goals and things that count or matter to your company as well as society. It helps you decide where to win on ESG as opposed to where to play. Focusing from the multiple different topics just to the few that that really matter. So purpose-driven ESG we think links from that core reason for being to core priorities and helps you focus.

What’s misunderstood, I think there’s several things. I mean, for example, ESG as a list of multiple topics, do you do them all? No, the answer is you need to decide what’s material to you across those different areas and then focus most on those particular areas. So focus is the key point that’s misunderstood. Often companies miss the importance of S and G and focus only on E. Now we have a planetary crisis. But there’s also an S crisis. COVID’s an S crisis. Social inequality, social injustice in America, those are S crises too. And it’s important to be focusing on them and having an integrated view. G, the governance side, is also the most visible of the different brackets because what you do, what you decide to do in terms of paying taxes, your board diversity is very visible. And so you need to be thinking about the governance side as well. So it really is an integration across ESG versus just picking one of those themes. And I would say too that was what’s very misunderstood today is the importance of a narrative in this area where there’s a company story which goes perhaps from a purpose statement but then cascades down into an understanding of where are we vulnerable, what’s the area where we are weakest, where we're a negative outlier across the ESG parameters and really focusing on fixing that. But also where are we strong and that then is what’s built into the muscle as part of your purpose. And then initiatives on those dimensions, both of them, are then cascaded through initiatives, metrics, accountabilities. So you're then seen by outsiders to have a real narrative and having actions which measure up to words. Those are a few points.

Michael Young:

Excellent. And Bruce, broadly, your view on how are corporations doing in that regard of understanding materiality, looking at the intersection between ES and G? If you were to just step back and look at the global 500, the global 1,000, how do you think overall corporations are connecting to this? And then the follow-on to that, I want to get into the tensions and the trade-offs between ES and G.

Bruce B. Simpson:

This clearly now a mainstream topic. With Fortune Magazine, McKinsey partnered with Fortune over the last year, and we did discussions with about 80 CEOs. The consensus was they're spending 50% of their time on this topic. It truly is now a mainstream opportunity or issue for them. At the same time, there is a lot of very valid criticism out there about purpose washing, green washing where companies claim to be doing certain things but actually when you dig a little, you find they're not so authentic in delivering on those topics. And so criticism is valid. But I would describe where we are as storming positively, right? We're not yet quite in the norming phase. There is a storm out there. There are rough waters and seas. But the wind is moving very strongly, positively behind purpose and ESG. We see actually today I would say a trifecta of underlying drivers which are moving the current in the right direction. Consumers, for example, who really are demanding for ESG products. Organic products, for example, in the consumer sector, they're 20% of the market but 50% of the growth.

We have a huge shift towards generation Z, wealth being handed down to these folks, and they want a say in decision making made by the brands that they're associated with. It’s a generation which has shifted from philanthropic giving to philanthropic living where they completely blur the lines between social sector, public sector, private sector. They expect from their brands, from their work a societal dimension which is important to them. Employees too are driving. 60% of employees want a say in what companies are doing. And what’s happening is if they don't like what the company is doing, they'll go to social media who are actually replacing boards to some extent. Many of the tech firms have seen this. Their own employees will get together, they will issue a letter that will be leaked to social media, creating the amplifier effect social media provides externally, and that then is seen to be a lever for corporate decision making. Employees expect to be listened to particularly during COVID and post-COVID. And then regulators, of course, are stepping in as well and being a lot more interventionist in terms of disclosure and so on.

So sea change is moving extremely fast. In the last month alone, we've seen shareholder resolutions that Dow Chemical, for example, which the last time won 7% of the vote, this time won 81% of the vote on disclosure of microplastics. Exxon needing to provide now three board members to a very small activist investor, and its argument was not a planetary argument. It was an argument around the risk to future earnings if Exxon doesn't actually shift and accelerate its focus on emissions reductions. So this is also happening. Now it’s not just about going to the dentist though. What we also see are companies like Oatley which had a blockbuster IPO just last week. Terrific value generated from a really good ESG story embedded into their muscle. And so there’s also shareholder benefits coming from the companies that are the first movers in this area.

Michael Young:

That’s great. And I'd love to dig into, I talked to another guest the other day about Engine 1 and Exxon in particular. And I think this connection between numbers and narrative is very important. And how should leadership and boards in particular be thinking about and managing these risks and these trade-offs? And what are some of the best practices in delivering on this new social contract where, to your point, employees can issue a letter or a very tiny activist shareholder can land three board seats at a major company? What should boards be thinking about and how should leadership be thinking about this?

Bruce B. Simpson:

Look, boards have been I would say largely missing in action this topic, and they have allowed themselves to be replaced by social media in terms of really engaging. That’s perhaps controversial, but I think boards need to step up. This a topic. Boards have a fiduciary responsibility to act in the long-term interests of shareholders. I mentioned that it’s in the long term that those interests meet with stakeholders. So they need to be on top of this. They need to be listening to stakeholders. They need to have lines of communication directly with employees too who have an option to raise issues through the management team directly to the board rather perhaps than going to social media first. And so boards have to step in. Now boards worry about being seen to meddle in management fairs. But on this topic, it’s squarely I believe fitting in the mandate of a board, and yet they're not doing it as much. I think only 20% or less boards in North America actually have a competence on ESG on the board. And of course, many of the boards aren't diverse, and you're getting there for a very limited perspective at the board which is visible unfortunately and needs to be fixed. So boards need to engage. This a topic they should drive with the management team in my view.

Now there are other attentions too which boards and management teams need to actually weigh into. And short term versus long-term, I mentioned in my view that the real trade-off isn't between purpose or profit. It’s between short-term and long-term. And so boards that are actually making the decision on capital allocation, for example, along with the CEO and the management team, they need to be having a purpose lens on some of those big decisions. Words versus action, we think it’s important that boards and management teams really stand and deliver on what we call purpose proof points. It’s one thing to have a purpose statement. But what are you actually going to stop doing as a result of your purpose effort? One thing, for example, that is tough to do but we think very helpful to do is where boards and management teams will array their products from most to least profitable and then most to least beneficial to society. And then have a good look at that. And if you aren't stopping something, you probably haven't dug deep enough. Linked to compensation, who actually gets paid less or more as a result of a purpose, an ESG journey? Have you engaged employees and stakeholders along the way? Are your targets short-term versus 2050? 2050 targets are a joke in this area, just not taken credibly. What are you doing now, this management team in the next one to three years? That’s a very big deal as well.

What we're seeing too under this banner if you like is a shift from brands to stands where employees and consumers expect brands to take a stance on social justice, for example. The cover of The Economist talked about the political CEO a couple of weeks ago, and of course, that carries challenges. CEOs are expected by their employees and consumers to actually take a stand in these social topics. However, if they do so, they better have a good story which stacks up with what the company is actually doing on those areas in order to be seen to be credible. So lots of tension but positive movements too. I would say lastly really embedding purpose and ESG into the DNA of the company. And there’s five P’s to remember. What that means is embedding it into your people; processes like PayPal has done; into your products, Unilever growing its organic products I think quite dramatically, 30% higher growth than their other products; embedding in your processes, Microsoft committing to net zero since inception, for example; into your external positions and advocacy, BP I think has resigned from several lobbying organizations on Capitol Hill; and then embedding it of course in your performance management, Starbucks, for example, embedding DEI targets into the compensation of their CEO which I think is a great move.

Michael Young:

Excellent. And I'd like you to unpack if you would your view on G and S in particular and the connection you make between those two and why that matters. And yeah, I've also heard you talk about robbing E to pay for S. Climate’s very much back on the agenda. Yet the social issues and inequality have not gone away. So again, a little more dialogue around the tension between all of these competing demands on organizational focus.

Bruce B. Simpson:

Yeah. Look, it’s all about building purpose and ESG into the muscle of the company to be taken seriously, and that does create some tensions. You mentioned G and S. So on governance, for example, governance is the most visible measure of whether companies are serious. And I mentioned a couple of the governance topics. So, for example, are you paying your fair share of taxes? Tech firms have struggled to live up to that. External positions, board diversity, the timing and integration of decisions. Companies, and there have been a few, that might make a positive statement supporting Black Lives Matter, but then in the same breath, laying off frontline employees which include many minorities. Perhaps doing a share buyback and then increasing CEO compensation. That’s a series of bad moves which will not play well. And so governance, you need to integrate your governance decision and the timing of them to use that as a way to integrate E and S. Now you mentioned S. We've seen companies robbing Peter to pay Paul. They've dialed back their environmental commitments to dial up on their S commitments. And you really have to add S on top of E and be seen to be doing both. And we've seen a very deep focus on S during COVID which, of course, is a big S crisis. And the single biggest issue to the American people today in this whole arena is, am I earning a living wage, for example, in a country where real frontline wages haven't gone up for decades and where almost half of workers in the Russell 1000 can't afford to live as a family of three even with both parents working and where net worth of a black family on average is 1/10th of that of a white family. So earning a living wages is very important, and then investing in in health benefits, training so people can promote themselves up the ranks more quickly, really living diversity and inclusion, and developing products which matter. Those would be the big topics of which companies need to be focusing on.

There are some wonderful outliers too. What PayPal has done in actually measuring financial insecurity of their own frontline and then investing in increases in pay, making the frontline shareholders too, is salutary. And interestingly they found that investment which is an immediate hit to short-term earnings paid for itself very quickly through an uptick in loyalty and engagement. And so that was a great story which shows that investing on S can also be beneficial to shareholders. In fact, there’s a strong correlation between companies that pay well and companies that do well to encourage others to do that. And Ikea, Walmart have done great things under the S dimension as well.

Michael Young:

And I think some of that relates to another topic I've heard you talk about around strategic differentiation based on purpose. And you mentioned Oatley and you've mentioned PayPal. And where’s the future going in in that regard for organizations around differentiation on this topic?

Bruce B. Simpson:

Yeah. This I think very exciting, when we see companies whose whole differentiation is basically measured in ESG terms. Now I before we jump to those, I want to say a positive word for the brownfields. There are greenfields like Oatley we mentioned that have done a terrific job having wonderful multiples in their IPO. Beyond Meat also looks exciting and there are others like that. It’s easier for them because they built ESG right into the muscle from the get-go. There are also though companies like Orsted which Danish energy company went from 80% coal to 80% renewables in a period of 10 years and earning terrific shareholder returns during that that decade. Very impressive. And also generating value and now becoming differentiated as a green energy company. DSM, a Dutch Chemicals company doing something similar. So we see benefits for the companies shifting if you like, improving their carbon footprint. There’s a very strong correlation between a measurable improvement in performance on material ESG themes, and SASB does a great job of actually showing what is material in different sectors which all companies I think can benefit from.

But you mentioned differentiation. There are great stories of these new companies coming through that have really stepped up and others. I would mention Lego too which understood it’s vulnerable on plastic in the Lego bricks. They shifted to other materials which are more sustainable and then also understood their strength in terms of connecting to consumers and developed a purpose which is all about creativity through play at all ages and leveraging that strength in terms of engaging with consumers to build very, very strong consumer loyalty and then building out products and so on which have been strategically very, very positive. So PayPal, a great example too. PayPal has very strong data on the economic plight of communities in which they're actually financing working capital loans. They leverage that benefit by providing services to those communities. Beneficial for PayPal and for the communities and a great example of leveraging a strength to then developing new products and services.

Michael Young:

And Bruce, ultimately, this move from risk management, checking the box compliance to fully integrating purpose into the business strategy, into the muscle as you talk about it, who is going to drive that? Is that external customers and capital through activists are going to demand that? Is it all of that? And how do you see it ultimately playing out in the future and what are some of the watch outs that leadership needs to pay attention to here?

Bruce B. Simpson:

Look, notwithstanding the criticism of companies purpose washing and so much of which I think has been warranted, there are now an increasing number of fabulous examples where great companies are truly delivering triple bottom line impact and where governments have their hands full, of course. It’s perfect to see companies stepping up and filling the gap. And interestingly, consumers have the same expectation of companies as they do of governments in terms of delivering societal benefits. So therein lies the opportunity. Now I am very positive on the future. This is driven by a consumer trends. I mentioned generation Z and what they're demanding from their companies. Employees, COVID upended the corporate hierarchy. It was the frontline employees that kept us going, stocking those shelves in supermarkets, first responders in healthcare. And they want a say in decision making. They merit that, of course. And that’s if you like enhanced the dialogue of what we're actually doing to help and support and engage the frontline. 85% of top management get their purpose from work. 85% of the frontline don't, right? They don't. They get their purpose from other things outside work, and yet there is a huge benefit then—this where the puck is going—from companies that are able to actually marry that individual purpose every individual has and then what they can actually do at work to enable that purpose to blossom. We've seen 4X engagement from companies that can do that and that I think is a huge upside. In a year, in a decade ahead, where given demographics, there are enrollments to colleges in the U.S. will drop 100,000 every year for the next 10 years because the demographics. You want to win the war for increasingly scarce talent, you better have a purpose and ESG story to tell.

The largest, most exciting, most important climate conference in the history of the planet is happening this Fall, COP 26. And we're going to see a huge shift in that direction. Everybody falling over themselves to make declarations and commitments, countries and companies. That’s going to help drive this. But perhaps best of all, we're seeing for companies that are already there, higher top line growth, better management of cost, de-risking transition which has a huge value, increased employee engagement, lower cost of capital if you have a high purpose and stronger ESG performance, and then ultimately higher performance. So shareholders will win of those companies that step into this space, and we have I think terrific data now and leadership shown by increasing number of companies for them to follow.

Michael Young:

Excellent. And maybe a final thought around this. Ultimately, the shift from short-termism to long-termism, how can leadership think about that? What’s the future hold?

Bruce B. Simpson:

Short-termism to long-termism, I would say one, boards and management teams, look at the maths. It’s long-termism that wins. You want to earn more for your shareholders? Then think five to seven years and not to the next quarter. Secondly though, do bring your shareholders along. A great story, BestBuy run Hubert Joly during like a 10-year period. He’s now retired, but he led a bricks and mortar transformation of BestBuy, explaining very clearly to shareholders and board, the profitability is an outcome. That’s an output. It’s the result of us doing the right thing. We take care of our employees. They take care of customers. That takes care of business. That’s a narrative others need to understand. And there’s increasingly compelling maths that BestBuy generated I think 12X returns for shareholders during the time that Hubert Joly was the CEO which is fabulous for shareholders but at the same time, through a purpose, enriching lives through technology, they also improve their products and services, engaged their employees, and did the right thing by their own people.

Michael Young:

Fantastic. Well, Bruce, we're going to have to leave it there. I very much appreciate these insights. This has been a fantastic conversation. Thank you so much for coming on.

Bruce B. Simpson:

My pleasure, Michael. All the best.

Conclusion:

The Purpose, Inc. Podcast is a production of Actual Agency, helping innovators communicate in a changing world. More at www.Actual.Agency.