How Can A Company In The Beverage Industry Be Sustainable And Still Make Profit?

For many investors, sustainable business practices still mean a pure cost and a “grey” area where they don’t see clear mathematics for the return.

Sustainability, Sustainable Business, Innovation, Business, Industry, Beverages, Investment, Sustainable Investment, The SustainabilityX® Magazine

 

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Sustainability is becoming a market requirement and a factor of competitive advantage. More companies have no choice but must invest in sustainable practices. For many investors, sustainable business practices still mean a pure cost and a “grey” area where they don’t see clear mathematics for the return, which makes them reluctant to make decisions on funds. Once the relationship between the sustainability level of a business and its profitability is scientifically proven and described by a comprehensive theory, stakeholders will invest and help businesses to accelerate sustainability to gain more profit. In addition, recent studies conclude that sustainable businesses outperform others during economic crises (Gaio C., Henriques R. 2020, May).


The beverage industry has not been on the front for sustainability at the beginning, but during the last several years it has been catching up with a high pace. The question of the relationship between sustainability and financial performance is one of the most fundamental and strategic questions of almost any international beverage market player. Changes in market conjuncture, increasing competition, dependence on natural resources, and new government regulations push the companies in this industry to transform and invest in sustainable practices.


The regression analysis illustrated on the graphic below aims to find the answer to the questions if a company in the international beverage industry can be sustainable and demonstrate high financial performance and why some companies fail to accelerate on investment into sustainability and turn it into more profits.


The analysis was conducted using a dataset of 43 international beverage companies which participated in the assessment by S&P Global Market Intelligence in 2019 and obtained Dow Jones S&P DJI ESG Scores indicating their level of sustainability. 2019 was the first year when the scores were officially published. Return on Assets (ROA) was chosen as a profitability indicator.


Table 1: The Dataset of International Beverage Companies Used for the Analysis

Note: The list of the companies and the information about S&P Global scores are sourced from S&P Global Ratings (spglobal.com), and ROA data is sourced from www.finbox.com, www.gurufocus.com, and www.marketscreener.com.


A sustainability score benchmark of 50 points divides the dataset into two groups with a low and a high sustainability level – the left and the right cluster on the graphic.


Figure 1.0 Correlation between ROA and S&P DJI ESG Score for Companies in the Beverage Industry, 2019

Note. This figure is a graphic interpretation of the statistical analysis using the ESG scores from S&P Global Ratings (spglobal.com) and ROA data from www.finbox.com, www.gurufocus.com, and www.marketscreener.com.


The research on the companies performing the best in sustainability (the right cluster on Graph 1.0) allowed us to conclude that to be sustainable they have undergone organizational and cultural transformations to incorporate the values of sustainability into their corporate culture and strategy, they are advanced in non-financial reporting, follow UN guidelines and even turn to third-party audit organizations to approve the accuracy of their yearly sustainability reports. In addition, they design long-term strategic plans (usually 5-7 years) and understand that investment should be done at every stage of their supply chain. This group of companies is more transparent and strives to adequately measure the impact of their business on the environment, society, and economy throughout the whole supply chain.

 

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At the same time, there are beverage market players who still face difficulties to be assessed as highly sustainable businesses. The cluster of the companies located in the left part of the graph (Graph 1.0) is formed by these companies. For some of the companies in this cluster especially located in the emerging markets the reasons for a low score include lack of transparency and a very poor non-financial reporting system, that simply doesn’t allow the international organizations like Dow Jones, to receive accurate data about their strategies and actions. Besides, the culture of the organization is one of the key success factors, and in countries like China, India, and Peru, investment into sustainability is more a matter of a counter-response to the government regulations than values and beliefs of the organizations themselves.


However, large profitable corporations like Coca-Cola Co, Carlsberg, Keurig Dr. Pepper, etc. belong to the group with a low sustainability index as well. These corporations have already succeeded in the transformation of their culture and organizational structure, professionally market their investment into sustainability and think long-term. The reason for a low sustainability score is related to the complexity of their supply chain and exposure to ESG risks.


Figure 4.5. ESG Risk Rating Companies in the Beverage Industry

Note. From “Sustainalytics Industry Comparison” (Company ESG Risk Rating – Sustainalytics). Copyright © 2021 Sustainalytics.


One of the components of ESG Risks assessment is Controversy Rating, which means that not only disclosure of the investment and sustainability strategy are important, but the results of the practical actions as well. This is the area where these companies fail due to a lack of the mechanism for the correct calculation of the impact of the business on the environment, society, and economy. The estimations they have are limited to operations and final product manufacturing and delivery and don’t cover all other stages of their supply chain. When they estimate wrong, they set up too ambitious sustainability goals and when the independent authorities start evaluating, the goal appears to be impossible to achieve or needs much more investment than budgeted. These false estimations not only destroy the reputation of the company but demonstrate failure in the investment strategy. The example of Coca-Cola company`s “neutral water” commitment clearly explains this concept, when an ambitious target to reach “zero water footprint” was announced but was never delivered. The water footprint was estimated incorrectly, and that became obvious after the company applied the water footprint calculator, invented by Arjen Hoekstra, to measure the real scope of impact.


The companies in the beverage industry with a “longer” supply chain stretching from agriculture to manufacturing and final product delivery are exposed to more ESG risks and have got a much bigger supply chain environmental footprint than just a final product delivery or an assembly footprint. This phenomenon significantly influences the scope and complexity of investment into sustainability. The correlation between sustainability and financial performance for such companies can be more sophisticated and evolve over time.


In 2019, The Economist published a report based on the interviews with 250 senior executives, highlighting the challenges that the companies with complex supply chains face when investing in sustainability. The biggest is the ability to monitor the supply chain and to build out the mechanism to assess the suppliers. The second most important is the amount of investment required. This often finds no support from the top management. Most of the sustainable solutions require heavy investment and bring returns only in the long term. Therefore, the companies find it difficult to decide with a high degree of uncertainty.


The aspect of the supply chain is strongly related to the measurement of the real impact of the business on the environment, society, and economy. An accurate assessment of the impact at all stages of the supply chain determines the correct scale of investment into sustainability and helps to understand and manage the ESG risks at every stage. This will help companies and their stakeholders to achieve higher financial performance by investing in sustainability with a clear vision and estimation (Bianchi, Moreschi, Gallo, Vesce, Del Borghi, 2021).


This is one of the reasons why Coca-Cola's bottling partners belong to the group with a high sustainability index, and Coca-Cola Co. – to an opposite group. When there is an agricultural component in the supply chain of a beverage company, not only an accurate calculation of the business impact in that area should be done (and nowadays the methods are only starting to emerge) but managing ESG risks as well, which is much more difficult than at other stages of the supply chain. The agricultural part of the supply chain is resource-intensive and needs revolutionary innovative technologies to reduce the amount of water, soil, and other natural resources used for production. It may seem that the pressure on some international companies is more than on others, but it is in fact explained by the supply chain specifics and complexity.


The analysis of the companies failing to turn their sustainability strategy into profits showed that they are often characterized by a high level of exposure to ESG risks related to corporate governance. Several American beverage market players in the dataset demonstrate high financial performance resulting out of a very strong brand position, but lack heavily in corporate governance, being involved in scandals and unethical behavior. Changes in market competition, consumer purchasing behavior, and new government regulations urge these companies to transform their corporate culture and organization and tackle corporate governance problems in order to stay competitive.


Another component of the assessment that negatively impacts ESG Score is “preparedness”. The S&P DJI ESG Score takes into consideration not only the current state of events and how the company practically implements its sustainability initiatives and goals but what is more important how well it is prepared to manage future ESG risks: climate change, urbanization, water scarcity, ecosystem decline, cybersecurity, food security, and many others.


The Preparedness Score has got a tremendous value for the investors who can see how well a company in the beverage industry is prepared to sustain itself in a long-term period.


For a company with a more sophisticated supply chain, it means much more investment to be budgeted for this sort of future disruptions of business. Agriculture is highly dependent on climate change, deforestation, urbanization, it is resource-heavy and difficult to forecast. The more the scale of the business is, the more investment it requires to transform the whole value chain into sustainable, which can become even more complex with inaccurate calculations causing financial losses.


An interesting outcome of the research is an observation of high financial performers with a low sustainability score in the left cluster. These companies are already exposed to various ESG risks and face the urgency for transformation. There is a high probability that these beverage market players start “moving” towards the right cluster over time investing in sustainability and undergoing transformations.


Non-financial reporting plays a crucial role in the process of transformation of any international beverage company into a sustainable business. It is a powerful tool for building dialogue with stakeholders. Their support is vital when it comes to long-term and heavy investment. For a stakeholder, it is crucial to use non-financial reporting to get deeper insights into how effectively the investment into sustainability is working for a company's transformation and its future profitability.


The relationship between sustainability and profitability is complex and not static. It is described by some economists as U-shaped. A company undergoes several stages of transformation before the investment starts to pay off. It may experience a decline in profitability due to increased costs but can gain momentum in the future to return even to faster-growing profits.

 

References:

  • Goldstein, N. J. C. Robert and Griskevicius, Vlad (2008),“. A Room with a Viewpoint: Using Social Norms to Motivate Environmental Conservation in Hotels,” Journal of Consumer Research, 35(3), 472-82. https://doi.org/10.1086/586910

 

Irina Tsikun has a Master of Applied Sciences from Hague University where she researched the correlation between the level of sustainability and financial performance for companies in the international beverage industry. She continues her research work to make the world a better place through business and industry.