Understanding what matters, CSR and strategic focus

CSR has continued to move up the management agenda, to the point where few sophisticated businesses would underestimate its importance.

 

 “The ‘whether in principle’ conversation about CSR is over. What remains is ‘What specifically, and how?’”

In 1970, the eminent economist Milton Friedman wrote in the New York Times that the sole purpose of a business was to maximise the returns it made for its shareholders. Commenting on early moves by companies to reduce their impact on the environment and act responsibly towards the societies in which they operate, he commented that is was fine for executives to do good, but only at their own expense.

 

This article proved hugely influential, and arguably led to the short term ‘greed is good’ attitude that was so typical in business in the 1980s. Profit was all, no matter how it was achieved.

 

Events have proved this thinking to be wrong. Natural resources that once seemed infinite have started running out, chemicals casually used in the production of products have proved to have damaging effects on the environment and human health, and cut backs in maintenance made to increase profits have resulted in major disasters.  Escalating CO2 emissions are having an increasingly clear effect on temperatures and weather conditions.

 

Equally, ignorance of the poor working conditions and abuses of human rights that have allowed suppliers in some countries to keep their costs low is no longer an excuse. Alerted to the practices by campaigners, the public have made it very clear that such behaviour isn’t acceptable.

 

Over the years, this allowed CSR advocates making an increasingly solid economic case for their approach. Corporate reputation was becoming increasingly important, it was said, both for the customers a company wanted to sell to, and for the good quality staff it needed to attract. However the sceptics were not convinced. The argument raged on and indeed the notion that businesses exist primarily to make profit still remains widespread.

 

Profit remains fundamental to business. Most companies are legally obliged to generate profits for shareholders, and these give them the freedom to determine their own destiny. CSR has continued to move up the management agenda, to the point where few sophisticated businesses would underestimate its importance. This isn’t just about growing priority, although the scientific consensus on the reality of global warming has certainly focused minds. It’s also a recognition that CSR isn’t just about how a company spends its money, but about how it makes it.

 

“Boards are attending to CSR not just because there are real risks if you don’t, but because CSR offers a useful prism through which to view and set your strategic priorities and assess the opportunities that lie ahead,” argues Adrian Hosford, Director of Corporate Responsibility at BT.

 

This doesn’t mean that the philanthropy is dead. Certainly, it remains an important part of business culture, especially in the USA where foundations backed by wealthy individuals have done a great deal to help communities in need. The Gates Foundation, which recently received a multi-million dollar gift from Warren Buffett, is a prominent example.

 

Such generosity has to be a good thing in itself, but the idea of philanthropy can perpetuate the false dichotomy between a business seeking profit and ‘doing good’. Increasingly, these goals are complementary – one is essential to the achievement of the other.

 

Recent developments in BT, which has long recognised the importance of CSR at the highest levels of the organisation, indicate the way things are going.

“We have topped the Dow Jones Sustainability index for the last seven years,” Adrian Hosford explains. “That success is the result not just of the wide platform of initiatives we’ve taken across our company, but of changes in the way we embed CSR in our business. Our approach has moved subtly but significantly in the last two years or so to take on a true strategic dimension.”

The key concept here is ‘materiality’ which is reshaping how BT monitors and reports on its initiatives.

 

Materiality will be a familiar idea to professional investors and senior financial managers. Any factor which could have an impact of more than five per cent on financial performance is deemed ‘material’ and a company has an obligation to report on it.

 

Reporting is a fundamental discipline for CSR, since in its reporting a business formally recognises its accountability to its different stakeholders, and the process of review and reporting should focus minds on why a company is doing what it is doing. In recognition of this importance there are a number of global guidelines and best practice codes, such as the Global Reporting Initiative (GRI) and the AA1000 assurance standard, which between them set out a widely accepted framework for reporting. These have begun to include reference to materiality as a criterion for monitoring and measurement, though what might be material among CSR factors needs to be assessed differently from financial materiality.

 

So what is material when it comes to CSR? Building on the process BT developed to identify what was most important to its own business; the company has been working with AccountAbility, the not-for-profit steward of the AA1000 standard, and Lloyd’s Register Quality Assurance (or LRQA, which provides an external scrutiny of BT’s own reporting). Jointly they worked to develop a framework for materiality assessment that other organisations can use to set priorities among their material issues, helping them integrate their thinking about CSR with broader strategic goal setting.

 

Materiality demands further criteria beyond relevance. It requires that businesses look at factors that are measurably and directly significant to future and sustainable business performance.

 

Underlying this approach is the necessary recognition that, if the things you choose to count have a decisive influence on your business direction, then you had better be sure that the things you count are the things that matter.

 

“Combining the ideas of materiality and sustainability forces businesses to think harder and wider about the factors that can really affect their performance in the long term,” says Adrian Hosford.

 

This approach demands work at the outset to determine the issues that really do matter. This cuts both ways, for it could show that a CSR activity that is patently relevant to the business is not strategically important. This insight will then help to set priorities.

 

Secondly it means identifying the information you would need in order to assess what really matters. This is likely to involve financial analysis, but will demand a projection of that analysis over an extended period.  As ‘The Materiality Report’ (which presents the AccountAbility/BT/LRQA framework) puts it:

 

“Sustainability materiality processes aim to pick up not on issues that would impact on less than 5% of earnings in the next year, but on issues that could impact on 5%, 10%, 50% or more, or indeed on business survival, within the next five, 10 or 20 years.”

 

The report continues:

“This distinction based on time horizons points the way towards an understanding of how different assessments of materiality can be integrated. Making the time horizons which underlie materiality thresholds in financial and sustainability reporting explicit would provide a clearer basis to investors and other stakeholders to comparing the ability of different businesses to manage for long-term sustainability. It would also provide a clearer basis for integrating these issues into strategy processes, such as backcasting, scenarios and contingency road maps.” (1)

 

This approach has a number of consequences. It doesn’t preclude activities that are only relevant to a business, but those that are deemed material will be subject to a different scrutiny. Incorporating materiality tends to shift business thinking about CSR away from compliance (‘what do we need to do to avoid criticism or negative perceptions’) to activities that contribute real value to business performance in their own right. It demands that a business think about what it should be doing, rather than what it should not be doing.

 

Materiality reporting is likely to be useful to a wider group of stakeholders than financial reporting, though it’s important to note that even the traditional investor community is becoming actively interested in such information, seeing it as an indicator of general good governance. From October 2007, publicly-held companies registered in the UK are compelled by law to disclose information on environmental, employee, social and community matters, as well as on contractual and other arrangements essential to their business.

 

The materiality assessment framework put forward by the report is not prescriptive, offering some broad advice on the procedures that a company needs to follow in identifying material issues. Its five-part

‘materiality test’ offers a snapshot of this thinking, suggesting that any issue needs to be assessed against:

1 direct short-term financial performance

2 the company’s ability to deliver on its strategy and policies

3 best practice norms exhibited by peers

4 stakeholder behaviour and concerns

5 societal norms, particularly where linked to possible future regulation.

 

These criteria in themselves do not offer any guidance about assigning priorities, but they compare interestingly to the four criteria developed by BT for its own strategic priority assessment. The first of these are concerned with the direct impact of an issue on BT, while the second two look at broader stakeholder or social pressures that could have implications for what the company does.

 

1 Does BT have a policy on this issue? BT reviews what part of the business is covered by the policy and whether it includes performance targets.

2 What is the financial impact of the issue on BT? BT looks at the costs currently associated with the issue and then assess the potential costs of poor performance or future failure.

3 Are stakeholders interested in this issue? BT conducts research with customers, employees, and suppliers, probing the most important and environmental issues that they believe the company should be acting on. At the same time BT will be monitoring and analysing material offering insights about other key stakeholders, including legislators and investors.

4 Is there societal interest in this issue? BT actively monitors media reporting in seven of the most important countries where we are active, helping us to assess trends and weigh their likely impact.

 

The results are then put into a matrix, with one axis defined by the BT related criteria, and the other axis defined by the societal or stakeholder criteria. Issues that score in the upper right quartile of this matrix (i.e., they are important both to BT’s direct interest and wider stakeholder concerns) will be counted as the most material issues, and the company will ensure it has effective mechanisms to monitor its performance and report on it. Depending on where issues score outside this upper quartile, BT can make a judgement about their diminishing priority.

 

In practice, there is a close alignment between many of the issues that are important to BT and those that matter to its stakeholders, so it is straightforward to give these issues a high materiality score. Where there is divergence – usually between issues which the company thinks could be important but which do not figure so highly among its wider stakeholder concerns – BT will turn to its CSR Leadership Panel of external experts or to its CSR Steering Group of senior BT managers for an assessment and guidance.

Alongside this assessment, BT has a well-established process through which it weighs the business case for each CSR initiative it considers. This includes assessments of:

 

• the reduction in its exposure to risks (such as breach of integrity, climate change, health and safety, supply chain practices and diversity)

• the potential for cost reduction (for example, reductions in travel expenses that result when conferencing is used as an alternative to face-to-face meetings, reductions in energy bills through the more efficient use of power, and so on)

• the productivity value that could result from improved performance and increases in employee motivation (conferencing, for example, eliminates travel, making time available for other tasks)

• the impact on its brand and reputation (through improved levels of trust, customer satisfaction and so on)  

• the direct marketplace value (as measured through increases in sales, enhancements to competitive position, etc).

Again, this process is generic and could readily be applied by other businesses.

 

The next step is to have a parallel process for assessing CSR-related opportunities. This fits well with thinking about materiality, and the way it encourages proactive as well as defensive initiatives.

 

“The technologies we develop and sell have plenty of scope for helping customers in their own social responsibility, for instance by reducing their carbon footprints.” he explains. “If we are going to do this we have to make sure our own house is in order, and we can say with some pride that we have already reduced our UK CO2 emissions by 60 per cent since 1996. Our target is to reduce those emissions by 80 per cent (against our 1996 baseline) by 2016, by improving efficiency and using ‘green’ electricity. We have a leadership responsibility here, since BT alone consumes 0.7 per cent of the UK’s electric power output, but clearly there is a direct link to the way we can present ourselves commercially.”

 

Similarly, IT has the potential to enable potent new capabilities in its users, but can also be a force for exclusion. Initiatives that work for digital inclusion are obviously material to its business. Hosford agrees that such concerns might start from defensive thinking, but by highlighting the opportunity as well as the threat they illustrate how a materiality-driven approach intersects with strategic planning.

 

BT developed its materiality framework in 2005. Its impact on the company’s reporting was recognised externally when in 2006 the biannual Global Reporters survey named BT as the world’s leading corporate sustainability reporter (2). BT’s head of sustainable development and accountability, Dr Chris Tuppen, responded to the news by making the connection between reporting and strategic direction.

 

“Over the years, sustainability reports have got larger in size but have lost focus. We are now seeing a radical new approach to reporting which helps companies integrate sustainability into their core business in a way that helps deliver value to the business and its stakeholders.”

 

The application of materiality to CSR thinking should mark the end of the increasingly sterile profit vs. sustainability debate. It reflects the truth that sustainability might involve doing good things, but is fundamentally about business performance. In BT’s 2007 Sustainability Report, Sir Christopher Bland, BT’s chairman at the time, reflected on the increasing pressure from stakeholders for companies to put sustainability close to the heart of what they do.

 

“Our customers and our staff expect more of the company today than they did 20 years ago. Ten years ago, (CSR) was not that high up the agenda of most companies – now everyone knows what you are

talking about. Not only that, but I think the days of paying lip service to it are over. Pressure to perform, both internally generated and external, will increase.” (3)

 

The value of materiality is that it links this external pressure on environmental and socially responsible performance explicitly to long term (and sustainable) corporate performance, offering an invaluable tool for strategic planning.

 

1“The Materiality Report”, November 2006 p48. The Report is available as a PDF download from www.accountability21.net/publications.aspx?id=560&terms=the+materiality+report

2 The report is published by think tank, SustainAbility, in association with the United Nations Environment Programme (UNEP) and Standard & Poor.

3 “Changing World, Sustained Values”, May 2007, p2. Available as a PDF download from

 

Green information would like to thank BT for permission to reproduce this article.