RESPONSIBLE LEADERSHIP IN LUXURY

WHAT IF CSR IS THE FUTURE OF BUSINESS SUSTAINABILITY?

2019, December

The United Nations Industrial Development Organization (UNIDO) defines CSR as “a management concept whereby companies integrate social and environmental concerns in their business operations and interactions with their stakeholders; CSR being generally understood as the way through which a company achieves a balance of economic, environmental and social imperatives (“Triple-Bottom-Line- Approach”), while at the same time addressing the expectations of shareholders and stakeholders.”

Addressing CSR as “greenish pet projects” is no longer an option as the increasing exchange of information in our digital economy has led to more transparency and companies can no longer blame the complexity of their supply chains for their lack of oversight into issues such as child labor practices or worker underpayment. The reputational risk for companies has simply become too high and firms are being held accountable by very organized and reputable stakeholders.

As a result, CSR should be certainly or most definitely contemplated through a risk management angle but also, and more importantly, as a strong lever to create long term value. As an example, Friedman Stevens recently assessed a group of 19 players in the Beauty and Luxury space against a proprietary CSR index and, even if it might be somewhat premature, we observed a nascent correlation between the resulting CSR scoring and the market valuation, i.e. in the long term, financial analysts are starting to pay more for companies displaying more mature CSR practices as they are less exposed to reputational risk and more attuned to societal and consumption mega trends.

But managing CSR transformation is complex because it is an indefinitely fragmented topic – one must be able to handle countless types of opportunities/risks – that requires oversight of multiple decentralized actions as well as the ability to influence the behavior/conduct of various actors. Therefore, CSR programs then typically range from too-narrow to broad-sweeping approaches, neither of which produce substantial impact. The dilemma is that fully embracing the CSR transformation can quickly become incredibly costly, with a difficult return on investment. Developing CSR programs that drive high impact to the corporate financial, risk and strategy agendas is not an easy task, especially given a firm's limited CSR funds. Such a journey requires C-suite sponsorship and financial soundness. Appointing a CSR officer to build the vision and motivate teams teams is only the first step of a multiyear business transformation…

WHY DO BRANDS STILL CARE ABOUT CSR?

The transparency imperative has become a non-negotiable call to action as companies are being held accountable by more organized stakeholders than ever before. NGOs have now gained a global reach and publish research on a variety of topics, often citing the best and worst company policies and practices. Organizations like “Human Rights Watch” or “Labor behind the Label” monitor supply chains for risks of child labor, human trafficking and slave labor. Others like the “Rainforest Alliance” and “Earthworks” focus on topics such as deforestation and sustainable extraction.

Also, international unions have started laying out standards that companies are increasingly pressured into signing. One of the most successful examples is the Greenhouse Gas Protocol, which defines corporate reporting standard for disclosing Greenhouse gas emissions. This protocol was bolstered during the COP21 as a part of the UN Global Compact, a voluntary initiative based on the commitment of CEOs to implement universal sustainability principles.

Influential figures like former US Vice President Al Gore, a strong climate change advocate, have raised public awareness of various causes like that of global warming. Social media has amplified these voices, giving these advocates the credibility and the platform to discuss these issues.

There is also a generational shift. According to a recent Harvard Business Review report, 2016 Predictions for the Luxury Industry: Sustainability and Innovation, millennials are almost three times as likely to work for a company because of its social and environmental decisions and two times as likely to spend on brands with strong CSR policies. Indeed, the CSR focus has moved in the recent years. Environmental issues are almost being considered as table stakes. In societies where economic growth is weak and unemployment high, CSR also relates to what private companies can undertake to ensure well-being, stimulate solidarity and personal growth. Maybe the meaning of CSR has been eroded due to its overuse, thereby losing its appeal. In Luxury, sustainability resonates with durability, resilience, and timelessness. It refers to the very core values of the industry: premium material quality, excellent craftsmanship, and use of cutting-edge technology. In this context, could we even assume that the longevity of Luxury house may be linked to its sustainability practices?

This is an assumption that Friedman Stevens has been eager to verify through analysis. We mapped 19 leading luxury and cosmetics companies against a proprietary CSR index encompassing 17 criteria covering aspects such as scarce resource management, ethical supply chain or gender diversity. Transparency of the company’s CSR reporting made up a large component of the scoring, and the weighting of the scores emphasized the levels of detailed disclosure.

In Exhibit 1, we simplified and conceptualized the result of our analysis showing that:

As long as CSR remains in the field of complying with regulations and standard market practices, it is not a differentiator and it does not create market value.

As soon as a luxury or beauty company engages in CSR transformation (very few of which have successfully done so), its long-term value increases due to a perceived ability to mitigate reputational risk and bolster customer and employee loyalty.

There is a limit to the level of CSR investment, as such transformation is costly and produces diminishing returns at the higher end of the spectrum if not properly managed.

Exhibit 1 - CSR maturity vs. value creation (based on companies' CSR scoring and market valuation)

Source: Friedman Stevens proprietary CSR index, companies annual reports, broker reports, Friedman Stevens analysis

WHAT IS THE COMPLEXITY THAT HAS MADE CSR A “HOT TOPIC” FOR 15 YEARS?

CSR transformation covers myriad issue areas. Exhibit 2 shows the wide spectrum of CSR topics organized in four components.

Exhibit 2 - The four components of Corporate and Social Responsibility

ENVIRONMENT

Efficient companies will have developed clear policies on topics such as Greenhouse gas emissions, water and waste consumption, or recycling.

MARKETPLACE

Ethical and socially conscious companies will have deployed standards that ensure human rights are respected throughout the supply chain and will comply to key ethical trading certifications and rules.

WORKPLACE

Engaged companies will have ensured employee wellbeing, diversity and inclusion.

SOCIETY

Companies will have to demonstrate their willingness to promote the arts, support humanitarian efforts in society or local communities and grow future talents.

Source: Friedman Stevens

Managing CSR transformation is complex because it is a fragmented topic – one needs to handle countless risk types – that requires decentralized actions – one should be able to influence the behavior of countless actors. Therefore, CSR programs then typically range from too-narrow to broad-sweeping approaches, neither of which produce substantial impact. The dilemma is that fully embracing the CSR transformation can quickly become incredibly costly, with a challenging return on investment.

As a result, in most luxury companies, CSR programs weakly link the financial, risk, and strategy agendas. Securing greater leadership and engagement on sustainability is dependent on demonstrating that sustainability is integral to overall performance – not separate from corporate initiatives, such as developing products, responding to client demands, or improving supply chain resilience.

HOW TO APPROACH CSR TRANSFORMATION WHILE BEING FINANCIALLY RESPONSIBLE?

Luxury companies are exposed to the extensive CSR agenda. As a result, several rules should be followed for initiating a successful and impactful CSR journey, while not pouring water into a bottomless jar.

RUN A 360°SCREENING… BUT DEFINE YOUR PRIORITIES

Integrating sustainability risks into strategic and financial planning is not an easy task. Indeed, the time horizons for most sustainability risks (three to five years) far exceed those used in corporate risk assessments (six to eighteen months), which translates to difficulties quantifying these terms into meaningful financial terms. Given these diverging horizons, CSR issues are often considered “immaterial” and financial leaders acknowledge that they are poorly evaluated in corporate performance measures and return-on-investment calculations.

In order to integrate sustainability risks into strategic and financial planning, a couple of steps need to be taken. Firstly, leading organizations must included “sustainability risks” as exogenous risks into their Enterprise Risk Management (ERM) framework (financial, strategy or reputation), mapping how they could serve as risk accelerants to other key risks to raise awareness about these types of risks.

Next, organizations should internally map all relevant CSR issues, leveraging review of both internal (e.g. previous engagements) and external information (e.g. industry market scan). Subsequently, good practice would include a materiality assessment to prioritize sustainability actions. Richemont, for example, undertook a comprehensive review of its material issues, the key issues that matter most to their business and stakeholders, to define the focus of its CSR strategy and its business prioritization in that matter. This one-off exercise, based on surveying internal and external stakeholders, aims at gathering insight on the relative importance of specific CSR issues. “Materiality” is a term that was borrowed from the financial jargon in order to reconcile the sustainability agenda and corporate strategy. Analyzing stakeholder agendas quantitatively and qualitatively enables a company to determine the importance of any CSR issue in the context of the top corporate metrics and board-level priorities, such as financial loss, client impact, or reputation impact.

EMBED CSR IN COMPANY CULTURE... AND ENGAGE 100% OF YOUR EMPLOYEES

Sustainability executives should secure leadership support and ally themselves with corporate strategy stakeholders. Below are a number of best practices to secure executive CSR sponsorship:

Participation in cross-functional bodies that cut across silos, such as a loan committee that includes marketing, finance, and product development representatives, is a successful mechanism in many companies. As finance and sustainability leaders stress, “sustainability needs to be involved in cross-functional risk teams” and “sustainability leaders must be included in risk forums with business leaders from across the organization.”

Involvement of the Chief Sustainability Officer as a part of the ERM committee. In doing so, sustainability discussions can be integrated into an ERM process that is strongly focused on the economic and financial risks to the company by working closely with the Treasury, Finance, and Legal leaders of the annual ERM review.

Nomination of CSR Ambassadors across the business who are members of the local management committees so that the CSR topics are embodied by people who are knowledgeable (because their function/field of expertise is close to CSR issues) and can navigate across the organization to address them accordingly.

The Chief CSR Officer with a major Luxury Brand considers the absolute pre-requisite to be that of, CSR executives are given a license to operate from the Top management, a clear mandate that empowers them to organize the required change”. Because leadership is a prerequisite of a successful CSR transformation, organizations should ensure that managers across all levels are engaged. This effort should extend beyond communication and awareness, cascading CSR agenda and priorities at each level of management of the organization so that concrete objectives are both formulated and individualized.

MAKE ALL CSR BENEFITS VISIBLE… BUT STEER YOUR FINANCIALS

Corporate sustainability goals and programs need to be communicated in the language of the business and in terms of the core corporate metrics. The sustainability team must communicate the benefits and returns of sustainability-related targets or programs in terms consistent with those required from any strategic or operational business plan. Those might include a risk-adjusted return number, a range on the potential cost savings, or revenue increase or earnings increase, with a clear presentation of the assumptions and risks feeding into the presented range. Luxury and cosmetics companies have made progress in that respect and some have addressed evaluation challenges, like defining an internal carbon price to better incorporate sustainability risks into financial modeling or factoring externalities into corporate scenario planning.

Beyond embarking on an enterprise-wide CSR transformation due to its apparent benefits, Luxury and Beauty companies should implement the right tracking mechanisms to actively manage investments. As the Chief CSR Officer with a major Luxury house says: “CSR transformation should cost zero for a Luxury house, it is in our DNA to excel in defining the ‘what’ and to excel in executing the ‘how’… There is only a transition cost for moving from the CSR strategy to embedding it in our business-as-usual”. For that matter, some of our Friedman Stevens clients have, for example, set up an internal investment fund in charge of bringing tangible business projects to life and managing some transition costs, like financing certification needs, external consultancy or colleagues training. In essence, such an investment fund is and has to be a transition tool – It is a way to address the set-up costs by eliminating the underlying budgeting barriers, and then CSR requirements automatically and seamlessly convert into no additional cost.

The Luxury and Cosmetics houses have recently rediscovered how CSR makes up an integral part of their DNA. Luxury brands not only create timeless products through craftsmanship and sustainable use of the world’s rarest materials, but also are actively involved in the preservation of traditions, “savoir-faire”, niche sectors and local craftsmanship. All of these CSR characteristics are at the heart of Luxury brands. In today’s context, how can Luxury and Cosmetics companies maintain these traits that make up their DNA while developing a company-wide risk-management approach? How can these companies project themselves beyond what has always been in their genes and control new dimensions linked with their new scale resulting from 20 years of 5-11% annual growth ?

Not compromising on CSR is even more true today than in the past, and Luxury and Cosmetics companies, more-so than others, will have to constantly challenge and revisit the core principles of their approach to CSR in order to mitigate reputational risks. Taking action will require incorporating some of the below:

A collective shift in mindset to be orchestrated at all levels of the organization
Top-down management CSR sponsorship momentum from top management, including a strong vision and governance that will steer transformation
A structured and analytical approach to embrace CSR risks and define priorities as the CSR universe is too wide to address them all at once
A cross-functional approach to reconcile CSR/Finance/Risks languages, processes and governance mechanisms
The detailed cascading of the CSR priorities at the finest level of management to embed CSR actions into concrete action plans
A sound financial steering of CSR achievements and the related costs/ investments