Sustainability debt: The cost of making less sustainable decisions for enterprises

In the pursuit of profit and growth, businesses today often overlook a critical aspect—sustainability. According to the World Economic Forum, 90% of top executives believe sustainability is important, but only 60% of organizations have sustainability strategies in place. As the world grapples with climate change and social inequality, businesses are accumulating a hidden cost—sustainability debt.

Enterprises deprioritizing environmental, social and governance (ESG) responsibilities face the risk of incurring a host of liabilities that accumulate over a period known as sustainability debt. This article explores the nature of sustainability debt and how it accumulates, its potential consequences, and how organizations can begin to take proactive steps to manage and reduce this debt, leave an impact, and protect their bottom line.

What does sustainability debt mean?

Sustainability debt is the cumulative cost of suboptimal decisions that compromise a company's environmental and social impact. It arises from a disregard for sustainability trade-offs in business processes, infrastructure, investments, or business models.

Sustainability debt can manifest in various forms, including:

• Environmental liabilities: Pollution, resource depletion, waste generation, etc.
• Social liabilities: Labor abuses, supply chain issues, poor community relations.
• Financial risks: Regulatory fines, consumer boycotts, and decline in market value.

Just as a software developer accumulates technical debt by opting for short-term fixes over robust solutions, businesses pile up sustainability debt by prioritizing short-term gains over long-term environmental and social responsibility. Technical debt can be an expensive accumulation because of its compounding nature creating vulnerabilities and limiting software potential and innovation. Similarly, the implied cost from a convenient decision – mainly a less sustainable path - can have significant consequences that require a costly remediation.

For instance, a major Swedish fast fashion giant faced severe criticism for promoting unsustainable practices including a throwaway culture. The company reported having USD 4.3 billion worth of unsold clothes in 2018.

By continuously neglecting these environmental and social responsibilities, organizations are risking a multitude of financial liabilities. This disregard leads to an accumulation of various economic costs, worsened by the compounding effects of poor sustainable practices, thereby increasing their long-term financial vulnerability.

How does sustainability debt pile up?

Sustainability is now mission critical. The cost of not embedding sustainability at the core is very high and will compound over time. Let's explore how sustainability debt emerges for businesses and its compounding nature.

Emergence of sustainability debt and its compounding factors

1. Resource Depletion and Price Volatility

Unilever is a great example of sustainable resource management practices. The fast-moving consumer goods multinational has invested in regenerative agricultural principles to nourish soil, capture carbon and restore land. For instance, they source 100% of its palm oil from certified sources.

2. Inefficient Resource Utilization and Waste Management

Ineffective resource allocation and inadequate waste management practices lead to direct financial losses. The costs pertain to wasted materials, inefficient energy usage, and potential environmental remediation required to meet regulatory standards. These expenditures directly impact profitability and necessitate continuous mitigation efforts.

UN’s Global Waste Management Outlook 2024 estimates that the global direct cost of waste management to nearly double to a staggering USD 640.3 billion by 2050 . Enterprises need to act now by implementing waste prevention and management measures.

For example, IKEA plans to turn waste into resources and become a “zero waste to landfill” company by optimizing their operations to minimize waste and repurpose leftover materials.

3. Regulatory Compliance Costs

With stringent global regulations for environmental and social responsibilities, businesses are levied escalating costs and fines when they fail to comply with operational adjustments. Non-compliance leads to substantial fines and penalties, further escalating financial exposure. A World Bank report finds that revenues from carbon taxes and Emission Trading Systems (ETS) have reached about $95 billion in 2023.

Strategic adoption of sustainable practices is essential to minimize these compliance costs effectively. Following an agreement between the European Council and the Parliament, large companies working in the EU will be liable for fines equal to 5% of their global net turnover for breaching the Corporate Sustainability Due Diligence Directive (CSDDD).

4. Reduced Investor Confidence

A 2024 Morgan Stanley report states that 77% of global investors are interested in sustainable investing . Companies neglecting sustainability measures risk diminished investor confidence. In addition to direct financial impacts, stocks of companies with poor sustainability records may be deemed 'unsustainable assets' by investors. This perception can lead to exclusion from sustainable investment portfolios, further reducing stock value and limiting access to capital.

5. Declining Consumer Trust and Revenue Loss

In an era where consumers prioritize ethical practices and environmental responsibility, perceived negligence in sustainability can severely damage a company's reputation and consumer loyalty. This loss of goodwill directly translates into reduced sales, market share, and brand value.

A Harvard research states that GenZ and millennial customers are 27% more likely to purchase brands that care about its impact on planet and people. Further, highly trusted companies outperform others by up to 400% in terms of market value. Trust and transparency are significantly influenced by company’s sustainability imperatives.

6. Vulnerability to Market Fluctuations and Profitability Decline

Organizations that disregard sustainability face heightened vulnerability to market shifts. Further unsustainable practices generate external costs such as environmental damage and employee health issues, eventually affecting profitability. For example, traditional fossil-based energy markets are often subject to significant fluctuations due to global political affairs, supply chain dynamics and regulatory changes. In contrast, renewable energy sources such as solar and wind are less susceptible to these factors.

7. Foregone Opportunities and Limited Growth

Besides the financial burdens, companies that fail to prioritize sustainability risk missing out on significant business opportunities. A TIME and Statistica research study indicates that companies that prioritize corporate responsibility practices experience 20% increase in sales . A poor sustainability record can lead to exclusion from lucrative partnerships, restricted access to certain markets, and a diminished ability to capitalize on emerging opportunities. This ultimately limits long-term growth and competitiveness. Most organizations also profile their suppliers based on sustainability performance and intend to associate only with companies that have good ESG scores.

8. Debt Financing and Risk Perception

Financing the energy transition requires a massive reallocation of capital. A McKinsey report states that the funding needs for a net-zero transition can exceed USD 4.4 trillion annually through 2030. Therefore, debt holders, including banks and bond investors, increasingly factor ESG performance into their assessments of default risk during lending decisions.

Companies with inadequate sustainability practices are considered higher-risk borrowers, potentially facing higher interest rates to compensate for perceived risks. This results in increased capital costs that further strain financial stability.

Embracing sustainable practices is a crucial strategic imperative for building a strong and resilience business. It helps companies mitigate financial risks and thrive in a world increasingly focused on environmental and social responsibility.

How can enterprises manage sustainability debt?

A fundamental shift in mindset is required for enterprises to manage sustainability debt. Much like digital transformation, embedding sustainability requires enterprises to transform every organizational department, business function, and division from the core. Today, companies have started looking at ESG across 5 key areas to measure progress and ensure long-term value.

ESG across five key areas to measure progress and ensure long-term value

1. Define the strategy – aligned with the enterprise’s sustainability imperative can help develop a competitive advantage. Companies must closely evaluate the impact of their businesses on sustainability areas and pin down on the areas that matter most. An enterprise-level top-down push can help reduce siloed initiatives across business units and departments. Companies can further revisit their existing business models to understand the environmental and social impact. This helps understand risks and opportunities and draw new business models that are sustainable and resilient. 
   Let’s say a tech giant aiming to reduce its carbon footprint by 50% within a decade can start scrutinizing its energy-intensive data centers. By coordinating efforts across departments and functions, they can explore innovative solutions like energy-efficient hardware and renewable energy sources.
   
   
2. Establish governance – by redesigning the existing frameworks, metrics, and policies to accommodate sustainability goals, initiatives and progress-tracking. Forward-looking companies strive to align with regulatory and statutory requirements and focus on greater transparency and accountability through a well-defined RACI. All key areas of business, including marketing, sales, finance, and product, should be equipped with capabilities to measure and articulate the value delivered through sustainability.
   For example, a company might overhaul its performance review system to include sustainability metrics. Instead of evaluating sales figures, employees would be assessed on their contributions to reducing the company's carbon footprint.
   
   
3. Embed sustainability in decision-making – Identifying, assessing, quantifying and controlling risks and opportunities from a sustainability perspective across the company operations infuses the necessary thinking for long-term success. 
   For instance, inculcating transparency and traceability across the supply chain, supplier sustainability performance management and re-engineering products and services for sustainability embeds sustainability at the core of business.
   
   
4. Build data, platforms and technology – Integrating sustainability needs into the existing ecosystem by redesigning data platforms and by identifying the right data sources will help organizations draw ESG data-driven insights and actions. It is also important to ensure that the data is of sufficient quality, data collection and mining processes are sufficiently automated for enhanced visibility.
   Organizations can leverage trending technologies such as Generative AI for report automation and sustainability metric prediction to further draw value from sustainability data and drive proactive decision-making.
   
   
5. Drive change management – Creating a compelling and distinctive narrative around the organizational sustainability strategy in public markets, news and media will resonate with investors, customers and employees. 
   For example, organizations can develop a change management strategy to reinforce the necessary change needed for ensuring a sustainability DNA across the organization. Moreover, regular dialogues with employees, communication with the board and investors, establishment of clear incentives and accountability with ESG measurement can help achieve sustainability goals.
   
   
   

Companies should view sustainability as more than just compliance; it's an opportunity to innovate and gain a competitive edge. With eco-digital engineering, businesses can reduce their environmental footprint and reduce sustainability debt while unlocking new value streams. By integrating sustainable technologies and practices, companies can reinvent their operations around environmentally and socially responsible principles, creating a more resilient and sustainable future.

How can Nagarro help?

As a digital engineering company, Nagarro understands that organizations today are at different maturity levels in the sustainability journey. However, we believe that technology is a key player in ensuring sustainability is at the core of business, irrespective of maturity. 

We help organizations identify use cases and draw value at the confluence of technology and sustainability. If you seek a technology partner to further your sustainability journey, let’s talk! 

References

1. UNEP: We’re gobbling up the Earth’s resources at an unsustainable rate (unep.org) We’re gobbling up the Earth’s resources at an unsustainable rate (unep.org)
2. UNEP, Global Waste Management Outlook 2024, Global Waste Management Outlook 2024 | UNEP - UN Environment Programme
3. World bank, Record high revenues from global carbon pricing nearing $100 Billion, State and Trends of Carbon Pricing 2023 (worldbank.org)
4.  Morgan Stanley, Sustainable Signals, MSInstituteforSustainableInvesting-SustainableSignals-Individuals-2024.pdf (morganstanley.com)
5. HBR, Consumers’ sustainability demands are rising, Research: Consumers’ Sustainability Demands Are Rising (hbr.org)
6. TIME, How TIME and Statistica determined the World’s most sustainable companies of 2024, TIME/Statista World's Most Sustainable Companies 2024 Methodology | TIME
7. McKinsey, Banking on a sustainable path, global banking annual review 2022 banking on a sustainable path.pdf (mckinsey.com)