Every senior management team today is investing in sustainability. The priorities of each business typically vary across sustainability dimensions: for some, environmental concerns are paramount; for others, social initiatives are the most important concern. And across industries and geographies, achieving effective governance and meeting compliance requirements are absolutely essential—although, in our experience, companies invest in sustainability not just because they are compelled to do so but because they choose to make a positive difference for their many stakeholders.
The resources allocated to sustainability activities—not just capital but also management time and attention—are often enormous. Yet the investments can also become a black box: what returns do they generate, and what is the value at stake? In this article, we provide a framework to analyze the business case for sustainability activities, both in terms of playing defense (by mitigating against key threats to expected value creation) and offense (by capturing new opportunities such as revenue growth and green business building). Since the totals can vary significantly across industries, we present some nonexhaustive examples from different industries to illustrate how the approach works in practice.
Valuation principles
From a corporate finance perspective, the value a company creates comes down to the amount of free cash flow it generates over the long term. Past results are informative, but they aren’t destiny. Particularly for mature businesses, the base case can often be in decline, not least as a result of market forces and competition—challenges that extend beyond sustainability considerations. When assessing sustainability, the demand for unsustainable products will likely decrease (particularly if the price is approximately equal), and the probability of regulatory penalties, potential for litigation judgments, and possible reputational risks will likely increase—including the risk of losing consumers by misjudging their expectations. Free cash flow could decrease over the long term if sustainability investments miscalibrate stakeholder concerns.
Measuring the full value at stake from sustainability requires a multistep approach (see sidebar, “Methodology: A five-step approach to calculate value at stake”). In this analysis, for simplicity, we describe the effects of playing defense and offense on EBITDA, net of any investments required. Specifically, we sum the amounts, which are best measured as a range, that, on defense, can be preserved by (1) mitigating market decline and (2) mitigating legal, regulatory, and reputational costs; and, on offense, can be increased by (3) expanding revenue by launching sustainability businesses, (4) capturing growth and price premiums (including from new sustainability products), (5) greening operations and their supply chains, and (6) benefitting from higher employee productivity and morale (Exhibit 1).
Standard business principles apply: managers should resist the urge to make easy assumptions, such as expecting that every sustainability initiative will be value creating or anticipating straight-line growth for new, sustainability-friendly products. Moreover, as in all new initiatives, there are case-by-case questions as to whether it is better to be a first mover or a fast follower. New businesses may see all or a part of their first-mover advantage competed away or their products become commoditized, even if they are, for a period of time, protected by patents or other intellectual property rights. The first environmentally friendly laundry detergents, for example, were sold at a significant premium, but the high price points could not be sustained indefinitely. The first green products were also usually more expensive to produce; they did not necessarily generate high margins despite their price premiums., McKinsey Global Institute, August 14, 2024; “How playing offense on sustainability can power e-commerce performance,” McKinsey, March 26, 2024; Michael Birshan, Lisa Leinert, Tomas Nauclér, and Werner Rehm, “A different high-growth story: The unique challenges of climate tech,” McKinsey Quarterly, January 26, 2024; Marcelo Azevedo, Anna Moore, Caroline Van den Heuvel, and Michel Van Hoey, “Capturing the green-premium value from sustainable materials,” McKinsey, October 28, 2022; Rob Bland, Anna Granskog, and Tomas Nauclér, “Accelerating toward net zero: The green business building opportunity,” McKinsey, June 14, 2022; and Stephan Fuchs, Stephan Mohr, Malin Orebäck, and Jan Rys, “Product sustainability: Back to the drawing board,” McKinsey, February 7, 2022.
These dynamics will likely endure. Demand for green steel, for example, currently far outstrips supply—and is forecast to continue to do so for at least a decade. New opportunities will likely emerge across industries, as they always have before, and companies can capture more value by adopting a forward-looking approach now.
Some managers, when presented with this defense- and offense-minded approach, may ask, “What about capital expenditures—how will we pay for these initiatives?” A technical answer is that one can apply the analysis in net present value (NPV) terms. Rather than summing to operating profit at a point in time, one can consider a waterfall of discounted amounts that sum to enterprise value. A more comprehensive answer is that immediate-term net costs for sustainability may be lower than they first appear—though it should be acknowledged that every analysis is bespoke.
Sustainability regulation also imposes costs, and whether or not the investments required to comply with these regulations generate benefits under a traditional ROI analysis is irrelevant; companies must meet regulatory requirements. Socially responsible choices may not necessarily maximize value in the long term—at least, not with certainty. The result of multiple, iterative choices to meet stakeholder needs manifests in higher or lower free cash flows.
Value from defense and offense: Three industry examples
The total value at stake and the contribution of each sustainability category, as calculated by our methodology, varies by individual company as well as by geography. Usually, it varies most significantly by industry (Exhibit 2).
Extractive industries, for example, face great challenges on defense, to protect existing value; other industries could struggle to find enduring competitive advantage from offense-minded initiatives. A look at three industries—consumer, chemicals, and pharmaceuticals—illustrates the distinctions.
Consumer
Companies in the consumer sector have one of the highest rates of value at stake (VAS) compared with companies from other industries. The magnitude is driven primarily by rising expectations that products will meet sustainability norms and standards, low switching costs, an increasing number of green alternatives, and the existence (so far and for some products) of green premiums. By our analysis, the business-as-usual case from a company’s changes in market share and increases in legal, regulatory, and reputational risks would represent 18 percent of EBITDA by 2030.
On the defense side, companies will clearly need to mitigate against sustainability-driven market and demand declines. More than in other industries, consumer companies face a high likelihood that at least some consumers will change their purchasing patterns based purely on sustainability factors. Research shows that no other industry has a higher percentage of what we call sustainability-conscious consumers. Compared with carbon-intensive sectors, the risks for consumer companies of not being sustainability-conscious enough are relatively lower, as are risks from other regulatory causes (consumers may buy fewer of your products, but regulators will probably not shutter your factory). Even so, regulations—such as those that address certain ingredients—could be material on a company-by-company basis. Many food companies are shifting to alternative ingredients for several products. Similar dynamics affect food companies that are moving to sustainable cocoa.
On the offense side, consumer companies have significant opportunities to create value. Consider green business building. One leading retailer is responding to market demand for reuse and recycling by launching an initiative to sell secondhand clothes and accessories at its flagship store, and several fashion companies are creating vintage (used) businesses. Sustainability-friendly products have achieved disproportionately higher growth; between 2018 and 2022, consumer-packaged-goods (CPG) products with a connection to sustainability demonstrated a 1.7 percentage-point advantage in CAGR—a significant amount in the context of a mature and modestly growing industry—over non-sustainability-marketed products. Resource efficiency is also additive to EBITDA for consumer companies.
One CPG company, for example, is on track to fulfill its aim of being carbon negative in its operations by 2030, avoiding more than $400 million in cumulative costs and saving approximately $200 million annually through manufacturing, logistics, and other efficiencies. Leading organizations are also now deploying digital-twin technology to model net-zero value chains and translate this into reality through their supplier engagement.
In our experience, the impact of sustainability on employee productivity is generally lower than in sectors that are demonstrably purpose-driven (such as for healthcare companies or green energy businesses). Yet there have been remarkable successes, such as one retailer’s program to support working adult learners through reduced fees, coaching, and college credits. The initiative helped to reduce the company’s turnover rate by 1o percent—its lowest level in five years.
Chemicals
Companies in the chemical industry have a significant rate of VAS. While the amounts are, relatively, not as great as those for companies in industries such as consumer and real estate, the amounts are material and can be, depending on the business, existential: there are large variations depending upon the type of chemicals a company produces. The baseline, “do nothing” case is that value will decline, particularly for chemicals used in producing carbon-intensive products, such as construction materials, mining, and packaging. Not only will demand for these chemicals likely erode, but regulatory fines and other costs, in particular taxes on CO2, are expected to rise. In parallel, because sales for chemical companies are largely B2B, many corporate customers have their own sustainability challenges, targets, and commitments and will need appropriate chemicals to produce green products that enable them to meet their needs. Chemical companies that fail to meet customer demand may lose market share.
On the defense side, several chemical companies are allocating resources to mitigate risks in notable ways. The Saudi chemical company SABIC, for example, has a global corporate social responsibility strategic tool called RAISE (Reputation, Audience, Innovation, Strategy, and Endurance), which it uses to invest in programs that promote company values and to inform its resource allocation into its core strategic areas—science and technology education, environmental protection, health and wellness, and water and sustainable agriculture. Another global chemical company used insights from its expanded customer engagement to develop a portfolio sustainability assessment (PSA) methodology. Early results indicate that more than 75 percent of its identified initiatives are either at an advantage or highly differentiated in at least one sustainability impact category. Many chemical companies also include climate-related risks and opportunities in their enterprise risk management (ERM) programs to identify, measure, and mitigate their bespoke CO2 risks.
On the offense side, sustainability may offer chemical companies substantial opportunities, especially for “green chemicals,” green business building, and talent attraction and productivity. Likely, the opportunities will vary by region; Europe is expected to be a clear frontrunner, and differences will be evident worldwide. BASF, for example, contributed CO2 capture technology to Japan’s first demonstration of blue hydrogen and ammonia production from domestically produced natural gas. And several chemical companies maintain university partnerships to improve company R&D and enhance talent recruitment. Moreover, providing green materials can currently yield substantial price premiums (Exhibit 3).
Chemical companies are also improving their resource efficiency: one major firm, for example, realized cost reductions and entity synergies of more than $1 billion in a single year from initiatives such as optimizing crude oil procurement, increasing energy efficiency, and rethinking process units. While it’s an open question whether green products will continue to trade at a premium, many currently do, including for sustainable aviation fuel (in which premiums exceed 200 percent), green ammonia, ethylene, methanol, plastics, food additives, and fertilizers.
Pharmaceuticals
Sustainability, particularly in the social and governance dimensions, is highly material for pharmaceutical companies. There are substantial challenges from potential fines from regulators (the only other industry that experiences more fines is banking), universal CO2 reporting and reduction requirements, and the need to continue to attract and retain highly educated employees, a subset of the population that, at least in the United States, tends to be more supportive of sustainability priorities.
In terms of playing defense, multiple pharmaceutical companies are making substantial efforts to strengthen their community standing, such as by investing to reduce disparities in healthcare access, encouraging volunteer work and stronger community involvement, and working with a diverse range of partners across their value chains. Many pharmaceutical companies also self-report the revenue impact of sustainability-conscious customers to the CDP (a not-for-profit formerly called the Carbon Disclosure Project)—estimating an average yearly revenue impact of about 1.2 percent. Payors are also increasingly demanding sustainability commitments as a precondition for participating in tenders. For example, the UK National Health Service requires all suppliers bidding for contracts above £5 million per annum to publish a carbon reduction plan for their emissions from the sources included in Scopes 1 and 2 of the GHG Protocol, and a defined subset of Scope 3 emissions.
Regulatory fines erode pharmaceutical companies EBITDA by an additional 0.75 percent on average over a ten-year period. Pressure could increase across a range of concerns, including data privacy, animal rights (a common part of product testing), and emissions and waste from manufacturing and packaging. Many pharmaceutical companies are looking to mitigate these risks in multiple ways. Several large players have already achieved significant reductions in Scopes 1 and 2 GHG emissions in the past five years. Another leading company uses only approved animal vendors, contractually bound to legal and company standards, that are regularly audited by the company for appropriate animal welfare and care. There are numerous additional examples across companies and risk categories.
On the offense side, pharmaceutical companies are seeking opportunities for sustainable and inclusive business building. For example, the past few years have seen remarkable growth in women’s healthcare and the dawn of FemTech, with several businesses valued at more than $1 billion. Multiple companies are also investing substantially in animal health and wellness, developing veterinary medicines, vaccines, and diagnostics for both livestock and pets. In some cases, companies have realized green premiums, such as for high-density polyethylene (rHDPE), high-intrinsic-viscosity recycled polyethylene terephthalate (high-IV rPET), and bionaphtha. Moreover, companies are achieving greater resource efficiency. One India-based leader recently achieved a 48 percent year-on-year increase in profit after tax, which it attributed in large part to reduced materials costs as well as supply chain improvements. Finally, pharmaceutical companies are achieving notable improvements in employee productivity and retention from initiatives such as employee health and training programs.
There are clear, common sources of value from sustainability. The value at stake ranges across industries, and in practice, companies take different combinations of initiatives on both offense and defense. The alternative, do-nothing approach, by contrast, is a value destroyer—and falls short for society, as well.
