Who will be paying for vital sustainability initiatives - shoppers or manufacturers?

Reckitt is the latest fmcg company to launch a sustainability roadmap. Its key aims are to increase sales from more sustainable products to over 50% by 2030 and become carbon neutral by 2040. This ambition is being backed by £1bn of investment over the next 10 years.

Nestlé and Unilever were among the first to set out the scale of the investment needed – committing, in aggregate, more than $7bn in sustainability investments over the next five years.

However, the vast majority of listed companies have still not provided any guidance on how much their respective sustainability efforts will cost. Ahead of COP26 in November, this lack of transparency is a real concern, given a third of the world’s greenhouse gas emissions come from the food industry, according to the UN. It suggests many of these companies are not yet prepared to put their money where their mouth is, or are still working through what is a complicated and multifaceted issue.

The big three questions investors are asking on this topic are: firstly, how companies will fund these initiatives; secondly, whether they will have an adverse impact on profitability; and, finally, do consumers even care enough to pay a premium for sustainability?

Nestlé has said its climate investments over the next five years can be offset through productivity improvements and cost efficiencies, making it margin neutral over time. However, we doubt all fmcg companies will be in the same position to be able to self-fund. The timing could not be worse for the industry given inflation is at a 10-year high, and many companies are already finding it challenging to deal with unprecedented levels of cost increases in raw materials, coupled with huge distribution and supply chain pressures.

When you overlay that with ongoing Covid restrictions in different countries, the easy option for companies might be just to park sustainability initiatives for a year or two. However, we don’t see this as viable, given even small delays could put their 2025 ESG commitments at risk – and more importantly, because of the human cost unfolding before our eyes, as evidenced by the recent devastating floods in Europe and China and droughts in the Americas.

Nestlé said earlier this year the percentage of consumers ready to pay a premium for sustainable brands stood at 20% in 2020, up four percentage points vs 2019. A McKinsey study concurred with this view, but warned consumers’ willingness to pay drops away dramatically as the premium increases. For example, more than 80% of consumers would pay a 5% premium to pick a ‘green’ product. Only 50% to 60%, however, would pay a 15% premium, and fewer than 20% would be prepared pay a 25% premium.

Danone’s research showed consumer purchase intent for recycled plastic water bottles was significantly above that for regular plastic water bottles. So far, though, consumers have not been prepared to pay a price premium. It might be easy to conclude this is simply a higher cost of doing business. However, if it drives consumer choice and share gains, that might be enough of a reason to justify the upfront cost.

There are some categories that seem to be well placed to pass a sustainability price premium onto customers. We would highlight milk alternatives, plant-based detergents and eco-friendly diapers as categories where we see clear evidence of sustainability credentials translating into a price premium. Whether gross margins are higher for sustainable products is less clear to us, but consumers, for sure, are actively seeking brands that are eco-friendly, cruelty-free, toxin-free and more – which should translate into a higher willingness to pay a price premium.

One initiative that could be a game-changer is Unilever’s plan to introduce carbon footprint labels on its brands by the end of this year, which could have a dramatic impact on consumers’ purchase decisions. Unilever admits the labels may only be 85% accurate to start with, but speed is of the essence and the plan is to course correct with real-time feedback. Others, like Nestlé, are more sceptical, so it will be interesting to see whether this initiative gains traction and how quickly others might follow.

It is important to recognise many brands are only in the early stages of fully integrating sustainability into brand messaging and driving consumer awareness, which needs to reach critical mass before translating into incremental pricing and profitability. At least in the near term, we would expect sustainability spend to be more of a cost component for companies, but there are reasons to believe more and more consumers are eventually likely to pay a premium for ‘green’ products, which should make these heavy upfront investments economically viable in the longer term.