Lower Risk, Better Returns: How ESG Becomes an Opportunity for the Mittelstand

For some, it is an overdue step to hold business accountable for the consequences of its actions; for others, it is an opaque and, above all, expensive bureaucratic monster. We are talking about sustainable corporate governance, known by the abbreviation ESG. The fact is: the Mittelstand, too, will soon no longer be able to escape the growing requirements. Alexandra Becker and Carla Dausend provide an overview of what companies need to prepare for, which mistakes they should avoid, and how ESG can increase company value.

Today, companies face the challenge of making the impact of their actions on the environment and society transparent in addition to their financial performance. ESG, short for Environmental, Social and Governance, is not only about reducing CO2 emissions or resource consumption, but also about ensuring decent working conditions and responsible corporate governance along the entire value chain.

The pressure on business to get serious about sustainable corporate governance has been growing for years – and it is coming from more and more directions. The web of laws, regulations and directives surrounding companies is becoming tighter and more complex almost daily. Alongside the EU Taxonomy, which has applied since 2022, the requirements currently in force include the Supply Chain Due Diligence Act (also known as the Supply Chain Act) and the Non-Financial Reporting Directive. The proposed CSRD (Corporate Sustainability Reporting Directive) extends the scope of the EU Taxonomy and requires a larger group of companies to disclose information. These requirements apply to companies with at least 250 employees and revenue of EUR 40 million or a balance sheet total of EUR 20 million – and are therefore also relevant for the Mittelstand. A uniform EU supply chain law (CSDDD) is still under deliberation.

According to estimates, around 50,000 companies in Europe alone are likely to be affected by the reporting requirements associated with ESG; in Germany, around 15,000 companies will in future be obliged to implement the regulations.

It Is Easy to Lose Track in a Regulatory Thicket That Changes Daily

Many owners and executives in business perceive the ESG requirements, despite their central importance, as an additional burden in already demanding times.

Companies are, for example, obliged to constantly keep up to date on applicable and new provisions. Compliance itself is also often anything but trivial, particularly for multinational companies, because different laws apply in different countries.

Fundamentally, the entire ESG regulatory framework is still in its infancy. The fact that there is still no universally valid standard for companies that already have to report in line with ESG does not make things easier. A multitude of frameworks, standards and metrics has emerged in recent years, but uniform requirements remain scarce. In abundance, by contrast, are reporting requirements (more than 80 different ones) and requirements for data points to be collected in future (more than 1,100 in number).

Corresponding reporting systems can help companies document and verify their ESG measures. An independent review of ESG practices can additionally provide greater transparency toward stakeholders.

Transparency is, in fact, a key word when it comes to ESG, because the number of reports about new greenwashing cases seems to be rising steadily while more and more sustainability requirements are being introduced. Reputation-damaging behavior in which claims and reality do not match should be avoided at all costs – even if there is not always intent behind it, as various examples of “well-intentioned, but poorly executed” show.

What remains: the sheer complexity of ESG can quickly push companies to their limits, especially those that have so far had no dedicated departments or qualified specialists on board. For many, engaging external experts and advisors is therefore a sensible option, at least for the transition.

How ESG Becomes a Business Case

Reporting and implementing ESG practices have long become a matter of course for large corporations. This is evident not least from the growing number of elaborately produced sustainability reports.

But there are at least four good reasons for Mittelstand companies, too, to put the topic on the agenda now:

• Lower risk: By focusing on ESG early, companies can better analyze, understand and counteract potential risks – above all financial ones. This saves costs not only on energy and resources. Expenses for legal proceedings over violations of environmental regulations can also be avoided with the help of robust ESG strategies.

• Better performance: The fact that sustainable business is long since more than “nice to have” is also evident in “hard numbers”. Studies have shown that companies with a strong ESG focus tend to be more profitable, have lower capital costs (see below), are more resilient in crises and show better value development over the long term. According to one survey, every third company benefits from cost reductions through improved efficiency, and almost every fourth reports higher revenues by its own account. A third of companies also state that ESG has made them more innovative (source: ‘Innovating for a Sustainable Future’ by business and IT services provider NTT DATA).

• Better terms for raising capital: Investors, too, hold companies that meet strict sustainability standards in high regard. ESG criteria are also becoming increasingly important in financing, because banks will in future take ESG into account in ratings and in credit decisions. In addition, non-compliance or partial compliance with ESG requirements will be reflected in loan pricing.

• Better relationships with customers, employees and investors: Companies with a pronounced ESG strategy are perceived as responsible. Customers and employees increasingly give them preference in purchasing decisions. Good ESG performance also ultimately increases employer attractiveness. Employees are drawn to companies that cultivate sustainable values and a positive corporate culture.

Wanted: An ESG Strategy That Fits the Company

Developing a suitable ESG strategy is one of the central challenges of the coming period, particularly for Mittelstand companies. This process requires careful consideration of company-specific conditions, risks and opportunities. The ESG strategy must also take into account the company's core values, business model and long-term goals, in order to generate not only costs but real added value. One will look in vain for a one-size-fits-all recipe that can serve as a general “template”. Vaude can, however, serve as an inspiring and exemplary company, because it is particularly successful at making its constant pursuit of ever more sustainable solutions a central part of its ESG strategy. As a result, the company has even established itself as a pioneer across its entire industry.

But how best to go about developing an authentic ESG strategy? The following four points can serve as a guideline

1. Position ESG as a strategic topic. First, awareness must be created within the company that ESG practices are not only a social responsibility but can also deliver economic benefit. Sustainability is undoubtedly associated with effort and costs, but it can also create tangible competitive advantages and ensure better long-term value development.

2. Define responsibility. Responsibility for implementing ESG practices must be clearly defined. The task should not be anchored only in the relevant department and with the designated specialists, but holistically across the company and especially at management level.

3. Report and communicate transparently. Comprehensive reporting and open communication are crucial for implementing ESG goals and ensuring high performance levels. Companies should measure, monitor and report on their performance regularly. The results should be made accessible to all stakeholders, for example through sustainability reports or by integrating ESG information into annual reports. Through honest and regular communication of their ESG performance, companies can win the trust and support of stakeholders and strengthen their image as a responsible company.

4.   Work with partners. As with many other topics, the same applies here: there is no need to reinvent the wheel every time. Developing a strategy is often easier together with other companies, industry associations, governments, non-governmental organizations and other interest groups, and one can also learn a great deal from the experience and mistakes of others. Partnerships with industry-specific initiatives, NGOs or suppliers can also provide valuable input to reach one's own ESG goals faster.