The most common misperception biotech executives hold regarding sustainability is that ESG is mainly about managing greenhouse gas emissions and workplace diversity, equity and inclusion. Companies with modest carbon emissions and some diversity programs in place often wrongly conclude that ESG has nothing to offer. Climate change and DEI are important considerations, but their significance varies by company. Executives who recognize the breadth of ESG may choose to disclose metrics around supply chain, product affordability or other issues, but often do so without a strong rationale for why. These companies unwittingly set themselves up for accusations of greenwashing while failing to realize the full benefits of ESG.
Materiality is the key to unlocking value with ESG and avoiding the perception of greenwashing. Out of dozens of ESG issues relevant to an industry, only a handful will have the potential to significantly impact a given company’s performance over time—these issues are material. Given the wide range of industries and businesses that exist, it makes sense that not all companies face the same set of material risks and opportunities. In fact, company-specific factors mean businesses within the same industry may experience issues differently or be exposed to different issues. Materiality assessment, the process of identifying and prioritizing a company’s material issues, accounting for industry-wide and firm-specific factors, is the cornerstone of a sound ESG program.
Materiality assessment leverages global reporting standards, industry research, company-specific information and input from internal and external stakeholders to define the set of ESG issues material to a company. Surveying employees, customers, suppliers, investors and other key stakeholders provides a holistic view of the risks and opportunities facing a company, and its impacts on people and the planet. Material issues form the backbone of a company’s ESG program, the sustainability initiatives it undertakes, key performance indicators it tracks and the information it reports.
While an assessment is required to identify and prioritize a company’s material issues, the problem is bounded by a set number of issues typically relevant to the biotech industry. For example, child labor and sustainable agriculture are not typically material issues for biotech companies, but patient safety and human resource management are. Combining extensive research and industry experience with guidance from global reporting frameworks such as the Sustainability Accounting Standards Board and Global Reporting Initiative, Stern IR leverages a set of 12 material issues (not in order of importance) that address most risks and opportunities material to biotech companies:
- Affordability & Access
- Business Ethics & Ethical Marketing
- Corporate Governance
- Human Resources & DEI
- GHG Emissions & Climate Risk
- Innovation & Business Model Resilience
- Occupational Health & Safety
- Patient Safety & Quality Management
- Privacy & Data Protection
- Social Impact & Ethical Research
- Supply Chain & Materials Management
- Water, Waste & Environmental Management
Biotech executives may wonder why they need to conduct a materiality assessment if these twelve issues capture the universe of issues relevant to their companies. There are three key reasons materiality assessment is critical:
- Company-specific factors
- Degree of risk exposure
- Prioritization of issues
Even biotech companies treating the same indication may face different material issues because of differences in their business models. Consider two companies treating an endocrine disorder—one produces animal-derived biologics while the other synthesizes biosimilars absent animal inputs. For the biologics company, Social Impact & Ethical Research may be a salient issue because of the company’s dependence on animal-derived inputs, though its water consumption is negligible. The biosimilars company, while independent of animal-related risk, might rely on a water-intensive production process, highlighting Water, Waste & Environmental Management as a key issue. In either case, simply adopting the set of twelve issues above as “material” would misrepresent the company’s material risks and negatively impact strategy development and reporting. A materiality assessment narrows the set of material issues to those that pose an actual business risk to the company, avoiding this problem.
The next consideration is one of degree—some exposure to a risk does not imply materiality. In order to be material, a risk must exceed some threshold beyond which it poses a significant threat to the company’s business. We can think of the threshold for materiality as being a function of the magnitude and probability of a risk-related event occurring. Returning to the biologics company example, if the company uses only trace amounts of animal product in its production process, animal welfare may not pose a material threat to the company because the magnitude of any legislative impacts around animal welfare would be negligible. Similarly, if the biosimilar company’s production facilities are situated in a water-plentiful region, water use may fail to reach the threshold of a material issue despite using large volumes of water because of the low the probability of a water shortage.
Finally, companies have limited resources, and even for high priority issues they must stage-gate initiatives and investments over a period of years to accomplish their goals. A materiality assessment helps companies determine which efforts should receive funding and when. Larger, more immediate risks require heavier investments sooner. Prioritizing issues through a materiality assessment provides a sound basis for strategy and decision making.
Additionally, materiality assessments reveal stakeholder preferences, enabling companies to prioritize issues important to investors or other key stakeholders. Materiality maps are often used to convey materiality findings. The visual display of internal versus external preferences can help companies determine where to focus efforts to engage with and satisfy investors and other stakeholder groups.
Sample Materiality Assessment Map
This discussion brings us back to the original supposition that materiality assessment helps biotech executives create value through understanding which issues are material to their business and why. As we have seen, understanding which issues are material helps companies focus their efforts on real business risks and opportunities. Understanding why issues are material allows companies to identify policies, programs and initiatives that can effectively mitigate those risks. Back to our earlier example, if the biologics company knows animal welfare is a business risk, but does not understand why, it may waste time and energy on initiatives that are ineffective at reducing risk. If, however, it identifies that pending legislation limiting use of gestation crates in pig farming may cause the cost of its animal inputs to increase dramatically in the next 24 months, it can focus on strategies like supply chain diversification to address this near-term risk.
So what issues are material to biotech companies? As we’ve seen, it depends on the company. But some general conclusions can be drawn looking across a large number of companies. Four issues stand out as material for the majority of biotech companies:
- Patient Safety & Quality Management
- Affordability & Access
- Human Resources & DEI
- Innovation & Business Model Resilience
Other material issues, while important for some biotech companies, are not material for most. The two issues that are least commonly found material for biotech companies are:
- GHG Emissions & Climate Risk
- Water, Waste & Environmental Management
Sample Materiality Assessment Issue Prioritization
This finding does not imply biotech companies should not manage and report on environmental issues. SEC mandates, customer procurement contracts and investor pressure are common reasons why companies choose to address these issues, even when they are not material. An emerging best practice is to clearly distinguish material issues from relevant issues in reporting and disclosure. In this way, companies can be transparent with stakeholders about their material issues while still getting credit and visibility for managing non-material issues they consider important.
Biotech companies that leverage materiality assessments to build robust ESG programs create lasting value. ESG reports structured around sets of material issues help stakeholders assess whether companies are effectively identifying and mitigating business risks. Biotech executives who can speak with authority about their companies’ material issues convey credibility, avoid accusations of greenwashing, and are able to defend their ESG strategies and choices.
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Molly Podolefsky, Ph.D. (she/her)|Managing Director, ESG