Sustainability Materiality: Unpacking the Business Model

social, economic and ecological issues managers should pay attention to and which issues they should de-prioritize.  Unlike financial reporting, reporting on sustainability is voluntary.  This means that the process by which companies determine what issues are deemed relevant or material is largely left up to the company.  As a result, there does not exist a standardized process by which companies determine what is relevant or, in the context of this article, material.  Regardless, managers are increasingly working to conduct a sustainability materiality assessment and to produce a sustainability materiality matrix for their firms.  It is recognized best practice that a company report on those relevant issues that “have a direct or indirect impact on its ability to create or maintain or erode economic, environmental, social value for itself, its stakeholders, the environment, and society at large.”[i]

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What is Materiality?

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The term materiality comes from the field of accounting.  Materiality is defined as those items that should be reported in detail in financial statements because they are likely to impact the economic welfare of decision-makers.  In the accounting context, these decision-makers tend to be investors and the goals tend to be economic.  So, if a business decision, transaction, or event is significant enough that they could impact a investors’ decisions, it would be considered material and thus should be reported. 

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Sustainability materiality draws on this concept to some extent and has been applied to what is known as a materiality matrix.  A materiality matrix is a diagram that maps issues according to the perceived contribution the industry in question has on issues society or stakeholders deem important and the degree to which the issue impacts the company in question.  I illustrate this matrix below.     

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Traditional Sustainability Materiality Matrix

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Initial definitions of sustainability materiality refer to those social, ecological and economic issues that have a direct impact on business performance. Also called Single Materiality, these issues are deemed material because decision makers, like managers and investors, need to be aware of them and incorporate them when making informed decisions.  Consider the ecological issue of climate change and its relevance to the insurance sector.  Insurance companies are heavily impacted by a changing climate as unpredictable weather events can wreak havoc on the predictability embedded in insurance premiums.  Thus, climate change is a material issue for insurance companies because company profit levels are at stake as the issue grows in severity. 

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Much criticism emerged from this limited view of materiality because it omitted any issues deemed important by stakeholders that did not necessarily negatively impact companies.  Practitioners responded with Double Materiality or 'Impact Materiality', which refers to those social, ecological or economic issues that emerge as a result of company behaviour.  The definition of materiality from a sustainability point of view has therefore evolved from its origins where the stakeholder who is materially affected, typically the shareholder, also includes other stakeholders such as the environment, communities, consumers, among others.  The automotive sector lists climate change as a material issue no doubt because of its contribution to this issue.  Water conservation is relevant both from a single and double materiality perspective for a company like Nestle that is both reliant on accessible water and contributes to the issue of water scarcity as a result of their operations.  These examples represent double materiality. 

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How then does one goes about identifying material issues of a given company?  Do we seek input from stakeholders?  What if the issues vary by stakeholder?  Which stakeholder gets priority over other stakeholders?  Why?  While no doubt it is important to regularly seek feedback from a variety of stakeholders, determining what is material can only happen if one looks closely at the fundamental nature of the company's business model.  Doing so involves understanding three main tenets of how a business generates profitability and then analyzing the relationship between these three activities and the growth of social and ecological issues. 

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Business Model

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1. How does the business model reduce costs?

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The first area of focus is understanding a company's costs.  Single Materiality encompasses those sustainability issues that wreak havoc on a company's costs.  Costly disruptions in the supply chain resulting from labour disruptions, climate change, and increased regulatory oversight represent examples of Single Materiality.  Double materiality would encompass those social and ecological issues that emerge as a result of a company's cost structure.  In some cases, single and double materiality overlap as might be the case in grocery retail where increased food waste not only represents an environmental issue if not disposed of properly (double materiality) but could also carry cost implications for the company (single materiality).  

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It is most important to identify what is material based on whether a company’s natural incentive to reduce costs increases social and/or ecological issues.  This is quite different from a situation where social and ecological issues drive up costs.  Instead, these are material because the company has grown dependent on the exacerbation of these issues to demonstrate positive performance, specifically around cost reduction.

Retail giant WalMart might reduce costs by choosing suppliers that have found clever ways to reduce the input costs of clothing merchandise.  Toxicity in apparel runs rampant to the point that an increasing number of alarming findings have revealed toxins found in clothing that harm customers[ii].  What is more, the ecological impact of the clothing both in terms of the raw materials used and the short life span of the products is enormous.  In this situation, Walmart's efforts to reduce costs is positively correlated with the increase in customer and ecological harm.
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Because the effects of these products will take a long time to appear as material for Walmart, there is very little incentive for Walmart to change course.  What is more, Walmart has a strong incentive to undermine any effort to impose these costs on the sector.  As with any profit-seeking entity, it is in their best interests to protect this low cost strategy which, by the way, is fundamental to Walmart's business model.  As a result, material toxicity does not appear in Walmart's materiality matrix even though a majority of the clothing products on their shelves carry significant negative externalities.

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When sugar as a raw material increased in cost, food engineers found innovative ways to replace sugar with alternative ingredients.  One ingredient was high fructose corn syrup.  Not only was this ingredient found in food, but the more general innovation of using corn derivatives led to its use in a wide variety of products including diapers and batteries.  Yet while costs were reduced, health deficiencies in food increased at the expense of the consumer.  The same story has emerged with chocolate and confectionery, where the industry has seen ballooning cocoa costs.  In response, large confectionery companies turned to palm and soy oil substitutes for cocoa to keep costs down[iii].  Yet doing so has revealed a key material issue of deforestation as a $250 billion dollar industry now uses palm trees in their products.  In these examples, food and beverage companies have a strong impact on social and ecological issues (consumer health and deforestation) and this impact is inextricably tied to how the company aims to reduce its costs.  

In sum, in their efforts to truly understand what is material for a company, students of business must understand not only the impact of social and ecological issues on costs (single materiality), or how increased costs are correlated with increased sustainability issues, they must examine how the company goes about reducing costs both internally and throughout their respective supply chains to ascertain whether and how this cost reduction increases social and ecological issues. 

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2. How does the business model increase its revenues?

Understanding how a company earns its revenue is the second means by which to identify material sustainability issues.  Single materiality from a revenue perspective refers to those sustainability issues that could undermine a company's efforts to generate revenue.  The effect of climate change on the wine sector is perhaps an intuitive example, where some vineyards have struggled to cultivate reliable crops to produce and sell wine depending on their location.  Double materiality represents situations where a company's efforts to increase revenues is inextricably tied to sustainability issues.  In some cases, these efforts could cause a subsequent impact on revenue generation as might be the case with the contribution of the cruise line industry to climate change and the corresponding impact of an unstable climate on their ability to provide a reliable vacation service to consumers.

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But the contribution of a company to a sustainability issue is not necessarily going to lead to a negative impact on revenue generation.  In fact, these contributions actually increase revenues.  Intuitively, one can think of a wide range of companies that earn their revenue in ways that increase social or ecological issues.  That’s not to say that they don’t create benefits to society too but it is hard to escape the reality that some of these companies make a direct contribution to some of the greatest social and ecological issues of modern times.  Mining companies earn their revenue through practices that are directly tied to negative externalities whether that be pollution and deforestation or the prevalence of the mined materials throughout global supply chains.  In addition, securing these revenue sources often means ensuring relatively submissive communities that surround mining operations, resulting in Indigenous and community welfare becoming a key material issue for companies in mining. In these situations, an increase in these social and ecological issues is a necessary condition to secure revenue streams.  
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Not all material issues are as obvious as the example above from a revenue generating perspective.  Consider consumer electronics, specifically mobile or tablet devices.  Perceived obsolescence is a term used in this industry that refers to consumer perceptions that their device is becoming outdated.  An example might be the perception that having only one camera lens on a device is perceived as outdated even though there is arguably little reason to dispose of one’s phone because it doesn’t have multiple lenses.  But the perception is real, as consumers feel that their device is becoming out of date.  Practical obsolescence, on the other hand, is an explicit indication that a device is becoming unusable as reflected in lower battery life, slower processing speeds or compatibility issues brought up on software updates.  Unlike perceived obsolescence, practical obsolescence gives consumers little choice but to discard their current device. 

A company like Nokia’s revenue stream is contingent on both practical and perceived obsolescence.  The more this obsolescence exists, the greater the revenue potential of the company.  There is of course a limit here – if Nokia’s devices become obsolete after 1 year, a consumer revolt might ensue resulting in an impact on revenue.  This is as far as the business case for double materiality goes.  But with only 4-5 major players in the sector (Apple, Nokia, Samsung, Huawei, etc.), norms of when devices become outdated are largely determined by business, not by the market.  In fact, 2.5 years is the expected time that a device is expected to avoid the above types of obsolescence[iv].  With 5 billion smartphones expected to be discarded in 2022[v], this is, of course, at odds with ecological ambitions related to reducing e-waste.  Moreover, exposure of people in less developed countries to the toxins in these discarded devices has severe implications socially[vi].  Yet, the growth of these issues has very little negative impact on companies like Nokia and Samsung.  While these companies have cursory initiatives to reduce e-Waste, these initiatives represent band-aid solutions to a more fundamental issue related to how these issues are inextricably tied to their revenue model.

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A similar approach can be used when identifying what is material in the apparel sector.  Fast Fashion has had a detrimental impact on ecological systems given the disposable nature of clothing.  Yet, the repeat purchase behaviour that characterizes fast fashion is a revenue boon for apparel companies.  It is therefore surprising that retail merchants, when discussing waste as a material issue, in no way discuss, or measure for that matter, the longevity of the products on their shelves and the associated ecological costs of “disposable” and cheap products. 

Another example might be the fast food sector.  Portion sizes over the last few decades have ballooned.  A key part of the business model of the fast food sector is to increase prices and thus revenue to match an increase in portion sizes, but without the associated increase in costs.  No doubt, companies are incentivized to increase portions because they gain the additional revenue without the additional cost of doing so.  This means that adding more of a product to an order allows for a price and revenue boost but the cost, given economies of scale, hardly increases.  Yet the social costs associated with consumer health of these activities are enormous with obesity and obesity-related health issues reaching unprecedented levels.  So, a fast-food company’s natural incentive to increase revenues comes with a social cost. Because of the immense revenue opportunity associated with this tactic, the issue of consumer health is only considered to the extent that it represents single materiality or whether addressing this issue is aligned with revenue generation as might be the case with emerging niche markets in healthy food options.  But this is insufficient.  Only when we understand how companies are highly dependent on the growth of these social issues to meet revenue targets will we get to true materiality. 

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We can apply a similar approach to the automotive sector, where revenue growth in the last two decades has been in larger vehicles.  One only has to compare images of cars on the road in the 1980s and 1990s and those of the last decade to see how large personal vehicles have become.  Along with this change has been the movement towards sport utility vehicles over compact vehicles.  Yet, while these two trends are a boon for revenue and margin growth, this comes with a corresponding increase in carbon emissions.  Thus, although automotive companies tout efforts to combat climate change, they are virtually silent on statistics that measure CO2 per vehicle and how these levels have increased or decreased over time.    
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In sum, students of business must understand the ways in which companies earn their revenue, with a specific emphasis on how revenue opportunities of the company are inextricably tied to social and ecological issue growth.  This goes well beyond single and business case double materiality which only covers those company behaviours that increase social issues in a way that correspondingly negatively impacts revenue.

3. How do companies increase customer willingness to pay?

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A less obvious means by which students of business can identify material issues is by understanding how companies go about influencing customer perceptions of their products and services.  Oftentimes the price a customer is willing to pay is different from what the actual price of the product or service is.  Consider a smartphone.  A customer might perceive the value of the phone such that they’d be willing to pay $900.  But the price might only be $750.  To boost revenue, businesses want to increase customer willingness to pay because doing so allows them to increase price, especially if the industry is concentrated with only a few competitors.  While there is overlap with the previous section on revenue, it is important to distinguish willingness to pay from revenue when considering material issues. 

The best way to understand this is through an example.  

The food and beverage industry has developed strong competencies in food engineering.  Food engineering refers to the design of food products that uses a unique collection of whole food derivatives to make new food products.  Recall the earlier example of replacing sugar with high fructose corn syrup.  We already discussed how doing so allows companies to reduce the costs associated with whole foods.  But another part of the business model of food and beverage companies is to boost willingness to pay.  Doing so involves clever marketing tactics that give the impression of value add using, for example, claims of certain nutritional benefits like fibre and omega 3s.  Some even insert certification symbols to denote health benefits.  

It could also involve exploiting consumer psychological vulnerabilities associated with product consumption.  Nowhere is the latter more prevalent than considering the unprecedented growth of salt, sugar and fat in food products.  While they do reduce costs, the real value for companies is that they can be addictive.  In fact, they are so addictive that academic scholars have likened these food characteristics to tobacco addiction[vii].  In this example, boosting customer willingness to pay by inserting addictive ingredients has an adverse effect on the health and wellbeing of these consumers.

Another material issue that is often overlooked is waste from packaging.  No doubt that companies can attract consumers to their products if the packaging of the product is in is large and flashy containers.  Customers are more willing to pay for products that have shelf presence.  In an effort to persuade consumers to spend more, packaging is instrumental.  For those companies that rely heavily on packaging to demonstrate the value of their products, their efforts to boost packaging and thus willingness to pay has an adverse effect on the ecological environment. 

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Perhaps the most egregious example of how to identify material issues using willingness to pay as a lens is to consider social media companies.  Rather than use "willingness to pay", the more appropriate label is consumer "willingness to engage" in online content.  The level of sophistication associated with keeping consumers on the screen of social media apps is unprecedented and likely to get even more impressive as artificial intelligence guides the user interface.  What elicits the willingness to engage in content is the emotional response the content triggers.  Algorithms then identify the content that is expected to elicit the highest emotional response, feeding an echo chamber of a biased view of the world.  The business model is correspondingly predicated on predicting and influencing user behaviour and thus willingness to engage.  The more that a social media company increases this willingness to engage in content, the greater the social issues that emerge as a result, whether that be increased political division, biased worldviews, online aggression, among others.  

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In sum, while understanding how companies earn revenue is an important means by which to identify material issues, it is important to consider how companies influence a customer’s willingness to pay for (or engage in) products and services, the increase of which has adverse impacts on society and/or the environment.

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Revised Materiality Matrix

The materiality matrix illustrated at the introduction of this article implies that only those issues that are relevant to stakeholders and negatively impact businesses are considered material.  This would de-emphasize any issue that society or stakeholders deem important yet positively impacts a business' success.  As a consequence, we introduce a slightly amended matrix that replaces (Impact on Business) on the x-axis with "Influence on Business Success" to ensure that the matrix considers double materiality from the perspective of both positive and negative implications on business.  In the matrix below, we use, as an example, a company in the apparel sector.  An issue that might have less importance to stakeholders is political instability in the supply chain yet could also have a significant negative impact on a business that is heavily reliant on manufacturing in a given country facing such instability.  Labour issues in the supply chain has generated substantial interest among stakeholders and, at the same time, could wreak havoc on a company's operations if these issues turn into a key reputational risk for the company as was the case for Nike in the 1990s. 

In contrast, issues associated with fast fashion, including but not limited to, clothing waste and disposal due to short lifespans of products, mass production that results in deforestation, and the increased toxicity in clothing to drive down costs all carry importance to stakeholders but represent a key component to the success of the business model of the company.  While there are no doubt potential reputational risks associated with these activities in the longer term, they represent key success factors to how costs are reduced and revenue is generated, at least for the short-medium time period.  

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Materiality Matrix for an Apparel Company

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In sum, sustainability materiality as a concept has evolved over the last decade.  From single materiality to double materiality, we've grown to expand the list of stakeholders who might consider an issue to be material.   But what is most important when it comes to understanding how companies respond to sustainability issues is to understand the relevance of these issues to the fundamental business model of the firm.  Only then, can we have serious conversations about whether company response to these issues is reflected in changes to the business model that drives behaviour.

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​​[i] Page 2: NYU Stern (May, 2019):  Sustainability Materiality Matrices Explained.  https://www.stern.nyu.edu/sites/default/files/assets/documents/NYUSternCSBSustainabilityMateriality_2019_0.pdf. Accessed June, 2022. 

[ii] Wicker, A. (2023).  The Guardian: https://www.theguardian.com/fashion/2023/jul/02/fashion-chemicals-pfas-bpa-toxic.  Accessed January 10th, 2024.  Cowley et al., (2021).  CBC.  https://www.cbc.ca/news/business/marketplace-fast-fashion-chemicals-1.6193385.  Accessed January 10th, 2024.

[iii] World Wildlife Fund: https://www.worldwildlife.org/pages/which-everyday-products-contain-palm-oil

[iv] Komando, K. (2023).  USA Today: https://www.usatoday.com/story/tech/columnist/komando/2023/10/22/how-to-find-smartphone-expiration-date/71255625007/.  Accessed January 10th, 2024

[v] Gill, V. (2022).  E-Waste: 5 Billion Phones to be Thrown Away in 2022. BBC: https://www.bbc.com/news/science-environment-63245150, Accessed January 10th, 2024.

[vi] Vidal, J. (2013).  Toxic E-Waste Dumped in Poor Nations.  United Nations University.  https://ourworld.unu.edu/en/toxic-e-waste-dumped-in-poor-nations-says-united-nations, Accessed January 10th, 2024.

[vii] Elton, S. (2013).  Are sugar, salt and fat the worst, most addictive drugs ever.  Globe and Mail: https://www.washingtonpost.com/wellness/2023/09/19/addiction-foods-hyperpalatable-tobacco/, Accessed January 10th, 2024