Why sustainability is so challenging for millions of SMEs

In short:

• SMEs are the backbone of our economies contributing up to 70% to the global GDP
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• The pressure to become sustainable increases also for SMEs through regulation, investors, customers, and employees
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• Resource-constrained SMEs need easy-to-use do-it-yourself solutions
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• SMEs need one trusted “sustainability profile” they can share for reporting
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• We need more cost-effective support that tells SMEs HOW to improve

SMEs are crucial for sustainable development

According to ILO data in many countries, more than 90% of all companies can be classified as micro-, small and medium-sized enterprises having less than 250 employees. They create about 70% of employment and estimates for their contribution to the global GDP vary between 50% to 70%. In short, these companies are important! They are the backbone of our economies. Just by procuring a new phone on Amazon, you involve countless SMEs. Most likely, they were involved in the production of countless raw materials and components in your phone. They were involved in all the logistics that delivered the components across our global supply chains. And most likely, if something breaks, a contracted service provider will respond to your customer complaints and initiate the repair. SMEs are everywhere and this gives them tremendous importance for the sustainable transition of our economies.

The pressure to become sustainable increases also for SMEs

At the moment, there is great momentum towards more sustainable development. Worldwide, we see civil society demanding change. Fridays for Future is probably the most prominent example of this, but all kinds of people realize the increase in heat waves, droughts, and extreme weather events. This translates into changes in consumer behaviors that begin to opt for vegetarian/vegan food, pay a premium for sustainable products or choose trains instead of planes. But this also translates into massive regulatory changes. The EU is taking the lead in this regard with regulations like the Sustainable Finance Disclosure Regulation (SFDR) or the upcoming Corporate Sustainability Reporting Directive (CSRD). These regulations push financial market participants and large corporates toward more sustainable actions.

So how does this momentum affect SMEs, the backbone of our economies? Some SMEs are certainly leading the change voluntarily. There are innovative SMEs (incl. startups) that create new sustainable solutions at the forefront of the sustainable transition. For instance, there are countless vegan food producers, new packaging manufacturers or refurbished IT providers and many more (see e.g. the dealroom impact landscape). But they are only a small share of the millions of SMEs out there.

A majority of SMEs struggle to take action beyond the legally required. But this approach is no longer sufficient. Increasingly, regulations like SFDR and CSRD affect investors in SMEs and the corporates that procure from SMEs. This creates a non-regulatory, but equally powerful pressure on SMEs. Due to the regulatory pressure, investors in SMEs and corporates procuring from SMEs make sustainability an important factor when they decide to work with an SME. We see that SMEs must do three principal things:

1. Assess properly how well they are doing
2. Report their performance to their investors and corporate partners
3. Improve to remain attractive in the long-run

Each of these three elements creates important challenges for SMEs, but done right they can become highly beneficial.

Assessments methodologies must become more digestible for SMEs

SMEs are more resource constrained. This means they cannot afford to invest 70k€ or more for an in-house sustainability expert or hire consultants with daily rates of 1k€ or more. This leaves many SME decision-makers with the challenge to deal with sustainability themselves besides the day-to-day operations. Naturally, the complexity of sustainability can quickly become overwhelming and the quality of assessments suffers under these conditions.

But done right, sustainability assessments help SMEs to identify environmental, social, and governance (ESG) issues that pose financial risks to them. Many of the benefits are well known. With the current increases in energy prices, the benefits of energy efficiency are a no-brainer. In the “war for talent” particularly SMEs search for ways to attract talent among the millennials and generation Z, who aim for purpose in their work and expect an inclusive, diverse, and family-friendly workplace. And there is no doubt that good data policies, anti-bribery, and tax compliance are governance issues with clear linkages to financially successful companies.

To harness these benefits of sustainability, resource-constrained SMEs need easy-to-use do-it-yourself solutions. We need solutions that make it easy to start with sustainability and allow them to dive deeper step by step.

SMEs should not have to fill out countless different reporting templates

Current reporting requirements are super confusing for SMEs. As there is no direct regulatory pressure with clear guidelines. Instead, SMEs face a lot of fuzzy indirect pressure from society, investors, and their own customers. Large corporate customers send out countless different ESG “supplier” surveys and a range of different labels. Some labels address the sustainable management of the entire company like BCorp or the Gemeinwohlökonomie and there are countless domain-specific labels around organic, fair trade, and many more. The countless surveys create tremendous effort for SMEs and obtaining the labels adds significant costs to hold the label and pay for external audits.

If SMEs manage the various labels and reporting templates properly, they can draw a lot of value from them. For instance, research from Professor Tensie Whelan from the NYU Stern School shows that products marketed as sustainable stand for 55% of growth in consumer-packaged goods. Similarly, the research suggests that these companies have far better chances to attract talent and obtain funding.

But to make these benefits more accessible for SMEs we have to reduce the double work and costs. SMEs need one trusted “sustainability profile” with all relevant information that they can share with their stakeholders so that they do not have to fill out one reporting template after the other.

We need more cost-effective support that tells SMEs HOW to improve

The goal behind assessing and reporting on sustainability is to see actual improvements. But this is something where it gets really tricky for SMEs. Often they already have a rough idea of what issues might be problematic, but the real challenge lies in changing the status quo. How can they cost-efficiently change? Talking about SMEs we should think of companies with less than 250 employees. This means companies that have limited resources and negotiation power. Changes strongly depend on their partners. For instance, companies might only rent some office space without direct control of the energy supplier, they might construct buildings according to the client’s preference, or they’re manufacturing products that depend on certain materials without sustainable substitutes. Often the margin for change is limited.

But of course, there are things companies can do from tracking their energy usage, procuring sustainably where possible, or changing the way they organize the workplace. And the general momentum is positive. More and more office spaces provide renewable power, more and more construction projects aim for sustainability and new sustainable materials are in development. So increasingly the challenge lies in pointing SMEs to the concrete improvement measures that they can implement and helping them to understand how.

Gladly, there are first helpful self-service resources for SMEs like the SME Climate Hub with many useful resources or pivot with real-life stories of improvement measures. These are great starting points, but they still require SMEs to search for suitable measures. In times when every user of Netflix or Spotify obtains tailor-made content recommendations, it should be possible to do the same for sustainability. Companies should focus on implementing sustainable measures, not research them. Therefore, we need more tailor-made improvement suggestions that fit the specific needs of companies.

Conclusion

The current developments show that sustainability is becoming more and more mandatory for SMEs. So far, SMEs lack the resources and tools to minimize the efforts related to sustainability assessments, reporting and improvement. But the more we can reduce the efforts for SMEs the more we can turn sustainability from a burden to an opportunity that helps SMEs to cut costs, attract talent, obtain funding, and secure customers. Knowing that SMEs are responsible for 50% to 70% of the global GDP helping them is also one of the most important levers to accelerate the sustainable transition of our economies.

Interested in joining the discussion on this topic? Then visit the corresponding Linkedin Article to this blog post.

FAQ

In short, how does the SFDR and the CSRD specifically impact SMEs, and what are the key challenges they face in complying with these regulations?

SFDR Impact on SMEs:

1. The SFDR imposes transparency requirements on financial market participants, including SMEs that fall under its scope, necessitating disclosure of sustainability-related information. This includes detailing how ESG factors are integrated into investment decisions and risk management processes.
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2. Compliance with SFDR involves assessing and reporting on sustainability risks and impacts, which can be particularly challenging for resource-constrained SMEs. They often lack dedicated sustainability teams or expertise, making it difficult to conduct comprehensive assessments and compile required data.
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3. SMEs may struggle to navigate the regulatory complexity of SFDR, given the multitude of disclosure obligations and the need to align with evolving standards and guidelines. Understanding the specific requirements applicable to their business size and industry context can pose a challenge.
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4. Furthermore, SMEs may face difficulties in accessing appropriate tools or resources to streamline SFDR compliance, as many existing solutions are tailored for larger enterprises with greater financial resources.

CSRD Impact on SMEs:

1. The CSRD expands sustainability reporting requirements beyond the financial sector to a broader range of companies, including SMEs, operating within the EU. It aims to enhance transparency and comparability of sustainability information disclosed by companies.
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2. For SMEs, complying with the CSRD entails disclosing comprehensive non-financial information, covering aspects such as environmental performance, social impact, diversity, and anti-corruption measures. This may involve additional data collection, reporting, and assurance processes.
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3. SMEs may encounter challenges in aligning their existing reporting practices with the expanded requirements of the CSRD, particularly if they lack standardized reporting frameworks or established sustainability reporting processes.
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4. Moreover, SMEs may face resource constraints in meeting the enhanced reporting obligations of the CSRD, including the costs associated with data collection, reporting software, and external assurance services. This can pose a barrier to compliance, particularly for smaller businesses with limited budgets.

In summary, both the SFDR and the CSRD present significant challenges for SMEs in terms of understanding, implementing, and complying with sustainability reporting requirements. These challenges include resource constraints, regulatory complexity, and the need for tailored solutions to facilitate compliance effectively.

How exactly are existing tools or platforms streamlining the sustainability process for resource-constrained SMEs?

Tools like ImpactNexus, and also others, are helping SMEs in several ways:

1. Simplified Assessment and Reporting: Many tools offer user-friendly interfaces and intuitive workflows that simplify the assessment and reporting process for SMEs. They provide customizable templates and questionnaires tailored to SMEs' needs, guiding them through the assessment of their sustainability performance across environmental, social, and governance (ESG) criteria.
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2. Automated Data Collection: Technology-enabled platforms automate data collection from various sources within SMEs, such as operational systems, financial records, and third-party databases. This reduces the manual effort required to gather sustainability-related data and ensures accuracy and consistency in reporting.
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3. Standardized Reporting Templates: Tools often provide standardized reporting templates aligned with regulatory requirements, such as the SFDR and CSRD. These templates help SMEs structure their sustainability disclosures according to recognized frameworks and guidelines, facilitating compliance with regulatory obligations.
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4. Integration with Existing Systems: Some platforms integrate seamlessly with SMEs' existing software systems, such as enterprise resource planning (ERP) or customer relationship management (CRM) systems. This integration allows for the seamless transfer of data between different systems, eliminating the need for manual data entry and ensuring data integrity.
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5. Educational Resources and Support: Many tools offer educational resources, tutorials, and user support to help SMEs understand sustainability concepts, navigate regulatory requirements, and maximize the value of the platform. This support helps SMEs overcome knowledge gaps and build internal capacity for sustainability management.
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6. Cost-Effective Solutions: To address the budget constraints of SMEs, some platforms offer flexible pricing models, including subscription-based plans or pay-as-you-go options. These cost-effective solutions make sustainability tools accessible to SMEs with limited financial resources, enabling them to leverage technology for sustainable business practices.
   

Since it's important to reduce the burden of sustainability reporting for SMEs, there is also the need for more tailored improvement suggestions to help these businesses implement sustainable measures. What are these tailored improvement suggestions, and how they can be effectively integrated into the operations of SMEs to drive meaningful change?

1. Energy Efficiency Measures: SMEs can implement energy-saving initiatives such as upgrading to energy-efficient lighting systems, optimizing heating and cooling systems, and installing smart meters to monitor energy usage. Tailored improvement suggestions may include conducting energy audits to identify inefficiencies, investing in renewable energy sources like solar panels, and implementing employee training programs to promote energy conservation practices.
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2. Waste Reduction Strategies: SMEs can adopt waste reduction strategies such as recycling and composting programs, reducing packaging waste, and implementing lean manufacturing principles to minimize material waste. Tailored improvement suggestions may include conducting waste audits to identify opportunities for waste reduction, establishing partnerships with local recycling facilities, and incentivizing employees to participate in waste reduction initiatives.
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3. Supply Chain Sustainability: SMEs can improve the sustainability of their supply chains by sourcing materials from environmentally and socially responsible suppliers, conducting due diligence on suppliers' sustainability practices, and implementing ethical sourcing policies. Tailored improvement suggestions may include developing supplier codes of conduct, conducting supplier assessments to evaluate compliance with sustainability criteria, and providing training to suppliers on sustainability best practices.
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4. Employee Engagement Initiatives: SMEs can engage employees in sustainability efforts by fostering a culture of sustainability, providing sustainability training and education programs, and encouraging employee participation in sustainability initiatives. Tailored improvement suggestions may include establishing employee-led sustainability committees, implementing incentives for sustainable behavior, and incorporating sustainability goals into performance evaluations.
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5. Community Engagement Programs: SMEs can contribute to their local communities through initiatives such as volunteering, charitable donations, and partnerships with community organizations. Tailored improvement suggestions may include identifying community needs and priorities, developing strategic partnerships with local nonprofits and NGOs, and engaging employees in community service projects.

To effectively integrate these tailored improvement suggestions into the operations of SMEs, it's essential to:

• Customize Recommendations: Tailor improvement suggestions to the specific needs, resources, and capabilities of each SME, taking into account factors such as industry sector, size, location, and business model.
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• Provide Practical Guidance: Offer clear and actionable recommendations that SMEs can easily implement within their existing operations, considering factors such as cost-effectiveness, feasibility, and impact on business performance.
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• Offer Continuous Support: Provide ongoing support and assistance to SMEs throughout the implementation process, including access to educational resources, training programs, and expert advice.
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• Measure and Monitor Progress: Establish key performance indicators (KPIs) and metrics to track the effectiveness of sustainability initiatives, allowing SMEs to measure progress, identify areas for improvement, and celebrate successes.

By offering tailored improvement suggestions and supporting SMEs in implementing sustainable measures, businesses can drive meaningful change towards more responsible and resilient operations, while also enhancing their competitiveness, reputation, and long-term viability.