Grocers’ sustainability opportunity in transforming the food system

Increasingly severe global weather events and the urgent tone of the 2021 UN Climate Change Conference (COP26) have made it crystal clear: now is the time to truly prioritize sustainability. And while climate may be top of mind, it can no longer be separated from other concerns about how we live and make supporting economies more sustainable. To address these problems, it is crucial to consider the food system, which accounts for 34 percent of global greenhouse-gas (GHG) emissions.

It’s not simple to reform a system relied on by more than 500 million farmers, workers, and employees around the world that also plays a critical role in people’s health. Yet pressure from stakeholders has never been stronger: consumers are demanding sustainable products and services, investors are shifting to sustainable investments, regulators are implementing new and tighter sustainability regulations, and pressure from nongovernmental organizations (NGOs) is increasing.

We believe grocers are in a unique position to be a driving force in this much-needed sustainability transformation. They’re ubiquitous—even the smallest town has a grocer. They’re integral to local and national economies, often being the largest private employer in an area. They have the power to both influence consumer choices and collaborate with farmers, suppliers, and even other grocers. And, finally, they can benefit from the transition, because sustainability can go hand in hand with value creation. In fact, our analyses show that while sustainability presents potential risks, it also offers opportunities for grocers’ top lines, margins, and costs—adding up to around 25 to 30 percent for a typical North American grocer.

Making sustainability a strategic imperative

Many food retailers have already kick-started their sustainability efforts with portfolios of initiatives that typically span decarbonization, packaging, assortment, and social sustainability. A recent survey of sustainability leaders from North American and European grocers suggests two-thirds of grocers have quantified their starting point (baseline) and defined concrete actions to address sustainability topics, and 50 percent have defined concrete targets. Yet only half the respondents were confident they could achieve their sustainability targets.

The problem? Grocers associate sustainability with significant costs and have not solved the challenge of creating value through “commercialization” of green activities, which has slowed progress. They are simultaneously juggling other critical strategic transitions, such as digitalization. And it is difficult to set up much-needed upstream collaboration with farmers and suppliers.

We believe grocers need to make sustainability an integral part of their businesses with a strategic perspective based on value creation and tailored to their circumstances. We have identified three areas of focus that will help grocers succeed:

1. the five key sustainability themes for holistic impact
2. levers grocers can use to capture efficiency, growth, and margin improvement opportunities while managing potential downsides
3. an operating model enabling grocers to successfully manage the sustainability transformation

1. Focusing on the five sustainability topics that matter

While looking at the food system’s sustainability from an environmental, social, and governance (ESG) perspective is a good start, grocers can go further. We sought to create a framework for grocers to provide insights about the most important dimensions. Our research into stakeholder requirements and external costs of the food system suggests grocers focus on five explicit dimensions: health, the environment, the economy, animal welfare, and livelihoods (HE²AL). Within this framework, we further identified 15 topics that should matter most to grocers (Exhibit 1).

1

Retailers should focus on all HE²AL dimensions and look at the full value chain to maximize value creation and sustainability impact. Looking at the full value chain is important because many value creation opportunities and much of the sustainability impact come from interactions with suppliers and customers.

Let’s take decarbonization as an example. While the food system accounts for more than a third of global GHG emissions, only about 4 percent of grocers’ direct contribution is from grocers’ own operations (Scope 1 emissions) and from purchased electricity and heat (Scope 2 emissions). Most emissions are generated along the value chain (Scope 3), with about 80 percent stemming from land use, agricultural production, food processing, and packaging (Exhibit 2).

2

This means grocers need to focus on two elements. First and foremost, they should work on their own footprints and optimize their own operations. This can be a significant—and expensive—investment of time and resources, requiring anything from making thousands of stores energy efficient to sourcing green energy and reshaping cooling technologies and logistics. But it holds the potential for grocers to both make a sizable contribution to sustainability and create value.

Second, grocers should take a holistic view of GHG emissions created along the entire value chain, reviewing how their assortment and sourcing choices and policies contribute to them. Reducing Scope 3 emissions while creating value can include actions such as introducing transparency requirements for all products, changing product assortment (for example, introducing lower-emissions alternatives), adjusting specifications (such as specifications on shape or size that can cause farmers to waste “nonfitting” produce), supporting farmers who want to develop emissions-reducing agricultural production, or improving supply chain financing based on the GHG footprint of the supplier. Tackling Scope 3 emissions can be quite complex, because grocers need to collaborate with their partners in the value chain. However, given the large share of total emissions and grocers’ central position in the value chain, this step is required to decarbonize the food system.

Along the five HE²AL dimensions, grocers should identify opportunities to fundamentally—and credibly—differentiate themselves and create competitive advantages, allowing them to maximize sustainability impact and value creation. This does not imply grocers need to be sustainability leaders across all 15 topics, but they should make conscious choices about where they want to lead, where they want to benefit from resource productivity gains, and where they just want to comply with regulations. The following five factors can help grocers prioritize their efforts:

• the company’s starting point (baseline)
• the position of competitors
• stakeholder expectations, especially those of (future) consumers and regulators
• the company’s “appetite to do good,” reflecting its purpose
• the overall resulting potential for value creation, including upsides and downsides

These opportunities then need to be translated into concrete targets that can be communicated internally and externally.

2. Creating value from the sustainability transformation

Grocers can generate significant value from a well-positioned sustainability transformation. The value generated can come from five types of value creation levers, which can be further grouped into reducing downside risks and seizing the opportunities sustainability offers (Exhibit 3).

3

Managing risks

A strong sustainability strategy reduces several downside risks companies might otherwise face, meaning it can provide an important source of value. Companies with a low ESG rating will face increasingly higher costs of capital as capital is moved to sustainable companies. By improving their ESG ratings, grocers can ensure access to capital at better rates. Several NGOs are also lobbying regulators to extend the carbon tax to food, increasing the cost of these products. By proactively working across the supply chain to reduce GHG emissions, grocers can avoid these additional costs. In addition, as consumers increasingly patronize more sustainable companies, there is a risk of losing market share to sustainability leaders. By offering a wider range of healthy and sustainable options and by decarbonizing their own operations and the value chain, for example, grocers can gain market share. Although there is still considerable uncertainty around how sustainability will play out, there’s a clear business case for acting to mitigate downsides.

Capturing opportunities

Sustainability strategies can do more than mitigate risk and reduce downsides; they can also give grocers a competitive edge and allow them to take advantage of new opportunities. We outline some potential strategies for grocers below.

Portfolio strategy: Grocers can begin reorienting portfolios toward sustainability at the level of their broader ecosystems. They can rigorously allocate capital—for example, by investing in sustainable parts of the business, managing unsustainable parts through cash flow, or scaling down and divesting—and think about organic and inorganic moves. There are many attractive sustainability value pools beyond grocery, often with significantly higher growth and margin potential. Grocers can evaluate their potential to extend beyond their core business, whether by focusing on adjacent segments that strengthen the core business (such as Walmart’s expansion into Walmart Health, which was launched in 2019 and now offers low-cost, doctor-staffed healthcare services in four US states¹ “Introducing Walmart Health,” Walmart Health.) or by leveraging consumer data as an ecosystem backbone to provide highly valuable services.

Sustainable business building: Disruptive sustainable innovators are emerging in the food system, from vertical farming (such as AeroFarms and Infarm) to protein alternatives (Planted or Beyond Meat) to packaging circularity (TerraCycle’s Loop). Yet established grocers typically struggle to build new sustainable businesses successfully. While they face real challenges, such as brand credibility and incubating agile new ventures within larger corporate structures, established grocers are also held back by a lack of ambition and an unwillingness to disrupt themselves before someone else does. These are missed opportunities. Established grocers have significant advantages that should make them the natural owners of sustainable-business building.

Market share and margin gain: Consumer companies are increasingly gaining market share and margins by differentiating through sustainability. The three principal levers are branding and marketing, sustainable value propositions and differentiation, and green pricing—especially as sustainability premiums begin to materialize. For example, sustainability leaders disproportionately allocate shelf space and resources to sustainable products, which are outgrowing conventional products by a factor of seven.²“Sustainable Market Share Index,” NYU Stern Center for Sustainable Business, March 2021. California-based grocer Raley’s, for example, seeks to further propel competitive differentiation by promoting shelf guides to help shoppers navigate sustainable products.³“Shelf Guide: Find your healthy,” Raley’s.

Sustainable operations and supply: More sustainable operations can be value accretive and significant drivers of better performance. Often, we find up to 50 percent of operational levers can be net present value–positive (NPV-positive) or NPV-neutral and can improve financial performance through cost reductions. Grocers should therefore approach sustainability investments as they approach other investments: by prioritizing the most economically efficient options. Grocers can use marginal abatement cost curves to prioritize NPV-positive or NPV-neutral levers (Exhibit 4). Such cost curves show the cost of each investment and rank them by their return on capital.

4

3. Setting up the sustainability transformation for success

Maximizing sustainability impact and value creation requires a holistic transformation approach with the right operating model. Like any business transformation, sustainability is hard to do because it requires a substantial number of changes to the business and to cross-functional collaboration. As mentioned above, only half of retailers that set a sustainability target are confident they will reach these targets.

Sustainability efforts should therefore be anchored by the CEO and board, who should model a green culture. They should be supported by a central team led by a chief sustainability officer who reports to the CEO and acts as the main orchestrator and know-how provider across the organization. Business units should take the lead in developing and executing specific sustainability initiatives, with sustainability embedded in performance management as a measure of progress that can ensure accountability both internally and externally. Moreover, grocers should invest in data collection and reporting across the value chain to be able to manage upstream and downstream impact (Exhibit 5).

5

The food system requires fast, systemic change to become sustainable. Grocers can be a driving force and create significant additional value, but this is a multiyear challenge requiring leadership and focus throughout the organization, as well as investments. We recommend three steps leaders should take now:

• Assess your sustainability baseline and define your sustainability ambition with concrete impact targets (such as financial, carbon abatement, waste diversion, and supplier engagement). These should be based on your starting point, your purpose and internal “appetite to do good,” the behavior of competitors, your stakeholders’ expectations, and, last, the resulting potential for value creation.
• Implement a well-defined and prioritized set of sustainability initiatives that maximize your sustainability impact across the HE²AL dimensions and generate value for your business across all five types of value creation levers. Think strategically about how to involve suppliers, differentiate through sustainable own brands, and invest in transparency.
• Adapt your operating model to anchor sustainability in the day-to-day business decisions most relevant to your articulated ambition across the value chain. This enables consumers to make sustainable choices, optimizes your operations, and allows you to collaborate with farmers, suppliers, and peers.

Download the full report here.