Special Topics~ Dialogue with the Third-Party From Social Responsibility to a Source of Earning Power. Mariko Kawaguchi Chief Researcher Research Division Daiwa Institute of Research Ltd. × Yoshiaki Nishimura Representative Director Chairperson of the Board & CEO

Dialogue with Stakeholders
Shareholders and Investors, Customers, Suppliers and Other Trade Partners, Employees, Local Communities, Global Environment

* This dialogue is appeared in "Integrated Report 2015".
* The position titles are as of the date in which the dialogue was held.

Considering "Quality" of Profit

Nishimura:This is Sumitomo Riko's second integrated report. Although our intention in publishing an integrated report was to place emphasis on our management policy, business model, and other non-financial information, it can also help shape new thinking among young employees and others in the company.

Kawaguchi:Although non-financial information, including information about corporate social responsibility (CSR), doesn't appear to be directly connected with current sales or profits, it's a factor that contributes to earnings over the long run.

Nishimura:Until now, I paid little attention to ESG*1 in management. Although I was aware of socially responsible investment (SRI), your report on SRI made me recognize anew that ESG investment is a step beyond SRI. When considering ESG, the question of how to establish key performance indicators (KPI) is important. Although we have quantified our environmental activities using environmental accounting, it seems to me that from now on it will be necessary to use indicators that enable management of overall activities using ESG. By the way, return on equity (ROE) is an indicator that is frequently referred to these days, isn't it?

Kawaguchi:ROE is a shareholder-oriented indicator. But a management policy of earning profits only for the shareholders is tantamount to coercing employees and other stakeholders, and it eventually has negative repercussions for the shareholders themselves. As the expression "going concern" suggests, companies have a responsibility to remain in business. I think we should understand the meaning of the term "profit" in the context of earning profits while achieving sustained growth and maintaining appropriate stakeholder relationships in order to benefit society.

Nishimura:To be sure, in management we must pay due consideration to all stakeholders. ESG is a guiding principle for that, and the ideal is to increase ROE while attaining a balance between shareholder interests and the interests of stakeholders as a whole.

Kawaguchi:Although some companies buy back their own shares to increase ROE, I think that they should focus on increasing net income, the numerator of the ROE equation. Although capital efficiency is also important, I think that focusing attention solely on reducing shareholders' equity, the denominator, goes against the original intention. The intent of the Ito Review*2, which came up with a target ROE level of 8%, was that there must be collaboration between the industrial and financial communities for Japanese companies to achieve long-term value creation. The review also mentions expectations for integrated reports that include non-financial information as a means of achieving this. From now on, the number of investors who make investment decisions from a multifaceted perspective that includes management philosophy, long-term strategy, leadership, and ESG factors is likely to increase.

Nishimura:KPIs that take into account that perspective will become necessary, won't they?

*1 ESG:
ESG (environment, society, governance) are areas in which companies are required to show consideration and responsibility when engaging in business activities. ESG is attracting attention as an evaluation criterion when measuring the investment value of companies.
*2 Ito Review:
The Ito Review was compiled as part of a project of the Ministry of Economy, Trade and Industry chaired by Professor Kunio Ito of Hitotsubashi University. The aim of the project was penetration of "Japanese-style ROE management" as a guideline to lead to sustainable growth through a favorable relationship, not confrontation, between companies and investors. It places emphasis on non-financial information and promote management from a long-term perspective enabled through innovation.

Understanding the Trend Toward ESG

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We want to approach new investor classes.

Nishimura:Sumitomo Riko has articulated a long-term vision for growth through selection and concentration on the basis of our expertise in polymer materials technology in six growth markets: automotive; information and communication technology (ICT); infrastructure; dwelling environment; medical, nursing care and health; and resources, environment, and energy. However, even though we explain our long term vision at results briefings and other venues, the interest of analysts tends to focus on short-term business results. Since business performance in fiscal 2014 was rather poor, we had no choice but to focus tightly on an explanation of the business results and countermeasures.

Kawaguchi:Since the number of analysts who specialize in ESG has been increasing recently, why not hold IR meetings focused on ESG? For instance, you might have a dialogue with ESG analysts about the social value of, and growth scenarios for, the "medical, nursing care" and health business or the "resources, environment, and energy" business.

Nishimura:I see. We definitely want to approach new investor classes. I've heard that nearly half the investment funds in the UK are ESG-related funds.

Kawaguchi:The UK is a nation built on finance, and you can sense its strong desire to lead the world of finance. To the British, ESG investment is one form of 21st century financial innovation.

Nishimura:Will the behavior of institutional investors in Japan change with the introduction of the Japanese Version of the Stewardship Code*3?

Kawaguchi:By June 11 of this year, 191 institutional investors had signed the code. The GPIF*4, one of those investors, has stated in regard to its medium-term objective that it will "Consider taking into account ESG, a non-financial element." I think this movement will gain impetus.

Nishimura:Sumitomo Riko is currently at the stage of considering the "2020 Group Vision." I think that we must incorporate the ESG concept into our next management plan with a view to realizing high-quality sales and profit that will lead to enhancement of corporate value.

Kawaguchi:The ESG concept may be better suited to new business areas with clear social aspects. The combination of conductivity and the supple texture characteristic of rubber realized with Smart Rubber, introduced in last year's report, left quite an impression on me. I sensed the potential for creating products that will find acceptance among seniors and children.

Nishimura:Smart Rubber is conductive rubber that defies the conventional wisdom. It's a material that we expect to see appearing in motion sensors and various other applications. We want to create and nurture a number of products beneficial to society.

*3 Japanese Version of the Stewardship Code:
"The Principles for Responsible Institutional Investors" provide a code for a wide range of institutional investors to appropriately discharge their stewardship responsibilities with the aim of promoting sustainable growth of investee companies through constructive dialogue with them and for realizing transparency in activities.
*4 GPIF:
The Government Pension Investor Fund, the world's largest pension fund, invests public pensions in Japan. In November 2014, GPIF reviewed its investment policy and announced that it would increase the proportion of stocks in its portfolio.

Looking Ahead to a New Era

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CSR is a coefficient of business strategy.

Kawaguchi:In business development, it's also necessary to pay attention to risks. Overseas expansion is a key challenge in the automotive products business and other fields, and doing business overseas entails human rights risk and water risk. The situation is so serious that there have even been cases of companies being forced to relocate plants built in China because of severe water shortages.

Nishimura:Since the number of business sites we have in emerging countries has increased, we need to pay greater attention to such risks.

Kawaguchi:It's important to consider the positive aspects of such risks as an opportunity even while minimizing them. There have recently been calls to build national resilience, and "resilience"*5 and "ethical"*6 have emerged as key concepts.

Nishimura:From the perspective of resilience, I think that preparation for a possible major disaster is necessary. We make dampers for large structures and for wooden houses. Although it might be a stretch to call it an ethical product, one environmentally friendly product we offer is "Refleshine™" heat insulation window film.

Kawaguchi:Both are examples of products that can make valuable contributions to the sustainability of society.

Nishimura:In addition, we are proceeding with development of an active mattress, walking assist suit, and other nursing care products madeusing Smart Rubber, the material you mentioned. We are also working on prototypes of a bedsore prevention mattress for guide dogs.

Kawaguchi:For sustainability, it's important to make social contributions integral to the actual business, isn't it? The case of a certain real estate developer provides an example. The developer has a popular social contribution initiative to encourage volunteer activities by employees, which invites employees those likes countryside life, to the activity of cultivating abandoned rice paddies and fields in Yamanashi Prefecture to grow rice and vegetables. Then the company proposed the activity as a service for the residents of condominiums it has developed, and it has become a highly popular service. I think there might be an opportunity for the developer to sell high-rise condominiums that come with fields in the countryside. This is an example of a social contribution activity contributing to a company's business.

Nishimura:This example shows that CSR and ESG also serve to uncover latent demand among stakeholders.

Kawaguchi:Something that begins as a way of contributing to society can become a business somewhere along the way.

Nishimura:We have a social contribution activity we call the "Beauty Caravan" in which we collaborate with a university and an NPO to help bring some joy to the lives of elderly people living in nursing homes by offering them an opportunity to pamper and beautify themselves. It has been confirmed that beauty treatment has a beneficial effect in patients with Alzheimer's disease, and we are trying to find a way of achieving linkage with the nursing care and health business.

Kawaguchi:CSR also involves meeting stakeholder needs that don't constitute a viable business opportunity. Beauty Caravan may be a case of bearing the cost of meeting needs as a social contribution cost until those needs reach a certain scale, after which they are developed as a business.

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Nishimura:That's another role of CSR, isn't it?

Kawaguchi:An increasing number of young people today attach greater importance to social contribution than personal advancement at work and place importance on ethical considerations when buying things. Isn't it necessary for companies to prepare now for a future in which these people play a leading role?

Nishimura:In our core automotive products business, procurement positions are increasingly held by younger people. One approach might be to ensure that people understand that superiority in environmental and social responsibility is a form of value and give us credit for this.

Kawaguchi:Recently I have come to think that CSR is a coefficient of business strategy. I mean that if a company's business is multiplied by a high coefficient, corporate value itself increases.In business development in the ICT field, this equation is likely to become increasingly evident.

Nishimura:So, formulating a solid business strategy and integrating CSR activities and ESG factors into management contributes to sales and profit. These days CSR should be considered a source of a company's "earning power," not a cost. Thank you for your thoughts today.

*5 Resilience:
The use of a term employed in psychology and other contexts to express the ability to recover from difficulties has recently been expanded to economics and accident prevention. In Japan, the term "national resilience" is used to express the notion of adapting to difficulties through "strength" and "flexibility."
*6 Ethical:
Recently the work "ethical" is used to refer to the consumption activity of choosing products beneficial to the environment or society. The concept includes eco-friendly products, fair trade products, and local production for local consumption.

SUMITOMO RIKO COMPANY LIMITED.

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