Special Topics~ Dialogue with the Third-Party A Company Existing in Harmony with People, Society, and the Earth. Aim of the new management vision and non-financial KPIs. 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 2016".
* The position titles are as of the date in which the dialogue was held.

Sharing the Company's Direction Group Vision and Non-financial KPIs

Nishimura:This is Sumitomo Riko's third integrated report. In the third-party opinion section of our previous integrated report, you offered the thought-provoking observation that ESG*1 will become increasingly important in corporate management.
The Company has formulated the Sumitomo Riko Group 2020 Vision ("2020V"), a new management vision for the period up to 2020, in which we announced non-financial KPIs*2. We have also considered and discussed matters such as our vision for the Group in 2029, the Company's centenary, which we concretely express using the term "Global Excellent Manufacturing Company," meaning a company that contributes to the safety, security, and comfort of human beings, society, and the Earth. How does the vision connect with non-financial KPIs such as CO2 emissions and waste discharged, water resource management, and lost-time injuries frequency rate? I am confident that the management vision and non-financial KPIs were discussed in the same process.
In formulating 2020V, senior management got together for four executive retreats to consider these matters. I believe that the process of developing non-financial KPIs and that of formulating 2020V were organically linked and properly implemented.

Kawaguchi:Executives tend to be occupied with their individual duties. Furthermore, we should expect their perceptions and understanding of social issues and vision of the future to vary considerably. That is why you sought to foster sharing of awareness at executive retreats, isn't it?

Nishimura:Since Sumitomo Riko has historically focused on the nuts and bolts of manufacturing, rather than on the environment, society, or governance, some of our people may not yet fully recognize just how critically important these issues are. In the past, according to the typical mindset, it was sufficient if executives focused exclusively on their responsibility for their own business divisions and everything was OK as long as they achieved their performance targets.

Kawaguchi:It takes tremendous energy to shift a corporate culture that places emphasis on sustainability both in terms of the company and society. For instance, in Japan where water resources, clean air, stable supplies of electricity, and observance of basic human rights are taken for granted, investment in these areas to make society sustainable tends to be considered a mere cost increase. But in many other parts of the world, whether a company takes these factors into consideration or not has an important bearing on business opportunities and risks.

Nishimura:Regulations governing emissions of CO2 and VOCs (organic compounds that cause air pollution) are being introduced one after another in China and other emerging countries. The Sumitomo Riko Group observes these regulations not only to ensure legal compliance, but also to achieve our goal of becoming a "Global Excellent Manufacturing Company" that contributes to the safety, security, and comfort of human beings, society, and the Earth. It's important to recognize the difference between simply complying with regulations because they exist and complying because it accords with the Group's vision.

*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 KPIs:
Key Performance Indicators

SDGs and the Role of Non-financial KPIs
Reaching Out to an Evolving Investor Community

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Kawaguchi:The viewpoints of investors have changed greatly in recent years. A hot topic among investors today is that Japan's Government Pension Investment Fund (GPIF), the world's largest pension fund, has begun contacting corporations in accordance with Japan's Stewardship Code*3 and PRI*4 through external asset management institutions, in order to reflect ESG perspectives and other non-financial information in corporate valuations. Many asset management companies have commenced ESG evaluations, too.

Nishimura:The trend toward ESG investment is gaining momentum as institutional investors deepen their understanding of ESG, isn't it? What is the global trend?

Kawaguchi:Statistics bear this out: as of 2014 the global ESG investment market was worth 21.3 trillion dollars, or 2,560 trillion yen. In Europe, 60% of assets under management are subject to ESG scrutiny. In these circumstances, in 2015 there were two crucially important developments reflecting expectations as to how business will be done in the future worldwide. The first was the establishment of 17 specific action goals and reduction goals to achieve the Sustainable Development Goals (SDGs*5). The second was the agreement to limit global warming to less than 2℃ above pre-Industrial Revolution levels reached at the 21st Conference of Parties to the United Nations Framework Convention on Climate Change (COP21), held in Paris.

Nishimura:17 icons represent the SDGs, and I think they depict them in a way that is concrete and readily understood. When we consider the global situation, the COP21 agreement was much essential.

Kawaguchi:I agree. In formulating their corporate visions, companies are already setting targets reflecting their unique circumstances and goals, in line with the SDGs and COP21.

Nishimura:With regard to the non-financial KPIs that Sumitomo Riko uses, we first prepared 26 initial proposals selected from among 113 items through deliberations in which we referred to the GRI Guidelines, and then we incorporated the most important ones in 2020V. I think that the SDGs dovetail with these non-financial KPIs and our vision.

Kawaguchi:It must have been difficult to decide on the non-financial KPIs. After all, people in the company hold various views.

Nishimura:We held executive retreats to study management issues in depth, including the non-financial KPIs, and narrow them down. The discussions at the retreats were also an opportunity for participants to deepen their understanding of the issues.

Kawaguchi:I think that if you can quantify non-financial objectives, clarify their connection with the SDGs, and develop a narrative to explain how they contribute to financial performance, investors and other stakeholders will understand them. It is important to not merely announce a new product, but to concretely quantify the benefits, such as reduction in CO2 emissions or of material inputs. But if competitors provide that kind of information first, you have no choice but to follow them. At the same time, in Japan, the GPIF has fueled a sharp increase since April in the number of investors adopting an ESG perspective, and these investors have begun seriously considering how to incorporate this perspective in corporate valuations. At our firm, we received a request from a client that wanted to learn about the environmental policies of various countries, starting with the basics. We advised the client to start by checking the relevance of its strategy to COP21 and the SDGs.

*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 PRI:
PRI, the abbreviation of "principles for responsible investment," is an investor initiative in partnership with the UN Environment Programme – Finance Initiative and the UN Global Compact. The GPIF signed the PRI in September 2015.
*5 SDGs:
SDGs, the abbreviation of Sustainable Development Goals, follow and expand on the Millennium Development Goals (MDGs) for the purpose of eliminating social problems such as poverty from the world. They consist of 17 goals and 169 targets relating to sustainability of the human race and the planet, and there are high expectations of active participation by companies. The objective is to achieve the SDGs by 2030.

Linking Employee Growth to Future Product Creation
Changing the Corporate Structure Through Steady Growth

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Kawaguchi:I notice that "Increase the percentage of female managers (general managers)" is one of the 26 initial proposals for non-financial KPIs. It would likely require considerable effort to entrench this goal among middle management. There has been a lot of talk recently about promoting diversity through cultivation of an environment conducive to individual success regardless of ethnicity, nationality, gender, age and so on. However, it seems that although executives tend to grasp the importance of diversity and promote it, changing the mindset of middle management is quite a challenge. Immediate superiors in the workplace may not understand the importance of diversity and prejudice against women persists.

Nishimura:To be sure, a key challenge for the future concerns the extent to which we can obtain recognition of the significance of the individual non-financial KPIs and ensure their implementation by our employees including middle management.

Kawaguchi:I once heard from a specialist who does research on the motivation of people and organizations that whereas people usually think internal training is for selected highly capable people, the proactive provision of training to those who were not given the opportunity dramatically increases individual motivation and is highly effective. It is important to communicate the company's expectations.

Nishimura:Sumitomo Riko's management training program to prepare for the future covers all middle managers and is not restricted to selected individuals. We also offer training covering integrated reporting and non-financial KPIs to all employees.

Kawaguchi:The Daiwa Securities Group offers lectures given by external instructors for clients of operating companies. Ms. Kimie Iwata, former representative director and executive vice president of Shiseido, recently spoke on the topic "An Active Role for Women." Although her lectures are usually thought to be for human resource directors, many executives from the financial division attended. The lecture was well received, and several participants said that what she had to say was valuable, albeit painful to hear.

Nishimura:We had a labor management expert speak to our managers, including those in areas other than human resources. This is because personnel-related matters are of interest to all employees.

Kawaguchi:Employees tend to view CSR and ESG as good things but as something superfluous and unrelated to the real business. I wish these concepts could be linked to the work of individual employees to raise awareness. Many Japanese manufacturers possess excellent technology and think that provided they make good products, they will sell and all will be well. However, the important thing is the conception of what constitutes a good product. Even if a product were good for the customers, one group of stakeholders, it would be unacceptable if its manufacture involved environmental pollution or use of child labor. Whereas in the past everything was fine as long as the customer considered the product good, nowadays it is unacceptable to trample on the interests of other stakeholders.
Companies must create products that reflect consideration not only of customers, shareholders, and other economic stakeholders, but also factors such as the environment, workers, and human rights in developing countries. In short, the process of creating products has been brought into question.

Nishimura:Even good products won't sell if they don't match customer wants and needs, and companies must meet the wants and needs of society as well as those of customers. I would like to create a growth scenario based on that principle. The ability of companies to manufacture based on an accurate understanding of their stakeholders is being tested.

Kawaguchi:Moreover, it is important to incorporate social and environmental solutions into manufacturing itself. For instance, the other day a major IT manufacturer held an ESG meeting for investors where it publicized its development of servers that operate at a room temperature of 48℃ and 97% reduction of product CO2 emissions over ten years. The meeting was a great success.

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Nishimura:The temperature in our server rooms is 25℃. Does that mean computers are more finicky about room temperature than humans (laughing)? The Sumitomo Riko Group has some promising technologies that are already showing up in products or are approaching commercialization. For instance, Smart Rubber, a functional rubber, is expected to find a major application in the sensors for automatic driving that automakers are now developing, in addition to current applications such as in a bedsore-prevention active mattress and a CRP training sensor (Shinnosuke-kun, Homepage Link, Japanese only). In addition, Refleshine™ is a window film that has excellent heat insulation performance and helps reduce CO2 emissions.
We designated "Enhancement of environmental technology" as a business strategy in 2020V and will focus on releasing environment-related products in which our technologies are applied. It might sound pretentious, but this is a strategy devised in part to contribute to protecting the Earth. For that purpose, we will continue to undertake product development, contribute to the realization of a sustainable society, and make this strategy a cornerstone of corporate development.

Kawaguchi:I think that's a very illuminating perspective. If Sumitomo Riko's vision produces results, employee motivation is likely to increase. The content of middle management and workplace training tends to focus solely on management and rules. Documentation proliferates, and people feel increasingly harried. I think it would be better if training included success stories.

Nishimura:There are plenty of failure stories, aren't there (laughing)? For automotive products, which account for a high proportion of our sales, we recently won our first order from a non-Japanese manufacturer in China, an accomplishment honored with the President's Award.

Kawaguchi:If accomplishments evaluated based on ESG factors are included among these success stories, not only will more people become aware of the importance of ESG in business but also workplaces will be energized. And, at the same time, external valuation will improve.

Nishimura:That is certainly true. I want to see more development of products based on new ideas, as well as progress in reducing CO2 emissions and the amount of water used in manufacturing processes. In addition, encouragement from customers also motivates use. It may take time, but such factors create a positive atmosphere that will help assure the success of 2020V.

Kawaguchi:The dawning awareness of the importance of non-financial KPIs among participants at the executive retreats augurs well for the future. In time, the accumulation of such experiences will likely have a positive impact on the corporate culture, too. I think it would be good if you could visualize the connection between the non-financial KPIs and the Group vision and the extent of their financial impact.
It is noteworthy that top management has set an example by shining a light on non-financial KPIs. From now on, harnessing the workplace skills of middle managers is likely to lead to sustainable growth.

Nishimura:Thank you, Ms. Kawaguchi. Every time I have the opportunity to have a discussion with you, the direction we should pursue becomes clearer. I hope to continue to benefit from your input in the future.

SUMITOMO RIKO COMPANY LIMITED.

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