Social factors – the S in ESG – have been a driver of company performance in emerging markets since long before sustainability became a mainstream consideration for investors.

Emerging market countries combine lower average household incomes with higher levels of inequality and a greater level of state interference in the domestic economy. Together, these factors mean companies that get it wrong on social issues tend to pay a high price, both with their consumers and their regulators. Conversely, companies that embrace the opportunity to make positive change at the individual, community or national level can create significant value.

We can consider three sets of company examples to help bring this theory to life.

First, consider the relationship of a company with its employees. It is obvious that companies with happier employees are likely to perform better, but we think this is particularly true in emerging markets, where the gap between the best and median employment experiences are likely to be much larger. This is why employee attrition is a key metric we track for all our investee companies who disclose it, and why we engage with those who don’t disclose the measure and ask them to publish it.

At the centre of our investment case for Tata Consultancy Services (TCS) is the fact that its current 7% attrition rate is one third to a half of that of its peers, creating a virtuous circle between employee satisfaction, customer satisfaction and growth.

EXHIBIT 1: TCS EMPLOYEE FIGURES

Source: TCS annual reports

How does it keep its employees happy?

• By giving them significant autonomy to make their own decisions. This is best understood by looking at the organisational structure. Although the company has $25bn of revenues and 500,000 employees, it is organised into over 50 separate business units, each with its own P&L and its own “mini CEO”. This empowers more junior levels of management and allows for quicker decision making.
  
  
• By putting staff welfare at the centre of management decisions. Covid-19 created significant disruptions for the Indian technology sector, but TCS not only sent employees home without any business loss but also developed a new working model, Secure Borderless Workspaces™, which has become an industry standard for distributed working. It then directly arranged vaccines for all employees and their families and made a 24/7 medical helpline available to staff.
  
  
• By offering them significant training opportunities. TCS employees logged over 43 million training hours in the last fiscal year, and the company has built its own internal learning platforms to encourage employee participation through gamification and by tying skills gained to employee career journeys.

Source: TCS annual reports

How did this better treatment of employees translate into superior business outcomes? Over time TCS’s lower attrition rate has driven better client experience and higher profit growth. The graphs above compare its employee turnover and profit growth with its nearest competitor.

Second, consider the relationship of a company with its surrounding communities. The question “How can we improve the lives of people around us?” has been a particularly profitable one to ask in emerging countries in recent years. Safaricom, the leading telecom operator in Kenya, launched its mobile money service M-Pesa in 2007 to help bring financial services to the large unbanked domestic population. This was one of the first mass scale financial inclusion programmes in the world, and has bought much wider benefits. What are these?

• Creating higher productivity and more jobs. Although Safaricom only has 6,230 permanent, contracted and temporary employees, it estimates that it supports more than 1 million jobs directly and indirectly in the local economy.
  
  
• Enabling payment distribution. The existence of a digital payments layer in the country meant the Kenyan government was able to distribute payments to its population efficiently and safely during the Covid crisis. Safaricom also suspended payment fees on peer-to-peer money transfers below KES 1,000 in value to encourage the domestic population to use electronic money rather than cash, to reduce disease transmission risks.
  
  
• Supporting the community. Safaricom’s business is sufficiently profitable to create excess capital that the company can reinvest back into community projects. In 2021, for example, the company started the Keeping Girls in School initiative, through which it distributed three months’ supply of sanitary towels and underwear and information on menstrual hygiene to around 800,000 girls.

Safaricom was an early corporate adopter of the UN Sustainable Development Goals, aligning its strategy with the goals back in 2016. As well as benefiting its local society, Safaricom has also been a world-beating investment, with profits up 5x and the shares up 10x over the past 10 years. This demonstrates that there don’t have to be trade-offs between societal impact, profitable growth and return to shareholders.

EXHIBIT 4: TRUE VALUE ASSESSMENT

Source: extracts from Safaricom annual report, 31 March 2011 to 31 March 2021.

Finally, consider the relationship between a company and its customers, and thus ultimately its regulators.Time and again, we have seen a failure to respect social obligations to customers come back to haunt companies, particularly in emerging markets, where the state is often more interventionist than elsewhere. Let’s look at a decade of history in China by way of example. The infant milk scandal of 2008, when baby formula was found to contain melamine, continues to echo in the market today, with foreign players still controlling a majority of the market due to the mistrust of domestic brands. The regulatory and reputational problems that engulfed Baidu in 2016 after its search engine promoted potentially dangerous medical treatments continued for several years, and lost the business its once dominant position as a trusted information source.

Of course, with the right focus, consumer trust can be regained. A change in management team and corporate strategy eventually allowed Yum China to recapture consumer hearts after a food quality scandal in 2015; we now view it as best-inclass on sustainability. What did Yum China do to turn around its corporate image? It has continually put doing the right thing ahead of short-term profits.

• Prioritising wages and conditions. The company has ensured employee wages and working conditions are significantly better than regulatory minimums or industry averages. This goes beyond basic financial packages – for example, it provided health insurance to restaurant managers and their families as the Covid pandemic started. To take an even simpler example, delivery drivers who work for KFC can enjoy heavily subsided meals, which is not the case for their peers riding for delivery platforms.
  
  
• Investing in food safety standards. Yum China has invested significant sums in ensuring food safety standards are upheld. Most recently, this involved investing several hundred million dollars in an upstream poultry farmer that is the company’s key supplier. This might not please short-sighted investors who like their companies “asset light”, but Yum China has sought to take a more balanced, long-term approach. Even with this investment, it can deliver attractive profits and free cash flow, and it has secured the resources to keep delivering this performance even further into the future.
  
  
• Supporting the community. The company has used its physical infrastructure – upwards of 10,000 stores and 400,000 employees – as a base from which to benefit the local community, for example by setting up education initiatives such as reading clubs onsite. This type of activity raises staff morale while also enhancing brand quality and government relations.

Source: extracts from Yum China annual report: http://www.yumchina.com
The companies above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell.

Conclusion

In emerging markets, social topics get magnified. The gap between the best and worst performers is wide, and the opportunities available to those who can address problems are vast. This is why integrating social issues into decisionmaking is a vital part of any emerging markets investment approach.

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