Thursday, December 27, 2007

The Sustainability Advantage

Christmas has come and gone, and one of the gifts I received was a copy of Bob Willard's DVD "The Business Case for Sustainability". I just watched the 55 minute video and found it to be well-made, interesting, and organized to help activists interested in promoting sustainable business to speak the language of business to business people. (image from Swinburne University of Technology)
Mr. Willard starts off by admitting that we are overwhelmed with the terminology around "sustainability"; terms like CSR, sustainable development, sustainable business, etc., are used interchangeably within the community of people that "get it". The problem; many people do not "get it". Mr. Willard goes onto address the three-legged stool of sustainability in terms of managing a company's assets. He breaks company assets into five categories, Manufactured Capital, Natural Capital, Social Capital, Financial Capital, and Human Capital. When we start using terms to describe sustainability that involve the management of assets, we are speaking the language of balance sheets and income statements, the language of business. We are getting away from "soft" terms like environmentalism and social responsibility that make some business executives quake.

Mr. Willard's description of the iceberg of company value is quite interesting, as are the statistics he provides on the percentage of a company's value tied up in intangibles. What we're talking about here is the premium the market pays for company ownership above and beyond the company's book value. This can be thought of as a company's goodwill or brand premium. From 1981 to 1998 the percentage of a company's value tied up in intangible value increased from 17% to 71%. The market is placing a higher premium on what a company represents in terms of image and future earnings than what their net worth is from the balance sheet. (I suppose one way to look at this is that there are many overvalued companies).

What does this have to do with sustainability? Everything. Since most of a company's value is placed in the market's fickle perception, there are tremendous risks associated with losing that perception and premium. Outright malfeasance or a lack of forward-thinking leadership that leaves the company exposed to risks that might otherwise be avoided can certainly destroy this value. If the future earnings of the company are threatened by climate change and management does not have a strategy to hedge those risks, what are investors likely to do? Flee to other investments that have hedged those risks and stand to benefit from market changes bringing opportunities they are prepared for.

Investors represent only one stakeholder group the company is accountable to. What about employees (imagine a time when an employee refuses to partake in a business activity that may comply with existing regulatory requirements, but contributes to climate change or environmental degradation. Could the employee take a stand on moral grounds and say no?), governments, customers, vendors, (with Wal*Mart's pressure on their supply chain to reduce packaging and be more efficient, you can bet others will as well), bankers, insurers, NGOs, etc. Climate change is on all of their radar just makes sense to be investigating it's potential impact on an organization.

In the DVD, Mr. Willard illustrates this with the example of the Enron disaster. He does not talk about Enron itself, but the collateral damage to the accounting form that no longer exists, Arthur Anderson. The consulting business was re-branded as Accenture in 2001, but the accounting and auditing arm ceased to exist. It destroyed the trust it had in the marketplace and payed the ultimate price.

Investors have become increasingly vocal about business risks associated with climate change. The Investor's Network on Climate Risk (INCR) comprised of 65 institutional investors with $4 trillion under management has requested Congressional action on GHG emissions and is asking the SEC to require listed companies to disclose climate change risks. The Carbon Disclosure Project (CDP), started in 2003 with 35 institutional investors with $4.5 trillion under management and now up to 315 signatory investors with $41 trillion under management in, has helped companies quantify their risks associated with climate change in an open and transparent process. The realization from the CDP; manufacturers could lose 40% of their market value.

So, there are clearly risks associated with climate change, what about the opportunities? Mr. Willard highlights 7 areas that companies stand to benefit if they take action on climate change and sustainable business:
  1. Reduced recruiting costs - more graduates are making decisions to join companies that have a higher social purpose. Company is viewed as an innovator in a field of identical companies.
  2. Reduced attrition costs - employees are engaged in a higher mission and are less likely to leave
  3. Increased employee productivity
  4. Reduced manufacturing expenses - energy efficiency, recycling, products designed for reuse, resource productivity
  5. Reduced expenses at commercial sites
  6. Increased revenue & market share - competitive advantage, customers will start to demand clean & green products
  7. Lower insurance and borrowing costs - Lower risk premiums for borrowing
Companies are facing increasing pressure globally to operate efficiently and maximize their profitability. To ignore the activities that lead to a potential increase in profitability, whether climate change is the reason or not, may not be the best idea.

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