Net Impact’s Conrad Young and Trucost’s Paul Druckman analyse how accountants can help value sustainability
The combined cost of pollution and other damage to the environment caused by the world’s biggest companies would wipe out more than a third of their profits if they were held financially accountable. This is the conclusion of a major study by Trucost for the UN-backed intitiative Principles for Responsible Investment and the United Nations Environment Programme. The study found that estimated combined damage was $2.2tn (£1.4tn) in 2008, a figure bigger than the national economies of all but seven countries in the world that year.
With a few exceptions, these figures won’t appear on the balance sheets of any of those companies. Quantifying externalities, to use the jargon of economics, is an emerging science. And creating a fair and effective framework setting ownership of these externalities is one of the most difficult – but necessary – tasks in global policy.
Sustainability professionals may agree with Adair Turner, chairman of the UK’s Financial Services Authority, that “capitalism needs to be saved from itself”. But many accountants see the challenge as meeting the incremental demands of new regulation and capital market analysis. They may be asking the more manageable question: “What do governments and shareholders want us to report in the next couple of years?”
Accounting’s remit extends beyond totting up annual profit and loss. At the most strategic level, accountants help managers to anticipate the trends of revenue and cost in the business and explain to investors how this is being handled.
Availability of hydrocarbon supplies is clearly a material cost issue for companies in the packaging industry, reliant on oil-based polymer products. And carbon emissions, to capped sectors like energy generation, are clearly tradeable and need to be accounted for. But sustainability professionals recognise many other environmental factors that, depending on the sector, are directly or indirectly material to long-term economic success. Water resources are particularly relevant for drinks companies and many process industries. The quality of the ecosystem, in terms of plant-pollinating biodiversity, is important to agricultural and horticultural industries, and so on.
Net Impact has identified three leadership paths for a company faced with these data for the first time.
1. Environmental evangelism: accept the calculation of the company’s share of responsibility – expressed in financial terms – and unilaterally act to reduce all significant impacts to zero.
2. Traditional accountability: reject the implication that a corporation is accountable for impacts beyond the operations for which it is directly and legally responsible for, today.
3. Engaged accountability: seek to understand the data, even if some of the business implications are not yet clear.
In our view there are weaknesses in taking the first two paths. We have examined these through the example of “consumer services” companies, a category which includes media, retail and transport.
A pure-play environmental assessment of the relative impact of environmental externalities in the consumer services sector suggests solid waste management is a low priority and greenhouse gas emissions a high one.
Yet in some locations, avoidance of solid waste can yield financial benefits. For example, landfill tax in the UK is increasing on a per tonne escalator of £8 every year. One FTSE 100 consumer services company in the UK invested in a low cost recycling service to divert waste from landfill and in the process saved £250,000 over three years. This obviously frees up money for shareholder dividends or to pay for reducing larger environmental impacts.
Another UK-based FTSE 100 consumer services company employed an environmental evangelism strategy when first faced with its greenhouse gas footprint. To reduce its biggest impact category to zero it made a number of investments in carbon offsets – ones that were not matched by its competitors. This clearly reduced shareholders’ returns and the availability of a budget for environmental cost saving measures with a positive return on investment.
Companies with a traditional accountability mindset treat their direct impacts reactively as a compliance cost issue and rarely engage with indirect impact at all. Wal-Mart in the US took this approach to its operations until 2006. In the words of Lee Scott, Wal-Mart chief executive at the time, faced with demands for corporate environmental responsibility “we would put up the sandbags and get out the machine guns”.
But Scott led a fundamental review of this approach, applying Wal-Mart’s considerable analytical capabilities to the financial dimensions of the company’s environmental impact. When applied to its direct operations, environmental impact reduction yielded annual savings of $25m through using auxiliary power units on trucks, $300m through engine fuel efficiency and $7m through installing energy efficient lighting. Now, via a similarly rigorous sustainable product index, the company is intending to reduce indirect impacts generated by suppliers and buyers of own brand and other products.
Transcending traditional fears of being held accountable for something beyond the company’s control, Wal-Mart took on the challenge and made it pay.
In the UK, Marks & Spencer’s Plan A has accomplished a similar achievement to Wal-Mart’s. But there are other examples, in the UK public and private sectors, which illustrate engaged accountability.
Customers of Alliance Boots could be forgiven for thinking the company’s biggest sustainability issue is its choice of shampoo ingredients. The sale of pharmaceutical, nutritional and personal care products is what is distinctive about the Boots brand. Is this where the company needs to account for its sustainability impact?
Of course it does. But the products arrive in the stores with an extensive R&D, manufacturing and logistical distribution footprint. And they depart the shops with another “use phase” footprint.
Bringing together the right data-sets in one place allowed the Boots back office, in 2007-08, to tackle multiple costs and opportunities – eg better routing, double-deck trailers, telemetrics and backloading. This cut 8.5m road kilometres, 4.9% of total transport emissions and £1.8m of fuel costs.
Alliance Boots expects the cost of fuel to increase in future, and a requirement to track CO2 in the supply chain to emerge. The company is therefore systematically collecting that data, linking to other retailers with complementary challenges and is prepared to take further action in different scenarios.
Each year Northern Foods buys more than £600m of ingredients, raw materials and services from over 3,000 suppliers. The company makes food at 17 production sites and delivers to more than 1,000 supply points. In 2008 it spent $21m on energy consumed in the UK.
Paula Widdowson, responsible for corporate social responsibility strategy at Northern Foods, says: “Measuring the impact is necessary and publicly declaring our impact, both non-financially and financially, is an important step in enabling the business to better understand the value of this work.”
At the end of 2009, Widdowson was able to claim upwards of £2m of additional contribution to the bottom line, through effective sustainability accounting over the preceding 12 months. She forecast an additional £10m of savings in the upcoming 12 months.
Lisa Scott is head of corporate governance and performance reporting at the UK government’s Highways Agency. She is a professional accountant but perceives limits in the way the accounting discipline is set up, which makes it inadequate, on its own, to tackle challenges such as climate change.
“Implementing accounting for sustainability will never be enough. What really counts is the ensuing change that it drives in decision making and behaviour,” Scott says.
Evaluation of assets and liabilities, and the flow of resources in and out of an organisation needs to be done consistently and in a way that allows comparison across years and between companies. Accountants have done this, effectively, for millions of companies, over decades. Yet accountants are often focused on quarterly or annual reporting, whereas the sustainability mindset is, of necessity, longer term.
Scott confirms: “One of the key areas for any organisation to address is for finance teams to be closely aligned with sustainability teams.”
In this way the management of value over the long, medium and short term becomes better articulated. For example, the Highways Agency has incorporated accounting for sustainability not only into its monthly reporting processes but also its year-end annual report in order to show its taxpayer stakeholders that “what gets measured gets done”.
The environment includes variables such as greenhouse gas emissions and other “traditional” pollutants, finite consumable materials such as hydrocarbons and rare components whose replacement cost increases as the asset base depletes. There are also recyclable resources such as water, where the value can be recaptured somewhere in a business ecosystem. At the edges of this picture are variables that do not behave like traditional assets or liabilities, and for which an accounting mechanism seems far off.
Most organisations recognise the growing demand – at the level of consumers, and within government – to engage with these variables. Today’s consumer campaign to protect apes, for example, is tomorrow’s product boycott and a short step to regulation putting a price on the impact. In order to avoid the expensive mistakes of misplaced green enthusiasm on the one hand and missing efficiency opportunities or losing customers on the other, organisations need to get familiar and competent with integrated environmental and accounting data.
The radical view of Net Impact’s Called to Account focus group is that the disciplines need to be merged, so instead of two telescopes being trained on different goals, the organisation becomes equipped with a set of binoculars, focused on a single objective.
Whatever the configuration, it’s clear that the disciplines of accounting and sustainability need each other to translate these variables in financial value and risk intelligently. Applying traditional financial and management accounting skills helps environmental advocates to make a better return on investment calls. And sustainability experts can help accountants to understand better the long-term and systemic risks and opportunities within the wider environment. An organisation that has made this connection is well placed to weather the storm when it is called to account.
Paul Druckman is chairman of Trucost, a global environmental data provider based in the UK.
Conrad Young is chairman of Net Impact London Professional. Net Impact is a global non-profit membership network, with 15,000 members committed to using business to create positive environmental, social and economic impacts .
The Trucost/UNPRI report will be published this summer.