COMMENT: What if cost of environmental damage caused by businesses were subtracted from their profits?
Source: Flickr/Cherryl Mari Nadela
By Yvo de Boer
Our world is increasingly crowded, depleted, resource-hungry yet resource-constrained, and starting to experience the consequences of climate change.
Businesses are at the sharp end of these challenges and face considerable commercial risks as a result. At the same time, we rely on businesses to come up with the solutions to our social and environmental problems, even when they may not see the potential to profit greatly from doing so.
Many people, including myself, believe that the current way we measure the value of companies is not fit for purpose in this changing world. We place too much emphasis on short-term financial performance. We pay too little attention to whether or not a company is able to manage risks in the long-term and unlock the opportunities. We ignore the value a company creates or destroys for society as well as its shareholders.
Thankfully company value is not a static concept but a dynamic one. Definitions of value have changed throughout history according to the political, business and societal conditions of the times. For example, the value of the Medici banking empire in fourteenth century Italy was quite different to the value of a modern day bank, and hinged more on its influence in Rome and its ability to navigate politics than it did on the financial returns on investment.
Today, companies are valued in a narrow monetary terms. Short term financial performance, and an obsession with quarterly profits – little else matters. This blinkered view, popularly known as “quarterly capitalism” arguably fails to incentivise business leaders to build long-term value or to consider the impact of their companies on people and the planet.
However, companies must grasp the substantial opportunities of the green economy and manage risk in what is a rapidly changing world, in order to survive in the long term. Winning businesses will be those who innovate, invest wisely and create long-term value.
Megaforces
The need for a new vision of value is being driven by 10 megaforces that many predict will hit the global economy, society and the bottom line of business much harder than the recent economic crisis.
These 10 megaforces are identified by KPMG International, in its report Expect the Unexpected:
- Climate change, with dire physical impacts and economic losses predicted
- Soaring global population – 8.4 billion in 2030
- Water shortfall of 40% by 2030
- Not enough food
- Increasing energy insecurity and price volatility
- Strain on material resources
- Collapsing ecosystems
- Disappearing forests
- Ever-expanding cities
- Exploding global middle class
These are not future risks; they are impacting now. Some companies are becoming focused on the potential this offers rather than the risks. There are real opportunities to cut costs and increase efficiency; for new partnerships with governments, NGOs, other businesses and to innovate new products and services.
New business model – True Value
The opportunities for business in the green economy are substantial. As always, it will be the companies who move early and strategically who are likely to be the winners in this race.
KPMG member firms have been helping companies place the green economy at the heart of their corporate strategy, not only by strengthening management structures, but by developing the concept of True Value.
True Value takes environmental and social performance into account, as well as financial performance. What happens when the financial cost of the damage companies inflict on the environment is calculated and therefore the impact on the wider economy? What happens when that is subtracted that from their profits?
On a global level, profits would be 87% lower in the electricity sector, 64% lower in mining, and food producers would see profits wiped out more than twice over. When we factor in social impacts as well, profits fall lower still. But that is only half the story.
Business also creates environmental and social benefits. Benefits such as economic gains from green innovation. Smarter, more efficient, green cities. Healthier, more productive workers. Not to mention the benefits of safeguarding a license to operate by engaging with local communities, respecting the environment and building the trust of governments. What if that value was factored into the valuation of businesses? Then True Value is achieved.
The result is a game changer. Clear incentives for companies to minimize their negative impacts on people and the planet, and maximize their positive impacts. And importantly – True Value can help business adapt and become fit for purpose in the modern business race, where growth opportunities are maximised, and new risks are managed intelligently.
Is this a fantasy? I don’t think so. Business is already moving in this direction as they are being forced to use resources more wisely. There are more commercial opportunities in products and services that address environmental and social challenges. Green regulation is also growing in the form of carbon trading, mandatory sustainability reporting/integrated reporting, human rights principles and green taxes.
Added to this is the increasing scrutiny by stakeholders. People hold companies to account for environmental and social transgressions, and corporate reputations are becoming ever more vulnerable. There is a growing acceptance that current ideas of purely financial value are becoming outdated.
Momentum is building, there is a beginning of an understanding of what True Value should be and why it is important in the 21st century. We all know that “necessity is the mother of invention”. It is a necessity – not an option – to address the enormous environmental and social challenges the world faces. As such it is also a necessity to assess the True Value of businesses in this context.
Yvo de Boer is the global chairman of Climate Change & Sustainability Services at KPMG, and former executive secretary of the UNFCCC.